Low interest rates, moderate inflation and a strong recovery in corporate profits. For the time being, the environment for equities remains extremely favourable, according to James Ashley, Head of International Market Strategy at Goldman Sachs Asset Management (GSAM).
After a successful roll-out of corona vaccines, a strong rebound of the global economy is on the cards for next year. GSAM expects global growth to be 6%, a little above the consensus of 5.2%. If growth turns out to be that high indeed, it may result in an unexpected spike in inflation as monetary policy continues to be extremely dovish.
According to Ashley, however, the likelihood of an inflation shock is small. ‘In some sectors, the price level could clearly rise. The travel sector is an example of this, as people go out again after the lockdowns. However, a broad and sustained rise in prices is not obvious. Despite the expected recovery, output still remains below pre-corona levels, and unemployment is at a relatively high level, which weighs on consumers’ purchasing power.’
Even in the somewhat longer term, Ashley sees no inflationary pressure. In fact, we expect a continuation of pre-pandemic trends, i.e. a prolonged period of moderate price increases. This means interest rates will not rise for the time being. Should inflation return in the next three to four years, central banks will not immediately pull the monetary reins. They then want to be sure that inflation has structurally risen to a higher level.’
‘S&P 500 to 4300 points’
An environment in which interest rates will remain low for longer is conducive for risky assets, Ashley believes. He is optimistic about equities not only for 2021, but also for the years after. ‘The gradual reopening of the economy will bring about a strong recovery in profits for most companies, but this will come with trial and error and take time. In addition, central banks have indicated that they will continue to provide ample liquidity support, not only for the coming quarters but perhaps for some years to come.’
In this respect, he points out that the European Central Bank has extended its buy-back programme until at least March 2022 and that the Fed has indicated that it will not raise interest rates for the time being. ‘The central banks are not taking chances, and will continue to pursue an ultra-dovish monetary policy for an extended period of time, even if the economy returns to normal,’ says Ashley.
The continued liquidity support, cheap financing and the expected recovery in profits are, he says, fuel for the stock markets. ‘For the time being, the bull market is holding up.’ The Goldman Sachs research team has a price target for the S&P 500 of 4300 by the end of 2021. That would still have an upward potential of around 18%. For the pan-European Stoxx 600, the analysts are aiming for a position of 430, almost 10% above the current level.
No bubble
Ashley is not too worried about the valuations. ‘Stocks are not cheap, but they are not overvalued either. You also have to take the bond market into consideration too. Since the risk-free interest rate in the US and Europe is likely to be virtually 0% for years to come, a structurally higher valuation of shares is justified. Only in the event of a radical change in monetary policy will the risk-free interest rate rise and the price/earnings ratio fall. For the time being, valuations are appropriate’. As far as Ashley is concerned, this also applies to the relatively expensive technology sector.