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Sector rotation reinforced by earnings momentum
Despite the disruption caused by the Omicron COVID-19 variant in December, consensus 2022 earnings forecasts have continued to rise over the past four weeks, albeit modestly. Our favoured sectors of energy, banks and insurance remain close to the top of the EPS upgrade charts. Furthermore, earnings momentum for European equity markets is outpacing that of the US. In price terms, US equities and global technology have underperformed in the year to date. Recent earnings momentum suggests this underperformance may have further to run.
Exhibit 1: Global estimates have nudged higher in early 2022
Source: Refinitiv, Edison calculations
We believe investors in global markets are now looking beyond the peak in Omicron infections and towards later in the year when COVID-19 may have evolved into an endemic disease with relatively few economic and political ramifications. This transition from pandemic to endemic has been driving interest rate expectations higher in recent months, combined with a progressive normalisation of long-term government bond yields as central banks’ asset purchase programs are wound down.
Exhibit 2: Global sectors – banks, energy and insurance outperform in 2022
Source: Refinitiv, YTD return to 16 January 2022 in US dollars
At present, traditional sectors such as financials and energy remain favourably positioned, in our view. Both sectors enjoy relatively cheaper valuations compared to the rest of the market. Unusually for unloved sectors, earnings momentum is now outpacing that of many other sectors and the fundamental drivers for this trend remain in place.
High energy prices are being sustained by a reluctance to invest in new fossil fuel infrastructure even as demand returns as the global economy opens up after COVID-19. Monetary policy normalisation means banks and insurers are likely to benefit in 2022 from an extended period of rising expectations for interest rates.
In contrast, we note that US earnings momentum has for now fallen behind that of many European equity markets over the past month. Furthermore, US consensus forecast earnings growth of 9% for 2022 is lower than the global average of 11%, which calls into question the significant premium US equities trade at compared to the rest of the world.
Exhibit 3: US equities have underperformed in early 2022
Source: Refinitiv, YTD to 16 January 2022 in US dollars
A correction in relative valuations is already underway as US equities have underperformed those in Europe in the year to date, except for the Netherlands where the equity index is disproportionately weighted towards technology. Despite recent underperformance, we continue to view US equities as overvalued as they still trade close to a record-high premium to their long-run average price/book value. US equities are also at the epicentre of this year’s rapid schedule of US Federal Reserve interest rate increases, in contrast to Europe where the ECB is pursuing a softly-softly approach to avoid derailing the comparatively earlier-stage economic recovery.
Exhibit 4: 2022 one-month global sector earnings revisions
Source: Refinitiv, Edison calculations. Note: Sectors are equally weighted.
We remain with an overall neutral strategic outlook on global equities. We acknowledge the US equity market’s remarkable valuation premium on the one hand and the opportunities available in non-US markets and traditional sectors of the economy still exposed to positive earnings trends on the other. This is especially important in an environment where cash has a negative real yield due to above-target inflation. Our favoured sectors and regions continue to benefit from valuation levels closer to historical norms and relatively strong earnings momentum.