Equity markets: Why are they wobbling?
This week we thought we’d speak to our strategic investment partners about the recent turmoil in equity prices. In essence, there are four main factors at play influencing sentiment.
- Corporate earnings
- Inflation
- Monetary policy
- New Covid strains… Omicron!
The first three factors I’ve spoken about at length but the impact of new Covid strains are difficult to predict but at least we have degrees of protection unlike when Covid-19 first came to our notice in 2020. There will be much ebbing and flowing in sentiment depending upon news flow and equity prices will follow suit. This has been evident throughout this week.
Legal & General Investment Management (LGIM)
Their first comment was weakness in market sentiment provides a great opportunity to invest and possibly to increase risk across portfolios. They are watching data about transmissions, mortality and vaccines but a replay of 2020 looks unlikely.
With so much cash about across businesses, companies are keen to put it to work, especially with interest rates so low and therefore merger and acquisition activity seems set to continue. This in turn is boosting share prices.
Corporate earnings were discussed. Coming out of a solid third quarter earnings season this year, their economics team view is consistent with US earnings growth being in the high single digits in 2022. A slowdown to what was predicted, but solidly positive.
The biggest threat to next year’s earnings, COVID-19 aside, are US corporate taxes. Assuming about half of the initial proposals from the Biden administration become law this would take circa 5% off earnings growth estimates. The latest proposals, however, have come in a bit weaker than previously estimated. It’s possible the statutory tax rate could stay unchanged with the focus mainly on foreign income, a minimum tax rate and a buyback tax. The ‘hit’ to US profits could end up being significantly smaller than 5%.
Another factor to consider is the possibility of slowing growth in China. However, the impact on US profits should be manageable. LGIM estimate that if 1% comes off Chinese GDP growth it will result in less than 1% coming off S&P 500 profits. Given the other uncertainties around earnings growth, this should not be a dominant driver of the US earnings debate next year.
Seven Investment Management (7IM)
Ben Kumar, their Senior Investment Strategist’s views are as follows:
Ben commented that investors are finding it hard to shake off the economic and financial habits established during the Global Financial Crisis – a world of low growth, low inflation, and low confidence.
Yet, Ben is confident that the next decade will be different from the last, commenting:
“Individuals have left a recession with more money than they started, while governments are ready to spend, and business confidence is surging. More confidence means more spending, which creates more jobs and more demand: a virtuous circle leading to a genuine wave of growth.”
In order to take advantage of this expectation, Ben says 7IM are positioning for a strong rebound in economic growth over the next few years.
“We are tilted away from the winners of the last cycle, such as mega-cap tech, and towards the winners of the next one. This includes looking at undervalued sectors and regions, such as industrials, mid-caps and emerging markets.
“There is also a greater focus on cyclical, smaller businesses, spread out across the world, rather than just in the US, as well as longer-term thematic investments into healthcare companies and businesses looking to tackle climate change, rather than the mega-cap tech media platforms.”
In the fixed income space, Ben says government bonds will still protect portfolios in periods of turmoil, but real returns here are likely to be low. As interest rates begin to grind upwards, an allocation to higher-yielding parts of the universe therefore offers more protection in the form of higher coupon payments, he suggests.
Thoughts from LGT Vestra
I really liked their communication this week which provides further perspective on why equity markets are rising in times of such turmoil. Their communication was aptly titled “The wall of money”.
There is currently an unfathomable amount of money flowing around the world. US household net worth is up $23 trillion year on year, representing more than 20% annual growth; a growth rate of this size has not been seen in 70 years. A large portion of this increased wealth is being funnelled into equity markets, pushing them higher, and with bank interest and bond yields so low, the old phrase ‘there is no alternative’, is in full flow. No wonder equity markets keep rising as there are no alternatives to equities which offer comparable levels of return. That equity funds have taken in more cash this year than in the previous two decades combined is proof of this sentiment. ‘Meme stocks’ like GameStop and various cryptocurrencies have also been beneficiaries of this huge increase in savings and net worth.
Inflows to equities exceeds combined inflow of past 19 years
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