Credit Suisse recently upgraded their full year outlook on the back of stronger economic conditions. They no longer see risks of a second half double dip (see here) and now believe the S&P 500 will reach 1,270 by year-end. Their mid-year target is still S&P 1,220. Their upgraded outlook is based on 5 factors:
1) We still expect GDP growth to surprise positively (41/2% global GDP growth this year)
2) Corporates are under-invested (if corporate FCF normalises investment could rise by 32%)
3) Aggregate labour income looks set to surprise positively (as corporates have over-shed labour)
4) China should have a soft landing (economic overheating is limited
5) Fiscal/monetary policy is still loose and the impact of a property-price decline looks manageable).
In addition, they say equities are still attractive compared to other asset classes and most investors are caught underweight equities:
“Equities still offer value relative to other asset classes. The equity risk premium is 5%. Our long-standing target (based on ISM and credit spreads) has been 4.5% (implying a 9% return), but if credit spreads stay unchanged, the ERP could fall to 4.1%. Equities also hedge investors against the two risks that we are most concerned about longer term: inflation and sovereign credit risk.
Mis-positioning: Pension funds and insurance companies still have abnormally low equity weightings. Since March 2009, retail investors have sold $82bn of equity and bought $93bn of bonds, and have just started to buy.”
The disconnect between credit and equity has widened as the economy has improved. Credit markets are back to levels where equities were at 1,335:
“The major macro and credit variables are back to levels when the S&P 500 was last at 1,335.”
Most importantly, CS says the new bear market is unlikely to begin in 2010. They now expect the bear market to begin in mid-2011:
“We postpone our expectation for the start of a new bear market to mid-2011E from end-2010E. We still believe that the big problem is $6.5trn of excess leverage, but this becomes an issue, in our opinion, only when we get a rebound in demand for private credit. This is unlikely to occur until mid-2011E as tighter bank regulations postpone a rebound in lending.”
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
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