Contrasting views are seldom rare when reading market outlooks, particularly at the moment given the backdrop of rising Covid-19 cases coinciding with the opening up of economic activity in a number of countries. Concerns over new infection waves weighed on equities, with Wall Street surrendering early gains late in the day.
Given the substantial rebound in asset prices, plenty rests on underlying activity over the coming months vindicating the high hopes reflected in equity and credit valuations. This is driving a pretty active debate among investors. Let’s start with the camp that suspects a recovery far stronger than many currently believe looms, or what Unigestion judges:
“Is just ‘A Question of Time’.”
The asset manager believes that hefty global fiscal stimulus in the region of 10 per cent of the world economy, “will help earnings to recover quicker than market and analyst expectations and will reinforce the V-shaped recovery in the coming months across and within assets”.
Already, there is chatter that the better than forecast tone seen in economic data may well be followed by a second-quarter earnings season that springs a surprise in not being quite so shocking for both US and European companies.
By any measure, global earnings growth will plumb the depths for the past quarter, so any guidance over the coming weeks that bolsters expectations for a stronger rebound stands to affirm equity and credit sentiment.
FactSet Research notes the bottom-up S&P 500 earnings per share estimate for the second quarter (aggregating the median Q2 EPS estimates for all the companies in the index) “declined by 37 per cent (to $23.25 from $36.93)” during the past quarter.
Such an outcome would represent the largest decline in the quarterly EPS estimate since FactSet began tracking this data from the start of 2002, eclipsing the minus 34.3 per cent recorded for the final three months of 2008.
Kristina Hooper at Invesco says that a decoupling between equities and the economy in recent months means “there is the potential that earnings season could reunite them, albeit temporarily, and make stocks more sensitive to rising infection rates as well as a possible lack of fiscal stimulus”.
Poor guidance from companies shapes as a wild card for equity sentiment and here, FactSet note:
“The total number of S&P 500 companies issuing EPS guidance for Q2 (49) is well below the 5-year average for a quarter (106).”
Anything that suggests expectations of an earnings bounce in 2021 looks misplaced will provide a challenge to market sentiment. Next year, “analysts are projecting earnings growth of 28.2 per cent and revenue growth of 8.5 per cent” according to FactSet. Here’s how bottom-up estimates look over the years and from analysts for 2020 and 2021.
Judging by the recent performance of tech shares — although the Nasdaq eventually retreated from a foray into record territory on Tuesday — investors are sticking with the winners from lockdowns.
Here, Unigestion focus on growth-oriented assets and express a preference for “quality” equity indices such as the Nasdaq. They observe:
“Unlike during the dotcom bubble, earnings in the technology sector are strong, and likely to stay elevated.”
David Riley at BlueBay Asset Management takes a circumspect approach and says:
“Investors are in danger of extrapolating a bounce in the economy from the unprecedented declines in activity in the second quarter into a rapid and complete V-shaped recovery.”
David makes a valid point that “it is simply too early to make a definitive judgment on the shape of the economic recovery, but it is optimistic to believe that the pandemic will not have deep and lingering effects on consumers and businesses even as the virus is brought under control”.
Indeed, there does appear a sense that the reopening of economies comes hand in hand with higher Covid-19 cases. This can be managed to some degree via localised shutdowns, but the danger remains a lengthy hit to business and consumer confidence that tempers a broad economic recovery.
One important consideration from the coming corporate earnings season is whether expectations that the worst is behind the market are affirmed.
Luca Paolini, chief strategist at Pictet Asset Management, takes a dour view of current earnings expectations that forecast a decline of one-fifth and believes:
“Globally, earnings could drop 30 to 40 per cent year-on-year.”
Normally that would entail quite a reckoning for shares and credit, but Luca says the massive presence of central banks “suggests the decline in earnings per share will be offset by a central bank-inspired hike in price-earnings multiples”.
Pictet expect the Federal Reserve will inject a further $1.3tn of stimulus this year while the European Central Bank will add an extra €1.1tn.
Quick Hits — What’s on the markets radar?
Momentum is a powerful factor and the performance of Chinese equities is driving emerging market returns. China’s share market represents 41 per cent of the MSCI EM index and heading the list of the most widely owned are Alibaba and Tencent, with a respective weighting of 6.9 per cent and 6.3 per cent. Their combined weight in the MSCI index of 13.2 per cent is bigger than the 11.7 per cent share of the S&P 500 from just Apple and Microsoft.
This leads Nick Colas at DataTrek to make this interesting observation:
“Both Alibaba and Tencent have been leading the recent rally. We would note that their market caps are $640bn—$650bn apiece, or about 40 per cent of Apple and Microsoft’s equity valuations. Given that AAPL and MSFT have larger addressable markets, that discount makes sense, but whether it should be ‘just’ 50 per cent still leaves some wriggle room for these stocks to work their way higher.”
EM equity investors following the MSCI benchmark certainly hope such an outcome eventuates.
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