Equities have generally generated solid returns so far this year, and the gradual rollout of corona vaccines and the reopening of the global economy are continuing to support economic growth. That is good for equities and other risk assets.

However, equities look expensive in P/E terms – which is the price investors pay for one unit (USD, DKK, EUR, etc.) of earnings in a company – and the massive economic momentum from reopening looks set to fade in the not-too-distant future. That will limit the return potential from equities in the coming year, which is why we at Danske Bank have just a slight overweight in equities – in other words, we have slightly more equities in our portfolios than we expect to have in the long term.

Slight overweight in equities still justified 
There is no playbook for how investors should navigate as the world emerges from a pandemic.

“In essence, we have been through an economic cycle on steroids, transitioning in the space of a year from decent growth to deep recession and now an economic boom. Right now, investors have to get the most out of the economic boom driven by the global reopening, but at the same time be prepared for the wave to potentially peak soon,” says Frank Øland.

More specifically, we at Danske Bank expect global equities to generate a return of -1 to +4% in the coming 12 months (in EUR). 

“While this is a modest return expectation, we nevertheless assess it to justify a small overweight relative to bonds, where we see an even more limited return potential. However, we acknowledge that the risk-return ratio for equities now looks less attractive than at the start of the year,” explains the chief strategist.

Where we see the greatest return potential
Frank Øland currently sees the greatest return potential in European equities. First, because Europe still has more reopening momentum to come than, for example, the US, where the vaccine rollout is more advanced. Second, the European equity market has a larger share of cyclical equities, which typically perform best during economic upswings. These include equities from among the financial, industrial and materials sectors. 

Nevertheless, Frank Øland emphasises that investors should not underestimate the significance of bonds in their portfolios.

“Bonds provide return stability for portfolios, not least during periods of turmoil, and while the economy and the financial markets are continuing to ride the reopening wave, it is sure to dip along the way,” says the chief strategist.

Inflation fears overblown 
Risk-wise, new virus variants, a sluggish vaccine rollout or a re-escalation of geopolitical conflicts could be detrimental for the financial markets. However, Frank Øland is currently keeping a particularly watchful eye on interest rates and inflation, which have triggered several periods of market turmoil this year and will presumably do so again going forward.

A demand boom coupled with shortages of various commodities and components, such as computer chips, has resulted in rising prices of late. This has increased investor worries about when central banks might begin to tighten monetary policy to keep inflation under control. Tighter monetary policy, in the form of rising interest rates, for example, would be an impediment for the economy and equity markets.

“However, we estimate the higher rate of inflation is largely due to temporary imbalances, in part because we will continue to buy additional material goods as long as the opportunities to spend money on experiences and holidays remain limited. Our main scenario therefore does not envisage inflation and rising interest rates as being a major or enduring hindrance for equities and other asset classes in the time ahead,” explains Frank Øland.

Yet, this does not prevent fears of inflation and rising interest rates being in themselves enough to trigger periods of market jitters and volatility. Likewise, says the chief strategist, we could see a negative market reaction when signs emerge of growth having peaked – even though we can expect growth to remain solid thereafter.

This content is not investment advice - you should always speak to an advisor about how a possible investment matches your investment profile before making an investment.