Global stock markets have remained stagnant in recent weeks, amid a flood of positive results and economic data, but analysts believe the rally will resume.
Corporate earnings season is shaping up to be one of the most competitive in history, with more than a third of blue-chip companies reporting so far, Barclays analysts noted on Thursday. In the United States and Europe, earnings per share growth has well exceeded forecasts, and the percentage of earnings beats is approaching a record high.
Analysts have indicated, however, that high expectations have been largely priced in, implying that the share price reaction so far has been marginally negative.
A increase in inflation has also been cited as a factor in some investors’ reluctance to invest in risk assets, as fears remain that central banks will begin growing their unparalleled monetary stimulus.
A increase in inflation is not the end of the rally.
Recent inflation readings from the United States and Europe have risen sharply, and UBS strategists expect this trend to continue in the coming months, with signs of lingering price pressures.
They attributed this, however, in a note to investors on Thursday to base effects and short-term supply constraints, rather than systemic problems.
According to UBS Global Wealth Management Chief Investment Officer Mark Haefele, this indicates that the inflation increase is likely to be temporary and should be seen as a source of uncertainty rather than a long-term threat to the stock market rally.
“With economies continuing to operate below potential production, we do not forecast a sustained rise in inflation that would force central banks to tighten monetary policy,” Haefele said.
Jerome Powell, chairman of the US Federal Reserve, referred to this following the central bank’s monetary policy meeting on Wednesday. The Fed believes the current inflation surge is temporary and that there is still significant slack in the labor market, implying that policy will not be tightened in the near future.
According to Haefele, the Fed really needs inflation to exceed its 2% goal in order to compensate for a long-standing undershoot in recent years.
He also noted that profit margins seem to be unaffected by the temporary increase in costs.
“While input costs have increased for many businesses, we do not anticipate this to have a material impact on earnings,” Haefele said.
“In a strong market demand climate, we anticipate sales growth to help offset the drag from input costs,”
Although a temporary inflation spike can trigger some investor jitters, UBS anticipates that equity markets will continue to rise, preferring cyclical stocks — those whose output is more closely tied to macroeconomic conditions — as the global recovery broadens.
Barclays noted that mutual fund purchases have slowed significantly from their record levels in the first quarter, while trading volumes and retail interest in capital markets have declined significantly, indicating that cash is being invested in the economy as it opens up.
The British lender previously warned that unfavorable technicals and seasonal trading patterns may indicate that the market is vulnerable to a pullback in the event of a significant negative trigger.
Although the market is more susceptible to bad news, Emmannuel Cau, Barclays Head of European Equity Strategy, believes investors will continue to buy dips given the market’s good results, ample liquidity, and current high level of bond and cash holdings.
The S&P 500 opened at record highs on Thursday, despite a lack of direction over the last two weeks following a rebound of more than 12 months from the March 2020 coronavirus crash’s recent lows.
He argued, however, that with the reflation trade stalling, value stocks — companies with shares priced below their fundamentals — offer a better risk-reward profile than cyclicals.
“While Cyclicals continue to benefit from strong earnings, we believe valuations and positioning have deteriorated, necessitating a more balanced allocation to the less exciting but cheaper Defensives,” Cau wrote in a note to investors Wednesday.
“We continue to view value as an attractive hedge against rising inflation and yields, as well as a potential target for momentum strategies.”
David Marchant, chief investment officer of Canada Life Asset Management, told CNBC on Thursday that the market might be underestimating the extent of the economic recovery and its possible effect on corporate profits, given that businesses cut costs during the pandemic but will now see revenues increase. He did, however, reiterate Barclays’ recommendation that investors protect against downside risks.
“While I believe that given where we are and the continued support for markets provided by monetary policy, equities will likely remain elevated and will continue to drift higher, I believe investors should exercise caution and be a little more cautious about where they invest their money,” he said.