06 Sep 2021

Have equity markets lost touch with reality?

Miles Nesbitt

Investment Director

Many investors were surprised by the quick recovery in equity markets following the sell-off in March last year.

In less than 12 months, many global indices were back to pre-Covid levels (the FTSE100 being one notable exception) and US equity markets have hit successive all-time highs.[1] Our clients sometimes ask the question: ‘Have equity markets lost touch with reality?’. The rapid development and roll-out of highly effective vaccines and new treatments is certainly a game-changer, however Covid will continue to present a significant challenge for some time yet.

To answer the question one has to acknowledge that valuations, in particular those of US equities, do look rich by traditional valuation metrics and one cannot ignore the sharp rise in speculative investing by amateur investors this year, from cryptocurrencies to meme stocks (e.g. Gamestop) and Special Purpose Acquisition Vehicles (SPACs). For some commentators this is proof that we’re in a bubble.

However, since the start of the year analysts have consistently revised upwards their expectations for global growth and importantly for equity investors, corporate profits are forecast to rise by 62% this year and a further 11% next year.[2] If that is the case equity markets can grow into their current valuations and go on to deliver decent single-digit returns over the next 18 months.

There are likely to be further Covid related setbacks along the way and inflation expectations and the timing and speed of interest hikes in the US will continue to sway market sentiment. We would view any weakness in the coming months as a buying opportunity.

I am also often asked: ‘Where do you currently see value?’ The easy answer is UK and Japan equities, which look attractive on a relative basis, however headline indices fail to capture the whole story. Even the US equity market offers pockets of value and our research capabilities enable us to gain exposure to these via direct US stocks and ‘best of breed’ active 3rd party fund managers.

That is not to say we avoid investing in the more optically expensive parts of the market. In fact, our investment process has a quality/growth bias which naturally leads us to companies that rarely look cheap, including the technology sector and we’re happy to pay up for quality and higher growth prospects. But even the best tech companies have the odd bad day in the market and we are ready and waiting to snap them up for our clients, at a more attractive price.

[1] S&P 500, Nasdaq and Dow Jones
[2]
Factset Workstation, 23 August 2021

To contact or read more about Miles Nesbitt, visit his biography here.

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