US equities power to new records as positive vaccine news (Pfizer, Moderna) more-than-offset concerns regarding the short-term economic outlook
US Equities continued to rise, with the S&P 500 Index (SPX) at 3627. The reflation trade, that has supported risk assets since US elections, strengthened in the last trading sessions, with positive vaccine news (Pfizer, Moderna) dominating surging Covid-19 infection rates in developed economies. US benchmark equity indices have climbed to or are near all-time highs with MSCI EM Asia following suit, whereas year-to-date laggards (Eurostoxx, FTSE100) have recorded double-digit gains during November.
In a similar vein, year-to-date sectoral stragglers led the recent leg of the equity rally (see table below). Indeed, Energy (due to higher oil prices), Financials (due to lessening concerns regarding asset quality) and Industrials (e.g. Transportation due to expectations for a significant portion of recreation and business travel returning to previous norms) have increased by 10% to 25% since US elections and Pfizer’s vaccine announcement. Still, these sectors, alongside consumer services (travel, leisure and gaming) probably offer the most leverage to vaccine (and mass vaccination) developments given current consensus’ expectations for corporate profitability.
While bottom-up analyst 2021 EPS estimates for S&P500 of $167 is circa 4% above 2019 EPS level, 2021 earnings’ expectations for Energy (-59%), Banks (-25%), Transportation (-36%) and Consumer Services (-68%) remain significantly below 2019 EPS levels. The above-mentioned gap from pre-crisis earnings levels suggests that these sectors (prices) should beneﬁt from an anticipated growth acceleration in 2021 conditioned on positive vaccine developments. The improvement of the earnings subcomponent could drive prices higher even if the valuation subcomponent (P/E) remains stable or compresses.
Note that Transportation (18.2x), Materials (18.9x) and Consumer Services (32.3x) stocks trade on average at the 100% percentile of the historical distribution of 24-month forward P/E ratios reflecting subdued earnings prospects (the denominator) and a relatively immune numerator (price based on year-to-date performance – see table below).
On the other hand, valuations of Energy (17.6x) and Banks (10.3x) trade on average at the 79% and 69% percentile, relatively, of the historical P/E distribution as both investors’ (-41% and -25% ytd losses, respectively) and bottom-up analysts’ (2021/2019 EPS gap of 59% and 25%, respectively) have penalized these sectors.
All told, global markets appear to discount a return to normalcy in 2021 based on equity price performance in the fortnight. On top of that, central banks are expected to continue with ultra-loose monetary policy despite promising clinical trial tests as short-term risks to the economic outlook remain significant given the sharp upswing in cases (Europe, US) and the prospect of more stringent containment measures. Having said that, as economic activity in Q4/early Q1 is expected to contract, particularly in the euro area and considerable uncertainty remains vis-à-vis (i) the final impact of a vaccine on economic activity and (ii) US fiscal policy, some caution ahead is warranted for risk assets.