It’s been a bumper month for stock markets, with a wholesale re-embracing of risk over the past month. Does it leave increasingly little margin for error?
- After a significant drop over the summer, markets rallied during November.
- Markets remain sensitive to the ebb and flow of inflation and interest rate data.
- A harder landing for the US economy is not priced into valuations
Investors have decided to end the year with a bang. The MSCI World has moved almost 5% higher over the past month, as US recession remains elusive and inflationary pressures ebb. But has this ‘everything rally’ moved too far, too fast?
It is possible to argue that this is simply a rational adjustment to a better economic outlook. The oil price has dropped from over $90 in the summer to around $70 today, removing a key inflationary pressure point. US GDP growth has outpaced all expectations, with a rise of 5.2% for July to September. At the same time, inflationary data across the major economies shows a sharp fall.
Equally, markets had dropped a long way since the summer. From the end of July to the end of October, the MSCI World had fallen 10%. This was a response to the higher-for-longer trade, and fears of higher energy prices. This had left markets looking relatively cheap, with the notable exception of the US technology sector.
However, it also shows how fragile any recovery might be. Markets are still very sensitive to the ebb and flow of inflation and interest rate data. While it may be that inflation will remain benign and the US economy will dodge recession, it is not a given, and markets increasingly do not reflect an alternative outcome.
In the recent Bank of America Merrill Lynch fund managers’ survey, 75% of those polled see a soft landing or no landing as the most likely outcome for the US economy. This is a 10% increase on the previous month and shows how much optimism there is that there are no nasty surprises.
Yet a hard landing is not implausible. The US consumer has been a key feature of US economic strength, but is coming to the end of its pandemic savings, and many will have re-started student loan repayments in October. The world economy has had a major boost from falling commodity prices – gas prices are down 75-80% over the year - but this is likely to be more neutral looking forward. Central banks are removing liquidity from the system, which could also damage growth.
If the US economy does experience a soft landing, markets can probably continue their recent run of strength. However, there is increasingly little room for manoeuvre, and they look vulnerable to any data that suggests inflation and/or interest rates could go the other way. It is a precarious moment.
Read more 'The Week' articles, click here
