Manulife capital markets team forecasts recovery by the end of 2021By Kate McCaffery | July 17 2020 02:30PM
Manulife Investment Management’s capital markets strategy team has, collectively, worked though decades of economic and market cycles, and numerous global crises, but agrees it has never experienced an environment like the one we find ourselves in today.
Calling it The Great Pause of 2020, the team lead by Philip Petursson, chief investment strategist and head of capital markets research with Manulife Investment Management, says “the COVID-19 global pandemic has thrown all market dynamics up in the air.”
“The speed and strength of the recovery in equity and bond markets has left many market participants (us included) scratching their heads,” they write. Although they add that they love when markets go up, “we just like to know that markets are going up for the right reasons – because profits are, or will be, going up. That hasn’t been as clear since March as companies were navigating the impact of the lockdowns and consumers were effectively shut-in from shopping.”
Steep earnings declines expected to continue through Q2 and Q3
The strategy team says indicators suggest that steep earnings declines will continue through the second and third quarters, before giving way to the beginning of an earnings recovery in the fourth.
They also point out that the team is forecasting 18 months ahead, rather than 12. “We typically build our assumptions and set our asset allocation with a 12-month outlook,” they write. “In this unique environment, we believe the uncertainty is too great over the next 12 months to build reasonable expectations.” Near term uncertainty, they add, is being caused by COVID-19, by renewed trade tensions between China and the United States, and by the U.S. election.
In sharing its base case assumptions, Petursson’s team says it is calling for gradual economic recovery over 18 months, to a full earnings recovery for the S&P 500 by the fourth quarter of 2021 and the first quarter of 2022. The team says it favours global equities over Canadian equities, as oil prices can weigh on the S&P/TSX Composite Index. They say oil prices will likely trend higher, but not necessarily high enough to support a similar recovery in the Canadian index earnings. “A tepid demand recovery for crude is likely to keep prices below their 2020 highs. The energy sector, therefore, may likely be a drag on the TSX. As such, we prefer U.S. and international equities (or global equities) over Canadian.”
Inflationary forces of fiscal and monetary stimulus
Central banks, meanwhile, are expected to remain accommodative, and yield curves are expected to steepen as the recovery, “combined with the inflationary forces of fiscal and monetary stimulus, push longer-term yields higher.”
Their outlook: an economic contraction that is sharp but short, where Purchasing Managers’ Indices (PMIs) start to recover and stabilize, and U.S. unemployment peaks and begins to trend downwards, also calls for 2020 S&P 500 Index earnings to fall 20 per cent, before recovering to 2019 levels through 2021.
“Our conclusion is that despite the run-up in markets and relatively high price-to-earnings level on the S&P 500 Index and its developed market peers, valuation is fair. Stocks are neither expensive nor cheap. And therefore, their attractiveness should be guided by their earnings potential.”