Equities in a ‘sweet spot’, but keep an eye on valuations

Global equities are to remain in a ‘sweet spot’ for the next six to twelve months at least as masses of central bank liquidity and a lack of a compelling investment case for other asset classes are likely to underpin stocks.

But investors will need to keep an eye on overly-optimistic valuations as many markets have staged dramatic recoveries from March lows - particularly the major United States (US) indices like the S&P 500 which is now close to its previous highs - and the NASDAQ 100 which has made a series of new all- time highs in the past week alone.

The market is pricing in a ‘V-shaped’, almost straight-line recovery which means it expects things to return to normal very soon. Data from Johns Hopkins University however shows that global cases of Coronavirus (COVID-19) are still on the rise while analysis from US wealth manager Glenmede shows that US economic activity has so far only recovered 19% of what was lost in lockdown.

There also seems to be much optimism about the speed of the development a safe and effective vaccine which is the only thing that will guarantee a return to normal. Markets have essentially already priced in this development as a given, but typically, vaccines take years to develop before they can be certified as safe, effective and reliable, and so on a valuation basis, the market is getting ahead of itself.

So while there are reasons for caution there are also good reasons to have selective equity exposure to those regions that have responded quickly and rationally to the pandemic and are now emerging from lockdowns and restrictions on economic activity.

We therefore favour exposure to some market sectors in the US, Europe and developed Asia for now and think it prudent to avoid Latin America, Africa and parts of South Asia such as India for the time being as economic and health risks are still rising in these areas.

We think investors should favour resilient growth stocks like Microsoft, Visa, Alphabet and Johnson and Johnson. We would avoid so called ‘value’ stocks even though the underperformance of value stocks is lagging that of growth by the most in twenty years.
Value stocks were poorly rated before the ‘Coronacrash’ and likely to remain so: if they couldn’t perform in a favourable economic backdrop, they are unlikely to do so now in a much tougher economic backdrop.

So while the environment is favourable for equities, due to market liquidity, we don’t think it’s time for aggressive or overweight positions, as valuations are too optimistic about the speed of recovery. Earnings will need to show signs of recovering first to justify even more substantial gains in overall stock prices.