Credit Suisse’s global equity strategists just issued fresh guidance to stock investors: The near term doesn’t look great, but the next year looks promising.
That long-term bullishness informs the firm’s recommendation to buy stock-market dips when given the opportunity. It may take a while for solid gains to materialize, but Credit Suisse said such a strategy would pay off for patient investors.
“We would be buying into weakness and expect end-21 market levels to be much higher,” the team led by strategist Andrew Garthwaite told clients in a Wednesday report, referring to the end of 2021.
At Credit Suisse, the strategists boiled down their thinking to five main points around why the current environment lends itself to buying opportunities.
The risks they list to this overall thesis include “early fiscal tightening” from the government and limited immunity among people who have recovered from the virus. Many Wall Street strategists have pointed to the number of new coronavirus infections as the chief metric in assessing the market’s direction and recovery.
1. ‘We should approach pre-virus GDP levels in the US and Europe by end-2021.’
With an estimate for a year-end 2021 recovery, the strategists are drawing on Credit Suisse economists’ views around when gross domestic product will return to previrus levels.
That’s more optimistic than the view of the International Monetary Fund, which the firm views as “consensus,” and does not call for a recovery in economic output soon.
“To a large extent, we think we have now seen the appropriate monetary and fiscal response required to return to pre-virus levels of GDP by end-2021,” the strategists wrote.
Last month, the Federal Reserve lowered its benchmark interest rate twice, and the federal government passed a $2 trillion stimulus package to aid the US economy. Part of that effort included a small-business-loan program to assist struggling businesses and their employees.
“The key is whether we have the appropriate level of loan guarantee schemes in place to prevent a very large rise in bankruptcies and very large amounts of fiscal easing to offset the rise in the saving ratios,” Credit Suisse wrote.
2. The government’s efforts to alleviate some pain will ‘remain easy.’
The strategists think fiscal policy “will remain easy” and that “easy money, easy fiscal policy, and central banks encouraging an inflation overshoot will allow inflation to rise” to between 2.5 and 3%.
In other words, Credit Suisse thinks eased lending conditions from the Fed — combined with government-led fiscal-stimulus efforts — will buoy the market in the future.
In fact, the team believes the “only economically and politically pragmatic solution” out of this crisis is a “very extended period of negative real rates.”
At the same time, they said modern monetary theory — a theory that says governments can print more money to avoid a deficit while keeping a lid on inflation — would now give the government cover to maintain loose fiscal policy.
3. Equity risk premium is proving to be a more reliable gauge of the market’s direction than its price-to-earnings ratio.
The strategists untangled two complex gauges of market returns and value in one of their main reasons for forecasting a market recovery next year.
Equity risk premium is reflecting a more accurate picture of the market’s health than its price-to-earnings ratio (P/E), the measure of a company’s share price to its earnings per share, they said.
“The ERP remains supportive, unlike P/E,” they wrote.
Equity risk premium (ERP) refers to the extra return investors should expect to receive by investing in stocks, traditionally riskier assets than safe-haven government bonds, for instance.
“Based on P/Es, one would expect the market to hit new lows,” they wrote. “But the key is that a permanent fall in the real bond yield pushes up the ERP,” they added, referring to yields that account for the rate of inflation.
4. The dividend-futures market has fallen too far, suggesting there’s upside ahead.
Another reason the strategists believe the broader equity market is poised to rise next year is that the market has dramatically fallen for dividend futures. In their eyes, it’s been too extreme of a move.
Dividend futures are sophisticated exchange-traded derivative contracts that allow investors to place bets around a company’s future dividend payments to shareholders.
That market’s direction can offer insight into how companies are planning to spend their cash and, by extension, paints a picture of their broader health.
“Clearly the market does not trade earnings futures, but it does trade dividend futures,” the strategists wrote, adding that dividend futures for the US, Europe, and particularly the UK “look too pessimistic.”
“We really struggle to see 2021 DPS in the US, Europe and the UK down by 28% to 56% from pre-virus levels given our view on the recovery,” they added, referring to dividends per share.
Several companies have pulled back their planned dividend payouts in an effort to preserve cash in recent weeks.
For instance, Ford said last month it would suspend its dividends, a move that will save the automaker $2.4 billion annually, according to a Reuters estimate.
5. ‘History is not a guide.’
“History is not a guide this time around” for assessing the market environment, the strategists said.
They floated the idea that the market’s recent recovery from March lows was a “bear-market rally,” or a short-term bounce in the middle of a longer-term bear market. Bank of America analysts likened the recent move to the bear-market rally during the global financial crisis, Markets Insider reported this week.
But that doesn’t appear to be the case, and the S&P 500 won’t dip below the March lows, Credit Suisse said.
According to the strategists, bear markets paired with economic recessions usually experience lows at least six months after a market tops out. But since 1940, bear-market rallies have been no greater than 21% — whereas stocks have jumped 28.5% at their peak this month.
“This is the largest bear market rally since 1940 … if it is a bear market rally,” they wrote.
They added: “The key question is whether the current situation is sufficiently different from past downturns to convince us we have seen the market lows; we believe it is.”
Junior Trader Radi Djuma