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MACRO RESEARCH
14 July 2021

Equities Face More Moderate Path Ahead

Equity market returns have moderated somewhat over recent weeks as the US economy has shifted from an early-cycle re-acceleration phase to a more moderate stage. Data releases remain solid, but have stopped improving. We believe that this pattern will hold over the coming months. As a result, markets will likely grind higher as the trajectory in earnings remains quite steep, but a renewed multiple expansion is unlikely. From a regional point of view, we have a preference for Emerging Markets equities.

We have passed the strongest phase of this rebound

After a phase of strongly accelerating growth, which lasted well into the first half of 2021, the economic cycle in the US has entered the next stage: macro data remain generally strong, but have stopped getting stronger. Equity markets reacted as they have (almost) always done during similar periods in the past – they have stopped moving higher. Valuations are being tested as the market is reconsidering its assumptions about the future path of the recovery and market leadership has changed as the cyclical rebound is pausing.
Global equities have been flat since mid-April
global_equities_flat.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
The strong and long-lasting outperformance of cyclicals ended in mid-March and tech-heavy sectors have given up most of their gains since the beginning of the year, while defensive sectors were able to regain some ground and benefit from the reduced upward pressure on US rates. The only pocket of the market, which has seen little to no disruption to its upward trajectory, has been value, with financials and energy extending their outperformance over the past months.
The cyclicals rally has cooled
cyclicals_cooled.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
The moderation in the pace of the recovery could predominantly be felt in lower valuations, which did not only come under pressure as prices flat-lined, but also on the back of strong upgrades to earnings expectations.
In particular large-cap tech has de-rated
tech_derating.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
On this note, the current cycle looks distinctively different to previous ones. The recovery in earnings has been nothing short of remarkable, with corporate reports producing one record quarter after another. In the US, 87% of companies beat consensus expectations in the first quarter, marking another record high after an already strong second half of 2020. Earnings revisions have surged as a result, hitting multi-year highs in the US and an all-time record number in Europe.
Earnings revisions have surged in Q2
earnings_revision_surge.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
Support for equities in the second half of the year, however, will likely be a lot more muted. While the trajectory for earnings remains fairly steep, with consensus projecting 12-month forward EPS in the US to end the year 5% above current levels, upgrades will likely slow in the months to come.
The earnings trajectory remains steep
earnings_trajectory.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
At the same time, valuations appear to be priced for a fairly solid macro scenario. This is not to say that we expect pronounced market weakness or economic data to weaken meaningfully. But the combination of elevated valuations, slowing macro data momentum and central banks that could turn more hawkish at the margin, are good reasons to be less cheerful than we were at the beginning of the year.
US revisions are unlikely to rise further
us_earnings.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
In terms of regional preferences, we are starting to see more value in Asian markets, which have been following their own macro cycle since the beginning of the year. After a strong performance in 2020, the pull-back in the Chinese credit cycle has weighed on the region’s markets. As the momentum in the US economy seems to top out, we could well see domestic stimulus in China return again in the months ahead.  
The China credit cycle has been very weak
china_credit.png
Source: Refinitiv, J. Safra Sarasin, 27.05.2021
If the Chinese credit cycle were to turn, it would be a very positive signal for a market that has suffered more than any other region since the beginning of the year.

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