The shifting of the gears after the first phase
It’s often the case that the second 12 months after a bear market ends sees more constrained and volatile gains in shares. As shown in the next table, the average gain in Australian shares in the first 12 months after a bear market ends is 28%, whereas the average gain in the second 12 months is just 7%. Similarly, the average gain in US shares in the first 12 months is 42%, followed by an average gain of just 8% in the second 12 months. This reflects a combination of the bear market undervaluation being removed by the initial rally, a shift in growth leading indicators from acceleration to expansion and the unwinding of stimulus. It’s basically a shifting of the gears between the first valuation recovery driven phase to a tougher earnings driven phase. It highlights of course the danger in investors thinking they will wait to get back in when uncertainty falls – but by then the easy gains have been seen.
Data is for US S&P 500 and All Ords and covers the post WW2 period. Source: Bloomberg, AMP Capital
So where are we now?
Shares have had a big rally from their lows in March last year but it’s most likely that we are now in the transition between the initial recovery (Phase 1) and earnings driven growth (in Phase 2) and still a long way from the overheating and exhaustion that is evident at the end of a cyclical bull market. The best way to look at this is to assess market valuation, economic growth and inflation pressures, monetary conditions and investor sentiment.
• Measured in isolation against their own history, shares are not cheap with forward price to earnings ratios well above their long-term averages. However, despite the surge in bond yields this year, shares still offer a decent earnings yield pickup relative to the bond yield (see the next chart).
Source: Bloomberg, AMP Capital
• The global economy is set for very strong growth this year helped by stimulus and vaccines. This in turn is fuelling a strong upwards revision in earnings expectations, with US December quarter earnings about 12% stronger than expected and Australian earnings growth for this financial year being revised up by around 13% since mid-January.
• While economic and profit growth is likely to be very strong this year, there is a still a long way to go to use up spare capacity in product and labour markets. This means that while headline inflation is likely to spike in the months ahead - due to the deflation of last year dropping out of annual calculations, higher energy and commodity prices and bottlenecks in some goods markets - underlying inflation and wages growth is likely to remain soft in contrast to the excesses normally seen prior to cyclical downturns
• As a result, while Fed and RBA rate hikes may come earlier than the three years or more that they often refer to, it is still likely to be at least two years away. And the ECB and Bank of Japan are likely even further behind.
• Finally, while investor optimism is high it doesn’t appear euphoric (Bitcoin periodically aside!). In Australia, sentiment towards shares as a wise destination for savings remains low and more investors still prefer bank deposits.
So, from a broad-brush perspective we are not seeing the signs of exhaustion that come at cyclical peaks and so the cyclical bull market in shares likely has further to go.
Of course, that is not to say that shares aren’t vulnerable in the short term to a further correction, in response to the spike in bond yields. In particular, high PE tech stocks remain very vulnerable after years of outperformance partly on the back of falling bond yields and they are less likely to see an offset from higher earnings growth. So far, they have borne the brunt of the correction. Ultimately this should leave cheaper, less tech heavy, non-US share markets including Australian shares better placed to outperform this year.
Shane Oliver, Head of Investment Strategy & Chief Economist
THIS ARTICLE WAS RELEASED BY AMP CAPITAL 10 MARCH 2021, FOR MORE AMP CAPITAL UPDATES GO TO WWW.AMPCAPITAL.COM.AU
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