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2 December 2016
Global
Equity Research
Investment Strategy
Global Equity Strategy
Research Analysts
Andrew Garthwaite
44 20 7883 6477
[email protected]
STRATEGY
2017 Outlook: Equities, Regions and Macro
Marina Pronina
44 20 7883 6476
[email protected]
Robert Griffiths
44 20 7883 8885
[email protected]
Nicolas Wylenzek
44 20 7883 6480
[email protected]
Alex Hymers
44 20 7888 9710
[email protected]
Mengyuan Yuan
44 20 7888 0368
[email protected]
Alexander Evans
44 20 7888 1595
[email protected]
Source: iStockphoto
Equities: We increase our mid-year 2017 target on the S&P 500 to 2,350 from
2,200. The key positive for 2017, in our judgement, is that investors are
overweight deflation hedges (i.e. bonds) relative to inflation hedges (equities)
at a time when policy makers are moving away from NIRP towards fiscal
stimulus, and inflation expectations are set to continue rising. Other supportive
factors are: earnings revisions at a five-year high; a still reasonably elevated
equity risk premium; excess liquidity; and rising economic momentum.
However, we see a down market in H2 2017, hence our year-end 2017 target
of 2,300. The second half challenges include the potential negative impact of
US bond yields above 3% (3% being the CS view for end-2017); the growing
pricing power of US labour squeezing profit margins; and the risk of China
refocusing on reform rather than pro-growth policies. We continue to prefer
equities to both bonds and gold.
The macro backdrop is one of a modest acceleration in global GDP growth,
with upside risks to the CS view of 3.0% global GDP growth in 2017.
Regions: We add to our overweight in continental European equities
(Germany remaining our top pick, upgrading France to benchmark, reducing
the size of our underweight of Italy) and we remain overweight in Japanese
equities. We reduce the size of our overweight in GEM equities (focusing on
China, Taiwan and Korea), and downgrade UK equities to underweight from
benchmark. We stay underweight the US in a global context as it is the worst
performing market when global growth accelerates, the USD strengthens and
bond yields rise; and valuations relative to other regions are extreme.
DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST
CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-U.S ANALYSTS. U.S. Disclosure: Credit
Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware
that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report
as only a single factor in making their investment decision.
2 December 2016
Table of contents
Key charts
4
Executive overview
6
Index targets
20
Equity outlook: a year of two halves
21
What factors might help lift equity indices in H1? ................................................... 22
What worries us about equities? ............................................................................ 46
Prefer equities over bonds
58
Bond yields: upside risks remain ............................................................................ 58
What is the bull market view on bonds? ................................................................. 73
Regional scorecards
78
Continental Europe: increase overweight
82
Increase our overweight ......................................................................................... 82
What are the risks? ................................................................................................ 95
European countries ................................................................................................ 99
Japan: remain overweight
132
The positives ........................................................................................................ 132
What are the problems? ....................................................................................... 155
GEM: reduce overweight
166
Why the modest reduction? .................................................................................. 166
Why do we avoid a downgrade to benchmark? ................................................... 175
Country selection .................................................................................................. 190
UK: downgrade to underweight
226
What are the negatives? ...................................................................................... 226
What are the risks to an underweight? ................................................................. 236
UK domestic sectors ............................................................................................ 236
US: remain underweight
241
What are the challenges? ..................................................................................... 241
Where could we be wrong? .................................................................................. 246
Global Equity Strategy
Macro outlook
247
Gold: remain cautious
283
Appendices
289
2
2 December 2016
The team wishes to acknowledge the contributions made to this report by Revelino
Sequeira, Pranali Deshmukh and Neeraj Chadawar, employees of CRISIL Global
Research and Analytics, a business division of CRISIL Limited, a third-party provider
of research services to Credit Suisse.
Global Equity Strategy
3
2 December 2016
Key charts – Equity Strategy
Figure 1: Global earnings momentum is close to its
strongest level in 5 years
40%
Figure 2: Equities tend to re-rate until inflation rises
above 3%
22
20%
20
0%
18
12m trailing P/E
18.8
S&P 500 average P/E, 1871 to present
12m fwd P/E
17.0
16
-20%
14
-40%
12
MSCI AC World
-60%
-80%
1998
2001
2004
2007
Earnings revisions,
4-wk
13-wk
2010
2013
2016
10
-3% or -3 to - -2 to - -1 to 0 to +1 to +2 to +3 to +4 to +5 to 6% or
below 2% 1% 0% +1% +2% +3% +4% +5% +6% above
Inflation range shown
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Figure 3: The gap between the consensus and
warranted equity risk premium is still reasonable
Figure 4: Equity to bond returns discount a modest
fall in macro momentum, yet it should accelerate
50%
11
US ERP on consensus EPS
40%
US Warranted ERP
30%
9
Global equities vs global government
bonds, total returns (6m % chg)
OECD leading indicator (6m % chg,
rhs)
3%
2%
1%
20%
10%
7
0%
0%
-1%
-10%
5
-20%
-2%
-30%
3
-3%
-40%
1
1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
-50%
1997
-4%
1999
2002
2005
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Figure 5: Global excess liquidity is consistent with a
re-rating of global equities of around 25%
Figure 6: The profit and wage shares of GDP tend to
move inversely to one another
18
OECD excess liquidity (3m lead)
Global equities, 12m % change in PE (3mma, rhs)
14%
13%
16
95%
14
12
65%
10
8
35%
6
4
5%
2
0
-25%
-2
-4
1983
52%
% of GDP, US
53%
Profits
Wages, rhs, inverted
12%
54%
11%
10%
55%
9%
56%
8%
57%
7%
58%
6%
-55%
1988
1993
1997
2002
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2007
2011
2016
5%
1950
59%
1961
1972
1983
1994
2005
2016
Source: Thomson Reuters, Credit Suisse research
4
2 December 2016
Key charts – Regions
Figure 7: Correlation of regional performance with
10-year US Treasury yields
0.32
Figure 8: As US index linked bond yields rise, GEM
equities tend to underperform
0.22
-2.0
GEM relative to global equities, 6m % chg
13
-1.5
US 10-year TIPS yields, 6m chg, rhs, inv.
0.12
8
0.02
-0.08
-0.18
-0.28
Correlation of local currency relative
performance with US 10 year yields
-0.38
-1.0
3
-0.5
-2
0.0
0.5
-7
-0.48
1.0
-12
1.5
-0.58
Japan
Europe ex.
UK
US
GEM
-17
2009
UK
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Figure 9: The US is on a 38% premium on HOLT's
value to cost ratio relative to the global market
Figure 10: GDP growth differentials suggest c20%
relative upside for European equities
1.37
US HOLT P/B rel to Global
1.32
Cont.Europe equties relative to global, LC
terms
145
Euro area GDP growth relative to global-ex- 1
euro with 2016 CS fcst, pp gap, rhs
0
135
-1
125
1.27
-2
115
1.22
1.17
1.12
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
105
-3
95
-4
85
1997
-5
1999
2001
2003
2005
2007
2009
2011
2014
2016
Source: Credit Suisse HOLT®
Source: Thomson Reuters, Credit Suisse research
Figure 11: In the UK, earnings momentum tracks
sterling closely
Figure 12: Japanese EPS is more than just a yen
story
40%
-24
UK: 13-week earnings revisions relative to global
30%
GBP TWI, % chg Y/Y inv., rhs
20%
10%
60%
-14
40%
-4
0%
-10%
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2014
2015
2016
-25%
-15%
-5%
-20%
6
-60%
5%
15%
25%
-80%
-100%
2004
-35%
JPY TWI (% change Y/Y, rhs, inv)
0%
-40%
11
Japan earnings revisions, 4 week net upgrades (%)
20%
1
-20%
-30%
2009
80%
-19
-9
2
155
35%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
5
2 December 2016
Executive overview
Equities: 2,350 mid-year S&P 500
We see more upside than downside risks for equities in the first half of 2017 and thus raise
our mid-year target on the S&P 500 to 2,350 from 2,200. However, we see the second half
as more challenging and thus establish an end-2017 target of 2,300. We see the following
factors as supportive for equities:
■ Earnings revisions near a five-year high: Global earnings revisions are close to a
five-year high, and we revise up US EPS growth for 2017 to 6% from 3% on the back
of the rise in commodity prices (adding 3.8pp to EPS), a recovery in nominal GDP
growth relative to wage growth, and a lower corporate tax rate. These positives come
at a time when gross margins, excluding tech, are already at normal levels.
