Equity markets, mainly in the US, are discounting solid EPS expansion in 2021 despite the unknown path of the pandemic and elevated macro volatility
US equity markets have traded sideways since early September, with the S&P500 in a wide range of 3100-3600. Year-to-date gains amount to circa 6% despite the fact that the 2020 recession is expected at -4% (see below), covid-19 infection rates are on the rise and political-induced volatility is ample. On the other hand, euro area equities have been stuck since early June with year-to-date losses of -10% (-5% in USD terms) as, inter alia, European bank equities remain under selling pressures due to increasing uncertainty vis-à-vis underlying asset quality trends (Covid-19 impact). The recent decline of EUR interest rates has contributed to the dual overperformance (SX7E vs SXXE and SXXE vs SPX). A renewed wave in Covid-19 cases and local lockdowns sent German Government bond yields significantly lower.
Having said that, global economic prospects remain conditional on pandemic developments. Indeed, the International Monetary Fund (IMF) revised up (as expected) its forecasts for global GDP compared with its respective projections in June, in view of better than previously expected economic outturns in Q2 and in recent months, mainly in the US. Specifically, the IMF now estimates global real GDP growth of -4.4% yoy in 2020 (still an unprecedented contraction), versus -5.2% yoy in June. The projection for the US was upward revised by +3.7% to -4.3% yoy, by 1.9% to -8.3% yoy in the euro area and by 0.9% to +1.9% yoy in China. For 2021, the IMF projects global real GDP growth of +5.2% yoy (US: +3.1% | euro area: +5.2% | China: +8.2%), little changed compared with June. Following the contraction in 2020 and recovery in 2021, the level of global real GDP in 2021 is projected at levels 0.6% above that of 2019 (c. -2% for Advanced Economies).
The baseline scenario incorporates the assumption that social distancing will continue largely unabated into 2021 and subsequently fade gradually, in conjunction with favorable medical developments against Covid-19 (e.g. a vaccine alongside expanding population coverage, improving therapies). Low levels of transmission are presumed to be achieved everywhere by the end of 2022. Furthermore, major central banks are assumed to maintain their current (ultra-accommodative) policy settings throughout the forecast horizon (up to the end of 2025).
On the negative side of the ledger, a rapid acceleration of infection rates, a slower than anticipated progress on treatments and vaccines alongside countries’ access to them being insufficient or/and unequal, could lead to sizably worse economic outcomes, in view of renewed, stricter, social distancing or even more generalized lockdowns. On the other hand, a more rapid progress with vaccines and treatments, as well as adjustments in workplaces and by consumers that could achieve a more benign trade-off between reducing coronavirus transmission and safeguarding activity, would result in a more rapid recovery.
Another major upside risk (especially for 2021), is additional fiscal policy support, given that IMF’s baseline scenario, factors in measures already implemented and announced. In the event, the IMF estimates that insofar discretionary revenue and spending measures in advanced economies, amount to more than 9% of GDP, with another 11% in various forms of liquidity support mainly via “forgivable” loans and state loan guarantees. On the flipside, the ratio of public debt to GDP in advanced economies is projected to rise by 20 pps (versus 2019) to 125.6% by the end of 2021.