The information in this article is current as at 2 January 2022.
Overview
The MSCI World (ex-Australia) Accumulation Index (AUD) returned 11.7% over the six months and 30.1% over the twelve months to 31 December 2021.
Outlook
Over the next 12 months we expect corporate earnings will continue to grow, but at a slower pace than in 2021. Headwinds include a moderation in global growth as fiscal stimulus is gradually wound back, a higher interest rate environment, and the continual spread of the Omicron variant.
Our expectations for stubbornly high inflationary expectations to eventually feed through to higher US interest rates has strengthened. Annual growth in headline US inflation was 6.8% in the year to November with a rising contribution from house prices likely to drive the index higher in the months ahead. This has prompted the Federal Reserve (‘the Fed’) to revise its forward guidance, with three rate rises of 0.25% each now expected in the year ahead. As asset prices are a function of overall expectations of future earnings, higher earnings will be partly offset by a higher cost of capital (that will effectively reduce the present value of the future income stream), potentially limiting share-market gains over the next 12 months to single digits as was the experience in 2018, the most recent tightening cycle in the US. In 2018, global equities only returned 1.5% for Australian investors. As shown below, the US remains overvalued (investors overpaying at current share prices) with potential downside corrections ranging from 18% to 31%. The US accounts for the vast majority of total market value in global equities (70.6% as of 30 November1) so this downside scenario suggests caution remains advised for overall international exposure.
Omicron could further exacerbate inflationary trends by shutting down production or slowing trade which could add to the Fed’s case for higher near-term rates. Finally, bond markets are arguably pricing in a policy mistake with the yield curve inverting in recent weeks as longer-term yields have been falling (implying weaker long-term growth expectations) while short-term yields have picked up. This implies that bond markets think that any aggressive tightening from the Fed could derail the economic expansion, leading to much weaker outcomes over the medium to longer term.
Valuations
In the United States, operating earnings for S&P 500 companies are currently expected to rise by 9% in 2022. Assuming a 10% growth rate in 2023 and conventional long-term multiples, we estimate that the United States sharemarket (as measured by the S&P500) is overvalued by between 31% in the near term and 18% over the medium term.
| 2021 Calendar Year Forecast | EPS earnings Estimates (US$) | S&P 500 Fair Value Estimate | Upside/(downside) S&P 500 = 4,710 |
| Consensus | $202 | 3,232 | -31% |
| If 10% below | $182 | 2,909 | -38% |
| If 10% above | $222 | 3,555 | -25% |
| 2022 Calendar Year Forecast | EPS earnings Estimates (US$) | S&P 500 Fair Value Estimate | Upside/(downside) S&P 500 = 4,710 |
| Consensus | $220 | 3,520 | -25% |
| If 10% below | $198 | 3,168 | -33% |
| If 10% above | $242 | 3,872 | -18% |
| 2023 Calendar Year Forecast | EPS earnings Estimates (US$) | S&P 500 Fair Value Estimate | Upside/(downside) S&P 500 = 4,710 |
| Consensus | $242 | 3,872 | -18% |
| If 10% below | $218 | 3,485 | -26% |
| If 10% above | $266 | 4,259 | -10% |
Source: S&P consensus estimates for 2021 and 2022 as at 15 December 2021, 2023 is an assumption
In contrast, forward Price-to-Earnings (P/E) multiples broadly remain either below or in-line with longer-term averages in most other major markets, as follows:
| Region | MSCI Forward PE2 |
| All Country World (ex-US) | 21.2 |
| Emerging Markets | 12.2 |
| United Kingdom | 11.5 |
| Japan | 14 |
| Eurozone | 14.8 |
| China | 12.4 |
Conclusion
Recommendation: Move from slight underweight to underweight.
We anticipate earnings growth to be positive in 2022 (supported by elevated household savings) but weaker than 2021 given headwinds from scaled-back stimulus spending as well as risks such as emerging coronavirus variants, the latest being Omicron. Share prices are also expected to be challenged by the prospect of higher interest rates in the US which will make other asset classes such as cash and bonds relatively more attractive, posing a headwind to further price appreciation.
1 MSCI World ex Australia Index as at November 2021: https://www.msci.com/documents/10199/c27eeea3-ad05-4944-bef4-fbaef9ef34ec
2 Forward PE = price divided by 12-month forward consensus expected operating EPS. Source: https://www.yardeni.com/pub/mscipe.pdf (as at 8 December 2021)
Liability limited by a scheme approved under Professional Standards Legislation. Any advice included in this article is general only and has been prepared without taking into account your objectives, financial situations or needs. Before acting on the advice you should consider whether it’s appropriate to you, in light of your objectives, financial situation or needs. You should also obtain a copy of and consider the Product Disclosure Statement for any financial product mentioned before making any decisions. Past performance is not a reliable indicator of future performance. Advisors at Pitcher Partners Sydney Wealth Management are authorised representatives of Pitcher Partners Sydney Wealth Management Pty Ltd, AFS number 336950.
