May 21, 2022

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Head of Analysis Thomas Itzen: - The stock market does not understand what is about to happen

Head of Analysis Thomas Itzen: – The stock market does not understand what is about to happen

On Friday, the US stock market fell sharply, and the Nasdaq tech composite index had its worst month since the financial crisis. So far this year, the index is down more than 21 percent, while the S&P 500 is down 13 percent.

The challenges have not diminished since the beginning of the year, but are increasing more and more. The war in Ukraine has sent energy and commodity prices soaring, dampening the growth prospects for the global economy, while new lockdowns in China have further strained already-fragile supply chains. Inflation in the US continued to rise, reaching 8.5 percent in March.

Huge fear of inflation

This week, the US Federal Reserve will take a new interest rate decision, which may have to choose between plague and cholera. The interest rate weapon can curb inflation, but at the same time stifle the desire to invest and consume. The fear is that an increase in interest rates will lead to a recession, usually defined as a decrease in economic activity in two consecutive quarters.

If the alternative to a recession is a repeat of the 1970s, a decade of tossed pants and high inflation, the Fed picks a recession every day of the week. The fear that inflation will take hold is so strong that it would be an easy option for central banks, says Thomas Itzen, director of credit analysis at SEB.

The Fed’s preferred indicator of inflation, personal consumption expenditures, was 6.6 percent in March, well above the long-term target of 2 percent.

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This means that the Fed has lost control, and they have to panic. Itzen says the fixed income market has been trying to tell risk markets this for a long time, but the stock market just doesn’t understand what’s about to happen.

You can get 0.75

A “double increase” was priced at 0.5 percentage point for the week, and now there is talk of 0.75 percentage point, something that was completely unlikely a few weeks ago. It’s Bloomberg as I wrote this weekend that brokers in the US bond market now in total give this scenario a probability of about 50 percent.

By early next year, the market thinks the key policy rate will be three percent, which would mean the biggest rise in interest rates since the 1990s.

How did we end up here? Elizabeth Holvik, chief economist at Sparebank 1 Markets, says the central bank has been very keen to stimulate the economy during the pandemic.

Elizabeth Holvik, chief economist at Sparebank 1 Markets.

Elizabeth Holvik, chief economist at Sparebank 1 Markets. (Photo: Oyvind Elfsburg)

We entered the year with high inflationary pressures and a tight labor market, so it’s vulnerable to shocks like the war in Ukraine and the shutdown in China. This reminds us of the inflationary period of the 1970s. One of the challenges is that the necessities such as electricity, fuel and food are what are most rising in prices, with the main problem being getting enough production. It is not certain, then, that monetary policy is the right tool, Holvik says.

Kari Due-Andresen, head of analysis at Akershus Eiendom, stated that it is the risk of persistently high inflation that is frightening the market.

– Central banks suddenly switched to a completely new situation, having previously said that inflation is temporary. Now they have to make a very difficult trade-off between inflation and the destruction of the real economy. Deo Andersen says that the higher the interest rate, the higher the risk of deflation.

The US GDP fell surprisingly in the first quarter, and the new drop in the second quarter would technically be a recession. Deo Andersen doesn’t think that will affect the Fed.

The GDP numbers showed good growth in private consumption and investment, which is the most important, and moreover, most of us expect to see positive growth numbers again in the second quarter. That’s not a big concern, says Deo Andersen.

Carrie Deo Andersen, chief economist at Akershus Eiendom.

Carrie Deo Andersen, chief economist at Akershus Eiendom. (Photo: Fredrik Solstad)

continued decline

Higher interest rates mean more expensive loans, which is generally negative for stocks. Pessimism in the stock markets has now reached record highs, as measured by various indicators of sentiment.

People who work in the riskiest parts of the investing world all agree that it’s scary now. The stock market is largely governed by central banks, and central banks are governed by inflation, Itzen says, and until last week, the quoted stock markets should be doing just fine.

Itzen believes the decline is still high.

The stock market tumbled in April because it finally realized interest rates were going to go up, but I still think they underestimate the consequences, Itzen says.

The fact that tech companies have fallen so much this year is due to weak growth and high interest rates. Technology stocks are often called growth stocks, which have a greater share of their earnings in the future. Investors constantly calculate the present value of future cash flows and profits for companies, and this value will be lower as interest rates rise.

– If the interest rate rises from zero to seven percent, the krona the company earns in ten years is equal to 50 euros today, Itzen says.

Apart from that, higher interest rates are also not positive for all so-called value stocks, but often lead to a shift from growth to value, where earnings today will be favorable relative to future earnings. It was noted that this happened last year, after several years with a low interest rate climate where growth stocks outperformed value stocks.

Energy and commodity-rich Oslo Boroughs, which also owns a larger stake in valuable stocks, has opposed the influx this year with an increase of more than three percent.

Do you want to be a part of that crisis?

In theory, central banks could also wake up from quantitative easing of death and cut interest rates, if things go wrong in the economy. But Itzen thinks it will be difficult this time.

As long as inflation is as high as it is, the Fed chair can say he doesn’t care about the other. There will be no central bank bailout this time around, not until things get too much worse. The usual statement is that the Fed will come back if there is a crisis, but do you want to be part of that crisis first?

As inflation approaches the double digits, there will also be no real return if the percent increase increases. Investor legend Warren Buffett (91) said Saturday that inflation is “fooling everyone,” whether stock investors, bond investors or people with money in bed.

An absolute return may not be the goal for 2022. If you do it less badly than neighbor, that’s okay, Itzen says.(Conditions)Copyright Dagens Næringsliv AS and/or our suppliers. We would like you to share our cases using a link that leads directly to our pages. All or part of the Content may not be copied or otherwise used with written permission or as permitted by law. For additional terms look here.