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Investors must beware low equity valuations

Expectations of persistent pressure both on markets and economic growth will create a challenging environment for stocks as corporate profits suffer, according to DWS.

Low valuations in equities do not automatically herald a big buying signal given the market backdrop, and investors need to be mindful of today’s dynamic environment and associated risks.

This stems from the lack of clarity over when the inflation and rate-hiking cycle will end. Further, believes DWS, growth will likely remain under pressure, in turn impacting corporate profits.

“We do not expect a short-term U-turn,” said Stefan Kreuzkamp, chief investment officer of DWS. “We slightly cut back on our economic growth forecasts for Europe and the US in 2023 and also revised our price targets for the stock markets downwards by 5% to 10%.”

Alongside rising yields on bond markets, stagnating corporate profits are a difficult environment for stocks.

“Risks are particularly high in Europe, [where] the high reliance on Russian energy is painfully felt. The valuation discounts of European stocks versus their US counterparts are correspondingly high,” Kreuzkamp added.

Watch and wait

In general, DWS sees the performance of the first six months of 2022 as disillusioning for stocks, amid a wash of red.

For example, Latin America has been the top performing region, with the MSCI Latin America recording only minor losses of -0.3% in the first half of the year.

Despite significant price losses on most of the other stock markets, DWS believes it is too early for an all-clear. “An equity losing 70% of its value is not automatically cheap,” explained Thomas Schuessler, global co-head for equities at DWS.

The key question he raises against the background of already sharply reduced prices is how corporate earnings will develop.

“The current forecasts of many equity analysts might turn out to be over-optimistic, and the currently low price/earnings ratios might not correspond with future reality. If expected earnings growth rates were revised sharply downwards, lower valuations would all be gone in one swoop,” said Schuessler.

Regional equities potential

In this difficult environment, DWS pinpoints high-dividend stocks with sound fundamentals as most promising.

This is partly the case for the eurozone, where aside from the volatility triggered by high energy prices and the uncertainty as to whether Russia will completely turn off its gas supplies, high dividend and commodity stocks look most promising.

In emerging markets, meanwhile, development in China is an important factor for the equities landscape.

In DWS’ view, the current price levels seem to discount most of the uncertainties.

“An end to China’s zero-Covid policy and new state fiscal measures could set off a recovery,” said the firm.

The outlook is less promising for US equities, suggests DWS. It expects the rate-hiking policy of the Federal Reserve to result in a faltering domestic economy in the fourth quarter, sliding into a mild recession in the first quarter of 2023. This should exert further pressure on US equities and dampen price potential, added the firm.

Part of the Mark Allen Group.