Last week showed that in May the markets, led by the USA, have returned to the usual upward trend seen at the start of the year. The approaching earnings season indicated that the world’s largest economy is still going strong, but next week’s financial data will reveal whether US consumers have started tightening their purse strings.
Last week was quiet in terms of data disclosures, and the market showed steady positive development. Now it appears that after an unsettled April, the markets have resumed their upward trajectory.
At the Fed’s meeting on the 1st of May, Fed Chair Jerome Powell announced that the central bank does not intend to raise its key interest rate in the near future. The statement caused the interest rate level in the USA to slide, which in turn had a positive impact on other asset classes. The interest rate spread between Europe and the US has narrowed in May.
General price volatility has decreased, and last week the VIX index measuring it came close to the March nadir. The index is based on an estimate of future volatility derived from a derivatives valuation formula, and it is also called the “fear gauge” because it describes market sentiment and investor nervousness. The index is now clearly below its historical average, which is typical when all is well on the market and equities are performing well.
The upswing in the equity market has been more robust in markets that have not performed as well in the long run. This means, for example, the Helsinki Exchange, which has risen almost five per cent in the past month.
Equity valuations are currently clearly above the historical average in the USA; in other words, historically speaking, the US market is now expensive. In Europe and the emerging markets, however, the valuation level is close to the historic average.
The steady uptick has also been boosted by the US earnings season’s better-than-expected figures. As much as 80% of companies have exceeded market expectations, which is a higher share than average. Earnings have grown by roughly five per cent and net sales by around four per cent on average. Earnings growth expectations for the full year rose to nearly ten per cent thanks to the strong earnings.
The Magnificent 7 tech companies, which played an especially significant role last year, have accounted for a slightly smaller share of market growth this year. Last year, the giants accounted for no less than 40 percent of global equity market returns, while this year their share has hovered at around 30 per cent, when disregarding Tesla’s share, which fell sharply.
The European earnings season, for its part, has offered weak but still better-than-expected figures. In a situation where two thirds of companies have reported their earnings, some 60 per cent have exceeded expectations, which is below the historical average. Earnings have shrunk by an average of five per cent and net sales by four per cent. The raw materials, energy, car manufacturer and logistics sectors in particular have performed poorly this earnings season. Europe’s expected earnings growth for the full year is a modest one per cent.
The most important data to be released this week is the US inflation figures due out on Wednesday. Their significance is highlighted particularly by the fact that the past two inflation reports have shown prices rising faster than expectations, which has caused some bumps in the price moderation trend. If inflation proves again higher than expected, the Fed will face a difficult situation.
In the USA, inflation is currently made up almost entirely of services inflation, which is typically persistent, i.e. it rises and falls slower than other inflationary components. The impact of food, energy and goods on inflation, however, is quite low at the moment.
Other important data to be released next week is retail sales figures, which will shed light on the position of the American consumer. This data is of interest to the markets, because the USA’s domestic consumption covers roughly three quarters of the entire country’s economy.
If the figures are worse than expected, they could reinforce the market’s anticipation about a weakening in the position of the US consumer. One of the reasons that, e.g. the rise in interest rates has not had the same impact on the USA as it has on Europe so far is that mortgage interest rates in the USA are tied to long-term interest rates, which means the impact of the rise in interest rates appears to those with mortgages after a delay.
Europe will also receive inflation data this week, but it draws less attention, since inflation has developed significantly more linearly on this side of the Atlantic, with no major surprises in store.
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