Stock Markets Face Deteriorating Outlook, And Returns, Worldwide

Risk off is here. Even if the market looks positive. Don’t get ahead of your skis on this one. Markets can go downhill fast.

Beyond the Federal Reserve, there are 15 other central banks joining in on the rate hiking mania. This is issue No. 1 for the stock market right now.

“It’s as if the only answer to inflation is to reduce consumption. The other answer is to increase production. Which means you make more stuff,” says Vladimir Signorelli, head of macro investment shop Bretton Woods Research in Long Valley, NJ. “More stuff means lower prices.”

The new trend of macro volatility is playing out. Business activity is slumping and inflation in the U.S. is still over 8%. It’s closer to 9% in Europe, which is worse than big emerging markets Brazil, India, South Africa and China. Within the BRICS, only Russian inflation is worse than Europe and the U.S.

That means the Fed, European Central Bank, the Bank of England are all going after inflation with rate hikes despite being aware of damage to growth.

“Expected policy rates have jumped further since we downgraded developed market stocks in July – and recession risks still aren’t factored in,” says Wei Li, global chief investment strategist for BlackRock Investment Institute. They are underweight the U.S. and Europe.

Business activity is stalling in the U.S. and Europe, with last week’s FedEx FDX news giving investors the heebie-jeebies. Last week’s U.S. inflation report showed inflation was proving more entrenched than the market had hoped, and so the Fed will do whatever it takes to lower inflation.

Li at BlackRock thinks the Fed and ECB “will overreact,” especially to any upside inflation surprises. Expect policy “overtightening,” she says, which means recessions in the core economies. “Our whole portfolio approach prompts us to reaffirm our view on reduced risk,” Li says.

Federal Reserve, ECB are Hugely Negatively

Recent economic data out of the U.S. has been lackluster, despite a still-strong labor market.

Last week’s retail sales data had negative implications for the pace of consumer spending, and the Atlanta Fed cut its GDPNow tracking estimate for the third quarter to just 0.5% annualized, down from 1.3% previously. The only positive is that it ends the technical recession caused by back-to-back quarters of negative GDP. Now that the U.S. is looking up, some investors might come in and buy on the lows. But there is a consensus now in the market that greater lows are coming. Investors can wait for even deeper discounts in global share prices.

“It’s important to remember that the Fed only cares about economic growth to the extent that it affects their two mandates, which are price stability and full employment,” says Solita Marcelli, CIO for the Americas for UBS Financial Services.

Last week, falling gas prices helped to limit inflation to a 0.1% month-over-month increase, but overall CPI showed a 0.6% increase. Stubborn inflation has raised fears that this is becoming entrenched now.

“We still think that underlying trend is toward slower inflation,” says Marcelli. “But at this point, it does not appear as though the Fed is on track to hit its 2% inflation target on an acceptable timeframe.”

Meanwhile, across the pond, the European Union is doing what Western governments do best these days. To tackle a crisis, including those of its own doing, enact emergency powers to gain more control of the economy.

EUs proposed supply chain emergency powers is a big deal, if it ever comes to fruition. To Wall Street, it signals that Europe will be a more challenging market to short. “If it becomes more than just a proposal, it means more federalism is coming for Europe,” says Signorelli, a move that would eliminate a lot of the sovereign powers of individual member countries.

“It might mean more predictability for markets, but all of this is in its infancy,” Signorelli says. “I wouldn’t be all in on being short, but I would not be buying any European stocks right now. The German economic powerhouse, without cheap energy, is no more. They have to figure out a way to keep that. If I had a European portfolio to manage, I’d rather buy UK stocks,” Signorelli says. “Love her or hate her, (newly minted Prime Minister) Liz Truss has the right idea on taxes and energy — lower taxes and increase energy production.”

BlackRock is underweight the U.S. and Europe, but remains neutral weight emerging markets.

China’s economy is back in stimulus mode, though this will not be your garden variety China stimulus package. China’s stock market is in deep bear territory, so investors may react to this spending and start buying the big China ETFs like FXI MCHI and ASHR.

Consumer demand is still weak in China. Property prices have slumped and coronavirus lockdowns continued, most recently in Chengdu city.

Data released last week showed industrial production climbing 4.2% year-over-year as drought conditions and power shortages eased. Fixed-asset investment in the first eight months of the year was up 5.8% from the same period last year, suggesting that infrastructure stimulus was coming in hot.

The renminbi is trading at nearly 7 to the dollar, its weakest level since May 2020.

Uncertainty will remain elevated due to inflation. Even President Bidens recent declaration of the end of the pandemic phase of Covid, something the market would have cheered for earlier this summer, has done little to entice bulls to market.

“We see limited upside out to June next year,” Marcelli from UBS says. “Add selectively to exposure. We favor defensives, quality income and value stocks.”