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After a difficult end to September for global equities, October started well before a brief pause and then a sharp rebound. Inflation concerns linked to skyrocketing energy prices weighed on equity markets before strong company earnings reports brought relief. WTI crude oil rose by 11.4% to end October at USD 83.60, marking a high since October 2014.

Quarterly earnings and sales beat analyst expectations, but there were significant differences across sectors, depending on companies’ pricing power. Companies generally appeared to have avoided the margin squeeze analysts had expected. Forward guidance was generally encouraging.

These reports and favourable microeconomic factors put equities back on their upward track despite the rises in long-term bond yields. These had some investors questioning the valuations of major equity indices.

Equity markets in Q4: a strong start… 

Against this backdrop, the MSCI AC World index (in US dollar terms) almost regained September’s all-time high. It posted its biggest monthly rise of the year (+5.0%). In comparison, emerging market equities did far less well: +0.9% in October for the MSCI Emerging Markets index in US dollar terms and -2.1% over the year to date compared to +15.3% for global equities.

… despite upward inflation pressures

In the US, headline inflation came in at a fairly steady 5.4% year-on-year; core inflation (excluding food and energy) stabilised at 4.0%. Changes in the cost of shelter – an important component of US price indices –showed signs of rising.

The US Federal Reserve’s preferred measure of core inflation – personal consumption expenditures excl. food and energy – has remained steady at 3.6% YoY since June, paving the way for the central bank to announce that the pace of asset purchases under its pandemic-era quantitative easing programme would be reduced (i.e., tapering).

Eurozone inflation came at 4.1% in October and core inflation at 2.1%, exceeding the ECB’s target for the first time since 2002. Forecasts are still being revised up: 2.3% in 2021, 1.9% in 2022 and 1.7% in 2023 according to the latest survey of professional forecasters.

The ECB’s governing council appears to be divided: Several members are said to believe inflation could remain above 2% until 2023. Statements by President Christine Lagarde that inflation would not approach the 2% target ‘well before the end of the projection horizon’ and that there was ‘no reason to believe that wages are going to sustainably increase’, failed to damp market expectations of a rise in key rates before the end of 2022.

In recent weeks, the tone adopted by many central bankers has ranged between being a little less accommodative to being even more hawkish. Several banks have already raised their policy rate: South Korea in August, Norway in September, and New Zealand in October. Others have suggested that they are about to do so: the UK.

Equity investors appear to be getting used to this constellation, but how the Fed comments on this topic will be crucial as expectations grow of a first rate rise in 2022.

Resilient domestic demand

The pandemic has worsened, especially in countries with low vaccination rates, and several countries are now offering a vaccine booster to the most vulnerable. This has added to concerns over the length of the supply bottlenecks and inflation pressures, but activity has been solid. Shortages of goods and materials are still constraining manufacturing, but domestic demand is resilient, fuelled by a catch-up in services consumption.

The first estimate of US Q3 GDP growth came in at 2.0%, marking a sharp slowdown from the first half. Even so, there were encouraging elements. Services consumption was strong and while goods consumption disappointed, there are signs that activity will accelerate in Q4. Thus, the composite purchasing manager index rose in October and consumer confidence recovered after two consecutive falls.

Eurozone economic activity held up well amid the Delta variant wave. Q3 GDP growth came in at 2.2%. Business surveys provided conflicting signals for the beginning of Q4: The composite PMI fell in October to its lowest since April, while the EU economic sentiment indicator rose to close to its July level and hiring intentions improved further, setting a record in the industrial sector.

US and cyclical equities outperformed significantly

US equities outran their peers. Boosted by corporate results, the S&P 500 index rose by 6.9% from the end of September to set a new record. In the eurozone, the EURO STOXX 50 rose by a sharp 5.0%, supported by financial stocks and economic indicators showing that European economies generally avoided being hit by the pandemic wave of the summer.

Japanese equities fell despite the slight improvement in the economic outlook as reflected in business surveys, fewer Delta variant cases and a 2.4% fall by the yen against the US dollar.

Globally, cyclical sectors, led by technology and consumer discretionary, were the most sought after. Financials were supported by rising long-term yields and the energy sector was fuelled by higher oil prices. Only the telecommunications sector posted a monthly decline.

Inflation, pandemic, China, Fed, long-term yields – Any questions?

Inflation risk is becoming the main theme for financial markets, as energy costs soared. It now appears that inflation pressures will take longer than expected to fade. At the same time, services consumption has improved, signalling strong demand. This is also reflected by the good Q3 earnings season.

As winter approaches in the northern hemisphere, the pandemic remains a worry, but mobility restrictions that could weigh significantly on domestic demand now appear behind us, at least in developed economies.

In China, the next few months may remain challenging given the slowdown in Q3 GDP growth. Concerns about China are among the downside risks that could, in the short term, dominate on investors’ minds.

Questions about the Fed’s monetary policy and the direction of long-term bond yields will likely continue to fuel some market volatility as the year closes, now that major equity indices have set new records.

We may see profit taking or position adjustments in the coming weeks, but these should not impinge on the current bullish trends. In the medium term, our central scenario is for economic recovery, good corporate earnings prospects, and accommodative monetary policies. We expect fiscal policies to continue to underpin activity next year, supporting potential growth more structurally.