What has happened on the stock market?
Stock markets have been buoyant this summer – except in Finland.
In this post, let’s talk about what's been happening in the stock market while I was on vacation. This also helps me get back to the loop. Let's take a look at results, the bull market that skipped Finland and of course a little bit about interest rates. Finally, there are a few worrying comments about a new bubble in the US.
Market overview
The past stock market year has been marked by a global stock market rally, from which Nasdaq Helsinki has unfortunately been completely absent. The technology-driven Nasdaq index is up as much as 30% since the start of the year and the world's most followed stock index, the S&P 500, is up just under 20%. European equities are up 13%.
By contrast, Nasdaq Helsinki’s general index has rolled over more during the summer holidays and is more than 10% in the red since the beginning of the year. Dividends are a mitigating factor, but you have to pay taxes on them. The stock market is grumbling around the bottoms of last fall.
The present value of listed companies reflects their estimated future cash flows, so price movements are presumably at least partly driven by company fundamentals.
First, let's rationalize the powerful rise of the S&P 500 this year.
The Q2 earnings season for large US companies has been strong with just a 7% fall in earnings, which is better than the almost 10% drop in forecasts. 80% of companies exceeded expectations.
More important than the results of one quarter is where the results are expected to go in the future. You don't get points on the stock market for staring in the rear-view mirror.
This graph shows the earnings growth expectations for the second quarter and the next three quarters. The return to earnings growth, which was already talked about in the spring, is still expected in the fall. In the third quarter, results remain flat and are then expected to start recovering.
This longer-term graph, in turn, shows the S&P 500's projected EPS for the next 12 months. If the forecasts are in the right ballpark, the earnings downturn has come and gone. In a year's time, earnings should already approach the record level that was achieved last summer. In this sense, the S&P 500 approaching its all-time high is not surprising, as earnings are expected to do the same.
If you look at the results of Nasdaq Helsinki in a similar way, the fall in the share price has been logical. Nasdaq Helsinki is dominated by its largest companies.
Of the large domestic companies, Nordea and Sampo are doing better than ever, but the market clearly does not believe that Nordea in particular will continue to perform well. Otherwise, you wouldn't get a dividend yield of more than 9% from a bank with a ROE of more than 15%. The halcyon days of Neste seem to be a thing of the past as biofuels face increasing competition, with transport rapidly electrifying simultaneously. Nokia is Nokia. For our forest companies, the current economic environment is historically poor. Fortum is flatlining along with low electricity prices.
This graph shows the projected performance of Nasdaq Helsinki EPS, which is forecast to stay at current levels. After returning from my holiday, I've been reading up on listed companies on Nasdaq Helsinki and have ended up eating rice cakes for lunch at work. That’s how bland the results have been in a difficult economic environment.
The good thing about the Finnish stock market swamp is that not much is expected of listed companies. The operating environment in many sectors is already miserable. Thus, unlike a couple of years ago, investors have certainly not loaded up anything too fancy in the future of companies. This is my personal opinion, but investing in such a stunted environment is much more interesting than when everyone is having too much fun. Investing is best when it's not fun.
Nasdaq Helsinki is going through an earning slump now, but every dog has its day and presumably stocks will be priced a little more optimistically. Nasdaq Helsinki is trading at around 13.5x its forecast earnings, which cannot be considered a challenging level assuming that interest rates do not rise significantly further from current levels, or that the current recession-like situation turns into a deeper recession. Of course, it’s worth remembering that the quality of our average listed company, when measured in terms of profitability and growth prospects, is not very good. It is not a mega-discount either, lest anyone mistake this talk for ultra-bullish bellowing.
Of course, the economic environment in Finland – and Europe in general – is stagflationary, with the economy flirting with recession while inflation run rampant and interest rates remain high relative to post-financial crisis levels. Such an environment is not exactly favorable to equities, with earnings suffering in a downturn while bonds offer an option of an attractive safe haven. However, the Finnish stock exchange offers cheap shares with a tendency towards mediocrity in exchange for threats.
