Where next for equities after a sparkling first half?
Developed-market (DM) equities have benefited from a positive feedback loop in 2021, with stronger economic recovery increasing sales growth, improving margins and earnings set to rebound by 40% in 2021 in the US and Europe.
The Q2 21 reporting season is set to see a continuation of the recent trend of positive earnings surprises given the base effect comparison with last year will be particularly strong and bullish guidance from companies. Earnings growth in 2022 is expected to be healthy (over 10%). Equity valuations are rich but expected to gradually ease as equity positioning is bullish but not extreme.
After cyclical stocks’ strong outperformance versus defensives as the pandemic began to wind down, markets are becoming less polarised. As inflation fears abate, sovereign yields have fallen again, favouring growth relative to value.
Cash returns to shareholder are expected to be key again for equity returns going forward after equities’ strong price performance in H1. The Fed has already removed payout constraints on US banks and the ECB is set to follow suit.
After the strong recovery and upgrade to our year-end targets to take into account stronger earnings than initially expected, we are keeping a neutral stance on equities overall. Our new year-end forecast for the S&P 500 is 4375 and 465 for the Stoxx Europe 600. This compares to levels of 4358 for the S&P 500 and 460 for the Stoxx Europe on 6 July, indicating that we expect both indexes to make only modest extra gains over the remainder of 2021. Our neutral stance on equities balances the prospect of strong earnings with risks regarding corporate tax, bullish (but not extreme) equity positioning and rich equity valuations.
The strong momentum that lifted emerging-market (EM) equities at the start of the year was abruptly interrupted by the rise in US real yields and a pullback in Chinese equities, although Latin America and EEMEA outperformed the broad MSCI EM index during H1 on the back of fast rising commodity prices and stronger post-covid catch-up potential.
We remain cautious on the outlook for EM equities in 2H2021 despite a supportive backdrop of strong economic growth in the context of a global reopening The inherent inertia to China’s credit normalisation, the risk of a brisk rise in US real yields and the lag in vaccination campaigns in a number of EM countries remain tangible risks for EM equities.
We maintain our year-end target of USD1,400 for the MSCI EM (~5% upside), with a chance that the actual outcome is slightly higher.