■ A shift in policy: We believe that a change from negative interest rate policy (NIRP)
towards fiscal easing is currently underway as policymakers realise that, at current
levels, NIRP is increasingly counterproductive. We also think central bankers will be
prone to allow economies to run 'too hot' and rather risk inflation than deflation (as the
Swedish Riksbank is doing, in our view). In essence, this indicates investors need to
buy inflation hedges – equities – and not bonds, which are deflation hedges. We think
market-implied inflation expectations are still too low and equities should benefit as
these rise; in periods of rising inflation, the market has tended to re-rate to an average
of 20x trailing earnings. Only when the inflation rate rises above 3% do equities tend to
de-rate.
■ Equities are an under-owned inflation hedge: We see an 80% probability that
equities will outperform bonds in 2017, yet both institutional and retail investors are
mis-positioned for this, being structurally overweight bonds relative to equities. We
believe retail investors will follow momentum, with rising bond yields serving as the
potential catalyst for a meaningful change in asset allocation. On top of this, there is
scope for the corporate sector to continue to be a buyer, with 20% of US corporates
having net debt-to-EBITDA below 1x, $750bn of overseas corporate cash and private
equity having c.$1.4trn of dry powder. Recently, corporate buying has picked up and,
encouragingly, buyback as a style has started to outperform again.
■ The equity risk premium is still high and can overshoot: The US ERP is
reasonable at 5.3% on our below-consensus earnings numbers, versus a warranted
ERP of 5.2%. We see scope for the ERP overshooting because: (i) on consensus
earnings estimates the ERP is even higher – close to 6.4%; (ii) the long-run average
ERP is 4.2%; (iii) at market peaks the ERP has fallen to, on average, 2.4%; and (iv)
finally, some factors we do not model (e.g. minority shareholder rights, variance of
earnings estimates) suggest that our warranted ERP should be lower still. Above all,
the cost of equity, at 8.8%, is still only slightly below its norm, whereas most other
major asset classes remain more clearly overvalued.
■ Excess liquidity: Excess liquidity, which we define as growth in M1 relative to nominal
GDP, remains highly supportive, and is consistent with a strong re-rating of global
equities. Indeed, the BoJ could de facto finance President-elect Trump's proposed tax
cuts if Japanese investors sell JGBs to buy US bonds and the BoJ caps yields at zero.
■ Equities are not discounting an acceleration in growth: Looking at equities in
aggregate, no improvement in macro momentum is being discounted. In fact, the ratio
of equity to bond returns suggests a modest fall in lead indicators while we believe
global GDP will accelerate.
Global Equity Strategy
6
2 December 2016
■ There has been no clear excess in equities: Peaks in equity bull markets have
previously been marked by some kind of excess, whether in terms of investment fads,
sentiment, valuation or leverage – no such excess is apparent to us yet.
■ Disruption could be positive for valuations: There is a case to be made that
disruption could cause a re-rating of the equity market. Disruptive technology tends to
lead to greater excess savings, an increase in the efficiency of investment, a fall in the
NAIRU (as it is easier to match job offers with applicants), and is structurally disinflationary, which allows central banks to keep policies 'too loose'.
■ Trump – a net positive for equities: Our judgement is that the rhetoric on
protectionism and immigration will be toned down, while fiscal stimulus, corporate tax
cuts, de-regulation and repatriation of cash held overseas are all potentially growth and
EPS positive. Almost all of President-elect Trump's policies are inflationary and thus
support a bond-to-equity switch.
The risks facing equities
In spite of these positives, we see a number of downside risks facing equities, with a
heightened chance of these materialising in H2 2017, hence our projection of a correction
in equities. The main risks we see are as follows:
■ We see a risk that bond yields could rise too far: We do not think that rising bond
yields will become a headwind for equities until the US 10-year yield rises to 3.0-3.5%,
which would reduce EPS and undermine both relative valuations and corporate buying.
We judge that each 100bps on the corporate bond yield takes c.4% off EPS.
■ The US profits cycle has peaked: Despite seeing some near-term positives for
earnings in the US, our longer-term concerns remain. Namely, labour continues to gain
pricing power, which is bad for profit margins. A quarter of the US margin improvement
had come from lower rates and a third of EPS growth since 2012 from buybacks: the
former is now a headwind, the latter a reduced tailwind.
■ Business model and political risks remain unusually elevated: We are in a world
of abnormal risks, including business model risks – particularly because of China and
disruptive technology – and populism, which is trying to redress the capital relative to
labour share of GDP (via minimum wages and protectionism).
■ Heightened risks in H2: The second half of 2017 could be much more challenging for
equities as China potentially tightens policy following the 19th Party Congress, China's
loan-to-deposit ratio rises closer to the danger signal of 100%, and US wage growth
continues to accelerate (hitting profits).
■ Real equity returns: Real returns from the previous bull market peak are already in
line with their 140-year average.
■ Tactical indicators – no longer signalling pessimism: In the near term, tactical
indicators have rebounded to be optimistic (implying some likely near-term
consolidation).
Global Equity Strategy
7
2 December 2016
Bonds: we remain cautious
Credit Suisse rates strategists forecast a US 10-year yield of 3.00% by the end of 2017;
we would agree, and see a risk of bund yields rising to 1-1.5%. Our concerns are:
■ Changing policy backdrop: Policymakers are increasingly looking to fiscal policy,
especially as the world moves toward populism, which is typically inflationary (via
minimum wage increase, controls on immigration, protectionism or spending more on
infrastructure projects). In our judgement, President-elect Donald Trump's policies are
stagflationary at worst, or reflationary at best. Either way, bonds face challenges.
■ The return of inflation: Inflation expectations look perhaps 50bps too low in the US.
The 5 year rate implied in 5 years' time in the US and the euro area is 2.0% and 1.5%
respectively. We think it can rise to 2.5% in the US on the back of wage growth
continuing to rise from an eight-year high, headline inflation hitting 2.5% by mid-2017
and the Fed allowing a 'high pressure' economy. In the euro area, employment growth
is nearly 1 percentage point above the rate of growth of the workforce, and this will
ultimately push up wages. The ECB, like the Fed or BoJ, is likely to tolerate an inflation
overshoot. Even Chinese PPI has turned positive for the first time in 4.5 years, implying
it is exporting less deflation.
■ Markets still appear complacent: The New York Fed term premium model is now
around zero, versus a post-2010 average of around 1% and implied volatility in bonds
is still low. We believe that, outside of Japan, less financial repression is needed to
stabilise government debt-to-GDP and unemployment (the equilibrium real rate being
c.1% in the US and zero in UK); our fair value model highlights 2.8% on the US 10year, 3.2% if the Fed tightens in line with our house view (expecting three rate hikes by
end 2017); and we think over 2017, the ECB is likely to face growing logistical, legal
and political problems with QE, which will cause some fears of tapering.
■ Other cyclical measures point to upside for yields: The ratio of cyclicals to
defensives or industrial commodity prices is consistent with a 2.7% 10-year bond yield.
The bull case for bonds is that the US CPI diffusion index shows only half of prices rising
(but momentum is turning up); there is a risk of a hard landing in China (but none of our
hard landing indicators are flashing amber); and US margin pressure is a challenge for the
US cycle (but usually unemployment is able to significantly overshoot the rate consistent
with full employment before this happens) or disruptive technology causing dis-inflation.
Of all of these, the strongest factor is the final one. We cannot help but think that when the
longest bond bull market in recorded history ends, we are likely to have a reasonable bear
market (it is worth noting that of the eight bond market corrections since 1990, three lasted
longer than a year) and on average bull market corrections saw yields rise by 1.8%
compared with 1% so far.
