Equity Market Outlook: Growth and Quality Assets Are Most Likely to Deliver on Earnings
Buoyed by unprecedented monetary and fiscal intervention, global equities markets demonstrated their resilience in 2020. As we look forward to 2021, pandemic-induced uncertainty continues to be a dominant theme. A rising tide of COVID-19 infections, on the one hand, will pose challenges to markets, while signs of progress toward a medical resolution to the crisis will spark rallies.
In general, we favor equities compared with other asset classes because they continue to offer relatively attractive excess returns. The equity risk premium (ERP) for developed equity markets stands at 5.5% as of October 31, 2020 – 46 basis points higher compared with the same time last year. The ERP for US equities exceeds that in Europe, largely due to comparatively greater compression of US bond yields. (Earnings prospects for US companies also appear more promising than for European companies.) The equity risk premium for global emerging markets (EM), while slightly below last year, has come back in line with long-term averages.
That said, fundamentals continue to be thoroughly disconnected from equity price movements. This is the second straight year that equity returns have been driven primarily by stimulus-fueled multiple expansion – not by earnings. For equity markets to continue to perform, the pressure is on earnings to come through. Although governments could manage to deliver larger-than-expected stimulus packages, we see limited room for additional stimulus. Quantitative easing measures will not be enough.
On the earnings front, after lagging market developments for months, earnings expectations are beginning to reflect the reality of COVID-19’s impact. Compared with other regions, we believe earnings in North America are least likely to disappoint (see Figure 1).