Equity and fixed income markets have benefited from both stepped-up central bank support and governments shifting from austerity as a response to economic shocks to fiscal generosity. Equity valuations are now at 20-year highs, partly on the back of the fall in interest rates.
We believe the time has come for the baton to be passed to earnings growth as the driver of stock markets. However, increases in US taxes may limit the potential for earnings to grow and in bond markets, we expect a rebound in yields, driven initially at least by inflation expectations as the US economy swiftly resumes normal activity.
While low interest rates and inflation warrant a stock market premium, some normalisation of valuations looks inevitable. We expect a more rapid increase in company earnings than in share prices to help correct valuation multiples. It is difficult imagining when this would happen given the still extensive central bank and fiscal support for markets.
For more details, watch our video with Daniel Morris
Read our Asset allocation monthly – Passing the baton
