30 April 2021 / ASSET ALLOCATION VIEWPOINT
How Much Upside is Left in Equity Markets?
- 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
This material is being furnished for general informational purposes only. The material does not constitute or undertake to give advice of any nature, including fiduciary investment advice, and prospective investors are recommended to seek independent legal, financial and tax advice before making any investment decision. T. Rowe Price group of companies including T. Rowe Price Associates, Inc. and/or its affiliates receive revenue from T. Rowe Price investment products and services. Past performance is not a reliable indicator of future performance. The value of an investment and any income from it can go down as well as up. Investors may get back less than the amount invested.
The material does not constitute a distribution, an offer, an invitation, a personal or general recommendation or solicitation to sell or buy any securities in any jurisdiction or to conduct any particular investment activity. The material has not been reviewed by any regulatory authority in any jurisdiction.
Information and opinions presented have been obtained or derived from sources believed to be reliable and current; however, we cannot guarantee the sources' accuracy or completeness. There is no guarantee that any forecasts made will come to pass. The views contained herein are as of the date noted on the material and are subject to change without notice; these views may differ from those of other T. Rowe Price group companies and/or associates. Under no circumstances should the material, in whole or in part, be copied or redistributed without consent from T. Rowe Price.
The material is not intended for use by persons in jurisdictions which prohibit or restrict the distribution of the material and in certain countries the material is provided upon specific request.
It is not intended for distribution to retail investors in any jurisdiction.
Canada—Issued in Canada by T. Rowe Price (Canada), Inc. T. Rowe Price (Canada), Inc.’s investment management services are only available to Accredited Investors as defined under National Instrument 45-106. T. Rowe Price (Canada), Inc. enters into written delegation agreements with affiliates to provide investment management services.
© 2021 T. Rowe Price. All rights reserved. T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks or registered trademarks of T. Rowe Price Group, Inc.