Although valuations and sentiment call for a pause in the equity rally, the recovery trade should continue, in turn supporting cyclical exposures.
“Valuations across equities are stretched and certain sentiment indicators look less attractive,” said Thomas Poullaouec, head of multi-asset solutions for T. Rowe Price in Asia Pacific, speaking as part of the firm’s mid-year investment outlook.
As a result – and given that equity returns in 2020 were driven by price multiples more than earnings – the focus now should be on whether earnings make up a greater proportion of the returns, he said.
This is more likely to be the case in Japan and emerging markets, for instance, where prices have not yet caught up with revised earnings estimates, said Poullaouec.
Looking in the right places
In general, unprecedented stimulus measures amid Covid-19 combined with the vaccine rollouts have the potential to fuel both economic recovery and an earnings rebound this year, on the back of pent-up demand to spend money saved during the pandemic.
Not all economies will follow this trajectory, however. “Some economies are expected to slow down on a year-over- year basis as we approach 2022, so the major question is whether the economic momentum this year will be sustainable going into next year,” Poullaouec said.
“Services-related sectors, such as travel and restaurants, should see the greatest uplift from this when the major economy re-opens,” he added.
According to Eric Moffett, portfolio manager of the Asia Opportunities Equity Strategy at T. Rowe Price, equity returns should be broader based this year after being focused on a few specific markets, namely China, Korea and Taiwan.
“The largest stocks in Asia do trade at absolute multiples that appear high, but if one looks at return on equity, earnings before interest and taxes margin and net debt/equity, it is clear these are higher return, higher growth businesses deserving of a higher multiple,” he explained.
At the same time, the firm is overweight value sectors. “Value has outperformed growth for the past six months, but on a year-on-year basis, it is still down 10% compared with the growth style,” Poullaouec said. “Thus, we believe there is still room for value to catch up and outperform.”
Staying alert
More broadly, T. Rowe Price sees inflation becoming a growing concern in the second half of 2021.
“The base case is that inflation will be transitory, but a non-consensus view is that there is a risk that wage growth is faster than expected,” said Poullaouec. “That could lead to central banks moving quicker on monetary policy normalisation than expected.”
Yet Asia should remain resilient. Moffett, for example, believes the debate around inflation should be more focused on the US than on Asia. “There are no obvious signs of inflationary pressures in the region and in terms of Consumer Price Index, inflation looks under control in Asia.”
Ultimately, the key for returns will depend on rates and inflation. If they don’t surge upward, Moffett said high quality compounders should regain investor attention, particularly those in Asia, which beyond 2021 will still account for more than half the world’s growth.
If, instead, inflation and rates spike, that could foreshadow a regime change and impact stocks in the region, he added, as multiples of high-growth stocks could come under pressure and value-oriented stocks may retain investor support.
