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MARKET VIEWS

March, 11th 2021

Jan Viebig
Global CIO Private Wealth Management

Laurent Denize

Global CIO Asset Managment

A pertinent question for stocks from a valuation standpoint is whether profit growth expectations can continue to increase enough to offset the rise in the discount factor linked to the rise in long-term interest rates - 10-year US treasuries are now trading at 1,60%. US equities are already pricing in a lot of earning growth: analysts’ expectations for the S&P 500 ’s EPS* growth are 24% for 2021 and another 15% for 2022. Worth noting is that long term EPS growth expectations have skyrocketed for both US and Emerging Markets (EM) equities. In short, the main problem with US equities is that their valuations are expensive at a time when inflation and interest rates are set to rise. 

What should investors do?

The equity rally is entering a risky period and we recommend a slightly more cautious stance. Financial markets may resume selling off if evidence from the real economy corroborates the thesis of higher inflation. And make no mistake, next inflation figures are going to be much higher than the previous ones due to base effects and a transitory distortion between offer and demand. We are not becoming bearish; we are adjusting our positioning in line with the new developments of the market. Bond yields have risen briskly over the past six months. However, they remain very low in absolute terms. While rising yields can produce a temporary stock market correction, they need to move into restrictive territory in order to trigger a recession and an accompanying bear market in equities. We are not there yet.

Concretely, higher US bond yields entail that global growth stocks will underperform global value stocks. The former is much more expensive and, hence, is more vulnerable to a rising discount rate.
Also, global equity portfolios should underweight the US, adopt a neutral stance on EM and overweight Europe and Japan. Even for Europe, we favor mostly small cap equities on an EPS growth perspective. The market cap weight of growth stocks is the highest in the US followed by EM. In that sense, European and Japanese bourses are less vulnerable to rising bond yields. Finally, investors do not own enough energy, material, industrial and financial stocks. Conversely, they still own a lot of technological companies. The concentration of the five biggest tech caps in the S&P remains on extreme levels, even if falling a bit from their peak. Long duration stocks are at risk and their weight in the US indices is increasing the probability of a market stalling or even correcting somehow. In the technology sector, stocks with a reasonable valuation or more cyclical profile, look less at risk than higher growth names.

In a nutshell:

We move from an overweight in equities to a neutral and buy the dip stance, with a significant rotation in the portfolios. We are still confident that
once the market has repriced the increase of rates in the risk premium, the macro economic rebound will drive EPS sharply higher, hence valuations. A cautious stance is granted on government bonds everywhere. Favor High Yield bonds that are more immune to a raising long-term rates environment and break evens that have further to go. On a longer perspective we still favor quality stocks with high free cash flow generation with limited leverage. We do not forget we still live in a world where the potential growth remains subdued.

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This document has been prepared by ODDO BHF for information purposes only. It does not create any obligations on the part of ODDO BHF. The opinions expressed in this document correspond to the market expectations of ODDO BHF at the time of publication. They may change according to market conditions and ODDO BHF cannot be held contractually responsible for them. Before investing in any asset class, it is strongly recommended that potential investors make detailed enquiries about the risks to which these asset classes are exposed, in particular the risk of capital loss.