Global Equity Strategy
8
2 December 2016
Regional allocation
Continental Europe: Increase overweight
We further add to our overweight of continental European equities, making it our biggest
regional overweight together with Japan. We see the following positives:
■ Continental European growth to surprise on the upside: In our opinion, there are
several strong tailwinds supporting European growth: i) the recovery in domestic
demand, which has lagged US and Japanese domestic demand by 4pp and 10pp
respectively since 2008, is finally accelerating; ii) the monetary transmission
mechanism seems to be working again, with SME lending rates in the periphery having
fallen to core levels (nearly 70% of peripheral GDP is SME-related) and European
banks are easing lending conditions (75% of lending in continental Europe is done
through banks); iii) GEM headwinds are diminishing, with exports to China and Russia
growing again; and iv) the euro remains clearly undervalued. In fact, already year on
year GDP in Europe is just above that of the US and PMIs are implying c.2% GDP
growth. However, European equities have so far lagged the European recovery and
the growth differential between Europe and the rest of the world is consistent with c.2025% outperformance.
■ Fund flows suggest investor capitulation: Year-to-date continental European
equities have experienced 39 weeks of outflows, with two thirds of the inflows seen in
2015 having left. This is also reflected in our proprietary investor survey, where
sentiment towards continental European equities fell to an all-time low.
■ Political risk looks overstated: European outflows and the pessimism of investors
towards European equities seem to be mainly driven by fears of a deepening political
crisis in Europe. This concern has increased on the back of Donald Trump's surprising
win and Brexit, as investors have lost even more trust in opinion polls and the certainty
of political outcomes. However, we think this risk is slightly overstated.
While a "No" vote in the Italian constitutional reform referendum appears very likely, we
do not think there will be elections before the summer of 2017. Furthermore, the 5 Star
Movement's popularity has fallen in recent polls and, in our opinion, even in the event
of a 5 Star victory in a general election, the chances of Italy leaving the euro area are
very low over the next few years. Critically, survey data from the European
Commission suggest that support for euro membership among the Italian population
remains very high.
The chance of a victory by Marine Le Pen in the French presidential election is low, in
our view. We believe the election of Fillon is a more likely scenario and could bring
much needed economic reforms to France.
■ Continental Europe is a play on a recovery in global growth and rising yields:
Continental Europe has higher operational leverage than the US and the UK and
should outperform these regions as global growth recovers. Furthermore, owing to
Europe's overweight of financials, the Euro Stoxx typically outperforms global markets
80% of the time the Bund yield rises.
■ No stronger euro, despite stronger growth: Historically, a strong economic recovery
(proxied by PMI new orders in Europe versus the US) has tended to be offset by a
strengthening euro. Each 10% on the euro takes directly and indirectly 6p.p. off EPS
growth (with c.45% of European earnings coming from outside of the EU) and 1.1% off
nominal GDP. We think this will not be the case this time as the Treasury-Bund spread
is likely to keep the euro weak.
Global Equity Strategy
9
2 December 2016
■ Continental Europe has significant exposure to GEM: The euro area's exposure to
emerging markets is the second-highest of all regions (at 18% of non-commodity sales
for listed companies). European stocks with high GEM exposure have been
underperforming direct emerging market exposure recently by a near record amount,
suggesting that Europe offers relative value. While we have turned a little more
cautious on GEM equities, we still believe that GEM is likely to outperform modestly in
2017.
■ Valuations look reasonably attractive: While European equities trade on only a c.6%
discount to US equities on a sector-adjusted basis, the discount increases to c.17% on
normalised earnings and c.22% on aggregate 12m forward P/E. Furthermore, the
equity risk premium is unusually high at 8% versus a warranted ERP of 7.5% at a time
when German pension funds have just 15% of their assets in equities.
■ Earnings are supportive: While the expected earnings recovery in the euro area did
not materialise in 2016, our model is pointing to 6% and 7% earnings growth in 2017
and 2018, respectively, on the back of a recovery in nominal GDP growth, a low
domestic profit share of GDP, a lower interest charge and a weak euro. On consensus
forecasts, 60% of consensus euro area earnings growth in 2017 (6.5pp) is set to come
from just three sectors: financials, consumer discretionary and energy. Furthermore,
absolute and relative earnings revisions have turned positive for only the second time
since 2010.
What are the risks to our call?
The perceived political risk in Europe is likely to continue to weigh on the performance of
European equities for the foreseeable future. Italian political instability after a potential
"No" vote is likely to last some time, but we would look to this as a buying opportunity.
The fundamental weakness of the euro area has not been resolved. There is only a very
limited banking union and no fiscal or political union, and a stable monetary union in our
opinion requires all three. Our view remains that eventually the euro area will be severely
tested and chances are high that at some point a country will drop out. However, we
believe that this only becomes a problem when the majority of the electorate wants to
leave the euro and when unemployment is low.
One of the key drivers of US equity performance has been disruptive technology (the
growth in the cloud and the internet-related networks with mobile exposure). To a large
extent, this space is dominated by US names. Internet software and services and internet
retail account for more than 6% of market cap in the US, but just 0.2% in the euro area.
This gives Europe a structural disadvantage. However, a rise in bond yields causes long
duration assets to underperform, and thus this headwind should be less of a concern in
2017.
What to buy?
■ Germany – increase overweight: i) Germany scores close to the top on our
European country scorecard; ii) Germany is the most sensitive market to a weaker
euro; iii) German lead indicators will likely remain stronger than for the rest of Europe
as the economy is faced with an ultra-loose monetary policy (due to prevailing interest
rates being too low and the currency being too weak); the majority of the external
GEM-related headwinds for Germany (Russia, China) become tailwinds as export
growth to these markets recovers and Germany is the most competitive economy in
Europe as measured by the ease of doing business index; iv) German equities appear
inexpensive, trading at close to a 15% discount to continental Europe on 12-month
Global Equity Strategy
10
2 December 2016
forward P/E (Germany is the third-cheapest market on EV/EBITDA); and v) relative
earnings revisions are at a seven-year high.
China remains our key concern with regards to German equities with most of the
outperformance of the DAX coming from autos and chemicals, the two sectors with the
biggest exposure to China. However, the DAX excluding these two sectors is now
outperforming and our economists are reasonably optimistic on the Chinese economy
ahead of the 19th Party Congress.
We particularly like German real estate (Deutsche Wohnen), companies with high
German exposure (Deutsche Telekom) and Outperform-rated German stocks with an
eCAP (Fresenius Medical Care, SAP).
■ France – increase to benchmark: i) Based on opinion polls, Francois Fillon has the
greatest likelihood of being the next President of France, proposing to bring (in our
opinion) much-needed economic reforms (including an increase in the pension age,
scrapping the 35-hour workweek and a €40bn tax cut for companies); ii) France offers
an attractive combination by being one of the most exposed economies to the domestic
recovery and being the second-most sensitive European stock market to euro
weakness; iii) economic lead indicators (PMIs) are improving; iv) earnings revisions are
recovering; and v) sell-side net buy recommendations, a proxy on positioning, are
close to 20-year lows.
Why not overweight? Valuations are only neutral, an improvement in relative economic
momentum has already been discounted by equities, the CAC is overbought and
France is still an uncompetitive economy on many measures compared with the rest of
Europe.
We would look to buy French companies with a high proportion of labour costs which
might thus benefit from labour reforms (Orpea, Vinci).
■ Spain – stay overweight: Spain remains our most preferred country in the periphery.
We see the following positives: i) the performance of Spain is highly correlated to
banks and the macro backdrop for Spanish banks looks, in our opinion, particularly
attractive (they are cheap relative to European peers, loan growth is picking up, and
house prices are recovering); ii) economic lead indicators remain strong (PMIs in line
with 2% GDP growth and 3% employment growth); iii) Spain regained its
competitiveness on REER – as also shown by a current account surplus of 2.6% of
GDP; iv) the Spanish economy is the most exposed to the euro area domestic demand
recovery (with exports outside the euro area at less than 20%); v) improved political
stability following nearly 10 months with no government; and vi) valuations are not
unreasonable – Spanish equities are trading c.5pp below their norm on 12m forward
P/E relative to the rest of Europe, and on 13.1x earnings assuming normalised
margins.
■ Italy – reduce the size of the underweight: As discussed above, we think a "No" vote
in the constitutional reform referendum is now widely expected, based on recent polls
(see European political discussion above). Furthermore, we would argue that investors
are generally too negative on the risk of an Italian banking crisis and this leading to a
sovereign crisis (the worst case cost of covering NPLs is 1.8% of GDP in our banks
team's opinion and a worst case cost of covering broader Non-Performing Exposure
(NPE), in our opinion, would be 6% of GDP; neither would lead to a sovereign risk) and
retail investors are unlikely to be bailed in without compensation. Article 32 of the Bank
Recovery and Resolution Directive could end up allowing some degree of government
bail-out of banks.