Inflation and interest rates
Inflation and interest rates have been an enduring theme of What's Up with Stonks and rightly so because, alongside earnings, they influence stock market pricing. Based on data over the summer, persistent inflation continues to cool globally. In the US, inflation is now just over 3%. As you can see from this 100-year graph, inflation can be surprisingly bouncy, but so far the trend is right. This is a good reminder of the risk of how inflation tends to come back quickly if it is not properly controlled.
Several alternative measures of inflation, such as sticky inflation or average inflation, also show a cooling of price increases, although most remain embarrassingly high.
However, the market does not expect inflation to fall rapidly below the Fed's 2% target. This graph shows the market expectation of average inflation over the next five years, hovering around 2.3%. But the most important thing is that there is no longer any fear of runaway inflation like last year. As inflation becomes more predictable, listed companies and the economy will adjust. Inflation is bad if it surprises you, tolerable if it is under control.
The old grief of a super-tight labor market has shown no signs of abating. Even if inflation eases for a while but the economy continues to roar, there is little reason for interest rates to fall for fear of overheating again. According to the Atlanta Fed's gauge, wages will continue to rise by an annual average of 5.7% in the US. Real wages are rising briskly, supporting an economy that is already running warm.
There is certainly no recession at the door right now, although many are expecting one. GDP Now, a handy short-term macro predictor for the poor investor, forecasts the US economy to grow by as much as 5% in the third quarter.
It is against this backdrop of a hot economy that market expectations of Fed rate cuts have been steadily shifting. Although the policy rate, last raised in July, is unlikely to rise much further (*knocks on wood*), it is expected to hover around 4% in early 2025.
If you look at the US stock markets in terms of interest rates, the situation is becoming intriguingly dangerous. As I mentioned earlier, improving results in the future will support equities. But at the same time, you have to pay 19 times their (forward) earnings for US stocks, which is actually more than before the COVID pandemic even though interest rates are much higher now. In turn, the Nasdaq 100 index, populated by NVIDIA, among others, trades at 24x the expected result. This makes one wonder whether technology stocks in particular are in yet another bubble. It's a bit odd that investors didn't learn anything from the 2021 hype-bubble. However, investors' staggeringly short memories have surprised us before too.
Earnings growth expectations also rely on improving profitability, which in this wage inflation environment would be difficult. In addition, the hot economic situation is unlikely to improve significantly, at least from the current level, or interest rates will rise even further.
One could characterize the stock market in the US as being fully positioned in a scenario where there is no recession, the economy cools down optimally, and inflation comes down rapidly. If that happens, it will be good news for equities. If not, there will be a lot of pain in the next few years.
The US 10-year bond rate is acting as a gravitational force for global markets, and this rate is again hovering around last summer's level of over 4.2%. Neither equity valuations nor interest rates are at the levels seen at the onset of the tech-bubble in the mid-2000s, but even so, risks are increasing at a rapid pace. High interest rates were also a sign of a strong economy, but this strength has never lasted more than a few years and it is all fun and games until somebody loses an eye.
Investors were worried when interest rates started to rise in fall 2021 whether something in the system would break down when the money started to cost something again. This concern was quickly forgotten. So far, the pandemic-pumped economy has coped well with higher interest rates, but the back of my mind is itching to know at what point problems will arise again. Until now, the small bank crises and debt ceiling scandals have been nothing more than a hiccup.
The inversion of the yield curve, which reasonably anticipated the recession, has been going on for some time. This means that long interest rates yield lower returns than short ones. It has often heralded a recession. However, the recession has followed even years after the inversion, so the yield curve is not a very accurate predictor.
Besides, no indicator works forever, and it may well be that this time it will be different. But that has tended to be a dangerous phrase in investing.
Thank you for reading the post! Read analysis and make good stock picks!
