Asset Allocation

Equities: Macro risks ease and earnings improve

We continue to have a favourable view on equities for 2021 due to our expectations for a vaccine-driven economic recovery and revitalised global corporate earnings. While earnings in the US were negative throughout 2020, momentum turned sharply positive in the third quarter as a record high percentage of S&P 500 companies reported earnings above expectations.
December 2020

Keith Balmer

Director, Product Specialist, Multi Asset Solutions

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Risk Disclaimer 

Views and opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management.

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

We continue to have a favourable view on equities for 2021 due to our expectations for a vaccine-driven economic recovery and revitalised global corporate earnings. While earnings in the US were negative throughout 2020, momentum turned sharply positive in the third quarter as a record high percentage of S&P 500 companies reported earnings above expectations.

The fourth quarter of 2020 saw a recovery in value stocks and small-caps, which had lagged their growth and large-cap counterparts significantly over the past few years. Despite this short-term reversal, we recognise that long-term secular trends are at work here and we remain relatively neutral on both value versus growth and small versus large.

US equities still offer value

We expect the US economy and financial markets to perform well on the fiscal, monetary and vaccine developments discussed above. Elevated levels of personal income and savings that accrued from fiscal stimulus and reduced economic activity in 2020 should result in a burst of pent-up demand in the second half of 2021.

At present, equity market valuations are front and centre, with some investors fearing they have gone too high. It’s important to understand that comparing P/E ratios across time excludes many important variables: growth, interest rates, inflation, risk appetite and structural shifts in the market. Our long-term valuation modelling, which includes these considerations, indicates that equities are reasonably priced at current levels. There may be pockets in the market where exuberance has taken hold, but overall valuations would have to march considerably higher before action is warranted based on that consideration alone.

Europe could regain lost ground

In line with our expectations that the world gets back to something approaching normal in 2021, those regions and sectors that have suffered the most from the pandemic logically have the most to gain. On this basis, Europe should have a strong upside: it has suffered a much greater loss in terms of GDP and corporate earnings than either China or the US. Therefore, our strategy is to be ready to overweight Europe but only after we see clear evidence of outperformance on the economy and earnings.

UK economy needs to readjust

The UK faces its own challenges in the post-Brexit world. We closed our underweight on the UK earlier this year following significant underperformance and are now neutral. We expect to remain neutral, on the idea that the market will correctly price in the problems that the UK will face as it reconfigures its economy to the new world.

Emerging markets look well placed….

Emerging markets also look poised to benefit from a global economic recovery in 2021, with rates of growth again superior to those of developed markets. Debt-fuelled fiscal expenditure and accommodative monetary policy should help to achieve this growth, albeit indirectly, as developed countries have more flexibility in both forms of stimulus. The burden of COVID-19 and the associated restrictions, heavier in Latin America, emerging Europe and South Asia versus East or Southeast Asia, should be lifted thanks to the growing number of vaccines. This is likely to contribute to the unleashing of employment and pent-up consumption. Improvements already seen in trade and manufacturing — especially in East Asia where COVID-19 was better contained — could well continue. Upward pressure on commodity prices, consistent with a recovery in manufacturing, is expected to have a greater impact in emerging markets as well. Finally, the Fed’s policy shift to “average inflation targeting” means that the external risk to emerging markets of a strong dollar and tightened liquidity as growth accelerates has reduced considerably.

Positioning

Though it may take a few months to get the pieces in place for a pronounced recovery, we are optimistic that this can happen in 2021. In terms of positioning, we expect accommodative policy and a vaccine driven recovery to support risk assets. As a result, we are currently overweight U.S. and emerging market equities and underweight fixed income.

Risk Disclaimer

Views and opinions expressed by individual authors do not necessarily represent those of BMO Global Asset Management.

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

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