All signs point to earnings growth in 2021

Given the extraordinary events of the COVID-tortured 2020, there are many things investors may not be able to ignore in in what is hopefully a less-traumatic 2021. The pick for investors might well be a brighter and more-assured earnings outlook that boosts risk appetites.

In November, two developments reinvigorated the earnings outlook:

1. the outcome of the US election
2. the announcement of very encouraging vaccine trial results.

In the US elections, the lack of a strong Democratic wave improved the outlook for profit growth because it reduced the mandate and political leeway for new laws that would reduce corporate profitability.

The upbeat vaccine trials were an even more positive development. As we know, COVID-19 disruptions savaged household and business incomes in 2020 to such an extent that governments were forced to provide massive support to stabilise economies. 

A successful vaccination program would virtually eliminate the risk of further outbreaks and thus allow economies to recover.

While the vaccine results have reduced economic uncertainty, some investment risks remain (setting aside other risks such as ever-present Eurozone frictions and regulatory scrutiny of Big Tech). Some people might refuse to have the vaccination, while others might not receive a second dose. Questions about the order in which citizens and countries receive the vaccine need to be resolved. Accordingly, some uncertainty around the pace of economic recovery remains.

For investors, both developments point to a more attractive outlook for earnings growth. The vaccine should underpin growth in companies’ top lines, while the election result ensures that these revenues will fall through to the bottom line in a way broadly similar to how they do now. 

As a critical mass of economic re-opening is possible by the middle of the year, the second half of the year may produce strong earnings growth.

But equity prices mirror more than just earnings – they also reflect the level of interest rates. Here central banks have made it clear they will need to see a sustained economic recovery, slimmer output gaps and durable inflation pressures before they tighten monetary policy.

We think interest rates will remain low for some time as the longer-term factors that have reduced interest rates remain intact. A key swing factor for interest rates is inflationary pressures, which we also believe will remain low for some time. But risks of inflation have considerably declined rather than evaporated, so the size of output gaps, the pace of central-bank balance sheet expansion and private credit growth are key signposts as to the fate of interest rates. 

One thing investors can't ignore in 2021

The above wire is part of Livewire's exclusive series titled "The one thing investors can't ignore in 2021." The series will culminate in the release of a dedicated eBook that will be sent to readers on Monday 21 December. You can stay up to date with all of my latest insights by hitting the follow button below.