People walk past the New York Stock Exchange on September 1. US core inflation remains high, at close to 6 per cent. Photo: AFP
by Sylvia Sheng
by Sylvia Sheng

Policy tightening and recession risks mean summer stock rally is at an end

  • The outlook for the global economy remains uncertain despite signs of US inflation easing and resilient growth in developed markets
  • Central banks in major economies are expected to continue tightening monetary policy, dampening expectations for a rebound
The impressive summer equity market rally seems to have fizzled out after sharp corrections in recent weeks. After bottoming out in mid-June, the MSCI World Index – which tracks developed-market equities – was up over 14 per cent before it gave up more than half its gains in the past three weeks.

The strong summer performance was mainly driven by a swing in the balance of risks for developed economies. For many, growth appeared more resilient, suggesting less chance of recession.

Retail sales remained healthy across major developed economies in July, and the US jobs report defied expectations of a slowing rate of employment gains. Meanwhile, inflation also appeared to be slightly less of a concern.
July’s US consumer price index figures, which were lower than expected for the first time in recent months, seemed to increase the chances that the Federal Reserve would orchestrate a soft economic landing, with inflation returning to closer to its 2 per cent target while avoiding a major growth slowdown.

Taking a closer look, it seems that the summer rally was driven almost entirely by higher valuations. Easing market concerns about growth and inflation helped push valuations higher, which more than compensated for declining expectations on company earnings.

Equity market valuations have fallen in recent weeks and a significant rally appears unlikely, given expectations of weaker global growth and continued monetary policy tightening by major central banks to contain inflation.

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Global economic activity is slowing, albeit more gradually than expected. The global manufacturing purchasing managers’ index declined further in August, with weak factory output readings across Asia pointing to a softening of global demand for goods.
The US housing market, a sector particularly sensitive to higher interest rates, has seen monthly sales drop well below pre-pandemic levels. In Europe, the rapid rise in the price of natural gas and electricity is likely to weigh on household income and constrain consumers’ ability to spend.
On the inflation side, global food and fuel prices are moderating, and broader indicators show supply chain issues are easing. In the US, the easing of goods inflation seems to have started to cool headline and core inflation.
Nevertheless, US core inflation remains high, at close to 6 per cent, amid elevated services inflation. In general, inflation in services such as rent tends to be stickier and is unlikely to dissipate on its own. This is especially the case in an environment where wage growth is running hot because of tightness in the labour market.


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The August jobs report showed a modest easing in labour market conditions, with slower employment growth and higher unemployment. But employment growth remains strong by historical standards, and wage growth, at around 5 per cent, is still above the Fed’s 2 per cent inflation target.

Moreover, there is not much room for labour supply to expand. Therefore, the Fed will need to engineer a period of weaker demand to contain wage and overall inflation.

Hopes of a dovish pivot by the Fed have faded as officials reiterated the central bank’s commitment to further rate increases to tackle inflation. New York Fed President John Williams said last week that inflation was far too high and interest rates would need to stay in restrictive territory for some time, to slow demand and get inflation back to the Fed’s target.
Part of the Nord Stream 1 gas pipeline is seen in Lubmin, Germany, on March 8. Russia has halted all gas deliveries to Europe, raising the prospect of higher inflation and economic strife in the euro zone. Photo: Reuters
Meanwhile, in the euro zone, inflation hit another record high in August – 9.1 per cent – amid a weaker euro and higher commodity prices. With news that Russia has cut off gas supplies to Europe indefinitely, inflation risks have risen. While markets expect the euro zone to slip into recession in the coming quarters because of the gas shock, the European Central Bank showed that its focus is on inflation by raising its interest rates by 75 basis points.

Despite signs of resilience in developed economies’ growth and some cooling in US inflation, the outlook for the global economy remains uncertain. Global growth is expected to weaken as major central banks continue to tighten policy to contain inflation.

For equities in developed economies to rally significantly, they would need to be supported by higher valuations as company earnings are expected to fall to reflect a weaker growth outlook. However, this looks increasingly unlikely.

Sylvia Sheng is a global multi-asset strategist at JP Morgan Asset Management