Equities: Valuation reset underpins new highs – Danske Bank

Danske Research Team observes US equities extending their rebound, with the S&P 500 and Nasdaq posting fresh record highs and cyclical laggards leading gains. The team argues markets are not excessively optimistic, noting valuation multiples have compressed over the past year and quarter. They stress that future nominal earnings growth remains the key driver of broad equity performance despite energy and rate headwinds.

Record highs framed by cheaper valuations

"Equities continued its rebound yesterday, with both the S&P 500 and Nasdaq reaching fresh record highs, gaining 0.5-0.6% respectively. Unlike earlier this week, yesterday's session had a clear relief-rally character. Some of the weakest-performing sectors in recent months led the market higher, with utilities, real estate, and consumer discretionary up between 1% and 3% on the day."

"New all-time highs may seem inconsistent with the renewed escalation in the Middle East, sticky high oil prices, rallying bond yields and central banks' increasingly tightening. However, it is worth remembering that the S&P 500 has already shed roughly a fifth off its valuation multiple over the past year. Only over the last quarter, S&P 500 has become 5% cheaper, even after the recent rebound."

"For that reason, we disagree with the view that equity markets are excessively optimistic. In our view, markets have priced the current earnings backdrop fairly conservatively throughout this year."

"The fact that equities, credit markets, and bonds have reacted differently in recent weeks does not necessarily mean that one asset class is right and another is wrong. Rather, they represent different things."

"For equities, the dominant driver is future nominal earnings growth. The energy shock is visible, more so in certain sectors than others, and higher rates are restraining parts of the market. Nevertheless, earnings remain the key determinant of broad equity performance, provided that returns on investment continue to grow faster than the discount rate, which, so far, is the case."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)