Covid was Donald Trump’s downfall. It turned Wall Street and his financial backers against him, despite what he could offer in terms of the economy and business. Joe Biden has only been in office since 20 January, but some commentators have already described his presidency as a third Obama term. That may be premature, as Mr Biden could turn out to be far more welfare-minded than his former boss. He is already looking to raise the federal minimum wage to per hour and a hike in corporation tax from 21% to 28%, for example. A proposed ].9 trillion stimulus package will dominate the start of his term; it includes helicopter money in the form of ],400 direct payments to individuals.
The implications of such policies for public finance could have serious consequences for the markets. The Fed’s balance sheet is not expanding nearly fast enough to fund what the federal government is spending now, let alone plans to increase expenditure on infrastructure. This means that the Fed will either have to reconsider its self-imposed restrictions on intervening on Treasury bond markets or international savers will have to step up even more than they do already. If neither happens, the risk is that burgeoning government debt siphons liquidity from other financial and non-financial assets, potentially forcing a major correction to US equities. While this outcome is emphatically not our central scenario, investors would be wise to pay close attention to the way in which the US government finances its massive requirements in 2021.
For equities, 2020 turned out to be relatively straightforward in thematic terms. It was essentially a year for IT (up 42.8%) and discretionary consumption (up 34.1%), which of course includes internet shopping. As 2021 should be a rebound year, should investors switch out of last year’s winners and into sectors that fell behind? In our view, this year will be a lot less stark in sector terms and that stock-picking will be a better guide to performance. Investors will have to be quick to spot the companies able to adapt their original business models to a durable shift in the international environment. In geographical terms, the only major indices up on the year so far are Asian (MSCI China up 15% before retracing 6.7%), reflecting their lower sensitivity to the latest wave of the pandemic. We expect that the losses posted in Europe (down 1%) and the USA (down 0.9%) will gradually be recovered as vaccination programmes take effect and bring more visibility to subsequent economic recovery.
The US Q4 results reason has just started, and the first announcements from S&P 500 companies look very good. Despite upward revisions to earnings estimates, the steady rise in share prices since their lows in mid-March last year has left market multiples at high levels: its PER is between 22x and 23x future earnings, for example. That said, this figure should be put in perspective. Key US interest rates are at zero, Treasury yields are not far off (1.1% for the 10-year and 1.8% for the 30-year) and continuing massive liquidity injections by central banks are pushing the prices of risky assets up all on their own. Although Wall Street has flatlined since our edition of last month, a rise in the 30-year yield has reduced our S&P 500 objective to 3,603 points. That compares with a recent market high of 3,850 points before its retreat to 3,715 points at month-end. It would take a drop in the 30-year yield to lift the objective given by our model to above current prices (around 3,900 points with a 30-year at 1.5%). In Europe, by contrast, a combination of extremely low interest rates and the prospect of a sharper rebound in profits give us 17.5% upside potential for the main indices between now and year-end. We therefore recommend overweighting European equities relative to their US counterparts.
