Santa Claus rally on the stock market

Stock markets have rejoiced as inflation has fallen and central banks have turned their coats on monetary policy around. Christmas has come early for investors this year.

In this post, let’s talk about the ECB's interest rate decision and how interest rate cuts will benefit the European and especially the Finnish economy. I talked about the Fed's intentions to start cutting its policy rate next year in my previous post. We will also look at global industrial indicators. The bottoms may be at hand. This is good news for stocks that have already taken a head start.

A special Christmas edition of What’s Up with Stonks comes out on Thursday, where we take a closer look at the year and look ahead to next year. It will also be the last post of the year.

Interest rate cuts are good for Europe and especially for Finland

Last week's big news about the central banks' U-turn triggered a sharp rise in stock markets. Not that the market hadn't been anticipating this kind of monetary policy reversal for some time.

Investors' paradise scenario of a soft landing seems to be coming true. Inflation will cool, central banks will move to cut interest rates next year and economies will avoid a worse recession. We are talking about a proper nirvana for equities. Stock markets in most parts of the world have been rising for more than a year in anticipation of this. The MSCI World equity index is virtually at new highs. The bottoms coincided with last fall, when inflation peaked globally.

The European Central Bank did keep its policy rate unchanged, but at the same time it dropped the phrase: "inflation is still expected to remain too high for too long”. While inflation may pick up in the coming months, by 2025 inflation should be close to the ECB's 2% target. Most of the price pressure comes from labor costs, which is interestingly in line with the observations I’ve brought up in previous posts. But if the eurozone economy remains weak, wage pressures are unlikely to continue for long.

The ECB did not directly mention rate hikes or cuts, and cuts have not even been mentioned if you ask Lagarde. That's in direct contrast to the Fed, where interest rate cuts have been talked about in board meetings. But in practice, the central bank's forecasts of cooling inflation and a weak eurozone economy are further fueling market expectations of a rate cut. Thus, interest rate expectations fell a little further. The policy rate is now expected to be below 2% in a couple of years. The change relative to expectations since the last rate meeting in October is huge, almost a percentage point.

 

In addition, the ECB is cautiously starting to reduce its balance sheet. The central bank does not link interest rate and balance sheet measures. On several occasions, I have repeated the possibility of how central banks can use interest rates to beat inflation and at the same time use balance sheet measures to keep government finances rolling. Perhaps the ECB wants to have such room for maneuver.

All in all, for Finland in particular, interest rate cuts would be a cause for celebration. Finnish people have a lot of variable-rate mortgages. The 12-month Euribor has already fallen to 3.6%. Interest rates on government bonds are also changing rapidly. The debt-driven and large construction sector is in the doldrums from which lower interest rates could dig it out. Thus, falling interest rates support the economy quite directly. Lower interest rates will also weaken the euro as a currency, which will help the export-driven economy. More exports, more happiness.

Market interest rates have also fallen. Considered Europe's risk-free rate, the German 10-year bond has quickly climbed to 2%. Ten-year inflation expectations in Germany have fallen to below 2%. Thus, even in Europe, inflation is starting to be under control from a market perspective, although it’s always worth bearing in mind the risks.

Bottom of the global economic cycle at hand?

The global bull market in stock markets started more than a year ago. At the same time, the global economy has been grumbling along in relative weakness, especially in China and Europe, as I'm sure everyone knows. This is probably at least a big part of the reason for the weakness of Nasdaq Helsinki. The drivers of Finnish listed companies rely notoriously heavily on China and Europe. Because of this, signs of improvement in the global economy are welcome news.

This messy graph shows the global manufacturing purchasing managers' index. A reading above 50 indicates an increase in activity compared to the previous month, while a reading below 50 indicates a decrease. Based on this, global industry has been in recession for the past year. But exports from Chile, Taiwan and South Korea, which are sensitive to the global economy, have rebounded sharply in recent months. Historically speaking, this indicates that global industry should soon pick up.



JP Morgan's global purchasing managers' index survey also shows cautious signs of recovery. The index turned negative in fall 2022, recovered but slowed again towards the end of this year, indicating more subdued global economic growth. Industrial production has fallen for six months in a row, but in the latest survey the decline was minimal.

If you look at cyclical stock indices, investors around the world have been trying to time a turnaround for a long time. This can also be seen in many Finnish industrial companies. For example, Konecranes, Cargotec and Wärtsilä have almost doubled from last fall's lows. Goldman Sachs' index of EU cyclical stocks has risen 40% in just over a year. Cyclical stocks have also outperformed defensive ones, indicating an increase in investors' risk appetite.

 

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