There is hope in the financial markets

CURRENTLY, I get questions several times a day about how to handle investment portfolios and where the financial markets are headed. The first basic consideration in this connection depends on the individual situation, risk appetite, loss limits, own horizon on investments, among others, of an investor.

But, of course, I also have considerations about the direction of the financial markets. Overall, I see that the direction can go both ways, where the optimistic approach is that the financial markets are currently undergoing quite a hefty correction, which will continue to be painful for some time to come. The other direction is that the global economy is going completely black, and if one trusts in that direction, then it is time to reduce the investment portfolio.

The correction that contributes to the immediate sharp falls is from the same forces that stood behind the steep jumps in the markets. Some will call them speculative movements; I choose to call them flow movements or flow corrections. Such movements create nervousness but are not necessarily an expression of fundamental imbalances, like movements that led to Tesla having a market value of $100,000 at the beginning of this year and is now at $750 billion.

The large and fundamental correction is due to completely different macroeconomic forces. In short, I still see it as inflation that has been let loose because demand has been kept up for several years, while output/production has been reduced. I think that connection is understandable, but digging even deeper in the economies, one will also find several imbalances.

These imbalances have emerged as an aftermath of the financial crisis and are primarily present in Europe. An example is how the European Central Bank (ECB) has operated with such a significantly low interest rate to create a cheaper refinancing of the Italian

government debt. For a number of years before the Covid-19 pandemic, the ECB’s interest rate should have been around 3 percent instead of negative rates. It has pushed up the prices of securities far too high but has also created an unnaturally low interest expense for households and businesses in Europe. At the same time, Europe has chosen to import cheap energy from Russia, where it probably would have been better to pay more and avoid the current dependence. All these factors have contributed to the artificially low inflation for years, and the risk is that even part of this saved inflation will be corrected for now.

All the factors that I have mentioned from flow movements to a correction of saved inflation correspond to several risk curves coinciding at the same time (right now), which means that one has to add the curves, which can hopefully illustrate how such big fluctuations are created.

I consider myself to be optimistic, with the belief that the entire financial market is “only” in a major correction. It has the positive implication that there will be a bottom in the market somewhere and that there is life after the corrective phase — that belief will not be present if one believes that the bottom plug has been lifted out of the world economy and everything is about to flush out.

My primary scenario is that there will be no good economic news for the rest of the year, maybe a few good political developments, but it could be in August or September at the earliest, if at all. From that point of view, it is too early to say when the financial markets will gain a foothold again, which is why everyone refrains from predicting when and where the end of the correction might be, but I do not mind sharing a few thoughts, as this is something I calculate very often recently.

When it comes to US high-yield corporate bonds, sharp interest rate hikes from the US Federal Reserve have already been priced in the market, and to this I add an above average inflation a few years ahead, credit spreads, accompanied by a further rise in the US 10-year interest rate. It argues for an even higher interest rate in the market, where my best bet is another 2 percentage points up to an interest rate of 10 percent in the asset class US high-yield corporate bonds.

In the same way, I project back and forth on various factors in the stock market, where my best bet is that the US stock index S&P 500 may fall by a further 15 percent to about 3,300. This should be seen as my current forecast about where the bottom of the actual correction is, based on the factors I know about at the moment.

Peter Lundgreen is the founding CEO of Lundgreen’s Capital. He is a professional investment advisor with over 30 years of experience and a power entrepreneur in investment and finance. Peter is an international columnist and speaker on topics about the global financial markets.