BlackRock Commentary: Valuation – not a worry for now

Jean Boivin, Head of the BlackRock Investment Institute together with Elga Bartsch, Head of Macro Research, Scott Thiel, Chief Fixed Income Strategist and Beata Harasim, Senior Investment Strategist all part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.


Equity valuations have been top of mind after major stock indexes have scaled new highs. Last week’s volatile market moves as a result of technical deleveraging added fuel to these concerns. We do not see risk asset valuations as obviously stretched overall, and expect low interest rates – and a vaccine-led restart – to support risk assets over the next six to 12 months.

Article Image 1

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream. Data are as of Jan. 28, 2021. Notes: We use the implied equity risk premium that incorporates current market prices, expected future cashflows and risk-free rates. We use MSCI USA Index to represent U.S. equities.

 

Assessing equity valuations can be difficult. Structural shifts such as persistently lower interest rates make it difficult to judge the signals from traditional metrics such as price-to-earnings ratios. The key question is whether the compensation investors are getting to take on additional equity risk, after factoring in current low interest rates, is fair. This is why we prefer to gauge valuation by looking at the expected return of equities over the risk-free rate, and our estimates for the U.S. market don’t appear stretched, as the chart above shows. This approach helps us assess valuations across different interest rate environments, yet the metric is only as good as the assumptions that go into it. Our new nominal theme suggests rates will stay low amid stronger growth and higher inflation, as central banks lean against any sharp rises in nominal rates. This should keep “real”, or inflation-adjusted yields, negative, and support risk assets, in our view. But if rates were to revert to historical averages, valuations would look a lot more stretched.

The S&P 500 Index posted its biggest one-day decline in three months last Wednesday. Large price swings in a small set of stocks that have been popular targets of short sellers led to a wave of technical deleveraging that hit the market. The dramatic rise in share prices of these stocks triggered forced selling of other equities as some investors sought to cover their short positions. Worries about market exuberance are natural in such a climate, but we believe these stock swings are isolated instances triggered by market technicals – and are the wrong thing to focus on.

The more fundamental question: have markets moved too far, too fast? Global stocks have risen 16% from a year earlier – just before the start of the global pandemic that has killed over two million and forced unprecedented activity stoppage. Tech stocks have led the charge, with the Nasdaq 100 Index up over 40%. We don’t see a disconnect – because of the nature and visibility of this shock. We view it as akin to a natural disaster followed by a rapid activity restart, and see the cumulative economic shortfall as just a fraction of that seen after the global financial crisis – an outlook markets have been quick to price in. Valuations do not look obviously stretched, as our estimate of the compensation for taking equity risk shows. The flip side: The eventual restart may not give stocks as much of a lift as past recoveries. Earnings growth will likely need to be the primary driver of returns given today’s valuations, and we see potential for a strong earnings rebound ahead.

The equity rally does have implications for longer-term returns. We now see equity valuations as fair in our long-term capital market assumptions – and expect lower returns ahead as a result. This is why we are neutral on equities over a strategic horizon. What could change the benign environment for risk assets? An unexpected rise in rates could occur if the relaxed attitude of market participants to record high public debt loads were to change – and central banks abandoned their stance of leaning against any sharp rises in nominal rates. Our new nominal theme suggests this risk is low for now, but any change in the tolerance for high debt levels could flip this dynamic in the medium term, with major market implications.

The bottom line: We do not see overall equity valuations as being stretched today, although easy financial conditions and pockets of excess could spark further bouts of volatility. We are pro-risk overall on a tactical basis, and overweight equities and credit. We favor a barbell approach in equities: quality stocks on one end to counter any hiccups caused by the slow vaccine rollout and the spread of new strains; and selected cyclicals on the other to capture the upswing led by the restart.

Market Updates

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Past performance is not a reliable indicator of current or future results. Indexes are unmanaged It is not possible to  invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, January 2021. Notes: The two ends of the bars show the lowest and highest returns over the last 12 months, and the dots represent returns compared with 12 months earlier. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot gold, Datastream 10-year benchmark government bond (U.S. , German and Italy), MSCI USA Index, Bank of America Merrill Lynch Global Broad Corporate Index, MSCI Emerging Markets Index, J.P. Morgan EMBI index, Bank of America Merrill Lynch Global High Yield Index, the ICE U.S. Dollar Index (DXY), MSCI Europe Index and spot Brent crude.

