Equities

Anchor: equities

Equities

Equities still drive returns

Equities offer attractive return prospects as we move into 2021. The broad political backdrop should remain supportive given very loose monetary policies globally and continued fiscal support. The earnings slump in 2020 due to the pandemic should prove to be transitory. Consensus forecasts for global equities imply that 2021 earnings will exceed the 2019 level, which should support equities over the course of the year.

Don’t be put off by high valuations

On traditional valuation metrics such as the price-to-earnings ratio, equity market valuation appears elevated compared to longer-term historical averages. On the one hand, we believe this is driven by the ultralow or even negative yield environment, especially in inflation-adjusted terms. On the other hand, the fast and forceful interventions by policy makers, most importantly the US Federal Reserve (Fed), in response to the COVID-19 pandemic helped bring investors’ risk aversion down, allowing for the sharp market recovery in late spring 2020. In 2021, policy support should remain in place to curtail risk aversion.

Besides the risk of a credit crisis, we think that concerns over a late-cycle overheating have been pushed further out due to the pandemic-induced recession and policy makers’ increased inflation tolerance. As central banks continue to curtail those tail risks, risk premia might even decline further as the economic environment continues to stabilize over the course of 2021, which would underpin higher valuation ratios compared to the historical record. When comparing relative attractiveness across asset classes, which ultimately steers a substantial part of investment flows, equity markets continue to look quite attractive.

Since the beginning of 2020, real bond yields in the USA have declined by over 100 basis points, outpacing the decline in earnings yields (inverse of the price-earnings ratio), thus supporting higher valuation multiples.

CBOE S&P 500 Volatility Index expected market volatility as reflected by traded options

Currently the difference between the earnings yield and the real bond yield as a measure for the equity risk premium (ERP) is higher than the long-term average, suggesting that equities offer an attractive excess return over bonds. We acknowledge that in an uncertain environment, the ERP should be elevated, as investors demand a higher premium for holding risky assets. Nonetheless, as economies recover and growth returns, these concerns should ease over time.

MSCI World – Earnings yield vs. real bond yield (in %)

Catching the cyclical rebound

On a regional level, the differences in sector composition will matter most, in our view. Particularly the share of secular growth industries (e.g. technology-related companies) versus cyclical industries (e.g. financials) is expected to drive much of the regional return differential in 2021.

The COVID-19 pandemic has accelerated the trend of disruption, which will continue to be a strong and powerful force. E-commerce and online shopping will increasingly replace traditional retail stores, favoring warehouses over malls. Remote working setups deploying cloud computing, data security, wireless networks and video communication tools should continue to make office space less attractive, while increasing the appeal of suburban housing.

Furthermore, online education is increasingly replacing traditional in-person training, while telemedicine offers an affordable and quick alternative to doctor visits.

We continue to find attractive market segments that have the potential to disrupt and therefore have room to expand market share and profit margins, including technology-related industries and healthcare. We also see potential in materials, including construction materials, based on solid demand for commodities, a strong housing market and potentially more construction activity, especially in residential housing.

The disrupted parts of the economy, however, are likely to lose market share and their margins will come under pressure. Typical examples are brick-and-mortar retailers or print media. We also expect ongoing structural headwinds in the traditional energy and financial sectors.

After some temporary cooling, we expect economic momentum to reaccelerate in 2021, which would then allow investors to position themselves in cyclical sectors, such as travel and hospitality or automotive.

Whatʼs in style for 2021?

In 2020, we witnessed a strong divergence in returns between growth and value stocks. Going into 2021, we believe that value stocks have the potential to catch up, though the timing of such a rebound is not quite clear. In a typical economic expansion where gross domestic product (GDP) grows above potential and monetary policy is expansionary, an investment tilt toward value and small-cap stocks should eventually trump growth and large caps.

The adverse shocks stemming from the global COVID-19 pandemic have nonetheless accelerated factors for which growth is well positioned. This includes the ability to meet the shift in demand caused by decreased mobility, social distancing and remote working and learning. At the same time, relevant parts of value face structural challenges, such as car companies struggling with CO2 emissions.

The same is true for financials, with the lower-for-longer yield environment leading to margin erosion, and for energy, where decreasing appetite for fossil fuels and environmental issues are headwinds for stock prices. Heading into 2021, we prefer to maintain a small growth tilt, but expect to see periods when value stocks could outperform.

Note: Value stocks are stocks that stand out by their low valuation relative to their fundamentals (e.g. earnings, dividends or sales). They often have high dividend yields and tend to be sensitive to the business cycle. Growth stocks are stocks of companies with substantial growth prospects that retain most of their accrued earnings in order to finance growth.

Earnings volatility of growth and value (in %)

ESG here to stay

Sustainability has become increasingly important for investors. So much so that it has become mainstream. For the first time in its 15-year history, the World Economic Forum’s Global Risks Report 2020 exclusively listed environmental concerns as the top global risks by likelihood, as well as for the majority of risks by impact. Awareness of environmental, social and governance (ESG) factors is rising, as illustrated by the increase in online search engine queries.

Assets under management adhering to ESG standards are growing rapidly, putting greater pressure on listed companies to align business models and practices with ESG standards. Furthermore, fiduciary duties are gradually adapting to include sustainable investment principles, as regulators are increasingly demanding the consideration of ESG criteria. Benefits for investors include more protection against prominent governance incidents, resilient ESG performance, along with the soft factor of doing good. We believe this trend will continue, leading to further demand and support for sustainable investments.

