Strong company earnings results helped propel global equity markets higher this week, despite rising inflationary concerns and expectations for rate hikes being brought forward. US equities in particular recorded yet another new high, with Tesla, amongst others, reporting robust results for the third quarter despite ongoing supply chain issues. Almost all results now feature comments on rising input costs, with the differentiating factor being whether companies are able to pass these higher costs onto end consumers. Government bond yields, which move inversely to price, continued their recent ascent as markets increasingly prepare for monetary tightening away from emergency levels, introduced in the depths of the Covid pandemic crisis.
As of 12pm on Friday, London time, US equities rose 1.8% over the week, whilst the technology sector increased by 2.1%, although remaining slightly shy of its previous all-time high. European markets were up 0.8%, whilst the UK equity market fell 0.1%, with the materials sector, in particular, weighing on its performance. Japanese equities fell 1.1%, whilst the Australian market rose 1.3%. Emerging markets were up by 0.7%, with Hong Kong stocks rising 3.1%.
Yields on 10-year US Treasuries rose to 1.69%, as headline consumer price inflation reported last week came in above five percent for the fourth month in a row. The latest minutes of the Federal Reserve noted that US central bankers are sticking to the line that inflation will be transitory. Whilst the UK’s Bank of England new chief economist, Huw Pill, flagged expectations that UK inflation will rise above 4% by the year-end, despite September’s number coming in beneath expectations at 3.1%. Expectations for a UK rate rise have been brought forward by the market to November, with a further rate hike in the first half of next year. German bund yields rose to -0.08% with European headline inflation (including food and energy) coming in line with forecasts at 3.4%. However, German headline inflation came in at 4.1%, a level not seen for twenty-nine years.
Crude oil continued to grind higher, with Brent touching $86 a barrel intra-week, now trading at $85.5, whilst US WTI (West Texas Intermediate) is trading at $83.3. Gold rose 1.4% over the week, trading at $1,793 an ounce, whilst copper fell 3.2%, now trading at $10,078.
Inflationary pressures are not abating as central bankers had imagined, and expectations of interest rate hikes are being brought forward. However, this should be viewed in the context of emergency levels of rates being removed rather than an outright attempt to tighten monetary policy. Whether inflation proves to be transitory or not will not be known for definite until the first half of next year.
However, as most assets are priced off the risk-free rate, which more often or not is the US Treasury yield, this increase in yields will impact market valuations. Those companies in structurally growing industries, with strong earnings priced out into the future are most vulnerable to increases in yields. However, on the flipside of this argument, many of these companies also have pricing power and the ability to maintain their profit margins whilst operating in markets with many more years of growth forecast.
Whereas economically sensitive companies most geared into the economic recovery, the so-called ‘value’ stocks, with earnings expected to rise the most proportionally, often do not have pricing power. These companies typically trade on much cheaper valuations.
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