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Markets have rallied aggressively in the anticipation of strong earnings growth both this year and next. We are approaching the stage in the cycle in which investors will be looking increasingly to the delivery on that promise, and show tangible proof of earnings growth as opposed to just the promise of something better to come.
Valuations are stretched on a historical basis, with the price momentum in risk assets fuelled by forward looking metrics. This situation causes a higher level of anxiety among investors, with the potential for a more violent snapback than under normal conditions, should investors’ growth expectations not materialise.
The stage is set for global economies to bounce back. Leading indicators are all pointing to a robust level of growth in economic activity. It remains interesting to see how the pent up savings will ultimately be distributed throughout the different sectors.
The services sector is in pole position to benefit the most over the coming months. Malta itself is betting big on the resumption of tourism and all the ancillary services that come with this form of exportation. Investors should remain cognisant that this sector is also the highest risk sector, and historical correlations are somewhat biased given the ongoing fluid situation.
Many industries have been crippled by the pandemic, only retained on life support by the bold policy actions of governments and central banks. Despite this, certain sectors remain scarred, an example of which was recently reported in the local media regarding the staff shortages in the hospitality industry, as these were re-allocated to other industries or even countries for differing reasons.
The message is that despite a resumption in freedom of movement of individuals, a pre-Covid normalisation of activity is still a while away yet. Supply chains remain under pressure, certain regions of the world are still in a hard fought battle with the virus, most recently Argentina has been making waves for all the wrong reasons, and travel hesitancy is still a reality for most.
It is unquestionable that a recovery will happen, the uncertainty is over how and when this will materialise is key. The silver bullets provided by the vaccines have come a long way to normalising highly vaccinated populations, however this constitutes a relatively small portion of the world population to date.
Ever since the announcement that a viable vaccine was found, analysts aggressively increased upgraded their forecasts, creating in sense a self-fulfilling prophecy. Markets responded and today we’re at highly elevated levels with the S&P 500 trading in its 90th percentile over the last 30 years, therefore at extreme levels. Surveillance on the analyst upgrades and downgrades remains important, as these are often not just coincident to market moves, but leading indicators.
In my opinion, as markets become more frothy and sensitive to growth inputs, retaining a focus on the quality factor is paramount. The quality factor refers to the tendency of high-quality stocks with typically more stable earnings, stronger balance sheets and higher margins to outperform low-quality stocks, over a long time horizon. These stocks should have a lower sensitivity to underperforming growth expectations, thereby curtailing some of the risk in an already stretched market.
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