The XXL Biden effect
MONTHLY INVESTMENT BRIEF
“We are raising our performance targets on global equities based on higher earnings-per-share forecasts…”
A 1,900 billion dollar stimulus plan
We recently discussed the potential impact of the new reflationary environment on the valuation of risky assets and reiterate our message of caution in the short term. That being said, and as the equity markets’ forward march has recently been derailed by rising bond yields, a new boost to indices is likely to come in 2021 from earnings growth, which is far greater than expected. We are raising our performance targets on global equities based on higher earnings-per-share forecasts, i.e., +5% vs. our initial forecasts for 2021, hence a revised forecast increase of 32%. Our optimism is driven by the size of the “Biden stimulus”, which has passed both houses of Congress. We had been expecting no more than 1,400 billion dollars. The final figure is 500 billion dollars higher. The various stimulus packages now total an amount equivalent to 25% of US GDP. At 1,900 billion dollars, this stimulus plan is unprecedented in size, but also in its component measures, as it is composed mainly of direct payments to households and small business loans (SMEs) “guaranteed” by the Fed. We are therefore likely to see an unprecedented pick-up in consumer spending if the stimulus measures are accompanied by a vaccination-driven increase in household confidence. In addition to the “Biden stimulus”, remember that forced household savings (equivalent to about 10% of GDP) are also likely to contribute to a strong acceleration in growth to beyond its potential in 2021.
Upgraded earnings growth forecasts
The amounts at stake are colossal and justify an upgrade in our EPS forecasts, particularly those for the fourth quarter, which are likely to be even more robust than expected. Even so, this upward revision of earnings sequences represents only a 10% compound annual growth rate between 2019 and 2022e. Yes, this period includes the pandemic, but, on average and globally, companies have demonstrated a remarkable capacity for adjustment and resilience. For example, MSCI World companies’ EBITDA margin has slipped from an average of 17.5% in the past five years to 15.7% in 2020 but is likely to turn back up in 2021.
Equity valuations are still reasonable
The S&P 500’s aggregate P/E was 18.5 times forward earnings in December 2019, when the 10-year yield was about 2% and real yields 15 basis points away. We expect US-10-year yields to settle in at about 1.80% in 2022 and point out that, although 10-year real US yields have risen recently, from -1.10% to -0.80%, they are still far into negative territory. Pricing in this higher EPS forecast into forward valuations, P/E falls from 22x to 19.5x, which is still reasonable against the backdrop of financial repression on interest rates. Pay close attention, however, to sector, style and geographical dispersion, something we have commented on extensively. Regardless, the assessment is definitely positive for the year as a whole. A reversal in the trend would require a much steeper run-up in interest rates or a miscommunication by the Fed. And that is not part of our current scenario.
Caution nonetheless on risky assets in the short term
Our baseline strategy is to forego adding to positions at these levels and to take advantage of a likely consolidation to add to global equity exposure. The US has once again surprised in its responsiveness and flexibility, while the Eurozone is bogged down in supply and distribution bottlenecks, something that risks dampening the macroeconomic recovery. The differential in future growth of the two regions is a new factor to take into account. In the event of a marked gap in the coming months we will raise our weighting of US equities and reduce that of Europe, even though the cyclical bias is not as strong in the US.