Equity markets have been finding the shift to the post-pandemic landscape challenging. As Covid restrictions ease and consumer and business confidence brightens, the economic recovery should pick up again. However, in a sense, the recovery has become the problem.
These are some of the highlights of our quarterly equity outlook – A tricky transition
Supply is lagging due to supply-chain and job market bottlenecks. Prices have risen. We believe the disruptions will fade over time, production will recover and the ‘low-flation’ world will return.
Looking at price-earnings, price-book and price-sales, US equities appear expensive, while Europe and Japan have greater appeal. An alternative way is to assess the equity risk premium: this is above the 5.2% average, suggesting US S&P 500 valuations are at least fair value if not better.
Since we expect inflation-adjusted market rates to climb further, growth stocks could remain under pressure. Now that inflation expectations are picking up, value stocks may show some gains.
Among the sectors, higher input costs are less of a threat to the profits of IT, materials and industrials companies. On the other hand, consumer staples is already a low-margin business with limited pricing power, while in healthcare, prices are often difficult to change at short notice.
Small-cap valuations are attractive. The longer-term outlook may depend on the value of the US dollar. Should the dollar weaken further, small caps may resume their underperformance.
Emerging market equities face many headwinds. The main factor in their favour is comparatively low valuations. In addition, the sustained rise in commodity prices benefits commodity exporters. However, developments in China will be critical for the outlook for this segment.
On the earnings side, there will be comparatively more disappointments in the quarters ahead. So, expect market turbulence. However, a recovering global economy, reasonable valuations, and rising earnings all point to further market gains.
