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 quickly.

In addition to the Federal Reserve, there are 15 other central banks that are joining the rate-hike frenzy. This is currently the #1 issue for the stock market.

“It’s as if the only answer to inflation is to reduce consumption. The other answer is to increase production. That means you’re making 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 is collapsing and US inflation is still over 8%. In Europe, it’s closer to 9%, which is worse than in the big emerging markets of Brazil, India, South Africa and China. Within the BRICS, only Russian inflation is worse than in Europe and the US

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

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“Expected policy rates have continued to rise since we downgraded developed market equities in July – and recession risks are still discounted,” said Wei Li, global chief investment strategist at BlackRock Investment Institute. You are underweight in the US and Europe.

Business is flat in the US and Europe, with FedEx last week
News giving investors the Heebie-Jeebies. Last week’s US Inflation Report showed that inflation has proved firmer than the market had hoped and hence the Fed will do whatever it takes to bring inflation down.

BlackRock’s Li believes the Fed and ECB will “overreact”, particularly to upside inflation surprises. Expect “over-the-top tightening” of policy, she says, which means recessions in core economies. “Our whole-portfolio approach prompts us to reaffirm our view on reduced risk,” says Li.

Federal Reserve, ECB are very negative

Recent economic data from the US has been lackluster despite a still strong job market.

Last week’s retail sales had a negative impact on the pace of consumer spending and the Atlanta Fed cut its Q3 GDPNow tracking estimate to just 0.5% annualized from 1.3% previously. The only positive is that it ends the technical recession caused by consecutive quarters of negative GDP. Now that the US is looking up, some investors may jump in and buy at the lows. But there is now a consensus in the market that bigger lows are to come. Investors can wait for even deeper discounts in global stock prices.

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

Last week, falling gas prices helped keep inflation contained to a monthly gain of 0.1%, but the overall CPI showed a 0.6% rise. Persistent inflation has raised fears that it is now entrenching.

“We still believe that the underlying trend is towards slower inflation,” says Marcelli. “But as of this writing, it doesn’t look like the Fed is on track to hit its 2% inflation target in a reasonable timeframe.”

Meanwhile, across the pond, the European Union is doing what western governments do best these days. Issue emergency powers to deal with a crisis, including your own, to gain more control over the economy.

The EU’s proposed supply chain emergency powers are a big deal if they ever come to fruition. For Wall Street, this signals that Europe will be a tougher market to short. “If it becomes more than just a proposal, that means there’s more federalism coming to Europe,” Signorelli says, a move that would eliminate many sovereignty rights held by individual member countries.

“It could mean more predictability for the markets, but all of that is still in its infancy,” says Signorelli. “I would not agree to be short, but I would not buy European stocks right now. Without cheap energy there would no longer be German economic power. You have to find a way to keep this. If I had a European portfolio to manage, I would rather buy UK stocks,” Signorelli says. “Love her or hate her,[new PM]Liz Truss has the right idea on taxes and energy – lower taxes and more energy production.”

BlackRock is underweight the US and Europe but remains neutral in emerging markets.

China’s economy is back in stimulus mode, although this will not be your stimulus package for China. The Chinese stock market is in deep bear territory, so investors could react to these issues and start buying the big China ETFs like FXI MCHI and ASHR.

Consumer demand in China remains weak. Property prices have plummeted and coronavirus lockdowns have continued, most recently in the city of Chengdu.

Data released last week showed that industrial production rose 4.2% year-on-year as drought conditions and power shortages eased. Fixed investment rose 5.8% in the first eight months of the year compared to the same period last year, suggesting infrastructure stimulus is heating up.

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 Biden’s recent declaration of the end of the Covid pandemic phase, something the market would have hailed earlier this summer, has done little to attract bulls to the market.

“We see limited upside potential through June next year,” says UBS’s Marcelli. “Selectively add to exposure. We favor defensive, high-yield, and value stocks.”

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