Italian equities have become very cheap on almost all measures, including 12-month
forward P/E, where Italy trades at close to a 20% discount to continental Europe and a
Global Equity Strategy
11
2 December 2016
P/B relative to Europe (ex financials) at 22-year lows. Only Korea and Japan have a
lower P/B than Italy.
Italian bond spreads against German Bunds have reached a three-year high and seem
to offer a much more attractive risk/reward than they did in June, when we downgraded
Italy. Italy under Prime Minister Renzi has also implemented many important reforms
already.
Why not benchmark? Italy has, uniquely within the periphery, not yet seen an
adjustment to its REER, PMI new orders are consistent with only 0% GDP growth, the
major eurosceptic parties (5 Star Movement, Lega Nord and Forza Italia) could get
around 50% of votes according to recent opinion polls and the bank recapitalizations
are very demanding.
■ Netherlands – underweight: We are cautious of Dutch equities as: i) valuations are
expensive (trading 1.4 std above norm on 12m forward P/E relative and at a nine-year
high on P/B relative); ii) they have little exposure to the European recovery; iii) the
market tends to be a bond proxy (32% of market cap comes from consumer staples);
and iv) Dutch equities are already discounting a weaker euro.
■ Switzerland – underweight: We are cautious of Swiss equities as: i) they are typically
the worst performing when bond yields rise and European PMI new orders pick up; ii)
they look expensive (with the P/E relative to the rest of Europe almost 1 standard
deviation above its average); and iii) earnings revisions are worse than for the
European market.
Japanese equities: remain overweight
We lifted our weighting on 23 November 2016. The following factors are supportive:
■ Japan is a quintuple play on rising global growth and rising US bond yields.
Global PMI new orders have risen to a 19-month high and Japan has the highest
operational leverage and largest equity weighting in cyclicals of any major region. The
more US bond yields rise, the more the yen weakens and 10% off the yen adds c.15%
to EPS. Moreover, as the US yield curve steepens, Japanese buying of foreign bonds
steps up, and that in turn will likely cause the BoJ to increase its rate of domestic bond
buying to cap yields (something that will further reinforce a weaker yen). Finally, with
80% of inflation coming from higher import prices, at an exchange rate of ¥110,
Japanese core inflation turns positive in 2017E, and a rise in inflation expectations
could contribute to the gradual bond-to-equity switch underway.
■ Japan ranks at the top of our valuation scorecard. The P/E discount to the US is
c.17%, and its P/B discount to global markets is 33%, with a RoE discount of 28%,
having been c.50% in 2012. Japan's EV/EBITDA is the lowest of any major region and
61% of companies trade below replacement value.
■ Japanese funds flow is the most compelling of any market. BoJ and net corporate
buying amounts to c.3% of market cap. Until recently, this had been offset by foreign
selling, yet there are now clear signs that foreign selling is slowing (given the valuation
discount). Once foreign investors become net buyers, they historically keep buying for
around 1½ years. Moreover, under a blue-sky scenario, domestic actors could buy
11% of market cap (and even more if we include households), especially as private
pension funds have 6.5% of assets in equities compared to the GPIF's target of 25%.
■ Tangible signs of change. In our judgement, there are clear signs of change: outside
directors are being appointed (80% of Japanese companies now have two or more
independent directors), buybacks are strong, cross holdings are being unwound,
payout ratios are rising and Japan accounted for 22% of activist fund launches last
Global Equity Strategy
12
2 December 2016
year. Japanese EPS forecasts proved relatively resilient to yen strength through the
first half, implying corporate cost-cutting. We still see low-hanging fruit: cash on the
balance sheet is 22% of market cap, and the investment share of GDP is higher than in
any other developed region.
■ Domestic momentum. Japanese PMIs are now consistent with nearly 2% GDP
growth, with Japan now at the middle, not bottom, of our economic momentum
scorecard.
Clearly, many long-term problems remain: stagnant wage growth, full employment, 0.5%
trend GDP growth, labour laws in need of reform, and a reluctance to allow aggressive
M&A or widespread share options schemes, plus exports to China are 5% of GDP. For
now, however, we regard Japan as a warrant on US bond yields.
Emerging markets: reduce overweight
A year ago, we raised GEM to be our preferred region for 2016, before reducing the size
of our overweight in September. We now reduce weightings further, to a small overweight
and target 920 for MSCI EM for end-2017, in line with our GEM strategy team.
Why do we reduce the size of our overweight?
We take weightings down again largely to reflect a less favourable macro backdrop. The
key macro drivers for GEM performance are: (i) the dollar; (ii) US TIPS yields; (iii) the oil
price; and (iv) perceptions of China. The first eight months of the year saw a 'goldilocks'
environment for GEM equities, with the oil price nearly doubling, the dollar falling almost
9% to its year-to-date trough, the 10-year TIPS yield falling 67bps and China accelerating.
From here, many of these factors should reverse, with the dollar unlikely to weaken, a
small rise in TIPS yields, Chinese policy more likely than not being tightened, and oil being
largely range-bound. The combination of bond yields falling and commodity prices rising
that was so supportive for GEM is unlikely to repeat itself, in our view.
However, none of these factors are sufficient for us to downgrade to benchmark. We only
see modest dollar strength, and the key in our mind is that GEM currencies are, excluding
the RmB, 30% cheap against export market share. Further, dollar strength is not a
mechanical negative for GEM equities: on a 1-year view, GEM has been able to
outperform 30% of the time when the dollar strengthens. With regard to rising DM rates,
the sharp improvement in the basic balance of payments position means that EMs can
accommodate a higher TIPS yield (c.1%) and prior to 2012, GEM outperformed when US
rates rose because of their high operational leverage. It was only the deterioration in the
basic balance of payments position that caused this sensitivity to reverse. The biggest
external macro risk remains China, where policy is tightening but none of our four hard
landing indicators is flashing amber (let alone red) and we don't see a slowing in growth
ahead of the 19th Party Congress.
Why do we remain overweight?
The long-term fundamentals suggest an overweight of GEM and we see the following
specific positives:
■ A structural improvement in profitability: Unit labour costs are falling for the first
time in six years. This is a critical driver of margins and thus RoE.
■ Relative economic and earnings momentum continues to improve: Economic
momentum in GEM versus DM (using both GDP and PMIs) is improving and, with it,
relative earnings revisions have picked up, too.
Global Equity Strategy
13
2 December 2016
■ Plenty of policy response potential: Emerging markets have clear cut-policy
flexibility, with government debt-to-GDP at a third of DM levels and rates high in a
historical or relative context. We think structural disinflationary factors, largely from
disruptive technology, have been underestimated.
■ Valuations are supportive: The sector-adjusted P/E is on an 18% discount to
developed markets. On normalised earnings, the discount is much higher (31% P/B
discount and 9.7x Shiller P/E versus 26.6x in the US). Equities have lagged their usual
relationship with bond spreads, despite, in some regions, much of EV being debt.
■ GEM is still under-owned: Inflows have been just 10% of the cumulative outflows
seen over the past four years (with GEM, between 2012 and 2016, seeing total
outflows that were half of the post-2001 inflows). We still think there is mis-positioning
between the short- and longer-term views investors have on GEM: our most recent
survey indicated that over half of investors believe GEM is likely to be the best region
on a five-year view, but only 38% have such a favourable view for the next 12 months.
■ Emerging market politics, on a relative basis, is improving: The politics of
emerging markets is in general about de-regulation and structural reform, while politics
in developed markets is increasingly about the risk of populism.
■ Our GEM team's model gives 8% upside: Our GEM strategists' regression model for
emerging market equities (based on the US dollar, ISM new orders, global IP and
metals prices) implies 8% upside for MSCI EM to end-2017.
What do we buy?
We still think that GEM debt is too cheap, with EM7 real yield spreads over US Treasuries
close to seven-year highs. Structurally, we believe that disruptive technology is much more
dis-inflationary in emerging markets (given the undeveloped nature of the offline economy
relative to DM) than is appreciated. Russian, Indonesian and Mexican bonds look
attractive, in our opinion. We would buy companies with high GEM exposure but limited
China exposure and quality GEM stocks (i.e. an eCAP on HOLT) and with a high but
covered dividend yield (e.g. TSMC and AIS).
