Investment Environment April 2021

07.05.21

COVID-19 vaccination progress

The number of vaccines administered worldwide has accelerated since the end of February.  86 mil doses were administered at the end of January, 241 mil at the end of February, 574 mil at the end of March and nearly 1.2 bil at the end of April as shown in the graph.  Significant progress has been made but there remains a long way to go given the approx. 8 billion people in the world.

The progress in rolling out the vaccine has allowed governments to lift some restrictions and we have seen a considerable rebound in economic activity. Both of these data points continue to provide support for a “risk on” environment, although we are mindful that the vaccine success is very much in the developed world and the emerging markets need to catch up – most importantly India.

The IMF has produced GDP forecasts as shown in the graph for 2021 and 2022 that exceed the long term average since 1980 by a considerable margin. It is often argued that this is because of the base effect of negative GDP growth in 2020 caused by Covid, but that is not entirely true. The positive GDP growth must still be achieved as is shown by world trade volumes. China produced a 1Q2021 GDP growth rate of >18%.

The positive GDP growth has flowed through to commodity prices and this is also reflected in the share prices of miners which were relatively undervalued.

There has been a strong rebound in GDP in the US primarily led by consumer spending followed by Government spending.  This spending has been boosted by the various significant fiscal support and monetary stimulus injected into the economy over the past 12 months.

Fiscal stimulus, interest rates and risk free rate

Last month we spoke about the upwards movement in the US Treasury curve from 3 years out and the effect it is having on valuation of financial assets.  This has moderated and marginally decreased in April as shown in the graph. The fear of inflation, and the potential for interest rate rises is the biggest risk to financial markets. However, this is now a consensus view and well commented on by policy makers (eg Powell / the Fed) and should be “in the price”.

All indices were up in April as actual earnings surprised and the threat of a long time rise in inflation dissipates.  The S&P500 remains the best performing index over a 3 and 5 year period with technology and healthcare being the largest drivers of out-performance.  Emerging markets has been the best performing index over a 1 Yr period.

Earnings & Valuations

S&P500

The market eagerly awaited the Qtr1 earnings report from “Big Tech” which didn’t disappoint as shown in the graph.

Apple had a block buster quarter with product revenue growing across all of their product ranges.  This is quite unbelievable given the base from which these growth rates are measured.

Last month we commented on the probability of actual earnings outperforming analyst forecasts.  The table shows that growth in actual earnings has outperformed growth in forecasted earnings by 80% (i.e. 45.8% versus 23.8%), which shows the rebound in the economy and the bullish prospects for equities.  It should be noted that the actual growth rates per sector is broad based.

Full year 2021: Earnings growth is forecasted to increase by 31.7% (previously 25.7% ) meaning an upward revision as economies rebound and visibility on economic activity continues to improve.

From a valuation perspective, the S&P500 is trading at 22 times 1YF earnings which is above its 5 year average (17.9x) and 10 year average (16x).  Whilst this seems high today, earnings revisions and upgrades continue to surprise on the upside as the rebound in the global economy starts to take shape.  If the actual earnings are better than forecasted, this will go a long way to narrowing the valuation gap that currently exists.

With valuations stretched, particularly for growth stocks (eg tech) combined with the threat of rising interest rates, an argument is being made to switch to value stocks (eg mining and financials). While this argument has some validity, it makes little sense to give up on growth stocks who are experiencing the advent of the Fourth Industrial Revolution!

Conclusion

Internationally (particularly the US and China) economies look poised for a significant Covid bounce back which will be very supportive of equity prices. However, it is critical that central banks remain committed to allowing the stimulus packages to continue to flow and maintain low interest rates even though there is a threat of some inflation. Arguably some inflation is needed to support the economic growth!

South Africa, while showing the potential of a Covid bounce back, must also demonstrate the ability to curtail government debt (which is threatened by the SOE’s and government employee salaries) in order to have a more sustained GDP growth rate beyond the next 2 years.

For now equity investors can be cautiously optimistic.

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