The stock market has had a dramatic year. After a strong start, it plunged at record speed by more than 30 per cent. Since then it has shown a very strong performance, with remarkably small and few corrections given the great uncertainty prevailing about the coronavirus pandemic, economic growth and politics. Record-large stimulus measures have quickly calmed financial markets and contributed to a clear rebound in the real economy. We believe that elevated share valuations may persist, as will investor interest in IT, green companies and staycations.
This is a summary – read a longer article on page 13-19 of the latest Investment Outlook.
Better corporate earnings than feared
Earnings of listed companies during the second quarter of 2020 greatly surpassed deeply downgraded forecasts. Meanwhile sales only increased marginally, showing that companies quickly trimmed their costs, which may pay off even once the economy rebounds. Among the other probable reasons for the surprisingly strong earnings was that analysts underestimated the scale of government wage subsidies that companies received and of the improvement in demand between April and June.
Stock market rally on more solid ground than many believe
Stimulus from major central banks, in the form of liquidity injections and asset purchases, are probably of vital importance to the rapid recovery from share price lows in March. Stock markets are back above their year-end 2019 levels. Meanwhile the earnings of Swedish listed companies are expected to shrink by more than 20 per cent this year, instead of increasing by 11 per cent as anticipated as recently as in January. Earnings forecasts for 2021 have been adjusted upward again after the surprisingly strong Q2 reports and are now “only” about 10 per cent lower than in January.
We believe it is risky to dismiss this summer’s stock market rally as a bubble. The economic trend has been far less bad than many people feared during the stock market collapse earlier this year, and the stimulus measures introduced during the COVID-19 crisis may very well justify even higher valuations.
Uneven stock market recovery – expensive equities are more expensive
Strong overall stock market performance conceals dramatic differences between winners and losers at the company and sectoral level. The clearest difference is between equities with high versus low valuation multiples. High valuations normally imply better growth prospects, higher profitability and greater stability. During 2020, valuations of equities with already high multiples have been pushed even higher.
This pattern is repeated on all of the Nordic stock exchanges, as well as between them. One result is that Copenhagen stands out as by far the strongest Nordic exchange this year.
Differences in valuations and share price performance can also be described in part as a difference between sectors. Many of this year’s winning equities are included in one of three categories: health care, information technology (IT) or companies with green solutions and environmental technology. But the pattern of high versus low P/E ratios is also repeated within sectors.
IT and green equities on top
Both in the Nordics and internationally, we have seen strong share price performance for the IT sector and for “green equities”: shares of companies that provide solutions to improve sustainability. The two most notable exceptions in the Nordic region are Ericsson and Nokia, which have relatively modest valuations. Meanwhile two IT companies that few people had heard of just a few years ago – Sinch and Evolution Gaming – are among the equities that have pushed the Stockholm exchange’s total index up the most this year.
The digitisation of society was already a strong, significant trend even before the COVID-19 crisis. It is continuing to accelerate as a result of social distancing, which has boosted interest in both e-commerce and video conferencing to completely new levels. Current valuations will require very strong performance from companies for a long time.
We are convinced that many of the winning equities of the 2020s will be those that support the transition of our societies to more sustainable economic growth. Meanwhile the US presidential election in November will be an important issue for environmental technology companies. If the Democrats win and Joe Biden becomes president, US policies will probably support green economic stimulus measures and investments in more renewable energy.
Winners from the “staycation” trend
More time spent at home and social distancing have stimulated interest in home improvements, re-decorating, gardening, camping, pleasure boats, home gyms, cycling and more. In contrast to the hoarding of toilet rolls that characterised the first few weeks of the coronavirus crisis, we believe the staycation trend may very well continue for a long time. Keep an eye out for more staycation winners in third quarter corporate earnings reports.
Record-sized central bank stimulus measures have energised financial markets, and elevated market valuations may persist for a long time. Second quarter earnings reports were far better than feared. Large parts of the economy are already growing again. The economic downturn was extreme, but the worst is over. Yet the recovery in the stock market is very unevenly distributed. The staycation trend emerged and may continue. Green companies will be the winners of the 2020s, but after the surge in share prices, selectivity in choosing equities is needed. The US presidential election will be very important in the near term. There is still great uncertainty about the coronavirus, economic growth and politics. This entails both risks and opportunities for equity investors.