Stock prices reflect a weaker economic outlook

The rebound in prices in June rapidly lost momentum and was replaced by more declines in asset prices. Stock prices suffered in particular from the poor economic data from the USA and China and the market’s quick return to reality following the euphoric response to the resolutions adopted at the EU summit meeting. A strong upswing was seen towards the end of the month after ECB head Draghi underlined that the ECB intended to play a stronger role in helping to resolve the Eurozone debt crisis. Naturally, it remains to be seen how long this optimism will last, as some market participants appear to have interpreted the ECB’s comments as promising more than they actually did.
Nevertheless, looking to the weeks ahead, it seems possible that there will be some stabilisation on the government bond markets in the struggling peripheral countries, especially in Spain and Italy. In light of the rather pessimistic mood among many investors this may help set the stage for quite positive price developments in August. Nonetheless, right now it does not look like there will be a new, sustained uptrend, as the global economic outlook is too negative and there are still risk of more unpleasant surprises in the economic data. On the other hand, to a great degree the weaker economic outlook for the months ahead has already been priced into stock prices. Accordingly, as long as the negative news on the economy is not too bad, the potential for further setbacks in equity prices also looks rather limited.
For the next 1-2 months, the most likely development for stock prices is a continuation of the volatile sideways path, with prices moving briefly higher or lower depending on the news about the economy and the course of events in the Eurozone. Growth dynamics have now slowed down significantly around the world and most leading economic indicators suggest that this trend will continue. In this regard, it is possible that the massive, widespread drought in the USA will also become a major additional problem for the Emerging Markets. In recent months, prices for corn, wheat and soya have already risen sharply and in light of the poor harvest prospects it is more likely that prices will continue to rise rather than fall. As food accounts for a particularly high proportion of consumer spending in the Emerging Markets and food price developments are reflected strongly in inflation rates, this could result in numerous challenges for the EM economies. First, higher spending on food reduces the income available for spending on other consumer goods. Second, the resulting inflationary pressure makes it more difficult for central banks to stimulate the economy by cutting interest rates. And finally, it is important to recall that massive increases in food prices threaten the very lives of many people in the Emerging Markets and can thus also have a major impact on domestic politics.