Equities in 2011: More alpha, less beta
- Economy: heading for a dip in growth
- Upside potential for equities in H1 – weaker towards the end of the year
- DAX target of 7,600 points by the end of 2011
Despite the impressive growth this year, the global economy may still not be out of the woods yet because the upturn was brought about by monetary and fiscal policy measures. This "pump priming" will no longer be available in 2011. At the presentation of the bank's Outlook 2011 publication, which examines the prospects for the economy and the equity markets, WestLB's Chief Economist, Holger Fahrinkrug, remarked "For industrialised countries in particular, we ask how well will economies adapt to life without a stimulus cocktail and what withdrawal symptoms will appear". WestLB's economists expect the recovery in the global economy to continue – with the pace still varying considerably. Overall, the growth rate will weaken to 3.8%. Global growth will depend on the emerging economies – especially in Asia – even more than it did this year. The outlook is subject to high uncertainty, given the numerous imponderables. These include the effectiveness of quantitative easing measures, the impact of the eurozone debt crisis on growth as well as the question as to whether China can manage to achieve a soft landing. If it fails to do so, this would have severe repercussions especially on the German economy, which otherwise has good prospects of outperforming most other industrialised countries again as regards economic growth. WestLB's economists forecast that GDP growth in 2011 will come to 2% for Germany and 1.3% for the eurozone, which will however continue to exhibit major disparities.
Corporate earnings: continued upward trend is in doubt
In many sectors, memories of the dramatic collapse in the last recession have been overshadowed by the momentum at which revenues, earnings and margins have recovered. There are a host of risk factors that make an ongoing, multi-year dynamic upward move in corporate earnings less likely. The confidence in the consensus earnings expectations and in sentiment indicators appears to us to be too high, especially with a view to the debt crisis in the eurozone. Over the years until 2012, we expect only slight improvements in margins and a positive but far slower earnings trend than in 2010. The consensus is clearly overestimating, in particular, earnings growth contributions from cyclical companies.
A year of finding new favourites
Martin Gilles, WestLB's Head Equity Strategist, expects that "2011 could develop into one in which investors find new favourites in two respects ". First, we believe earnings growth will be fairly moderate – especially for cyclicals. Investors may well consequently focus increasingly on stable earnings and forecasting reliability. All things considered, caution is advisable with regard to earnings growth – less beta! At the same time, medium-term return targets could come more to the fore in asset allocation and point towards increasingly the use of diversification as a strategy to lower portfolio risk. Euro corporate bonds have lost their nimbus as a high-yield, low risk assets and the low returns German government bonds offer mean that they are not an alternative either. This too results in a switch to equities offering an attractive dividend yield – more alpha!
Equity markets are showing two different faces in 2011. We expect share prices to reflect a more traditional seasonal pattern during the year as well. In the first half of the year, the markets should still get some support from the earnings side. However, we see the greatest potential for share price gains stemming from a re-balancing in asset allocation. The renaissance of high-dividend stocks in particular is key for the market. An interim peak of some 10% beyond WestLB's target prices for the end of the year is possible. This would suggest that the relative strength of German equities will continue in H1 2011.
Over the rest of the year, the markets may well increasingly focus on the weaker underlying momentum in economic activity and earnings, and the valuation expansion observed until then may be reviewed critically, especially with a view to the prospects for 2012. The trend in H2 could also be negatively impacted by rising yields in rival asset classes triggering another rebalancing of asset allocations. Our targets for the end of 2011 are 2,900 points for the EURO STOXX 50 and 7,600 points for the DAX.
The WestLB Top Picks List for 2011 consists of companies: (1) that offer an attractive dividend yield and/or whose valuations we believe offer catch-up potential (defensive picks), (2) whose expected earnings trend is considered to be stable and not particularly dependent on macro conditions even in the event of an economic slowdown over the course of next year (alpha picks) and (3) with a business model that is transparent and offers a convincing growth story – this means that future earnings growth may also be able to justify further upside potential (selective beta/growth pick). The top picks for 2011 include: Deutsche Post, Ericsson, Hannover Re, K+S, Linde, Metro, Novartis, Telefónica, ThyssenKrupp and Volkswagen Pref.
Attachment
Forecast tables