2021 will be a story of recovery irrespective of how the pandemic evolves in the US and Europe. Future waves of the virus may well necessitate mini-lockdowns, with the inevitable negative impact on growth and corporate profits, but as we saw already in the rebound in growth and profits in the third quarter of 2020, a bounce-back should come quickly. While the structural changes from the pandemic and the lockdowns have reduced the long-term earnings growth potential in certain sectors, the scope for growth in other sectors has improved (see Exhibit 5).
Valuations are elevated relative to historical averages, but this primarily reflects supportive central banks, low interest rates and low inflation. Central banks have set aside their reluctance to monetise government debt and their support now extends to buying corporate bonds (including high-yield). The one part of the market where to some investors, index valuations appear quite high is US technology. The median price/earnings ratio of the stocks in the index is far less elevated, however, suggesting that there are still good opportunities for stock pickers.
Emerging markets should benefit from an improved tone in international trade relations, even if the fundamentals of US trade policy do not change radically. A growing US economy will still pull in exports from emerging markets despite a continued ‘buy American’ bias. The recovery in EM domestic demand may lag given the inability of many countries (or their unwillingness, as in China’s case) to compensate households for the loss of income from the lockdowns. On the positive side, repeated waves of infections appear less likely in emerging markets since the pandemic is either already under control or is further along its natural course towards burning itself out. Emerging market valuations relative to developed markets appear quite reasonable and we expect to see emerging markets make up some of their underperformance from the last decade.