Views from Asia Part 1: Equity Review and Outlook

The strong relationships we share with our world class manager partners provides access to insights from leading thinkers within finance. Accordingly, the investment team routinely receive invitations to prestigious financial conferences. In the following weeks we will highlight the most exciting and relevant topics from the UBS Great China Conference.

We begin this week with a review of investor expectations surrounding global equities. We examine how investors re-evaluated their pre-pandemic 2020 forecasts for Asian, European and US markets once the full effects of the COVID 19 became clear. We also share their outlook for 2021 and how this is taking shape.

Equity Review and Outlook

2020 Review

Even before the pandemic struck Asian markets had experienced a tough 2019. The Trump administration’s imposition of tariffs on Chinese goods made for a bumpy ride. However, in late 2019, a trade agreement between China and the US surfaced, reducing tensions between Washington and Beijing. Investors and economists started to look forward to a resolution that would reignite global trade and produce a pickup in earnings favouring businesses most exposed to the cyclical upturn.

As we approached 2020, an election year, attention shifted to how the US Presidential race would impact relations between the world’s two largest economies. Investors deemed a continuation of the Trump presidency as a potential catalyst for an easing back of the earlier heavy rhetoric around Sino US trade, further reducing tensions.

In the US, the path for monetary and fiscal policy was however becoming uncertain. This was mostly fuelled by the upcoming election and the fact that less market-friendly candidates such as Elizabeth Warren and Bernie Sanders were still serious contenders to become the 46th president of the United States. However, these fears were tempered by Trump’s high approval rating. Meanwhile, growth forecasts for the US domestic market were expected to lag other leading economies and no changes in market leadership were expected.

In Europe investors adopted a cautious stance as many businesses were also caught up in the US-China trade spat. Additionally, Brexit continued to raise concerns among global investors despite Boris Johnson’s general election victory.

2021 Expectation

Today, as analysts look ahead the key driver of sentiment in equity markets during 2021 is the pace of vaccinations. In the US, the goal is for 23m people to be vaccinated by February and then a further 35m by April. As more of the population become inoculated economies can reopen spurring a recovery in services spending. How robust this will be will depend on prevailing consumer attitudes once restrictions are peeled back.

Meantime, Covid relief packages have provided consumers with greater purchasing power. This is shown by the below graph; which outlines the US personal savings rate spiking up sharply. As economies reopen, consumers will begin redirecting unspent income resuming expenditure on services-based businesses.

Graph: Household Saving Ratio

Source: Bloomberg, data as of 21/01/2021

A similar picture emerges in Europe, where equity markets have benefited from investor willingness to look beyond rising covid cases and to focus on vaccine progress. One difference between the regions lies in the fact that European economies have been hit particularly hard by the pandemic effects, making the development of vaccine news of greater importance.

Asia has handled the pandemic better than all other regions and therefore vaccine progress is less likely to have the same uplifting effect as in western economies due to Asian governments’ firmer grip on the virus in its initial stages. The efficacy of their responses allowed them to reopen economies faster than in the West.

Graph: Confirmed Covid-19 Cases

Source: Bloomberg, data as of 21/01/2021

Aside from regional variations, certain business sectors have coped better than others, For example large e-commerce names like Amazon and Netflix have benefitted disproportionately over 2020; because their business models allowed them to operate normally and to receive an added demand boost. Therefore, investors expect a rebound in global growth will be of greater benefit to businesses operating below trend because of the pandemic. They have also been very out of favour with investors and sit on much lower valuations.

However, despite fears that high growth stocks are overvalued, they continue to operate with higher levels of profitability and generate copious amounts of cash to invest for future growth. These positive features counteract fears of a repeat of the dot-com bubble where investors bought blindly into loss making companies and paid excessive prices not consistent with reality.

What seems to be apparent is equity analysts expect the Consumer Discretionary, Energy and Industrial sectors to gain traction and possibly exhibit market leadership as the upswing gathers pace. A better macro backdrop will support better sales performance offering genuine potential to beat prior ultra-low profit expectations.

In the US, earning estimates are 10% for Q4, following the 19% earnings beat in Q3. Investors underestimated demand in the US and margin expectations were set too low. Additionally, the pandemic allowed many businesses to reduce operating costs such as office costs where space is in less demand. The fall in office occupancy has caused rent costs to drop by 1.5% on average. Meanwhile, labour markets have also slackened and wage pressure has fallen for businesses.

European equity markets have attracted more favourable comment because they have higher weightings towards the ‘back to work’ sectors mentioned, and less exposure to ‘stay at home’ sectors, which encompass technology stocks. Some participants forecast European earnings to have their most robust performance relative to US companies in 17 years as consensus figures for European earnings are expected to increase by 200%.

Conclusions

If 2020 has shown us anything, it is that forecasting financial markets is challenging.

Investors must remain diligent and attentive to a continually evolving market environment.

Navigating the many twists and turns that financial markets throw up is never easy.

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