The resilience of the global stock markets is impressive, especially as there are still numerous risk factors like high inflation weighing in on the economic activity.
Both the Dow Jones Industrial Average and the S&P 500 recently touched new all-time highs, as capital flows toward shares in lack of more attractive alternatives.
Interest rates on government bonds are still going up, which keeps the Nasdaq and the overall tech sectors underperforming, but thus far, the market will need much higher rates before that turns into a problem.
Inflation, Energy Crisis, Economic Weakness
According to International Monetary Fund estimates, consumer price inflation should peak during the fall of 2021, and ease towards pre-pandemic levels by mid-2022.
This is the baseline scenario and the IMF highlights risks such as energy prices and supply shocks, that can keep inflation figures elevated longer than expected.
On top of that, rent rates are increasing in developed nations, in line with wages, as employers struggle to find people to hire. All of these factors act as a drag on economic activity, yet the stock market is not yet pricing in a sharp contraction.
The bounce off the pandemic lows has been strong and now publicly-listed companies are enjoying strong revenues and pricing power.
How long these brands will manage to pass higher costs to consumers is yet to be seen. Rising prices can eventually impact consumption and thus all the optimistic revenue expectations might need to be revised lower.
Earnings in the Spotlight
In terms of stock trading activity, retail traders have been active again as of late and the 5% correction in all major indices was treated as a “buy-the-dip” opportunity. That assumption turned out to be true, as stocks bounced off the lows and now indices press the all-time highs.
New earning opportunities are now unfolding, with most of the companies posting better-than-expected EPS and revenue growth. The large tech names have not yet released their figures and that is where the focus will be once again when that happens.
When valuations are near record levels, even a slight miss from estimates can lead to sharp price developments in the underlying stock price.
Although long-term prospects have not yet been dampened, with the broad stock markets still edging higher, valuations are vulnerable to short-term surprises. During the past year, all of these setbacks were buying opportunities, as the market was deeply conditioned to buy on weakness.
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Stocks Still the Most Viable Assets
Stocks in companies that are still generating solid revenues remain a good hedge, especially now that inflation is elevated.
As long as interest rates don’t continue to rise aggressively, stocks are a better option when compared to bonds. Central banks usually intervene each time bad things occur, which is what has been keeping investor sentiment elevated.
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According to the Factset, S&P 500 has got the momentum after rising around 25% for a third straight year in 2021, which is good news for stock investors.
However, the main risk for this narrative is if inflation ends up not being transitory, which will require a shift in monetary and fiscal policy, something that can hurt stock markets.