"Sustainability has become increasingly important for investors."

Eurozone has the advantage

The Eurozone could outperform the USA over the course of 2021, as earnings offer catch-up potential and should benefit disproportionally from the economic recovery due to their cyclical sensitivity. The earnings cushion provided by the resilient and stable growth-related industries (e.g. technology) during the COVID-19 crisis was less pronounced in Europe. In addition, various regulatory measures regarding dividend payments, introduced during the crisis to ensure sufficient capital buffers in the insurance and financial industries, are likely to be phased out in Europe as economic stability resumes. This would increase the attractiveness of high dividend paying strategies, which tend to be more relevant for European equity markets. We currently calculate a relative valuation advantage for the Eurozone of close to 10%, which we expect to close over time.

Anchor: swiss-quality

Swiss quality

Swiss equities are of a defensive quality and therefore have a resilient earnings profile due to the strong concentration in the healthcare and consumer staples sectors, which account for more than half of the MSCI Switzerland index. During the pandemic-driven downturn, the Swiss market benefited from its defensive qualities. However, Swiss equities went on to lag the strong rebound due to this defensiveness and a relatively low share of technology-related businesses. Following the rally, we believe that the substantial share of global market leaders with high-quality products offers attractive earnings prospects for the Swiss market.

Solid and, most importantly, stable dividends are another argument in favor of Swiss equities, especially at a time when investors are searching for income generating assets due to low bond yields. As an export-oriented economy, the strength of the CHF due to its safe-haven status has been a drag on performance in the past. However, we expect this drag to lessen for 2021, as the continued global economic recovery should reduce the appeal of the CHF as a safe-haven currency.

UK – Brexit uncertainty keeps us sidelined

Since the Brexit vote in 2016, UK equities have underperformed global equities meaningfully, leading to a significant de-rating and a historically low valuation multiple compared to world equities. More recently, UK equities have experienced inferior earnings and sharper dividend cuts than global equities due to the UK market’s high exposure to the financial and energy sectors, which were substantially affected by the COVID-19-related lockdown. Valuation ratios and high-dividend yields indicate attractiveness, however the economic outlook remains clouded due to uncertainties related to the UK’s pending departure from the European Single Market under Brexit. Nevertheless, currency developments could help cushion the blow.

UK equities have a strong inverse correlation to the GBP due to the high share of earnings generated outside the country. We believe that a weak GBP, in combination with the attractive equities valuation, could help offset the hit to growth if Brexit uncertainty continues and there are additional COVID-19 outbreaks in the UK. Additional fiscal and monetary stimulus could also support the economy and domestic stocks in the near term.

Anchor: asia-stands-out

Emerging markets: Asia stands out

Emerging market (EM) equities are dominated by Asia, which accounts for approximately 80% of the global EM market capitalization. Asia has significant exposure to the so-called “new economy” industries and we therefore see a number of structural trends that support Asian equities, such as digitalization, the cloud and artificial intelligence.

We expect Asian equities to deliver attractive returns in 2021 given the current containment of COVID-19 in large parts of the region and the ongoing robust economic recovery in China. As valuations appear to have already largely priced in good economic prospects, a continued recovery in earnings will be key to drive the market higher. The broader economic recovery and strong growth from the technology segment should prove supportive for earnings.

Foreign investors are likely to focus on EM Asia as they hunt for superior growth opportunities. The COVID-19 pandemic more severely affected the other two EM regions, Eastern Europe, Middle East and Africa (EEMEA), as well as Latin America. The fundamental backdrop is therefore weaker for those two regions compared to EM Asia. However, equity prices have corrected due to the pandemic, leading to the potential for outperformance should concerns related to COVID-19 abate, for example through a globally distributed vaccine. Easy monetary policy and a weaker USD should prove beneficial for EM equities. One key risk for EM equities in 2021 remains the US-China trade dispute and the potential for further escalation.

Vaccine: The X-factor

Some 202 potential COVID-19 vaccines were being developed and tested globally, with 47 in human trials, according to the World Health Organization’s 3 November draft landscape of COVID-19 candidate vaccines. In November 2020, one particular vaccine reported encouraging phase 3 study news, likely leading to widespread vaccinations by mid-2021. This is remarkable, as typical vaccine development takes years, not months.

There are several questions linked to a vaccine, including its duration of protection, but also its safety and public acceptance. In addition, the availability of a vaccine and speed of production, along with the logistics in terms of global distribution are key in order to understand how quickly the world could return to “normal.” There is also the issue of near-term capacity, especially for poorer regions.

Nevertheless, any credible confirmation that an effective vaccine is available for wider distribution – and despite all the mentioned issues – would likely be positive for broader equities and overall risk sentiment. Indeed, equity markets already appear to anticipate such positive news based on results from ongoing vaccine trials and approval processes. In such a case, we expect that the sectors that have been most negatively affected by COVID-19, including travel, leisure and hospitality, could see a recovery. We would also expect to see a quick rotation within equities from “stay-at-home” equities and growth stocks into value and cyclical stocks, driven by positive earnings revisions and the potential for a valuation re-rating. Regionally, we expect tourism dependent and cyclical equity markets to begin to catch up in such a scenario after a protracted underperformance throughout 2020 (e.g. in the Eurozone).

Back to Main asset classes

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