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Market Outlook: Better earnings push up share prices

Global stock markets have generally continued to climb this past week, among other things because many companies have reported good fourth quarter 2020 earnings. Measured using the MSCI World Index (in US dollars), global equities gained another 1% or so and have risen by more than 5,1% so far this year.

Continued impressive strength in corporate reports

The fourth quarter report season has now been under way for some time both in Sweden and the United States. After two already strong quarters of recovery in Q2 and Q3 last year, market analysts were optimistic ahead of Q4. Companies thus had to deliver on their expectations. On the whole, they have done so and have stimulated investors’ risk appetite – which was also our hope and one reason why we have been recommending an overweight in equities.

Company sales are better than expected (analysts had predicted that they would be unchanged overall or slightly lower). But the big improvement was in earnings. Looking at the S&P 500 − a broad US equity index − after 373 of 500 companies had reported their results, sales were 2-3% higher than a year earlier, while earnings were up more than 6%. Although not all companies have published their reports yet, this implies that US corporate earnings have surpassed their pre-coronavirus crisis level. Full-year 2021 estimates for the earnings growth of companies included in the MSCI World index are now about 15%.

European Commission expects economic recovery

Although its vaccination roll-out has been sluggish, the European Commission’s latest economic forecasts show a stronger recovery, with gradually fewer pandemic-related restrictions helping the European Union to achieve 3.7% growth during 2021 and 3.9% next year − bringing gross domestic product (GDP) in the EU back to its pre-pandemic level by the second quarter of 2022. This is partly because the latest lockdowns have been more narrowly targeted and have thus not hit EU economies as hard as last spring’s lockdowns.
GDP is expected to increase in all EU member countries during 2021 and 2022, which Economy Commissioner Paolo Gentiloni described last week as "the famous light at the end of the famous tunnel". The fastest growth is expected in some of the countries that were most severely affected in 2020, such as France and Spain.

Chinese-US relations – so far so good

Together with American tech stocks, Chinese stocks are among the categories that have started off 2021 most strongly. The CSI 300 index of leading companies traded in Shenzhen and Shanghai has gained about 11.4% in local currency so far this year.

Economic activity in China has now almost normalised after the pandemic, and the country remains an engine of the world economy. China experienced both a smaller correction in growth and a faster recovery. Its economic strength also allows plenty of room for further stimulus measures by both the government and the central bank if necessary. This puts the country in a good position for 2021 as well.

We thus foresee good long-term potential for the Chinese stock market, although we wrote in January that there were possible near-term uncertainties about China’s relations with the US following the election to fill the last Senate seats. As we know, US trade conflicts with China culminated under Joe Biden's predecessor Donald Trump. These and other Chinese-US tensions may well continue under Biden, but they are not expected to be equally impassioned. It was thus encouraging that the outcome of the first lengthy telephone conversation between President Biden and his Chinese counterpart Xi Jinping was “so far so good”.

Our market view

Recovery will support stock markets

Last year's sharp stock market recovery is reason for caution, but if economic growth forecasts prove correct while interest rates, bond yields and inflation are under control, there is continued upside potential for equities.

In an economic recovery, cyclical value companies should be able to regain lost ground, but looking further ahead the digitisation trend will continue to benefit growth companies. Sizeable worldwide investments in sustainability suggest that last year's strong performance for companies with this type of strategy may continue.

Market analysts’ highly optimistic global earnings forecasts seem reasonable, provided our growth expectations are met and the spread of the coronavirus is limited as expected. Continued vigorous central bank support and new fiscal stimulus measures are also included in this scenario.

Share valuations today are undoubtedly high from a historical perspective but can be justified by lower interest rates and bond yields. These high valuations limit potential in the long term, but they are rarely a good signal to sell in a short-term per¬spective.

Continued potential, though a lot has been priced in

Investor surveys indicate that many fund managers already have a relatively high level of risk-taking in their portfolios, including a higher percent¬age of equities than the historical average. Combined with val¬uations that already factor in a bright picture, this reduces upside potential. But stock markets rarely perform poorly during periods of good growth. Given ultra-low interest rates and yields, it is hard to find good alternatives to stock market returns. Meanwhile, central banks and governments have established a floor by promising continued stimulus.

This suggests that the growth picture will have to become much worse, and/or valuations will have to be really high, for major down¬turns to materialise. However, profit-taking − with downturns of 10 or perhaps 15 per cent − will still be a natural element of this picture. We nonetheless expect positive, single-digit stock market gains this year.