Asset Allocation Video

How Much Upside is Left in Equity Markets?
Tim Murray, CFA Capital Markets Strategist, Multi‑Asset Division
Key Insights
  • Given the strong rebound in equity markets, stock valuations are elevated, and investors are wondering if the rally will continue.
  • We believe revisions in earnings estimates could potentially benefit small-cap, value, and emerging markets equities.

Equity markets have rebounded strongly, but revisions in earnings estimates could potentially benefit some asset classes.

Key Insights
  • Given the strong rebound in equity markets, stock valuations are elevated, and investors are wondering if the rally will continue.
  • We believe revisions in earnings estimates could potentially benefit small-cap, value, and emerging markets equities.

Equity markets have rebounded rapidly since the drastic coronavirus-induced sell-off a year ago and have powered past pre-crisis levels. As a result, stock valuations are elevated, and many investors wonder if the rally will continue. 

With extended valuations, hope for further upside mainly rests in earnings growth. Massive pent-up demand, robust fiscal stimulus, and the prospects of fully reopened economies are good reasons to expect strong earnings growth in 2021 and 2022. However, as shown in Figure 1, U.S. equity markets seem to have already priced in some of this expected earnings growth. Meanwhile, equity markets outside the U.S.—especially in emerging markets—appear to have more upside potential. 

Keep in mind, earnings estimates are continually revised, and a review of estimate trends during the first two years of recovery following the last two recessions shows that estimates generally increased. In our view, such upward revisions may seem likely in periods of strong economic recovery, as is expected in 2021 and 2022. Notably, the pattern for three- to seven-year periods after recessions, however, shows a decline in earnings estimates over time. 

Although positive revisions in earnings estimates could be supportive, most of the good news appears to be already priced into equity markets, and the upside potential going forward may be somewhat limited. Therefore, the Asset Allocation Committee recently decreased overall equity exposure but maintained a tilt toward segments most sensitive to economic conditions—such as small-cap, value, and emerging markets equities—that could likely benefit from upward revisions in earnings estimates.

The Upside Potential for Equities May be Limited

Upward revisions of earnings estimates could be supportive

(Fig. 1) Much of the Expected Earnings Growth is Already Priced In & (Fig. 2) Average Change in S&P 500 Earnings Expectations

As of March 31, 2021.

Past performance is not a reliable indicator of future performance. Actual future outcomes may differ materially from estimates.

Sources: Standard & Poor’s, MSCI, and I/B/E/S. T. Rowe Price analysis using data from FactSet Research Systems Inc. All rights reserved. See Additional Disclosures.

1 Comparing percentage change in earnings growth estimates for 2021 (and 2022) versus pre-pandemic earnings generated in 2019.

2 Shows the average monthly change in calendar-year earnings expectations during the first two years following the 2001 and 2007–2009 recessions.

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Additional Disclosures

The “S&P 500 Index” is a product of S&P Dow Jones Indices LLC, a division of S&P Global, or its affiliates (“SPDJI”) and has been licensed for use by T. Rowe Price. Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC, a division of S&P Global (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”). This product is not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P or their respective affiliates, and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500 Index.

MSCI and its affiliates and third party sources and providers (collectively, “MSCI”) makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein.  The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products.  This report is not approved, reviewed, or produced by MSCI.  Historical MSCI data and analysis should not be taken as an indication or guarantee of any future performance analysis, forecast or prediction.  None of the MSCI data is intended to constitute investment advice or a recommendation to make (or refrain from making) any kind of investment decision and may not be relied on as such.

I/B/E/S © 2021 Refinitiv. All rights reserved.

Financial data and analytics provider FactSet. Copyright 2021 FactSet. All Rights Reserved.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of May 2021 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Small-cap stocks have generally been more volatile in price than the large-cap stocks. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. The value approach to investing carries the risk that the market will not recognize a security’s intrinsic value for a long time or that a stock judged to be undervalued may actually be appropriately priced. All charts and tables are shown for illustrative purposes only.

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