Even the burger is not doing well. At McDonald's, sales fell by 2,5% due to the troubles in China (the security scandal) but also due to "the persistent weakness of the American market". But all things considered, the American economy seems to have started to turn again. Second quarter GDP unexpectedly jumped 4% and unemployment benefits are under control. If the data released this week slightly disappointed by indicating higher-than-expected new requests, it is still a level close to the lows of the last 8 years and a four-week moving average well below the average of the past year and close at 2006 levels. For some time now, experts and analysts have been thinking about the timing of the next rate hike, now at historic lows between 0 and 0,25%. The vice president of the Federal Reserve, Stanley Fischer, recently held back on this hypothesis: the US central bank will not opt for monetary tightening immediately, he said, explaining that the recovery in the United States and in global economies has so far been "disappointing" . The market is preparing for June 2015 while some economists assume that time x will change in the third quarter of 2015.
For Credit Suisse strategists, however, there is a concrete risk that the upside could come much sooner. In any case, timing does not matter: in the end, the experts suggest remaining overweighted on shares in any case until the rate increase. “We must not sell too soon – writes Andrew Garthwaite in the Global Equity Strategy of 13 August – since in the past equities have peaked no sooner than four months before the first rate hike and since the peak they have corrected on average only by 3%. After the first rate hike, the correction in equities fluctuated between 6% and 11%, but the markets tend to recover an average of 4% in the six months after the first hike”.
FED PREPARES TO RAISE RATES SOON
Credit Suisse economists believe that the first interest rate hike could come in the third quarter of 2015. The estimate was brought forward with respect to the previous one in the fourth quarter but is still more optimistic than the market which is currently pricing the increase for June of next year. However, even within Credit Suisse itself, forecasting is not so simple. Colleagues from the Global Equity Strategy area in their August 13 note believe that there is a "clear risk" that the increase could occur sooner than both economists predict and market prices. And this for some specific reasons.
US GDP growth could be stronger than expected: employment improvements are solid, hours worked are above the 2004-2007 average and some indicators are at peaks; real estate disappointed in 2014 but the weakness is expected to be transitory as houses are affordable relative to the past and banks are seeing solid demand for mortgages; the private sector reduced its debt; the willingness of the banks and the intentions of the CEOs are consistent with a recovery in corporate investment; inflation is no longer slowing down and wages have stopped falling. Finally, Credit Suisse experts believe that the Fed is currently much more willing to “take an inflation risk” (tightening monetary policy too late) than a risk of halting the ongoing recovery too soon by slamming the brakes too soon. . And this is because in the past years there have been too many "false dawns".
VOLATILITY COMING SOONÀBUT DON'T SELL TOO EARLY
When the Fed hikes rates, it will do so for the first time since June 2006. To understand the impact on equities, Credit Suisse strategists look back to the rate hikes of August 1977, December 1986, February 1994 and June 2004. “The S&P500 – explains the team led by Garthwaite again in the August 13 note – tends to reach its peak (with the exception of 1977) close to the moment in which rates rose. In both 1986 and 1994, the US stock market peaked in the same month as rates were raised while in 2004 the peak preceded the hike by four months. In any case, equity sell-offs before rate hikes have usually been small.
On average, the S&P500 lost 3% from its peak to the first rate hike. The exception is always 1977 with a drop of 9%”. After the rate increase, the stock market generally experienced greater volatility. "While hikes have historically led to greater volatility, they have not marked the end of bull markets. On average, six months after the hike, shares rose by 3,7%", the analysts of the Swiss investment bank still point out. In three of the four periods analysed, within 18 months of the first rate hike, the S&P 500 rose by at least 10%, with the exception of 1977 when it took two years to gain 10%.
And this round? For Credit Suisse, markets could become volatile towards the end of the year for the following two reasons:
1) the four-period analysis suggests that markets tend to peak four months before the first rally (which Credit Suisse strategists think could occur in the second quarter, before the estimates of the same Credit Suisse economists). Which means that the peak could be by the end of the year;
2)markets corrected 4-5 weeks before the end of Qe1 and Qe2. And, according to estimates by Credit Suisse economists, the Fed will complete the stimulus program in October, again suggesting possible falls at the end of this year.
“Our hypothesis – explain the strategists – is for a correction of 5% by the end of this year and for a sell-off between 5 and 10% three months after the first rate hike (in mid-2015). In both cases we believe that equities will be significantly higher than current levels before the correction begins and that the lost ground will be recovered thereafter.
WHO ARE THE POTENTIAL WINNERS?
Credit Suisse strategists identify six potentially rewarding themes:
1) Who earns in dollars. "Not only do we expect US growth to be stronger than expected - they explain - but we also believe that the euro will further weaken significantly against the dollar since the five main supports for the euro are failing": a) since the ECB's June meeting, the Eonia rate has fallen below the US rate and real ten-year bond yields are consistent with a weaker euro; b) the European SMEs were much stronger than the American ones in the first quarter, however this trend has already reversed and the effects of this on the exchange rate tend to appear after six months; c) the euro has so far been supported by a record balance of payments surplus, however Credit Suisse believes that this situation will change when demand starts to recover; d) the Fed will no longer expand its balance sheet after October 2014, while the ECB will launch the TLTROs in September.
The weakness of the euro, the experts recall, is central to Europe's recovery: every 10% loss of strength of the single currency adds 1% to nominal GDP growth and 10% to earnings per share, since more than half of European sales come from outside the euro area. Indeed, strategists note that there is a clear correlation between a weakening euro and improving profit revisions. “The potential winners of the weakening of the euro – concludes the team led by Garthwaite – are those sectors that have a high proportion of sales in the US and a negative correlation with the euro. These characteristics apply especially to healthcare, pharma and consumer goods. Conversely banks, utilities and real estate are among the potential losers”. Credit Suisse focuses attention on those stocks that have high cross-national exposure (more dollar revenues than dollar costs) such as Richemont, Ericsson, Atlas Coop, Sap, Siemens and Volkswagen (all of which outperform for the home business). Luxottica is mentioned among the Italians.
2) The second theme concerns technology, one of the sectors that currently offers several attractive aspects including a high exposure to corporate spending, valuations that seem convenient and positive profit reviews. More generally, experts advise looking at those sectors, such as technology, which have high operating leverage and low financial leverage.
3) Overweight cyclical sectors. Historical data indicates that cyclicals do best when two-year bond rates rise and maintain their best performance in the months after the first hike. Furthermore, at the P/E level, the valuations of this sector are not stretched compared to the defensive ones and are below the average both in the USA and in Europe. They are more expensive if you look instead at the P/b.
4) The fourth topic of possible beneficiaries concerns the increase in investments (capex) which are seen to grow even with the increase in interest rates.
5) Financials still remain an overweight sector. Credit Suisse analysts especially like European banks (overweight) and continental insurance companies
Finally, in this scenario there is no shortage of potential losers, including credit, European non-cyclical domestic securities with high financial leverage (utilities, telecoms and real estate for example), high dividend, overall US stocks penalized by a strong dollar. Finally, some emerging countries are still at risk, such as Brazil, Turkey and South Africa.