From a country perspective, our GEM Strategy team favours China, Korea, Brazil and
Indonesia. On the Global Equity Strategy team we use a quantitative approach to evaluate
countries, favouring those that have cheap currencies, cheap equity markets, spare
capacity in the labour market, good-quality internal/external balance sheets and low
exposure to China. We think the best combination is seen in Russia, Taiwan and Korea
(with CE3 scoring well). Below we focus only on those countries that score well on our
scorecard.
Taiwan: remain a small overweight
Both we and our Asia strategist, Sakthi Siva, are overweight Taiwan. We believe Taiwan
offers something of a hedge on a stronger dollar; it is one of the best performing emerging
markets when the dollar strengthens or global PMIs rise, as Taiwan is a particularly open
economy (exports are 62% of GDP) and 85% of revenues are dollar-denominated. Indeed,
36% of market cap is semis, which remains one of the most sensitive sectors to rising ISM
new orders. In addition, PPI inflation and earnings revisions have turned positive. Against
this backdrop, valuations look cheap (P/E is 10% below its norm) with a FCF yield of
nearly 7% and net cash of 8% of market cap. Funds flow is becoming more supportive,
with life insurers' risk weights for domestic equities having been reduced.
The main worry is the Chinese competitive threat, a China slowdown (we would note that
although 40% of exports go to China, half of exports are re-exported) and a less attractive
Global Equity Strategy
14
2 December 2016
outlook for semis. Our Taiwan strategist favours Hon Hai, TSMC and Mega Financial
Holding.
China: stay overweight, but cautious of banks
Excess liquidity (defined as M1 growth relative to nominal GDP growth) in China is
supportive for equities, with the gap between excess liquidity and equity performance
unusually large. There seem to be relatively few alternatives for Chinese investors, with a
sharp fall in property turnover, a tightening of both wealth management products and flows
overseas. Moreover, real bond yields in China look set to fall as inflation modestly picks
up. Valuations remain attractive (looking at the A-share dividend yields against corporate
bond yields) and outstanding margin buying has normalised. Earnings revisions look set to
go positive for the first time since 2014. Our worry remains excess leverage and NPLs,
and thus we structurally remain underweight the banks. Vincent Chan, head of China
strategy, favours Alibaba, Ping An and Geely Automobiles.
Korea: reducing the size of our overweight
Our regional strategists are overweight Korea across the board. We reduce the size of our
own overweight slightly given the risk of the yen weakening more than expected and some
deterioration in both Korean lead indicators and earnings revisions. We remain
overweight, however, because Korea is one of the most leveraged regions to a pick-up in
global IP; P/E relatives to both GEM and global markets are at levels from which they have
bounced in the past 12 years, the pay-out ratio is likely to rise and Samsung concerns
have been overstated, in the view of our analysts. Our strategists focus on E-Mart, Naver
and SEC.
Russia: top of our GEM country scorecard; stay overweight
The rouble, domestic bonds and Russian equities still look cheap (with domestic bond
yields particularly attractive, at 8.8%). Oil and earnings revisions are supportive. We would
buy domestically-exposed Russian stocks, with our screen highlighting M.Video, Magnit
and X5 Retail Group.
India: structurally overweight, but challenges near term
Indian equities do not rank especially well on our scorecards and our regional strategists
are cautious against a backdrop of dislocation created by GST implementation, demonetisation, negative earnings revisions, little valuation support and over-ownership.
However, we remain of the view that Indian equities represent the best long-term story of
any emerging market. Structurally, India has the best growth story (in terms of
demographics, urbanisation or productivity catch-up); a number of factors suggest that the
rupee is cheap (including discount to PPP, the basic balance of payments surplus,
accelerating FDI, a sharp rise in FX reserves); and we find a 2% real bond yield attractive.
In addition, there are clear signs of reform (GST, AADHAAR, the change in the bankruptcy
code, and an independent central bank), and the P/E premium is only 4% compared to
global equities for a 25% RoE premium. Oil is unlikely to be a headwind. The recent fall in
government bond yields and the fact that both GST and demonetisation are, in the long
run, net positives is also helpful. Our GEM Strategy team's model (relying on rupee, ISM
and money supply) gives 19% upside potential (though they are underweight). Our Indian
strategists' focus list includes Tata Motors, Cipla and Tech Mahindra.
Global Equity Strategy
15
2 December 2016
UK equities: downgrade to underweight
We downgrade UK equities to underweight from benchmark. The performance of UK
equities in a global context is essentially driven by four macro variables which are, in order
of importance: sterling, oil, emerging market equities and global lead indicators. After a
strong 2016, three of these drivers are now less supportive.
■ Sterling close to a trough: With c.70% of sales derived internationally (and 40% of
that dollar-denominated), there has been a very clear correlation between sterling
weakness and the UK outperforming (in local currency terms). We stopped being
sterling bears in the middle of October for the following reasons: sterling bear markets
in periods of crisis average around 32% versus the USD (and at that stage sterling had
fallen 29% from its peak); a 14% discount to PPP put sterling close to a 20-year low
versus the dollar; the current account deficit is set to fall sharply (as 90% of overseas
assets are foreign currency denominated but only 60% of overseas liabilities, and a
sharp fall in real wages will hit imports) and, most importantly, a hard Brexit is not a
forgone conclusion. For practical purposes it is quite conceivable that there will be an
extended transition period. The longer it is, the greater the chance of a second
referendum, we think.
■ GEM exposure not the positive it was: The UK's GEM exposure is directly 17% of
sales and indirectly (with commodities) c.35%. In this Outlook, we have turned
modestly more cautious on GEM in the face of USD strength and rising DM yields.
■ Commodities range-bound: 56% of forecast 2017 earnings growth is coming from
commodities, which account for c.20% of market cap. From here, we see oil rangebound, and certainly not set to replicate the gains seen in the first half of 2016.
■ The stage of the global cycle is problematic for UK equities: Outside of
commodities, the UK is a defensive market. The UK has the lowest operational
leverage of any region to global IP, and the relative performance of the market has a
strong inverse correlation with lead indicators. Moreover, it is the worst performing
region when the US 10-year bond yield rises.
■ UK growth poised to weaken: Our economists forecast 1.2% GDP growth in 2017,
from 2.1% in 2016. There are headwinds to growth arising from rising import prices and
thus inflation (with headline CPI set to rise to c.2.5-3.0% from 0.9% currently) which will
hit either profit margins or real wage growth. This is occurring at a time when
consumers have a limited buffer, with the savings ratio close to historical lows, at 5.1%,
and vacancy growth pointing to a slowdown in employment growth.
■ Valuations are only middling on our regional valuation scorecard.
Domestic sector observations: We went underweight domestic UK sectors in
September 2015, and lifted weightings in July 2016. We raised retailing to benchmark from
underweight (P/E relatives are at recessionary levels, earnings momentum is improving,
and it is the most sterling-sensitive sector); we are overweight non-London homebuilders
(outside of London and the south east, affordability on a rental yield versus mortgage rate
basis or house price to wage ratio is attractive); overweight UK life insurance (as a play on
rising gilt yields and abnormally cheap versus fund managers) but have remained
underweight UK office REITS (which tends to underperform as bond yields rise and is a
disrupted sector).
Global Equity Strategy
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2 December 2016
US: remain underweight
We stay underweight US equities within a global context despite having a year-end 2017
target for the S&P 500 of 2,300. With US equities accounting for c.55% of MSCI AC World
market cap, in some ways our view on the US is largely the opposite of our views on
Europe, Japan or GEM equities, and the funding mechanism for the risk we wish to take in
these regions.
Our underweight of the US is reinforced by:
■ Low operational leverage: The US is the most defensive of the global markets and
will typically underperform if global growth and US bond yields rise. This defensiveness
is a function of US equities having the lowest operational leverage (only the UK is
lower) to a pick-up in global IP, largely because margins are high. Also, the US has
greater labour market flexibility than other regions, and is thus able to cut costs more
quickly into a downturn.
■ Overweight growth stocks: A rise in bond yields causes long-duration growth stocks
to underperform (and tech and biotech are 19% of US market cap, compared to 12%
globally), and growth tends to underperform as bond yields rise. Normally a rise in US
bond yields causes the US to underperform. There has been a notable disconnect on
this front since Donald Trump's election, however.