Market backdrop

U.S. stocks scaled new highs before selling off briefly as large price swings in a small set of stocks that have been popular targets of short sellers lead to a wave of technical deleveraging. More than 30% of S&P 500 companies have reported fourth-quarter earnings, with over 80% beating expectations, according to Refinitiv. The Fed flagged a brighter economic outlook despite a recent soft patch and reinforced expectations for “low for long” rates, backing our new nominal theme.

Week Ahead

  • February 1st: Manufacturing purchasing managers’ index (PMI) for China, euro area and the U.S.
  • February 2nd: Euro area preliminary flash GDP
  • February 3rd: Services PMI for China the U.S.; composite PMI for the euro area
  • February 5th: U.S. nonfarm payrolls

This week’s U.S. nonfarm payrolls data will be in focus. Economists polled by Reuters expect an increase of 85,000 jobs, after a decrease of 140,000 in December – the first decline in eight months. The jobs report comes on the heels of the Fed policy meeting last week where policymakers downgraded the near-term outlook but upgraded the assessment further out.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of Feb 1st, 2021 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what their professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.


The Digest

Last week was certainly an interesting one for markets as the GameStop/Reddit/Melvin saga dominated headlines and led to volatility and deleveraging. The S&P 500 Index closed down 3.3% as global equity markets had their worst week of performance since October last year. This US-centric story spilled over into Europe, with the STOXX Europe 600 Index down 3.1%. Vaccine concerns for Europe, the kickoff of earnings season, and Italian politics were also drivers of the performance last week. Markets in the Asia Pacific (APAC) region were also lower across the board, with the MSCI Asia Pacific Index down 4.4% on the week.

What Happened Last Week?

A large group of retail investors connected via a Reddit forum decided to start buying some of the most shorted stocks in the United States. Some investors genuinely liked these stock, some wanted to target hedge-fund short sellers and some just enjoyed the ride of getting involved in what we’re now calling ‘meme’ stocks, which basically means a stock heavily influenced by people online.

GameStop is a US company that sells video games at brick-and-mortar stores (shopping malls) and was the first target to draw attention. There are plenty of investors who believe this is a dying business and thus shorted the stock (they were collectively short by more than GameStop’s entire free float). The Redditors collectively triggered a short/gamma squeeze in the stock, by buying shares and call options. Further weight was added when Elon Musk jumped on the bandwagon and tweeted his support for GameStop. GameStop closed the week up 400%. To give an idea of scale, it traded over US$100 billion on the week—more than Apple or Amazon.

Hedge fund Melvin Capital was hit hard by its large short position in GameStop and had to be bailed out by fellow hedge funds Point72 and Citadel and eventually closed out their short position, crystallising their losses. As the Redditors added more stocks to their target lists, we saw a rush to cover crowded short positions, creating volatility and immense pain for short-sellers.

We saw material deleveraging in other hedge funds forced to cover shorts and unwind consensus long positions as a result—contributing to the broader market selloff. Retail trading platform Robinhood tried to stop the pile on by restricting trades in the most impacted names, but the pushback was swift. Robinhood customers sued the platform shortly after the restrictions were put in place and US politicians even got involved in the fray, calling for investigations into the activity.

Whilst all of this was very US-centric, it was interesting to see the dynamic filter through to Europe. Midweek saw some aggressive deleveraging in crowded hedge-fund positions, which again migrated into selling of longs in the second half of the week. It’s worth noting that it wasn’t just impacting equities, with the Redditors targeting silver towards the end of the week. This is in turn boosted metals-related stocks and is still garnering a lot of attention as we kick off a new trading week.

The European retail market is different from the US market, as there aren’t the same widely used trading platforms such as Robinhood, which actually cancelled a planned launch in the United Kingdom last summer. There is certainly retail exposure to markets in Europe, but European investors have tended to be more risk-averse, more likely to use mutual funds for market exposure, and until now, we have not seen the same types of retail ‘mob’ actions to the same degree as seen in the United States.

That said, we did see extreme volatility in Nokia last week after the stock’s American Depository Receipts were targeted on Reddit, although the company stated it wasn’t aware of any material change in its business that would account for such magnified interest or such extreme moves.

The UK regulator Financial Conduct Authority (FCA) issued a statement that it ‘is aware of the situation and continues to closely monitor trading in UK markets. UK investors should take care when trading shares in highly volatile market conditions that they fully understand the risks they are taking. This applies to UK investors trading both US and UK stocks’.

(As an aside, Nottingham’s World Wide Robin Hood Society—to promote tales of Robin Hood— saw followers surge from under 400 to 50,000 over the past week. Investors seemingly mistook it for the Robinhood trading app Twitter feed. The Society gave ‘a big welcome from Sherwood’ 😊 but reminded new followers it was not associated with the trading app.)   

