A lengthy bull market is always nerve-wracking. Investors start to fret on valuations, on earnings, on the strength of economic growth. As valuations creep higher, but economic growth remains strong, we look at the bull and bear case for equities today. First, we examine three reasons why investors could be cheerful about the prospects for stock markets:
In early November, the Bank of England defied market expectations by not raising rates. Governor Andrew Bailey said the Bank had held off on a 0.15% rise to see whether wage inflation would take hold. At the same time, the European Central Bank has made it clear that rates will not rise until 2024 1. The Federal Reserve may be tapering, but let’s not forget the level of buying – the Bank has been buying $120bn per month for much of the past year, adding more than $4 trillion to its balance sheet. Early tapering is likely to see bond buying reduced by $15bn a month. There is still plenty of monetary stimulus knocking round the system and interest rate rises keep being deferred.
There is also fiscal stimulus. Much of this remains unspent. The European Union has only just started issuing green bonds to raise the money for its NextGenerationEU programme, while President Biden’s $1.2 trillion infrastructure bill has only just passed through Congress. This will take time to filter through the system. This should continue to support economic growth and, by extension, stock markets.
The current round of corporate earnings has been robust. Unigestion reports that with around three-quarters (73%) of firms in the US and Europe having reported their results for the third quarter, 83% have beaten their earnings estimates and 67% have beaten their sales estimates. For the 62% of Stoxx 600 firms reporting, 59% are beating their earnings consensus estimates and 63% are beating on sales.
Certainly, earnings estimates are conservative as Covid has made it difficult to forecast, but even against that backdrop, the numbers look impressive. Sales are up 18.5% and earnings 39.4% for reporting firms in the S&P 500, while Stoxx 600 firms are seeing 14.3% sales growth and 44.3% earnings growth. Many companies appear to have emerged from the pandemic leaner and more efficient, their cost base trimmed and their technology improved.
This earnings growth may moderate as recovery momentum fades, but not enough to derail markets. The BlackRock Investment Institute says: “Companies may well continue to exceed earnings expectations, in our view. The earnings revisions ratio – the number of companies with upward revisions versus those with downward revisions – remains in positive territory and is now higher in Europe than in the US.”
Lack of alternatives
In the end, stock markets may do well simply because of a lack of viable alternatives. As inflation mounts, fixed income is starting to look like an increasingly dangerous and difficult option. It certainly offers little for income-seekers. Cash may not have the same interest rate risk, but is still a risky choice with inflation running at 4-5%. Alternatives, such as commodities or private equity undoubtedly have a role, but have other problems such as poor liquidity or high volatility.
Against this backdrop, the stock market looks like if not the best option, then the least worst option. It pays a growing income, offers some protection against inflation and volatility is manageable. It is difficult to see investors moving away from the stock market if they have nowhere else to go.
None of these represent a compelling bull case for equities, but history suggests that bull markets tend to go on longer than people think and investors can make good returns even in the late stages. It has almost always been better to be invested than not over the long-term. Investors exit too early at their peril.