EC Is Today’s Bull Market Sustainable?

Earnings outlook: Robust growth to continue?

Switching to earnings, corporate profitability has experienced an even more impressive revival than the global economy. The two charts below highlight rolling year-over-year gains for the U.S. (top) and international (bottom) equity markets, compared to the yearly growth of trailing 12-month earnings for the respective index. The graph visualizes the leading properties of the equity markets, with annual advances in equity prices slightly foreshadowing earnings growth. For instance, equity prices bottomed in March 2020, while trailing 12-month earnings did so in December of that year.

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Source: Refinitiv DataStream, Russell Investments. As of June 1, 2021.

Considering the strength of the markets, earnings increases must validate equity price gains. To that end, based on earnings-per-share (EPS) growth estimates for 2021 and 2022, shown below, the outlook looks encouraging. Moreover, even though EPS growth in 2022 will naturally decelerate from post-reopening-boom 2021 levels, both U.S. and ex-U.S. earnings growth are expected to stay above their respective long-term averages. In fact, the resurgence of U.S. earnings was SO strong that S&P 500 companies regained their peak profitability by the fourth quarter of 2020 (on an unsmoothed basis).

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Source: Refinitiv DataStream, Russell Investments. Estimates as of May 28, 2021.

Market outlook: Could equity prices climb higher?

The outlook for both the economy and earnings over the next couple of years is naturally positive for financial markets. However, the challenge is that despite a robust outlook for earnings, current valuations, shown below, already reflect some of this optimism. Most regions are trading at a price-to-earnings (PE) ratio richer than their respective long-term average (LTA). However, the chart also makes the case that the current valuation is more interesting outside the U.S. for all regions shown. Moreover, international markets look less stretched relative to their own historical-average PE ratio. In other words, they trade at a lower PE premium versus the U.S.

For example, the U.S. PE ratio trades at a 62% premium to its long-term average (34.8 vs. 21.4) versus 30% (24.6 vs. 18.9) for the world ex-USA. The crucial takeaway here is that while valuations are no longer cheap, modest increases in equity prices are possible as earnings grow into current valuations. Moreover, regionally, non-U.S. markets appear better priced than the U.S.—with their appeal boosted by sector composition. Non-U.S. markets are more cyclical and will likely be more significant beneficiaries of a broader global reopening. 

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Disclosures

These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions ...

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