Outlook: it all goes on

Trends’ inertia


The covid vaccine is a fantastic breakthrough, and it is extremely welcomed by the suffering tourism, sports and culture sectors. It will significantly ease the business environment and support the rebound of the companies, which posted lockdown-caused losses this year. But it does not mean that the havoc of 2020 will reverse at once. Vaccination will take some time until herd immunity is ensured. To add, human behavior is sticky and consumer habits would be hard to reverse, while the businesses found their way how to become efficient and control their costs. Online shopping, working from home and zoom-conferencing have already become a habit for many, forcing companies to adapt and nurture these habits by increasing their digitalization level. Therefore, it all combined make us believe that many trends, which started last year, will continue to be present as a part of the new normal.


Stock market party to continue


Sub-section on Central Banks’ support travels from one our review to another, and we could not skip it also this time, as this is the primary force that drives the market (surely, high-quality companies also contribute). The balance sheet expansion of all major banks reached historical values in 2020 (see chart) and most probably we will see more stimulus to the economies. The support provided by Central Banks in 2020 could not be compared to the one provided during the liquidity crunch of 2007/2008. Financial support and negative interest rates will continue to sustain the willingness of investors to invest in equities as they did also in 2020, sending stock market indices to all-time highs.


Fig.1 Central Banks’ balance sheets

Source: Alphinox, Refinitiv


The talks about the return of inflation are popping up here and there, but no real threat is evident yet. And, probably, it won’t be seen until the economies recover, which presumably will not be a quick process. Therefore, stock investing remains attractive in comparison to more conservative bond investing, where due to negative rates one often gets value deterioration.


How fair is market valuation?


Inflation fears can be left completely unnoticed in the background as fear of the market overvaluation is playing the main role because many still try to compare the breath-taking run of the technology sector (46% in 2020) to the one we saw during the dot-com bubble. This comparison appears to be weird as a common trait of the current ‘runners’ is strong fundamental backing evidenced by the envious growth rates, huge user bases, talented workforce, extremely successful cross-selling and large R&D spending - many of which were lacking features of the newly established internet companies in 2000. Here are some examples supporting the value of giant eco-systems: 32% of the world’s population daily use Facebook products or let’s say, Apple, having already 1.5bn users, is able to bring tens of millions of new users into its ecosystem each year.


Fig.2 Valuation and fundamental characteristics of US market heavy-weights

Source: Alphinox, Refinitiv


Fig. 2 shows the five largest companies in MSCI USA with an aggregate weight of 20.5%, which has grown from 16.1% during 2020. These companies can be considered as high growth and high-quality businesses with a large economic moat as judged by the operating margins. Obviously, their above-average valuation is justified by their fundamental quality. It can be further seen when taking PE to earnings growth that is below market average.


Besides, stock market valuation should be considered in the context of the current interest rate environment, when bonds are not able to generate a decent amount of value. Compare the situation in 2000, when treasury yields stayed competitive, but the valuation went through the roof.


Fig.3 Market valuation and Earnings vs. treasury yield delta

Source: Alphinox, Refinitiv


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