European Union (EU) Vaccine Supply Concerns

Sentiment around the speed of the COVID-19 vaccination programme in Europe took a hit with the EU and UK drugmaker AstraZeneca facing off against each other. The issue centred around a deal which was agreed back in August 2020, wherein 300 million doses would be delivered to the EU post-approval. With that, the EU was expecting 100 million doses by the end of March 2021, but it appears expectations are now just for 25 million doses delivered in that timeframe. AstraZeneca has cited issues at its plants in the Netherlands and Belgium, and insists that the agreement was always made on a ‘best efforts’ basis, which the EU disputes.

The added complication is that there have been no reported complications in its contract with the UK government; the drugmaker said its contract with UK authorities was signed a lot sooner, meaning they could iron out any issues. However, the EU was not happy, and we heard warnings of a ‘vaccine war’.

The EU vaccination programme is lagging far behind the United Kingdom. Based on data from 28 January, the UK has vaccinated 11.4% of its population, compared with just 2.3% around the EU. With the latest setback in regards to EU vaccine supply, it’s unclear whether the pace the bloc requires will accelerate. There is clear pressure for the EU to resolve these supply issues. There is clear anger from the European Commission, as AstraZeneca’s supply to the United Kingdom appears to have been unimpacted, UK infection rates continue to drop, as they have done for nearly three weeks .The number of hospitalisations and deaths also have shown signs of plateauing.

The good news is that infection rates in the EU are also falling, even with a smaller proportion of the population vaccinated. It’s unclear what the impact will be on the number of people who fall seriously ill, however.

From a political perspective, the disparity in production levels by AstraZeneca between supply to the United Kingdom and EU puts the two on what could prove their first serious post-Brexit collision course. Any prolonged EU lockdown due to vaccine shortages could be a potential headwind for markets into spring.

In a slight easing of tensions late Friday, Brussels retreated from plans to create border restrictions between the Republic of Ireland and Northern Ireland. The plan had been intended to clamp down on vaccine exports from the EU, but unsurprisingly received strong criticism from politicians in the United Kingdom and Ireland.

Week in Review

Europe

European equity markets were broadly lower given the widespread risk-off theme throughout the week, with the STOXX Europe 600 Index closing the week lower. As noted, significant hedge-fund activity saw equity markets come under pressure and volatility was on the rise, culminating in the worst week for European equities since October 2020. As mentioned, a frustrating start to the COVID-19 vaccination programme in the EU added market uncertainty. Telecommunications and real estate were the only two sectors to close in the green for the week. On the flip side, oil and gas stocks, basic resources and insurers were all lower on the week.

In Italian politics, the stakes are high after Prime Minister Giuseppe Conte resigned last week. Italy needs a stable government to decide how to spend the country’s EU grant to counter the COVID-19 recession. President Sergio Mattarella began a round of consultations following the resignation to assess political party positions on the shape of the next government. Conte is expected to try to form a new coalition, but if he is not able to do so, Mattarella will see if a new coalition can be formed. The composition of the eventual ruling coalition will be key in terms of policy direction. Fresh elections also remain a risk, with Deputy Prime Minister Matteo Salvini having told the president last  Friday that the Centre-Right wants elections. Negotiations between the former majority parties will continue in order to find an agreement, and Mattarella may appoint a new prime minister or ask for new negotiations to be held. Expectations are for a new government to be formed and hopes are that early elections avoided.

In terms of macro data, fourth-quarter gross domestic product (GDP) reports for Germany, Spain and France were better than expected, suggesting the economic impact for the final quarter last year wasn’t as bad as feared. On earnings, 66.7% of STOXX 600 companies which have reported have beaten estimates so far; however, last week’s market dynamics meant that this wasn’t necessarily rewarded in stock price action.

United States

A memorable week for US markets with a wall of noise around the GameStop and Reddit situation. By the end of the week, the S&P 500 Index and the Dow Jones Index were both down 3.3%. Market volumes were huge, with last Wednesday a record volume day in the United States (although not the highest notional).

Looking at sector performance, defensives outperformed, while utilities and consumer staples slumped. The energy space slumped 6.6% last week on concerns over the impact of US President Joe Biden administration’s green energy policies on the sector.

It was a big week for corporate earnings, with a number of heavyweights reporting. Of note, we had Apple and Tesla both trading lower after reporting, though given they were both up significantly over the past year, so a little profit- taking is not too surprising.

