Our current world is full of contradictions, not least in UK Government policy but that’s a story for another day. The investment contradiction is massive and obvious, we’re in the middle of a pandemic, economic growth has cratered, opening up economies is bringing the virus back but stock markets, bar in the UK, have made a near full recovery. How come? It’s pretty straight forward really, equity markets are underpinned by the belief that Central Bank and Government policy support remains firmly and indefinitely committed to generate economic activity and protect incomes and employment allowing the market to pretty much ignore the deep recession in the anticipation of a relatively robust recovery in growth and earnings next year. Equities are also benefitting from a lack of alternative; with no return from cash or government bonds and meagre pickings in corporate credit they remain the only asset class with the seductive promise of some capital return. At some point, the markets will need to see evidence of this but thus far, hope is enough and early indications are that the corporate world is proving very adept at adapting to the challenge with Q2 earnings easily beating the (albeit) severely reduced forecasts.
Only time will tell if this proves to be wishful thinking and the market direction in 2021 will increasingly be driven by earnings growth, not ongoing policy support which is a given, but can’t, in itself, push water uphill forever. Indeed, in the UK, Rishi’s new Job Support Scheme is far less generous than the furlough scheme and aimed at supporting successful businesses, not propping up failing ones. FactSet is the Bible of US consensus earnings forecast and currently projecting a fall of 18% in earnings this year but back to the races with a 26% rebound in 2021. Earnings forecast need to remain firm and companies need to meet or exceed these estimates for markets to remain in a bullish frame of mind, not least because equity market valuations are now expensive. On balance, the sentiment is already far less bullish as markets understand the trade-off between economic growth and public health as restrictions are lifted and the downward pressure this places on earnings across many sectors.