This is where the most underpriced equities are hiding

Scott Berg

T. Rowe Price

Equity markets delivered extraordinary returns in 2020, but, given the return of uneven and contradictory news flow, the first quarter of 2021 will certainly test investors. Expectations of further monetary and fiscal stimulus, along with positive news on vaccines, have helped support equity markets. However, a new variant of the virus is putting increased pressure on healthcare systems, and we are seeing more and more countries locking down again. 

We believe this will have economic repercussions for many and, at a minimum, will defer some of the fundamental rebound investors have been anticipating. We also need to factor in political change. What does the “blue wave transition” in the US mean for companies and policy decisions, especially around taxation and US-China relations? 

As we look out to the rest of 2021, we remain optimistic when we analyse the return potential of global equity markets. However, volatility is likely to increase, in part, as higher dispersion within factors, styles, and sectors emerges. For investors to try to make money in this environment, they will have to be more selective and active, which may at times mean taking a more contrarian approach. 

Navigating through a COVID‑on/COVID‑off environment 

We expect the COVID-on/COVID-off trade to continue to flip-flop back and forth as it did through the later stages of 2020. We believe secular growth stocks, at the right price, should continue to compound good returns, but the setup into mid-year might imply a continuation of the rotation trade into value, small-caps, and non-U.S. stocks that began toward the end of last year. Certainly, increasing exposure to stocks with earnings sensitivity at this point in the market cycle could potentially reap rewards. But selectivity will remain crucial in a world that remains defined by extreme outcomes.

Further positive news on vaccines would also help those sectors that have been most damaged by the virus, such as travel, leisure, energy, and financials. Indeed, we have been adding individual names to these areas but have been very selective, using our global research platform to identify the best candidates.

We have increased our exposure to financials. However, rather than focusing on traditional banks, where zero and negative interest rates continue to hurt balance sheets - we have instead been concentrating on areas such as investment banking, insurance, and investment managers. These are companies that should actually benefit from a lower interest rate environment.

While new vaccines should eventually allow us to exit this pandemic, we believe that many of the trends that have evolved over the course of the past year will endure. COVID-19 has unleashed these trends even further. We expect increased adoption of digital payments, having food delivered to your door and using technology to connect with each other. 

There has been a meaningful step-change in the penetration of e-commerce globally, and we believe there is still a long way for this dynamic to go. The advantage for us, as global investors, is that the opportunity to scour all geographies using our global research platform to find, in our view, the best investment opportunities.

Looking beyond the US to discover new opportunities

With US equities having performed so strongly, we have been looking for better value elsewhere. Asia-Pacific and Europe are the two places where we have been increasing our exposure. 

It is our belief that Asia is the place where the gravity of the world is moving toward. It’s where markets are deepening the most, where economies have been growing the fastest, and where, currently, the most billionaires are now being created. In that sense, it is where the most unpriced change can be found for investors.

China’s recovery from the pandemic has been in stark contrast to developed markets. It is likely to be one of the few countries to see positive economic growth in 2020. More generally, while the emerging market (EM) growth premium has been decelerating for some time and collective earnings have been disappointing, many individual EM economies retain long-term advantages when thinking about the potential return generation from equities. 

Today, our preferred markets are in India, Indonesia, the Philippines, and Peru, while we also have high-conviction positions in Chinese consumer stocks.

We also believe that Europe now looks more attractive. Although it doesn’t offer the breadth of high-growth opportunities that the US or China can offer, there are a number of change-driven stocks we feel confident about in a world that should be marked by improvement, especially from spring 2021 onwards — either where stock valuations have fallen sharply, priming them for reversion, or where we have identified a fundamental change in a company’s earnings profile. Key for us, at this point in the equity cycle, is the ability to find profits growth, as this remains the most powerful driver of stock prices over the long term.

In a complex macro environment, a stock‑specific focus is key 

One natural concern is whether equity markets have rebounded too strongly and quickly, especially given the concentration of stock returns. This does create some potential for a broad bubble to form if good news is uninterrupted.

Our view, however, is that although valuations are at a premium in an absolute sense, we are also in a world of unparalleled monetary and fiscal support, which has naturally supported risk assets. Interest rates across the globe are at rock bottom, while at the same time, there is a huge wall of money looking for a home. On that basis, we don’t believe that valuations are extreme, and equity markets will continue to offer opportunity, especially relative to alternatives.

The environment, however, is inherently more stock-specific than it has been for some time. 2021 is likely to present opportunities to invest in bouts of volatility. This is certainly likely if conditions worsen before they get better, and we believe there will certainly be data points for market bears to point to in the coming months ahead. 

There are also clear concerns in the market that, beyond monetary support, there is no fundamental improving “bull” case for global equities. However, this aggregate top-down perspective on the world belies the ongoing breadth of stock-specific fundamentals we continue to find, especially in secular growth stocks benefiting from changes in society and in our economy. 

A world of dispersed valuations and corporate outcomes are ultimately beneficial to active investors, and we shall look to exploit those factors for our clients in 2021.

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Portfolio Manager
T. Rowe Price

Scott Berg is the portfolio manager for the T. Rowe Price Global Growth Equity Strategy.

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