■ Relative valuations are high: P/E and value-to-cost relatives to global equities are
close to all-time highs at 10% and 40% premia, respectively.
■ USD strength: Dollar strength is a headwind and international earners have not
responded as much to dollar strength as would have been supposed.
■ The shift from capital to labour: US labour is gaining more pricing power than any
other region and this causes margins to decline, with margins in the US still extended
relative to history and other regions.
■ Bottom of our composite scorecard: The US now scores at the bottom of our
earnings scorecard and second-to-last on our economic momentum scorecard, leaving
US equities last on our composite regional scorecard.
■ Investors not as underweight as they were: The under-ownership of the US has
somewhat reversed in recent months.
In our view, the risk to an underweight stance is the global cycle. If, as was the case in the
past two years, the current pick-up in macro momentum falters and yields fall back, then
US equities will outperform. We would stress that we are overweight short-duration
technology (in the software, internet and semis space), and are thus underweight the US
excluding technology.
Global Equity Strategy
17
2 December 2016
Macro outlook
■ A modest, but broad-based, acceleration in global growth
Our economists forecast Global GDP growth to be 3.0% in 2017 from 2.5% in 2016, with
Global PMI new orders at a 19-month high, consistent with c.3% GDP growth. We believe
that a lot of the headwinds faced by the global economy over the past four years are now
sharply diminishing. Among these headwinds, we would highlight: fiscal policy, which had
taken 6.4% off GDP since 2011 in the US, and is now being eased; bank de-leveraging,
which is now slowing; oil-related opex and capex (which had taken c.2% off US GDP
growth in the past two years) should no longer be a drag, with the Baker Hughes rig count
now rising; GEM growth outside of China is improving as spare capacity is re-established,
while PMIs in the commodity exporters such as Russia and Brazil are now moving higher;
and US inventories, which were a drag on US growth for five quarters, are now set to add
to growth. Meanwhile, euro area GDP growth looks set to surprise and the euro area
economy is 75% of the size of the US (on a PPP basis). US employment continues to
grow steadily at 1.7%, prior to a fiscal boost.
■ The two key risks are China and US wage growth
China's nominal GDP has slowed from a peak level of 23% (in 2007) to a trough of 7% in
Q1 2016, at which point the Chinese government commenced a fiscal stimulus ahead of
the 19th Party Congress to be held next autumn. There are tail risks in China, but we do
not think 2017 is the year of a hard landing in growth.
On the positive side: i) China has fiscal flexibility (net government debt to GDP is
extremely low) and it can utilise this without losing control of the RmB (because the loanto-deposit ratio is still below 100%, and thus NPLs can be rolled over without the PBOC
having to buy securitised assets); ii) real estate looks extended to us, but mortgage debtto-GDP is low (c.25%) and even a 30% fall in house prices would lead to minimal negative
equity; and iii) none of our four hard landing indicators is flashing amber, let alone red. Our
economists see 6.7% GDP growth in 2017 on the back of infrastructure spending and the
weaker RmB boosting exports. We see three key risks: i) there has been no rebalancing
(the second-biggest credit bubble, the biggest investment bubble and some characteristics
of a real estate bubble); ii) two key drivers of GDP growth have rolled over, in real estate
and state/local infrastructure investment; and iii) there has been policy tightening in the
past few months.
The other main risk is the US labour market. US workers are getting pricing power, with
many measures of wage growth now at an eight-year high. The worry we have is that this
has a negative impact on corporate margins and in turn causes corporates to invest less.
This is problematic as corporate capex tends to lead the cycle. We hope that, as in the UK
or Japan, the unemployment rate consistent with full employment is lower than expected
(c4% not 4.8%), and typically unemployment has undershot the NAIRU by around 1
percentage point at the end of a cycle (currently, the unemployment rate is at the CBO's
NAIRU estimate). We think the key is to monitor lead indicators of capital spending, all of
which have improved recently.
On the Fed, our economists believe that the Fed will raise rates 3 times before the end of
2017 compared to market expectations of just over 2. We believe that all central bankers
will in general be much more willing to tolerate a growth overshoot than the opposite.
Global Equity Strategy
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2 December 2016
Currencies
We show CS FX strategists forecasts below: broadly, they are dollar bullish.
Figure 13: Credit Suisse FX forecasts
EURUSD
CS FX forecasts
3 month
12 month
1.03
1.00
USDJPY
111
108
GBPUSD
EURGBP
USDCAD
EURCHF
USDCHF
USDMXN
USDCNY
1.20
0.86
1.38
1.05
1.02
23.00
7.01
1.20
0.83
1.40
1.04
1.04
25.00
7.33
Source: Credit Suisse FX Research team
We would note that EURUSD has essentially been following the Bund/Treasury spread in
recent quarters, and near term this spread can widen further with the persistently dovish
stance of the ECB. We struggle to be bearish on the euro for the duration of 2017 given
PMI differentials, current account positions, discount to PPP (c.15% currently) and current
bearish speculative positioning. The key is the point at which the ECB tapers in response
to the weaker euro.
Our FX team forecasts USDJPY of 111. We would be more bearish. We see the USDJPY
being driven by US yields, especially with the BoJ capping JGB yields at zero. Only above
¥110 does Japanese CPI ex food and energy get above zero in 2017, according to our
economists.
Our FX team forecasts that the RmB will decline to 7.33 on a 12-month view. We continue
to see the RMB decline as being orderly (with the current account surplus of 3% of GDP,
and the RmB REER has moved very closely with China's share of global exports). The
worry, as noted elsewhere, is when the loan-to-deposit ratio of the banking system rises
above 100%. Until that point, we think margins can be sacrificed for market share without
the risk of the PBOC printing money to enable the roll-over of NPLs.
Gold: staying cautious
We turned cautious on gold in early August. In our view, the gold price is driven by three
factors: real bond yields, the relative performance of banks and the dollar. All three remain
headwinds, and on our models gold is 8% overvalued against these drivers. In our view,
gold is not cheap against other real assets (equities or US housing) or against other
precious metals. We acknowledge that the Credit Suisse house view on gold continues to
be much more constructive.
Global Equity Strategy
19
2 December 2016
Index targets
In this 2017 Strategy Outlook, we raise our weightings in Japanese equities (as flagged in
our report Japanese equities: upgrade to overweight, 23 November 2016), and also add
marginally to our overweight in continental European equities, to leave us with the same
scale of overweight in both regions. We reduce the size of our overweight in GEM equities
fairly significantly, but retain a positive stance. We take UK equities to underweight, and
retain our underweight in US equities.
The changes to our unhedged weightings largely reflect the currency views expressed in
this report, namely, some further US dollar strength, downside risk to the yen, stability in
sterling and some relative GEM FX resilience given the cheapness of these currencies.
Figure 14: Regional weightings
Region
Benchmark
w eight (%)
Recommended
over/underw eight (% factor)
Hedged
Unhedged
Change (p.p.)
Recommended over/underw eight
(bps from benchmark)
Hedged
Unhedged
Hedged
Unhedged
Continental Europe
15.1
13.0%
11.0%
1.0%
-1.0%
200
170
Japan
8.6
13.0%
8.0%
13.0%
8.0%
110
70
GEM
11.4
4.0%
5.0%
-7.0%
-8.0%
50
60
UK
6.3
-4.0%
-4.0%
-4.0%
-2.0%
-30
-30
US
58.5
-5.6%
-4.6%
-0.3%
0.9%
-330
-270
Source: Credit Suisse estimates
We also introduce 2017 year-end targets for the major regional equity indices, and update
our previously published mid-year targets. We forecast 5.6% upside for global equities in
2017, and 4.6% upside for the S&P 500, with a year-end target of 2,300. As discussed
elsewhere in this report, our base case incorporates a view that the second half will see a
modest correction in equity markets, and thus our year-end targets are lower across the
board than our mid-year targets. We adopt our GEM equity strategy team's target of 920
for MSCI GEM, as outlined in their report Global EM Equity Strategy: 2017 Outlook –
Staying the course, 1 December 2016.
