Beyond the Headlines | 06 Oct 2023

Why we think equities are still expensive

Javier Corominas

Director of Global Macro Strategy

Our latest video for asset managers

In our latest Roundtable, “Finding opportunities in a global downturn”, Javier Corominas, Director of Global Macro Strategy, examines why we think equities are still expensive.

During the Virtual Roundtable, we covered the following topics:

Diverging economic activity, impact from tight credit conditions and the prospects for inflation
Macro Strategy: How real yields are set to react in the months ahead
EM Strategy: The relative merits of local and hard currency debt

Download the full recording

Hi, I’m Daniel Grosvenor, Director of Equity Strategy at Oxford Economics. In this month’s equity allocation report, we discuss the implications of an end to the Fed’s hiking cycle. A peak in policy rates is often a positive catalyst for equities, but we think there are three key reasons why it won’t be in this cycle. First, we don’t expect swift rate cuts.

In his recent Jackson Hole speech, Jerome Powell made clear that the FOMC will keep rates in restrictive territory until it’s confident that inflation is moving sustainably towards its target. We believe that the Fed will remain on hold until next May, and we only forecast 75 basis points of rate cuts over the course of next year. Second, equity valuations are already extremely stretched.

Unlike the majority of previous Fed tightening cycles, P/E multiples have actually expanded over the past 12 months in advance of the peak in rates, and they’re now well above long-term averages. We think that leaves very little room for a further rerating. We think equities are particularly expensive when to the yields that are now available on safer assets. Our cross asset relative valuation indicator is currently at a level that has historically been consistent with equities underperforming bonds over a six- to 12-month horizon.

Third, we forecast further downside for earnings as profit margins remain under pressure. Our top-down models suggest that US earnings will fall by 7% this year and will not begin a sustained recovery until Q2 2024. We think this will provide an ongoing headwind for equities over the next couple of quarters, offsetting the support from lower yields. So overall, we think that equities will struggle to rally further despite a Fed pause.

We are underweight the asset class in our Global Asset Allocation and we remain relatively defensively positioned at the sector level.

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