Global stocks set for a correction as rally fizzles

But the rally is struggling to maintain its pace.

The spread of the Delta variant of the coronavirus and the U.S. Federal Reserve’s pending plans to taper its asset purchases are likely to leave equity markets exposed to turbulence over the coming months.

“The positive earnings season catalyst now behind us means some of the macro negativity is spilling over into equities,” Emmanuel Cau, head of European equity strategy at Barclays in London, said.

“Medium-term though, resilient economic/earnings growth and excess liquidity are likely to remain the dominant market drivers, in our opinion. This should continue to feed the ‘buy the dip’ mentality, although investors may stay on a wait and see mode for now, given the lack of meaningful correction in the past 12 months.”

Last week, world stocks suffered their biggest fall since June but have recovered from nearly all of those losses.

Still, nearly two-thirds of analysts who answered an additional question – 66 of 107 – said a correction in global equity markets by end-year was likely. The remaining 41 said unlikely.

“The fundamental situation is still very supportive even if markets have rejoiced and risen with vigour. Nevertheless the strongest economic momentum is peaking, which leads to a somewhat more uncertain terrain,” Tomas Hildebrandt, senior portfolio manager at Evli Bank in Helsinki, said.

“Will the levelling growth be enough for markets?” he asked.

STIMULUS CAN’T LAST FOREVER

Nearly all of the 17 indices polled were forecast to retain the double-digit gains made so far this year, according to the median views of over 250 equity analysts taken Aug 11-24.

However, a still-uncertain outcome for $3.5 trillion of proposed fiscal spending in the United States and the threat of higher inflation forcing central banks to dial back stimulus measures are likely to dent the risk-on sentiment that has been in play.

“The market is being driven now by huge amounts of government stimulus and low rates. But that can’t last forever,” Dan Morgan, senior portfolio manager at Synovus Trust in Atlanta, said.

All but two indices were forecast to trade around current levels or gain less than 4% by the end of this year, that despite analysts upgrading their expectations for nearly all of the equity bourses from a May poll across the polling horizon.

Despite global central banks preparing the ground to end stimulus measures enacted at the height of the pandemic, analysts expected corporate earnings to hold up, underscoring the ongoing recovery in the global economy.

Nearly 90% of analysts – 97 of 110 who answered an additional question – said corporate earnings over the next 12 months will rise. While seven expected them to stay the same, the remaining six said earnings will fall.

If analysts projections are realised, only Japan’s Nikkei index (.N225) was forecast to outperform this year’s expected gains in 2022.

The benchmark S&P 500 (.SPX) index, which hit another record high on Tuesday, its 50th so far this year, was forecast to end the year around the same levels and then gain another 5% by end-2022.

Median projections also found a rally in emerging market equities will peter out by early next year.

“We suspect low yields were a key factor supporting the gains in equity market valuations last year, which boosted EM stock prices,” Thomas Mathews, markets economist at Capital Economics in London, said.

“We don’t expect particularly large gains in EM equities over the next few years, even as their economies recover from the effects of the pandemic.”