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Equities: looking for upside

04 October 2019

4 minute read

By Julien Lafargue, CFA, London UK, Head of Equity Strategy

Further upside in equity markets will likely be more muted, but opportunities to generate alpha remain intact.

Optimism on the rise

The two catalysts we highlighted in last month’s Market Perspectives, namely central bank action and trade détente, materialised in September. As a result, investors’ sentiment shifted again from “doom and gloom” to optimism and propelled equity markets back to record levels.

Yet, not much has changed fundamentally. Trade tensions have abated, though the US-China talks scheduled for this month are unlikely to deliver a comprehensive deal. Similarly, uncertainty around Brexit remains elevated and central banks may not have much more room to ease. Even if October brings more clarity on these issues, we continue to believe that the market may struggle to break from its current trading range.

Strong rally hard to justify

Equity markets rise because earnings move higher and/or investors are willing to pay more for future earnings (i.e. the valuation multiple expands). As we enter the final quarter of 2019 and look to 2020, we see limited upside to both sides of this equation.

Limited earnings upside

On the earnings front, expectations appear elevated already. The bottom-up consensus is for worldwide earnings to grow by 10% in 2020. That said, earnings will probably grow less than 2% in 2019. In a world where gross domestic product is expected to remain stable at around 3%, we see limited room for earnings upgrades, without any significant fiscal stimulus.

Valuations are fair

On valuations, global equities are trading in line with their 20-year historical average, which seems fair. However, this headline number masks some disparities.

Global equities are trading in line with their 20-year historical average, which seems fair.

US equities are trading at 17 times their projected earnings over the next 12 months. This is 7% above the historical average. While some optimists may argue that we are still far away from the 18.5 times reached in January 2018, we believe this reference is not justified. January’s figure was artificially inflated as the equity market rallied in anticipation of corporate tax cuts not reflected in analysts’ numbers. Adjusting for this, the S&P 500’s peak multiple never surpassed 17.5.

Opportunities remain

With limited upside to earnings and valuations approaching recent peaks, the outlook for equity markets may feel uninspiring. And yet, there is plenty to cheer about in our opinion.

First, downside risks should be contained. Indeed, investor positioning, accommodative monetary policy and hopes of fiscal stimulus should support equity markets. Second, although 2020 is unlikely to be another “20% return” year, continued earnings growth coupled with healthy dividend yields point to positive returns, assuming valuations can hold. Finally, beyond broad equity indices, opportunities continue to emerge at the sector and stock level, offering a supportive backdrop for active managers.

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Market Perspectives October 2019

Barclays Private Bank investment experts highlight our key investment themes. They show how security selection and a bias to quality companies can provide the yield and outperformance needed at a time when it may be tougher to produce positive returns.

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