Monthly Equity Market Topics

Navigating the US Equity Party

The spotlight is firmly on the United States as markets have surged in the wake of the election, buoyed by anticipation of a Trump-led administration, boosting an already robust economy. We believe this optimism is rooted in the promise of lower taxes, deregulation and protective tariffs to bolster US manufacturing. The momentum is palpable, and it’s become a popular consensus trade. Meanwhile, Europe seems to have missed the invitation, with sentiment on the continent significantly more subdued, primarily due to economic challenges in Germany and political stagnation in France. However, countries like Spain, Greece and parts of Eastern Europe are showing promising signs of economic health.

According to FactSet, the forward P/E ratio stands at 22x for the S&P 500 and 13x for the MSCI Europe. With the S&P 500 having rallied 26% over 2023 and a further 30% year to date, and with expected EPS growth of 14% next year, it’s clear the US market commands a premium. However, with high expectations already baked into valuations, US investors should anticipate returns in the ballpark of 15% to 16% over 2025, aligned with growth in earnings and dividends. While US market momentum remains strong, the unfolding of the new administration’s policies — and the influences shaping them — remain to be seen. It’s a challenging landscape to navigate with certainty, particularly as we watch for potential shifts in 10-year yields.

On the other side of the pond, Europe’s low expectations contrast with anticipated earnings growth of about 8% and an additional 3% in dividends for 2025, suggesting a total return of 11% to 12%. Several catalysts could potentially rerate European markets:

• A resolution in Ukraine might stabilize the region and reduce energy costs.
• Economic improvements in China could bolster European earnings, especially if accompanied by additional fiscal support.
• Upcoming German elections might lead to fiscal reforms, potentially relaxing stringent budget deficit restrictions.
• Positive real wage trends and potential ECB rate cuts could encourage consumer spending, which has been subdued.
• Lower ECB rates could benefit European companies as they have significantly higher exposure to floating rate debt that US companies. 
• Attractive valuations could make European companies prime targets for M&A.

For US investors, the strength of the US dollar is a critical factor when considering non-US returns. Although the dollar has strengthened post-election, the broader implications of US policies, including the Federal Reserve’s actions, will play a crucial role in shaping the dollar’s trajectory.  The status of the USD as the world’s reserve currency, coupled with robust demand for US financial assets, may continue to exert upward pressure on the dollar, although a weaker dollar could improve the trade deficit, something the incoming administration are seeking to remedy.

US Manufacturing Poised for Liftoff 

Last week we saw the Richmond, Dallas and Philadelphia Fed manufacturing expectations indices all move decisively upwards. In our opinion, this looks positive for a recovery in the US Manufacturing PMI. Recovering PMIs are typically a good sign for equities, specifically for riskier or higher beta, lower quality stocks. There has been some evidence of this, with small caps running higher on expectations of a recovery in earnings. 

But as has been the case with many things in the wake of the pandemic, not everything seems to be following a “normal” path. Credit spreads are already extremely tight, markets have rallied with valuations expanding all year as they have priced out macro risks and focused on growth and earnings over inflation. All of this before we have seen any meaningful recovery in manufacturing PMIs to whet risk appetites. 

Typically, it warrants caution when sentiment is so strong and the outlook for the US economy seems unanimous. We question the ability of the market to stage a further risk-on rally given where we stand today, with investors having seemingly discounted most concerns facing US equity markets. If the focus turns to inflation remaining higher than desired and driving 10-year rates higher, this could prove problematic for the equity market. The market can easily manage with inflation being in the 3-4% range, but there is uncertainty as to how the Fed will react. We also believe it is inappropriate, given the current set up, to be loading up on risk and beta in anticipation of multiples continuing to expand as is typical in a rising manufacturing PMI cycle. While there may be some additional incremental opportunities to be had across small, mid and large caps, it is important to focus on higher quality earnings and companies with stable and strong earnings outlooks and positive earnings revisions.

The views expressed herein are those of the MFS Strategy and Insights Group within the MFS distribution unit and may differ from those of MFS portfolio managers and research analysts. These views are subject to change at any time and should not be construed as the Advisor’s investment advice, as securities recommendations, or as an indication of trading intent on behalf of MFS.

No forecasts can be guaranteed.

Diversification does not guarantee a profit or protect against a loss. Past performance is no guarantee of future results.