Stock prices have been on their way up the entire week. How is that possible in the current situation?
The equity markets have been experiencing growth despite the war and rising interest rates. Stock indices have risen in Europe and the USA to the pre-war level or even above it, however with some exceptions, including the Helsinki stock exchange, which is still more than 10% below the level at the end of 2021.
Nobody knows for sure why stock prices have followed a clearly rising trend in recent weeks. One underlying factor seems to be investors’ buy-the-dip reaction. Buy-the-dip refers to buying equities when they are cheap, with the expectation that their value will rise again in the long run. Another possible factor is the return of private investors to the markets, which can be seen as a rise in technology stocks after the beating they took in January.
Even if there were increasing signs that the war is going to end, the challenges that lay on the horizon at the start of the year are still present. The war will also most likely accelerate inflation and increase uncertainty related to economic growth. Against this background, the markets’ strong momentum raises some questions.
Russia’s attack on Ukraine continues. How will the war impact Europe’s security of supply in terms of natural gas and wheat?
Russia’s invasion is one of the key market themes this week too. Especially in the short term, the war between Ukraine and Russia is still difficult to predict, and will therefore continue to cast a shadow of uncertainty over the markets. From the perspective of the economy, the challenges are above all related to the rise in raw material prices and possible supply issues. The problems are greatest for Europe’s economy, as Europe is dependent on energy imported from Russia. The deal made with the USA for the importing of natural gas is the first step, but the challenge remains significant, especially in the short term.
At the start of the war, the fear was that a decline in the supply of wheat grown in Ukraine and Russia might result in a global food crisis at its worst. Although Russia and Ukraine are major wheat exporters, the majority of the world’s wheat is consumed where it is produced and imports typically only cover a small portion of consumption, especially in Western countries. When it comes to emerging markets, however, the challenges are bigger and, for example, North African countries have relied on imports from Ukraine and Russia. It is unclear how well other wheat producers can make up for the export deficit and how global logistics chains can be adjusted to serve new export routes.
How does the price increase reflect on the general market situation?
Inflation has grown dramatically in Europe and across the Atlantic, and has still not shown any signs of dying down. The energy crisis in Europe resulting from Russia’s attack was also poorly timed in terms of the price index; prices were already on their way up before the invasion. Some easing of the growth rate of prices is expected during the spring, but the most optimistic scenarios of a return to a two-per-cent inflation level can be forgotten for this year. In Europe, the rise in prices is largely focused on energy and food, while in the USA, prices are rising more across the board.
The Fed has announced that it is prepared for steep interest rate hikes in order to curb inflation. Will the ECB follow suit?
For a while now, the Fed has communicated that it will tighten monetary policy over the next year, and it announced the first 0.25% key interest rate hike at its meeting on 16 March. The US central bank’s message is that the key interest rate will be raised several more times during the year, and the steepest forecasts predict that the key interest rate will rise clearly over 2 per cent by the end of the year. The strict measures will have a negative impact not only on inflation, but also on economic growth, but their impact will be softened by, for example, the USA’s full employment and good economic development of the past few years.
The ECB has not yet, at least, followed in the Fed’s footsteps by raising its key interest rate, although the European economy is also suffering from inflation. Inflationary pressures in Europe still remain lower than in the USA, and they are focused especially on energy and food, the prices of which are more difficult for the central bank to impact through traditional monetary policy. Furthermore, wage development is more moderate in Europe than in the USA, which is why the longer-term inflation outlook is more moderate. What is clear, however, is that the ECB must also react, and, in addition to ending the bond purchase programmes, a key interest rate hike looks likely before the end of the year.
What does all this mean for the equity markets?
Stock prices are still rising, but it is uncertain for how long. At the same time, the return on government bond investments, which were considered to be risk-free, has fallen significantly, eating away the past eight years’ real returns. On the other hand, the decline in the actual return means a rise in the expected return.
The rise in interest rates in both Europe and the USA has depressed returns on fixed income investments. The increase in spreads caused by the Russian attack has also impacted fixed income indices negatively.
The year-long rollercoaster ride experienced by various sectors has now settled down to last year’s level. The only permanent loser is the emerging markets.
Nothing presented here is or should be taken as an investment recommendation or solicitation to subscribe for, buy or sell securities. When making investment decisions, the investor must carefully familiarise themselves with the information given on the financial instruments and understand the related risks. The investor must base their decision on their own assessment, goals and financial situation. Risk is always inherent in investment activities. The value of the investment instruments may increase or decrease. The past performance of investment instruments is no guarantee of future performance.
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