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Even Europe is ready for economic growth

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With great interest, I have been looking forward to the many data releases concerning the expectations of European companies for the future. Most of the surveys were published within the last week and they show that large companies have optimistic expectations for the future, when everything re-opens after the Covid-19 lockdowns. An example is illustrated in graph one, it shows the German companies’ assessment of the current situation, which is on its way up back to the level that it was before the Covid-19 crisis broke out in 2020. Even more remarkable are the expectations for the future, which are even higher, and higher than what economists expected the survey to show. Overall, I believe that it fits into the global picture of optimism that is linked to the opening of the world again- this economic fundamental force I weigh with great importance in my assessment of the stock market.

The new steps which ease the lockdowns in many European countries should please investors, but the situation instead is that the nervousness in the financial markets has increased over the last few weeks and some investors now even fear a downturn in the stock market.

It is inflation that has taken the limelight, despite ordinary price increases not having been a theme since the global financial crisis. However, I only believe that inflation poses a risk when it becomes so high, it leads to capital flight, which is not a risk in the foreseeable future.

Inflation will rise for the rest of the year, and I continue to believe that it represents a threat to the bond market, as well as real estate investments, rather than to the stock market. I argue that the reason for the higher inflation can be explained, and as long as that is the case, I am less worried. Should equity investors become seriously afraid of inflation, it should be combined with decreasing economic growth, such as stagflation, which is not a risk in the next 24 months.

If the assessment of the stock market simply consisted of the consideration between the outlook for the coming higher economic growth versus the current rising inflation, then the assessment is pretty straightforward. But nervousness can arise due to many reasons, an example would be that the central banks have been rescuing investors for years. Understood in the sense that periods with losses have been short, whereas the periods with hefty gains have been long and abundant. The effect, however, is that as soon as the stock markets lose five to seven pct., panic spreads rapidly and everyone fears that the markets will fall apart.

I am aware that a major part of the stock market looks expensive, which is a consequence of the negative real interest rates that some central banks have provoked. However, I consider the bond market to be even more expensive, and it is where my concern is.

Back to the stock market, one could argue that the growth optimism I initially described was already priced in the share prices last year, which is correct. As the Covid-19 crisis drags on, this may mean that a correction in the market is justified, though just a correction.

If one digs deeper on the optimism of the large business corporations, one will find areas that can challenge investors, thus increasing nervousness. It is still unknown how life will be like after the crisis, so there will be up and down adjustments in expectations concerning different business sectors. One example I still find that many investors are optimistic about is tourism, but right now, the sector is standing still in many countries, and realistically, it will be in 2022 or 2023 before that sector is back at full speed.

My main worry remains with the small and medium-sized enterprises, which is a global threat, but more distinctively so in Europe. I look with concern at how many bankruptcies will surface during this current quarter, where graph two tells something about the situation in Germany. The German KfW Bank also measures the temperature among companies every month, and it can be observed that last year, the decline in exports hit the large German corporations. Since then, the downturn in the German domestic economy has meant that small and medium-sized enterprises are really hard hit now. Regarding the European labour market, it is in my view, quite uncertain how large the real unemployment rate really is.

All of these different uncertainties are complex to include in the pricing of the stock markets, and here I see a challenge for investors. I expect this kind of uncertainty to lead to higher fluctuations in the stock markets this year, but not necessarily to a downturn in the market.

These considerations remain straightforward. It is an inflation argument versus economic growth combined with other uncertainties, and these are certainly all of great importance, but still within the regular field of discussion. Though everything, including the current pricing of stocks, is based on the premise that the world will gain control of the virus around summertime this year.

But what if the virus continues to mutate so rapidly, that the entire world population needs a new vaccination against a mutation of the virus on an ongoing basis? This is far from my primary scenario, and on the contrary, I expect that in 2023, there will be medicine that can cure a Covid-19 infection. Though I mention this example because the valuation of the global stock market is currently based on one single premise, that the virus comes under control. If this risk should be converted into a risk scale, then this kind of risk is of a completely different calibre than the risk of a slightly higher inflation later this year.

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