On Wednesday of last week, the Federal Reserve (Fed) meeting was a benign event for markets, with little impact on indices. There were no policy changes and Fed Chair Jerome Powell reassured that there were no imminent plans to tighten fiscal policy. He stated: ‘It’s just too early to be talking about dates’ for tapering and that ‘the whole focus on exit is premature’.

Another key focus for investors going forward is the Biden administration’s proposed stimulus package. Biden is keen for a bi-partisan approach between Democrats and Republicans, but this has proved challenging so far as the two sides of the US political spectrum wrangle over the details. In terms of timing, Senate Majority Leader Chuck Schumer has said Congress will try to pass a stimulus bill in about a month. If this package is significantly watered down or delayed, it could be a headwind for markets in coming months.

COVID-19 trends in the United States are encouraging, as hospitalisations and the daily new-case rate continue to moderate from early January peaks. Roughly 22 million Americans have now received at least one vaccine dose, covering nearly 20% of the high-priority population.

Looking at macro data, US GDP (annualised quarter over quarter) came in at 4%, a bit lower than expectations. Interestingly, we have seen some analysts upgrade growth forecasts for this year on hopes for continued progress in controlling COVID-19 via vaccinations, and more fiscal support for the economy.

Asia Pacific

Asian equities came under heavy pressure last week, with the MSCI Asia Pacific Index closing the week down 4.4%. The market dynamics were similar to what we saw in the United States and Europe, with hedge-fund deleveraging have a significant impact. US-China trade tensions also remained firmly in focus, which naturally weighed on risk sentiment. In terms of sector performance, consumer staples outperformed, but still finished down on the week. Energy, technology, and basic materials were the notable laggards.

Last Tuesday, the US White House said there would be no change to President Biden’s ‘patient’ approach to China and the administration will review the former administration’s policies. However, Biden is determined to ensure that China does not use US technology to support its ‘malign activities’.

At the World Economic Forum, President Xi Jinping warned of a ‘new cold war’ if the United States keeps up its protectionist policies. He said that COVID-19 should not be used as further reasoning for reversing globalisation in favour of ‘decoupling and seclusion’. This came after Biden also signed a ‘Buy American’ procurement policy to prioritise domestic manufacturing.

The United States is giving investors more time to wind down transactions with companies tied to the Chinese military as the Biden administration reviews former President Donald Trump’s policies. The Treasury Department extended the deadline to 27 May from the original 11 January date, but left the 11 November date for a full investment ban intact. For now, markets will remain on tenterhooks with regards to relations between the two global superpowers.

In terms of macro data, Chinese industrial profit soared on manufacturing strength.

Elsewhere, the Australian consumer price index (CPI) came in ahead of expectations on housing demand and following the unwinding of government subsidies. Japanese retail sales fell on weakness in department store sales. Also, Japanese core deflation moderated whilst the unemployment rate unexpectedly held steady.

Week Ahead

In the upcoming week, focus will be on the Bank of England (BoE) meeting on 4 February. Strong CPI and unemployment data combined with a hot housing market is increasing the risk of no quantitative easing (QE) extension, though the base case from many economists is an extension. The BoE is expected to publish its assessment of negative interest rates, and while there has been some support for it, leading vaccination rates in the United Kingdom should reduce some of the pressure for the BoE to cut.

It will be a busy week in the United States, with the Institute for Supply Management (ISM) manufacturing (1 February), ISM services (3 February), and January monthly employment report  (5 February) coming up.

 


Franklin Templeton Key risks & Disclaimers:

What Are the Risks?

All investments involve risk, including possible loss of principal. The value of investments can go down as well as up, and investors may not get back the full amount invested. Stock prices fluctuate, sometimes rapidly and dramatically, due to factors affecting individual companies, particular industries or sectors, or general market conditions. Bond prices generally move in the opposite direction of interest rates. Thus, as prices of bonds in an investment portfolio adjust to a rise in interest rates, the value of the portfolio may decline. Investments in foreign securities involve special risks including currency fluctuations, economic instability and political developments. Investments in developing markets involve heightened risks related to the same factors, in addition to those associated with their relatively small size and lesser liquidity. Past performance is not an indicator or guarantee of future performance.

This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 1st February 2021, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

Issued by Franklin Templeton Investment Management Limited (FTIML) Registered office: Cannon Place, 78 Cannon Street, London EC4N 6HL. FTIML is authorised and regulated by the Financial Conduct Authority.


MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment and may be deducted from the invested amount therefore lowering the size of your investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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