Global economy is expected to see an uneven recovery from the COVID-19 shock.
Overweight U.S., China and South Korea with higher technology-related exposure to support growth.
Underweight Europe and Thailand on less attractive risk-reward.
The resurging COVID-19 cases late last year have not derailed our constructive outlook on global recovery. While the virus outbreak and lockdown measures have constrained economic activities, a gradual reopening should lead to the eventual normalisation of the global economy. However, we expect an uneven recovery across the markets, driven by economies that could potentially benefit more from an expedient vaccine roll-out and faster recovery of domestic consumption.
Read MoreNotably, the U.S. has continued to witness sustained momentum in its recovery although the unabating COVID situation is posing some headwinds. In comparison, Europe’s recovery momentum is already slowing following renewed restrictions resulting from a resurgence in COVID-19 cases. Similarly, Japan’s path to recovery remains fraught with challenges with the subdued labour market and weak wage outlook likely to weigh on domestic consumption. Uncertainty in external demand does not help either.
Within the developed markets, we are overweight on the U.S. despite the market’s rich valuation. We believe the U.S. enjoys an earnings advantage over its peers, as its large technology exposure has benefitted from the acceleration of long-term secular trends. Meanwhile, we are neutral on Japanese equities given the balanced risk-reward but are underweight on European equities. While European equities could still deliver positive returns in 2021 as global growth recovers, they are likely to continue to lag global equities especially given the limited technology exposure and demanding valuations.
We believe technology-related sectors remain well-positioned to benefit from key secular trends that have accelerated due to the COVID-19 pandemic. There are investment opportunities in not only software and related services, but also In hardware including semiconductors, where demand for equipment is expected to recover as corporate spending returns.
U.S. economic growth is projected to rebound in 2021, largely supported by further recovery in domestic consumption. Despite the recent rise in COVID-19 infections, U.S. consumer confidence surveys have generally remained stable. In addition, U.S. households have accumulated sufficient savings cushion during the crisis, which could serve as a source of funding for future consumption. As a consumption-driven economy, we believe the U.S. will remain on a self-sufficient path, with potential support from additional fiscal measures. On top of that, we expect monetary policy to remain accommodative for longer, providing additional liquidity to the market.
With better economic prospects, consensus is expecting U.S. earnings growth to recover to 21.5% in 2021 versus -14.6% in 2020. In fact, the U.S. has seen one of the best earnings revisions among developed markets, where the number of upgrades outpaced downgrades by 1.5 times. Meanwhile, earnings revisions have been broad-based across all sectors. Thus, we remain optimistic that earnings revisions will continue to improve as the economic recovery gains traction.
Looking ahead, we maintain our constructive outlook on technology-related sectors despite their outperformance last year. These sectors will benefit from secular growth trends that will continue to fuel their solid earnings growth as well as margin expansion. In addition, investors can also gain some cyclical exposure through the semiconductor segment, which is expected to register sales growth of 8.4% in 2021 versus 5.1% in 2020. While there may be risks of increased regulatory oversight, the upside potential from these technology plays will likely outweigh the downside regulatory risks.
Against this backdrop, we are positive on U.S. equities given the superior earnings quality, underpinned by the S&P 500’s high exposure of around 40% to technology-related stocks. In addition, the accelerating economic growth in 2021 could drive a big increase in capital expenditure, following the sharp expenditure cuts in 2020. This is expected to create a strong feedback loop for economic and earnings growth, thus supporting our overweight stance on U.S. equities.
While the Eurozone economy is on the mend, the recovery will remain uneven and is not without downside risks. The resurging COVID-19 infections in late 2020 are a good reminder that the region is not entirely out of the woods. Still, the unprecedented fiscal and monetary stimuli should lend support to European equities.
The ECB has shown its commitment to engage in further monetary easing when necessary, including the extension of its PEPP should economic growth deteriorate unexpectedly. Meanwhile, the EUR 750 billion recovery fund, in both loans and grants, will be made available this year in tranches and lend support particularly to the weaker European economies in the South.