Figure 15: Index targets
Current
End-2017E
2017 forecast
1/12/2016
2,199
target
2,300
price return
4.6%
Euro Stox x 50
3,052
3,300
FTSE 100
6,784
7,000
Nikkei 225
Market
S&P 500
Mid y ear
H1 2017
6.7%
2017
2,350
return
6.9%
8.1%
10.6%
3,350
9.8%
3.2%
7.0%
7,100
4.7%
9.2%
Total return
18,308
19,800
8.1%
10.1%
20,000
MSCI EMF GEM*
863
920
6.6%
9.6%
-
-
MSCI AC World
489
516
5.6%
8.3%
521
6.6%
* Forecast from CS GEM equity strategy team
Source: Credit Suisse estimates
Global Equity Strategy
20
2 December 2016
Equity outlook: a year of two halves
We see the following factors as supportive of equities in the first half of 2017:
1.
Global earnings revisions are near their strongest in 5 years;
2.
Investors are overweight deflation hedges (i.e. bonds) relative to inflation hedges
(equities) at a time when policy makers are moving away from NIRP towards fiscal
stimulus, and inflation expectations are set to continue rising;
3.
The equity risk premium can overshoot fair value substantially at the end of a bull
market and we are not yet in overshoot territory;
4.
Excess liquidity is rising, especially if the BoJ steps up its rate of QE in response to
Japanese investors buying more US bonds. In general, we believe that central banks
are more willing to risk tightening too little, too late than the reverse;
5.
The ratio of equity to bond returns is discounting a small slowdown in global growth
despite global PMI new orders rising to a 19 month high.
6.
Disruptive technology might potentially be positive for P/Es.
What factors could become more challenging for equities in the second half of 2017?
1.
Bond yields end up overshooting and upsetting equity markets (to a level above 3%);
2.
A roll-over in China post the 19th Party Congress;
3.
US wage growth continuing to rise;
4.
We could see some significant tapering from both the BoJ and the ECB by Q4 2017.
Despite raising our mid-year target on the S&P 500 to 2,350, we think it is appropriate to
be benchmark of equities because of:
■ Our concerns about the second half of 2017;
■ We struggle to see anything other than a temporary bounce in US profits;
■ The growing move from capital to labour;
■ The extremely high business model risk;
■ In absolute terms, equities are not cheap.
Global Equity Strategy
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2 December 2016
What factors might help lift equity indices in H1?
Why might we see a bounce in the first half of 2017? The following factors are, in our
minds, supportive:
1.
Earnings revisions are strong, and we foresee a rebound in US earnings
Global earnings momentum, as measured by the breadth of revisions, remains close to its
strongest point in the last 5 years using the 13-week average measure (which controls for
quarterly reporting). Recent US dollar strength has weighed on US earnings momentum at
the margins, but history suggests earnings momentum around current levels tends to be a
positive for equity markets. Indeed, as the second chart below illustrates, this level of
earnings breadth suggests that equities should have performed better.
Figure 16: Global earnings momentum remains
close to its strongest level in 5 years
Figure 17: The level of earnings breadth suggests
upside for global equities
40%
60%
20%
40%
0%
MSCI AC World net earnings
revisions
Year-on-year change in global
equities, rhs
80%
60%
20%
40%
0%
20%
-20%
-20%
0%
-40%
-20%
-60%
-40%
-80%
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
-60%
-40%
MSCI AC World
-60%
Earnings revisions, net
-80%
1998
4-wk
2001
2004
2007
Source: Thomson Reuters, Credit Suisse research
2010
13-wk
2013
2016
Source: Thomson Reuters, Credit Suisse research
This improvement in earnings momentum has happened at a time when we have already
seen something not far from a 'normal' US earnings recession. Since Q4 2014, when
operating earnings peaked, S&P 500 operating EPS fell 14% before stabilising. This
compares to an average downturn of 18% in previous cycles.
Global Equity Strategy
22
2 December 2016
Figure 18: S&P 500 earnings had already fallen 14%
from their peak…
140
Figure 19: …which was roughly in line with the
average earnings recession
S&P 500 12-month trailing EPS
120
Operating (S&P)
Profit cycle
Reported
100
IBES
80
60
40
20
Decline in operating EPS
Peak to trough
% of cycle rise
1970 - 1975
-10%
24%
1975 - 1982
-18%
38%
1982 - 1986
-5%
20%
1986 - 1992
-23%
60%
1992 - 2001
-32%
48%
2001 - 2009
-57%
99%
Median*
-18%
38%
Q3 2014 - Q1 2016
-14%
21%
*excl 2001 - 2009
0
1989 1992 1994 1996 1998 2000 2002 2005 2007 2009 2011 2013 2015
Source: Standard & Poor's, Thomson Reuters, Credit Suisse research
Source: Standard & Poor's, Credit Suisse research
Indeed, we identify four near-term supports for the US profits outlook.
■ Stronger commodity prices
The majority of the decline in US earnings from their peak was a direct result of the
collapse in commodity prices, with commodity sectors (energy and materials) alone
contributing 96% of the decline in net income from the peak.
In this respect, the end of the commodity bear market should be an unambiguous positive
for US earnings. The rebound in commodity prices is already consistent with a modest
increase in net income margins, and both the energy and materials sectors are forecast to
contribute c.3.8p.p. to 2017 EPS growth – one-third of earnings growth for the overall
market. It is this, we feel, that will be the primary driver of any near-term earnings
recovery.
Global Equity Strategy
23
2 December 2016
Figure 20: US EPS ex resources has remained fairly
resilient
Figure 21: The rally in commodity prices suggests a
modest margin recovery
6.0%
380
50
40
MSCI US ex res trailing earnings ,
1998 = 100
4.0%
30
330
20
2.0%
280
10
0.0%
230
0
-10
-2.0%
180
-20
-30
-4.0%
130
Annual change in US non financial net margin (p.p.)
80
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
-40
% change Y/Y in commodity prices (rhs, 6m lead)
-6.0%
-50
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
Of the 13% EPS growth that consensus currently expects for MSCI USA in 2017, around a
third comes from commodities (despite these sectors accounting for only around 7% of
total earnings), 20% from tech and a further 15% from financials, making these sectors the
key drivers of the earnings outlook.
Figure 22: US earnings and earnings growth by
sector
Figure 23: The energy sector is the largest
contributor to EPS growth on consensus forecasts
US sectors: contribution to 2017 EPS growth
MSCI USA sectors
Energy
EPS growth
2016
2017
absolute
growth (%)
-19.1
36.9
3.9
28.2
Materials
5.4
10.6
3.1
3.4
Industrials
5.6
9.3
9.3
4.2
Cons disc.
31.3
12.4
12.0
9.3
Cons stap.
-4.1
13.4
8.4
5.3
Healthcare
6.1
5.5
16.4
12.1
Financials
-14.0
15.4
18.5
15.3
IT
-3.2
17.7
21.9
20.8
Telecom
16.1
7.7
3.2
1.2
Utilities
-9.3
5.7
3.2
0.3
Market
0.2
12.8
Market ex financials
1.8
12.9
Market ex res and fins
6.5
8.5
Market ex resources
5.2
8.8
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Telecom
1%
Contribution to 2017 EPS
Industrials
4%
Materials
4%
Utilities
0%
Cons stap.
5%
Energy
28%
Cons disc.
10%
Healthcare
12%
Financials
15%
IT
21%
Source: Thomson Reuters, Credit Suisse research
24
2 December 2016
■ A modest recovery in nominal GDP relative to nominal wage growth
As a result of both stronger growth and higher inflation, US nominal GDP growth – which
had been very weak – is likely to accelerate, in our view. Although wage growth should
also rise as the labour market tightens further, we do not see wages picking up by as
much as nominal GDP; our economists forecast 2017 nominal GDP growth of 4.3%, which
is above the previous cycle's high in wage growth.
A widening of the gap between nominal GDP and wage growth, as shown below, would be
positive for profit growth.
Figure 25: …and the annual change in the nominal
wage/GDP gap has tended to correlate with profit
growth
Figure 24: The gap between nominal US GDP
growth and wage growth has closed as nominal
GDP growth has slowed…
10%
60%
50%
8%
10%
NIPA profits, % chg Y/Y
8%
Annual change in wage/GDP gap, rhs
40%
6%
6%
30%
4%
4%
20%
2%
10%
0%
0%
-2%
Gap between the two
Nominal GDP growth
Nominal wage growth
-6%
85
87
90
92
95
97
0%
-2%
-10%
% change Y/Y
-4%
2%
99
02
Source: Thomson Reuters, Credit Suisse research
04
07
09
11
14
16
-20%
-4%
-30%
-6%
-40%
1983
-8%
1987
1991
1995
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
Typically, at the end of the cycle, unemployment can overshoot the level consistent with
full employment by about 1pp. This allows a longer business cycle.
