Momentum may have been weak over the past few months, but stock markets have been showing high returns this year so far. They have been bolstered by supportive monetary and fiscal policies around the world, but high valuations are worrying investors.
It’s easy to see why: From a historical perspective and by most metrics, stocks look expensive. Interest rates are low, and so are the yield premiums for many fixed income asset classes. The difference between dividend yield and government bond interest rates is an indicator of how investors are compensated for taking stock risk, and this measure is at an all-time low.
While the ratings generally appear to be high, the actual picture is more accurate as the ratings are very high in certain areas and in certain sectors. In particular, it is currently relatively expensive, especially when compared to the UK and Europe. This assessment difference is largely explained by the sectoral composition of the dominant markets and industries. In the US, the highly rated technology sector is more prominent, while in Europe, lower rated sectors (mainly finance, energy, materials and utilities) have a higher weight.
Supportive earnings growth
The tech sector’s high valuation (NYSE:) is not unreasonable; It is underpinned by the sector’s strong growth at a time when low interest rates make growth particularly valuable. Corporate earnings in the technology sector grew almost twice as fast as the broader index. There is every reason to believe that this growth can continue: the pandemic has accelerated the trend towards increased use and adoption of technology. This helps justify the higher rating of the sector.
In general, the higher valuations of the stocks are supported by the expected earnings growth. 2020 saw a sharp decline in reported earnings due to the impact of Covid-19 on the global economy. As 2021 progresses, it becomes clear that economies around the world are recovering rapidly and that corporate profits will follow suit. For 2021 we expect earnings growth of around 30% compared to 2019.
There are certainly a number of risks to stocks. For example, increasing corporate taxes will reverse the recent trend of countries competing with each other to offer lower corporate tax rates to encourage job creation within the company and within the supply chain. Governments can no longer afford this generosity. The world’s 20 largest economies have signed on to a global reform plan that will provide a minimum tax rate for multinational companies and limit the ability of multinational companies to shift their profits to tax-friendly countries. This may hamper corporate profits, particularly in areas targeted by the policy such as: Bachelor of Technology.
What does this mean in practice?
For developed markets, we expect a return of approximately 6% annually in US dollars in the coming years. The dividend yield will likely be lower than in recent years due to higher valuations. We expect a dividend yield of around 1.6%. Dividend growth is a major component of long-term stock return. We expect corporate earnings to continue to rise in the coming years, so earnings growth is likely to outpace inflation. That should mean real earnings growth of around 3%.
With earnings rebounding, we expect a slight dip in equity multiples. At the same time, stock valuations should be above historical averages because lower returns on fixed income investments will keep valuations high.
In developed markets, we are more positive for the US than for Europe, despite the higher ratings. We prefer to rely on structural changes such as digitization and automation. Technology companies are also likely to grow faster than traditional sectors in the long run. Small companies (NYSE:) can also prove to be fertile areas as they enjoy higher earnings per share growth compared to large stocks. There are real opportunities even if the overall ratings seem high.
About Aegon (AS 🙂 Asset Management
Aegon Asset Management is made up of active global investors. Our 380 investment professionals manage and serve €391.1 billion / US$463.8 billion / £336.1 billion in assets as of June 30, 2021 for a global client base consisting of pension plans, public funds, insurance companies, banks, asset managers, family offices and foundations.
We organize our investment capabilities around four targeted investment platforms in which we have extensive experience in individual asset classes: fixed income, real assets, equities, multi-assets and solutions. Each platform includes dedicated teams that are organized globally and committed to maximizing their areas of expertise. These platforms are backed by teams dedicated to responsible investment and multiple management.
By organizing our investment teams globally, we work to make our research expertise and resources available across regional borders. We believe this increases our performance potential and contributes to better investment outcomes for our clients.
Across all platforms, we share a belief in fundamental, research-based and effective management underpinned by effective risk management and a commitment to responsible investing. Our investment platforms have the flexibility to organize their resources and operations in the way that best suits their respective focus.
We are a global company: our 1200 employees work across Europe, America and Asia. We invest globally and take care of our customers locally.
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