Ever since the first positive vaccine results were reported in autumn 2020, expectations have been high for both economic growth and the equity markets. These expectations were realised in the past quarter, Q2, with strong growth, global equities rising by around 7 per cent and yield spreads on credit bonds continuing to tighten.
Looking ahead, we expect the high rate of growth in the global economy to continue over the summer and into early autumn. We assess there to still be sectors in both the US and Europe that are not yet fully normalised, and some restrictions apply that still have to be removed. To this can be added accommodative fiscal and monetary policies.
Bo Bejstrup Christensen
Chief Portfolio Manager, Head of Macro & TAA, Danske Bank Asset Management.
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EQUITIES: Greatest potential in Europe
USA: With returns well above 10 per cent in H1 2021, equity markets welcomed the reopening. In fact, so much so, that we now estimate US equities are 10-15 per cent overpriced. Naturally, this means the future potential is considerably less attractive. All in all, we therefore expect modest positive return of around 0-5 per cent from US equities in the coming 12 months. We would stress, however, that the short-term risk of a price fall of 5-10 per cent is higher than normal, as growth could potentially fade faster than we expect at a time when valuations are on the expensive side. Nevertheless, should that happen, we estimate the market would quickly right itself again.
EUROPE: The story in Europe is a little different. We estimate the continental European equity market remains priced to the cheap side – around 5-10 per cent too low. In contrast to the US, the equity risk premium could thus be reduced a little more if our optimistic growth expectations are realised while the ECB at the same time maintains its accommodative approach. We therefore expect a return on equities of over 5 per cent in Europe in the coming 12 months.
EMERGING MARKETS: Emerging market equity valuations are, in our opinion, the most expensive of the three major regions. We estimate the broad emerging market index is currently 15-20 per cent too expensive. Naturally, this limits future return potential. On the other hand, high rates of global growth and the slow normalisation of US monetary policy, in particular, mean valuations should be capable of being sustained at a relatively high level. We therefore expect emerging market equity returns to be on a par with the US – in other words, 0-5 per cent over the coming 12 months.
BONDS: Expect a positive return in Europe
USA: Turning to bond markets, we estimate the yield increases seen during Q1, in particular, were justified, although we had not anticipated them. A surprisingly strong US fiscal policy and the current high level of inflation mean that the US central bank can normalise monetary policy significantly earlier than we expected 3-6 months ago. Nevertheless, we now assess US yields to be more or less fairly priced. Our overall expectation is for a return of around 0 per cent in the coming 12 months across the US government yield curve.
EUROPE: The picture in Europe is somewhat different. Given the latest yield increases and our expectation of a very slow normalisation of monetary policy, we view the German yield curve as attractively priced. We therefore expect a fall in European yields over the next 12 months as growth slows in the autumn and it becomes clear that the ECB – in contrast to the Fed – is far from its inflation target. We therefore expect a positive return from core Euro area government bonds.
This material has been prepared for information purposes only and does not constitute investment advice. Note that historical return and forecasts on future developments are not a reliable indicator of future return, which may be negative. Always consult with professional advisors on legal, tax, financial and other matters that may be relevant to assessing the suitability and appropriateness of an investment.