Credit Suisse: Don't Sell Equities; Defensives Offer Value

The analysts at Credit Suisse write in the global equity strategy note today:

We stick to our year-end target of 1,100 and our mid-2010 target of 1,150 on the S&P 500. There are, we believe, the following key supports for equities:

• Macro economic outlook: We envisage 4% global GDP growth in 2010, and 3% in the US, with muted inflation. The inventory build has yet to start, US housing is turning, China is set for 10% GDP growth, corporates are under-invested and have over-shed labour (non-farm payrolls should turn positive in Q1). We do not worry unless the US 2-year yield rises above 1.5% (in anticipation of a Fed hike, 2H 2010), there is a funding crisis (2011) or Chinese wages accelerate (2011).
• We forecast 29% US earnings growth in 2010. Our models suggest that the ‘cyclical’ improvement in margins only reverses when unemployment is sub-7%. Revenue expectations for 2010 are too low, in our view.
• When major macro and credit related variables were last at current levels, the S&P was 25% higher.
• Valuation is OK. On trend earnings, valuations are neutral-but on consensus earnings, the equity risk premium is 5.5% -leaving equities some 20% cheap. The gap between the FCF and corporate bond yield is extreme.
• Positioning/liquidity: retail investors continue to be sellers; institutions are underweight; excess liquidity is extreme (26% of announced QE is yet to be implemented).
• Tactical indicators: we do not want to downgrade equities tactically unless corporate net issuance is more than 1% of market cap (currently, it’s 0.1%); risk appetite/sentiment is in euphoria zone; or, earnings momentum and economic data start to disappoint.

We would highlight some defensive areas (as part of our bar-bell strategy), given that cyclicals have retraced all their underperformance seen in the year prior to the market low, have (unusually) decoupled from bond yields and look expensive on Holt (in the US, in particular). Our favoured defensive themes are: quality growth, European telecoms, consumer staples with high FCF and GEM exposure and high yielding stocks with better than market earnings momentum. We maintain our overweight in some corporate spend related cyclicals (tech, media, hotels) and steel.

Let's start looking at macro reasoning: I still see rather high inventories-to-shipments ratio in US, no rush to build inventories, in my view; US housing will turn only after excess housing units are reduced; China will report whatever is necessary and right for them; corporates have over-shed labour? Wait, just today I read Johnson & Johnson to slash 7,000 to 8,000 jobs, Nokia Siemens plans to eliminate as many as 5,760 jobs ... but those are global jobs...

However, one is clear - excess liquidity has been positive ... click on picture to enlarge, courtesy of Credit Suisse.