Our analysis of the impact of uncertainty on economic activity shows that renewed tensions could weigh on growth and delay the recovery in investment (see The Impact of Economic Uncertainty on Investment (groupama-am.com)). However, when uncertainty is already high, it is more likely to decline than to increase further. Consequently, the primary downside risk in our scenario is not linked to political, geopolitical, or trade-related uncertainty. In the "risk balance" underpinning our economic scenario, the main downside factor lies elsewhere, namely in financial instability and, more specifically, in U.S. equity markets (see the table "Risk Balance in Our Economic Scenario for Autumn 2024"). Following the strong rise in U.S. equities in 2024, driven by the AI theme, this risk factor has logically become more significant (see Charts 1 & 2).
Return to a More "Balanced" Risk Assessment
Positive (+) | Negative (-) |
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Reading note: The risk assessment indicates the most likely direction of a revision to our growth forecasts. Thus, a risk assessment now described as "balanced" means that an upward revision of growth projections is considered as likely as a downward revision.
Source: Bloomberg – Calculations: Groupama AM
Source: Bloomberg – Calculations: Groupama AM
The valuation diagnosis of equities should not be conducted against a "historical average", which is rarely a relevant benchmark. Just as bond yields are always assessed in light of prevailing economic conditions, equity analysis must also be framed within the broader macroeconomic environment.
With this in mind, we have modelled the return on U.S. equities, using the inverse of Robert Shiller’s CAPE ratio (the cyclically adjusted price-to-earnings ratio), based on five economic variables: interest rates, two cyclical indicators (the unemployment rate and inflation), and two structural factors (productivity and demographics, measured by the share of the population aged 30 to 64 in the total population). The gap between the observed equity return and its "theoretical" return therefore provides a valuation measure that takes into account the prevailing economic regime.
Our statistical analysis shows that the rise in equity markets during 2024 pushed U.S. equity returns into an "abnormally low" zone relative to both cyclical and structural fundamentals (Chart 3). Current equity returns are "too low" compared with their theoretical level, implying, in principle, a significant increase in dividends, potentially complemented by an adjustment in equity prices. While the magnitude of the valuation gap varies depending on the model used, all models indicate that the divergence has now reached levels not seen since the late 1990s (Charts 4 and 5).
