US equity valuations remain resilient

By Peter Garnry, Head of Equity Strategy at Saxo Bank

Equities are defying all negative forces from China slowing down, inflation pressures building, commodities rallying, and yields moving higher. In the short term it seems investors will rather hold equities than bonds in their quest to protect capital from rising inflation.

Despite inflation expectations are rising faster than nominal yields, China is slowing down, and a new potential commodity super cycle and supply chain constraints are impacting profit margins in the Q3 earnings season, global equities continue to rally with S&P 500 closing at a new all-time high on Friday. Our equity valuation model with the latest data for October shows that broad-based equity valuations on US equities were a tiny inch from setting a new all-time high. This is a remarkable feat by global equities and it seems like for now that investors are favouring equities over bonds amid rising inflationary pressures. We agree with that assessment and history shows that equities are able to absorb inflation well in the short-term, which brings us to the more serious question of sustained inflation.

If the world is moving into a world of sustained higher inflation rate and nominal yields suddenly reflects that, then global equity valuations will be reset to a lower level causing a substantial drawdown in equities. Our view remains that the themes investors should be overweight are mega caps, cyber security, semiconductors, logistics, India, and the commodity sector. Rising inflation and interest rates will also penalize companies with high debt leverage and low profit margins.

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