While the media are focused on an apparently endless cycle of Covid news, Wall Street has been setting one imagination-defying record after another.
The Nasdaq, IT and biotech have soared to new highs: the index has outstripped the S&P 500 by 62% over the past 15 years, with an acceleration in that trend since the pandemic broke out. Annual average performance over the past 30 years has been 12%, highlighting the extent to which society is being transformed. IT has penetrated deeply into every sector of the economy; its weight in the S&P 500 has risen from 13.6% at the beginning of 1997 to 28.2%, and of course it has been critical to the creation of giants in other sectors, such as Amazon and Tesla in cyclical goods and Google, Facebook and Netflix in communications. A great many other firms are based on digital technology. Back in 1997, the biggest company in terms of capitalisation was General Electric; it now a relative pygmy among industrial stocks, neglected by firms opting to subcontract blue-collar jobs abroad. Even Boeing has demonstrated an inability to make things properly. The next battleground will be automotives, where Tesla is attempting to become the sector’s iPhone and could well succeed. Volkswagen’s boss says that the future is in software and direct sales… Tesla is capitalised at over 5 billion and has stolen a somewhat provocative march on its German competitors by setting up shop in Berlin and offering to share its technology. Our economies are changing dramatically, and the pandemic has hastened it all through e-commerce, home working, transport and healthcare, for example. American monopolies have been the big winners, leaving Europe to import almost all its high-tech requirements and live off low-margin automotive and industrial products.
Growth opportunities are particularly attractive when interest rates are zero or negative, which is why GAFAM, hi-tech stocks and firms like Tesla are doing so well in stock market terms. Share prices for some niche healthcare companies have risen exponentially. In contrast, the pandemic has badly damaged the financial sector, energy and most cyclicals. The structural make-up of the US economy has made it more resilient than most: the drop in US profits is likely to be limited to 19% this year, compared with drops of 36% in Europe and even 40% for eurozone firms (and that latter figure is being revised lower). The MSCI World index has risen overall this year, but European markets are lagging. Our Digital funds are up, however.
US Q2 earnings held up incredibly well, posting a genuine surprise at 20% over expectations. The overall drop in earnings for the year has been revised from 24% to 20%. The decline in profits is concentrated in low PER sectors such as energy, finance and air transport. Some IT, healthcare and consumer staples companies are reporting higher profits. The consensus expectation is for a 28% rebound in 2021, but we are pencilling in 21%. And even with a PER of 20.8x 2021, the market’s earnings yield is 4.8%, compared with a 30-year yield of 1.38%… But these projections could collapse if the pandemic persists or if investors react badly to a Biden victory in the presidential election.
World GDP is expected to contract 4.4% in 2020. That number is revised from 3.85% in June, confirming that the post-lockdown rebound is not as vigorous as it had been assumed. The world economy is then expected to grow by 5.4% next year, albeit subject to a great deal of uncertainty related to the pandemic. Europe has been among the most badly damaged regions and we can only hope that the stimulus package agreed by EU member states will do its intended job. Some US macroeconomic indicators are looking better, notably a massive return to work and good PMIs. But America’s trade deficit has worsened, and together with massive Fed injections this has undermined the value of the dollar. We are planning to reduce our exposure to the greenback and are maintaining our buy recommendation on gold that we issued at the end of June.
Our S&P 500 valuation is up to 3,452 points on the back of better corporate results and we are sticking with our overweight recommendation. In Europe, our valuation suggests a market priced at fair value.
