gipa69
collegio dei patafisici
Idea of the Day – Upgrading equities (A Garthwaite)
- We tactically cut our overweight in equities in mid-February and reduced to benchmark in mid-April. Global equity markets have fallen 7% since mid- February. We now reverse half of our tactical downgrade by returning equities to 2% overweight from neutral.
7 out of 9 of our tactical indicators have fallen to levels consistent with the lows of a mid-cycle correction: these are macro surprises (bottom of its range), ISM (has to be below 55), equity sector and global risk appetite, the high yield/BAA spread, equity sentiment (which is approaching the lows seen last summer) and the proportion of stocks above their 10-week MA. Equities have not fallen by the 12% typical of a mid-cycle correction, but with so many other indicators consistent with a trough, we think it is appropriate to upgrade.
Fundamentally, we remain bullish and stick to our year-end S&P 500 target of 1,450 (our US strategist is more cautious): a) we think this is only a mid-cycle slowdown and look for global growth of 4% this year and for US growth to reaccelerate to 3% in 2H 2011, with global IP momentum bottoming now, according to our fixed income strategy team and our 10-factor indicator of US growth recently stabilising; b) equities offer relative value: the equity risk premium is 6.3% versus our warranted equity risk premium (dependent on ISM and credit spreads) of 4.8% (potentially falling to 4.5% if the ISM improves); c) equities hedge investors against rising inflation, until inflation rises above 4% (currently inflation expectations are 2.4%); d) margins typically peak 7 months after the developed market output gap has closed and the non-financial profit share of GDP is below its 1950-70 average. We forecast 14% US EPS growth this year and 9% next; we estimate re-leveraging can boost EPS by 10%; e) equities are still under-owned by insurance companies, while 85% of mutual fund flows since the start of 2009 have gone into bonds.
Risks: earnings revisions have turned negative (but are coincident with the ISM), uncertainty over Chinese inflation and risks associated with the Greek rollover (we believe that the ECB will continue to repo Greek bonds even if there is voluntary private-sector involvement). The indicators that have held up relatively well, and are therefore not the best way to exploit a risk-on trade, are commodity currencies, European cyclicals and credit spreads.
