Following the OECD in March, the IMF is now preaching optimism on the outlook for growth. Against a backdrop of a less severe contraction overall than had been feared in 2020, world GDP is expected to increase by 6% this year, up from a 5.5% forecast that the IMF issued in January. The main drivers are China (an estimated growth rate of 8.4%) and the USA (6.4%). Projections for eurozone growth are stuck at just 4.4%, even though the initial contraction in activity was far worse than in the rest of the world. One would normally have expected a spectacular European recovery that mirrored the preceding slump, but unfortunately this spring-back mechanism appears to be broken. The latest macroeconomic data point the same way. So while we can understand nervousness over higher inflation in Asia and the USA, exaggerated though it may be (see our letter of last month), fears of a general increase in the price level across continental Europe look particularly misplaced.
Given this difficult situation for private economic agents in Europe, support from the public sector looks even more important than it does elsewhere. But here too, European authorities are struggling to match the pace set in other parts of the world. The European Union’s ‘Next Generation EU’ plan was certainly a step forward in terms of the European project – it gives the European Commission new powers to borrow in its own name from the capital markets – but it may turn out to be more of a political than an economic success. The closer we examine the €750 billion European recovery package, the more it looks like a pale shadow of Joe Biden’s ‘Build Back Better’ initiative. After all, it amounts to less than 6% of the EU-27’s GDP. At a time when temperatures are rising between eurozone countries, the ECB has no option but to intervene massively to prevent the whole bloc imploding.
That said, equity indices are still trending positively on the back of the improving outlook for growth, stimulus packages and robust microeconomic news. The MSCI World is up 11.3% so far this year, compared with a 3.9% gain to the beginning of February, thanks largely to performance on American and European markets. Emerging and Asian indices started off the year very strongly but have since consolidated slightly (MSCI Emerging Markets up 6.8% year to date after 8.9% at end-January, MSCI Japan up 6.7% after 8% at end-January).
A new US corporate results season has just started, and the first announcements from S&P 500 companies are (to say the least) very encouraging. At the time of writing, around 25% of these firms (123, to be precise) have published, and 84% have posted higher earnings per share than analysts expected. Moreover, aggregate earnings for the S&P 500 as a whole are expected to be up 33.8% in Q1, up from a consensus estimate of 23.8% at end-March. This would be the biggest increase in earnings since Q3 2010… In terms of sector, and despite sharp upward revisions to estimates over the past month, we are not seeing any new pattern in performance relative to a month ago. In other words, Q1 is likely to have seen a rebound from those that suffered the most in the final three quarters of 2020: financials, discretionary consumer goods (cars, etc.) and basic materials.
Our valuation model suggests that Wall Street is in need of consolidation. Were interest rates to stabilise where they are now, the required correction would be around 12%. In our scenario that integrates the fact that higher taxes will affect US company profits from 2023 onwards, our model suggests a potential 16% correction with unchanged interest rates, or just 10% if long rates tick down to 2% (our main scenario). As we did last month, we recommend caution on US equities and would therefore overweight European markets relative to Wall Street.