Given the gradual improvement in macro outlook, STOXX Europe 600 (SXXP) earnings are projected to rebound to pre-pandemic levels by end-2021 after the estimated 35% decline in 2020. While European stocks have witnessed some support with increased optimism on a broader economic recovery, the positives may have been priced-in with the market having rebounded more than 30% from the bottom in March 2020.
Notably, SXXP is trading at more than one standard deviation above historical average valuation based on consensus forward price-to-earnings ratio.
In addition, there is potential for near-term earnings disappointment in view of the re-imposed lockdown restrictions in selected European cities. A less optimistic management guidance could also lead to renewed downward earnings revision pressure, particularly for the more economically-sensitive cyclical sectors. Coupled with the stretched market valuation, the risk-reward for European equities appear unattractive at current juncture.
Longer-term, European equities could continue to lag the global markets given the much lower exposure to secular technology growth. The information technology (IT) sector accounts for less than 10% of SXXP’s index weighting, which is much lower when compared to IT’s representation in MSCI AC World. In fact, the market has rarely outperformed global peers since the global financial crisis in 2008. As we expect the focus on technology and digitalisation to sustain even after the COVID-19 pandemic woes, European stocks may remain marginalised against their global peers.
In view of the above, we have an underweight stance on European equities given our expectations of sustained underperformance. Having said that, there are still pockets of opportunities in the market. In particular, there are a number of European-listed businesses from the healthcare and consumer sectors that have global market leadership and are well-positioned to benefit from the faster recovering economies around the globe, including China.
In addition, the market remains a good hunting ground for dividend plays, especially with the negative-yielding environment in Europe. This could include selected telecommunications stocks that are trading at valuations well below historical average levels.
In contrast, we are less sanguine on the European banking sector even though many of the banks are still trading below their respective book values. The banks could continue to struggle in a low interest rate environment with the yield curve unlikely to steepen significantly given the macro headwinds in the region. While talks of the banks restarting dividend payout and/or share repurchases could lift the sector, the extent of rebound may be limited by the numerous headwinds faced by the banks that will suppress their return profile in the medium-term.
Similar to its developed market peers, Japan’s economy has staged a V-shaped recovery since the trough in late March last year. The nation’s real exports have expanded for four months in a row, while household spending is expected to pick up, thanks to Japan’s well-coordinated fiscal and monetary stimuli. However, employment concerns remain elevated, weighing on the pace of consumption recovery. Thus, Japan’s economic growth is expected to rebound to 2.7% in 2021, trailing behind the world’s projected growth at 4.9%.
Japan’s earnings revision momentum has improved, similar to its peers, with more companies delivering positive surprises in the most recent earnings season. Notably, Japanese equities’ earnings growth is expected to recover strongly to 42.5% in the fiscal year ending March 2022. Still, our expectations of a modest yen appreciation against the USD could be a headwind for Japanese corporate earnings. In particular, a strong yen could threaten to depress the earnings growth of export-driven Japanese companies.
MSCI Japan is trading at forward price-to-book of 1.3x, which is more than one standard deviation above its 10-year historical mean. However, investor positioning looks light, with cumulative flows into Japanese equities near 10-year lows. Meanwhile, the technical backdrop for Japanese equities could remain supportive as the Bank of Japan (BOJ) has doubled the pace of equity purchases to JPY 12 trillion a year.
In addition, we believe the momentum of governance reforms will likely carry on under the new Prime Minister Yoshihide Suga. These policies continue to encourage companies to adopt practices geared towards enhancing shareholder value and bringing corporate operations more in line with global standards, which remain key to boosting equity performances. Thus, we remain neutral on Japanese equities.
Source: Factset I November 2020
Source: Bloomberg I November 2020
Source: Refinitiv I/B/E/S data I November 2020
Source: Bloomberg I November 2020