Global Equity Strategy
25
2 December 2016
Figure 26: In previous business cycles, the unemployment rate has been able to
overshoot the NAIRU
6
Deviation of US unemployment rate from CBO NAIRU
5
4
3
2
1
0
-1
-2
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
■ US corporate tax rates falling
The specifics of President-elect Trump's corporate tax proposals are difficult to pin down,
but the headlines are punchy: a 35% federal corporate tax rate falling to just 15%.
However, this potentially dramatic cut in the statutory tax rate will not be matched by a
similarly large fall in the effective tax rate.
Using data from HOLT, it is clear that a revenue-exposure weighted statutory tax rate has
had a far closer fit with the effective tax rate paid by US corporates than the US statutory
rate. Even assuming the Federal Statutory tax rate falls by 20p.p., Figure 28 below
suggests that the effective rate would be c.24% (in line with the global average), which
would suggest an 8.6% rise in EPS. If the effective tax rate were to fall by half this amount,
then the EPS boost would be just half this; c.4.3%.
Global Equity Strategy
26
2 December 2016
Figure 27: The US corporate tax rate is high within a
global context
Figure 28: Donald Trump's proposed tax cuts
suggest the effective tax rate should fall by 6p.p., to
24%
US corporate tax rate
Median effective rate
Effective corporate tax rate, %
35
60
Blended statutory rate (60% US, 40% global), with projection
30
50
25
40
20
30
15
20
10
5
10
0
Japan
US
France Germany
Global
UK
0
Hong
Kong
1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
Source: Credit Suisse HOLT
Source: Credit Suisse HOLT
Clearly, there is an offset to this positive, namely the recent rise in US corporate bond
yields and risk of a further rise. The boost to EPS from a fall in the effective tax rate to
24% (up 8.6% as noted above, all other things equal), for example, would halve were this
to be accompanied by a rise in corporate bond yields of 100bps (we note that the
corporate bond yield is up 35bps from election night already).
That is not to sound too negative: if President-elect Trump succeeds in cutting corporate
taxation, it will boost EPS. The magnitude of this boost, however, is likely to be in mid to
low single digit percentages rather than anything more significant.
Figure 29: In many instances, a modest rise in yields would offset a significant
proportion of the boost to profits from a reduction in taxes.
US EPS change under different effective tax rate / corporate bond yield assumptions
Increase in corporate bond yield
Effectiv e tax rate
20%
22%
24%
26%
28%
30%
0bps
14.3%
11.4%
8.6%
5.7%
2.9%
0.0%
50bps
11.9%
9.1%
6.3%
3.5%
0.7%
-2.1%
100bps
9.6%
6.9%
4.1%
1.4%
-1.4%
-4.1%
150bps
7.3%
4.6%
1.9%
-0.8%
-3.5%
-6.2%
200bps
4.9%
2.3%
-0.3%
-3.0%
-5.6%
-8.2%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
27
2 December 2016
■ Margins – excluding tech – are already low
To some extent, US margins have been flattered by the tech sector. Gross margins
excluding tech are already quite low. And when it comes to tech, we believe that very high
capitalised R&D to sales (in other words, significant barriers to entry) allows higher
profitability and margins to be maintained.
Figure 30: Tech is a significant driver of US gross
margins…
US non financials ebitda margin
18%
17%
15%
Global
IT Svs
20%
2015 CFROI
19%
Figure 31: …as its high barriers to entry lead to high
profitability
Software
Int. S/w
16%
15%
10%
Semis
Tech H/W
Cons Dur
Cons SVs
14%
Media
Retailing
Comm. Eqpt
Cap Gds
13%
5%
12%
Inc tech
Ex tech
1996
2000
2004
Source: Thomson Reuters, Credit Suisse research
Autos
Capitalized R&D as % of sales
Materials
11%
1991
Elec. Eqpt
2008
2012
2016
0%
0%
10%
20%
30%
40%
50%
60%
70%
80%
Source: Thomson Reuters, Credit Suisse research
We note that it is only the US that has high margins relative to historical norms. In the case
of Europe and GEM, margins are below their norm.
In light of the more favourable factors discussed above, we slightly revise our US EPS
growth figure for 2017 to 6.0%, from 3.3%.
Global Equity Strategy
28
2 December 2016
Figure 32: We look for 6% S&P 500 earnings growth
in 2017…
Figure 33: …which is 5.5p.p. below consensus
50%
Model inputs, % chg
US Real GDP
Coeff.
t-value
2016E
2017E
3.3
3.0
1.7%
2.3%
Non-fin. corporate GDP deflator
5.8
2.6
1.4%
2.6%
Total costs (ULC+NULC)*
-7.0
-5.8
1.9%
2.3%
USD trade-weighted
-0.3
-1.5
0.0%
3.0%
*ULC= Unit labour costs, NULC (nonlabor unit costs = 53%
depr./13% interest/ 34% taxes)
40%
S&P 500 EPS, y/y%
Model
30%
2016/17E
IBES
consensus
20%
10%
Model output - S&P 500 operating EPS
0%
IBES consensus
$117.0
$130.4
Credit Suisse
$116.9
$123.9
IBES consensus, y/y%
1.3%
11.5%
Credit Suisse, y/y%
1.2%
6.0%
Model specifications
RSQ
0.71
Intercept
0.00
-10%
-20%
2016/17E
CS
-30%
-40%
1986 1989 1992 1995 1998 2001 2004 2007 2010 2013
Source: Thomson Reuters, Credit Suisse estimates
Source: Thomson Reuters, Credit Suisse
2.
A move from NIRP to fiscal easing and central bankers allowing inflation
overshoots
As we have discussed previously, we are seeing a clear-cut policy change, with
policymakers moving away from negative interest rate policies and towards fiscal easing.
The former favours deflation hedges (i.e. bonds), whereas the latter favours inflation
hedges (i.e. equities).
We believe negative interest rate policies are increasingly regarded by policymakers as
counterproductive. They are seen to cause asset bubbles, create 'zombie capital' (by
allowing unproductive or loss-making firms to sustain themselves on cheap borrowing),
push up saving rates, hurt the profitability of banks, and increase the inequality of wealth.
By skewing gains towards asset owners (who tend to have higher savings ratios), QE has
likely placed upward pressure on the aggregate savings ratio and generated disappointing
nominal GDP growth, compared to a policy targeted at the less well off.
As these factors have come to be recognised by policymakers, they have made more
public their move away from NIRP and QE. Federal Reserve chair Janet Yellen pointedly
did not mention negative rates as a policy weapon at Jackson Hole when she discussed
the policy tools available in a recession, while the Governor of the Bank of England, Mark
Carney, has said he is "not a fan of negative rates".
In the case of Japan, NIRP has brought political challenges. In July, the largest bank –
MUFJ – stopped being a primary dealer in the JGB market, highlighting the pressure on
banks from having just over half of their assets in JGBs or deposits. We believe that this
was a signal that the banks, which are important funding contributors to the ruling LDP,
could slow down their political funding.
Meanwhile, there is a growing recognition of the potential utility of greater fiscal spending.
In Canada, Prime Minister Justin Trudeau in Canada has implemented a $60bn fiscal
programme. In the US, President-elect Donald Trump tax cuts have been costed at c.20%
of GDP over 10 years by the Committee for a Responsible Federal Budget, while his
infrastructure spending plan (on which his transition website places a number of $550bn)
Global Equity Strategy
29
2 December 2016
is worth a further 3% of GDP. This fiscal policy could be even more simulative if there
were enhanced investment tax credits at the expense of reducing interest tax deductibility
and some US $2.5 of US cash repatriated from overseas finds its way into GDP (via
buybacks and consumption or via investment).
In the euro area, Mario Draghi has noted that "countries that have fiscal space should use
it". Jean-Claude Juncker's infrastructure plan has expanded in size to €620bn from
€375bn, while Spain and Portugal were not fined or penalised for missing their deficit
targets. In the UK, the recent Autumn Statement saw the announcement of a £23bn
National Productivity Investment Fund over the next five years, along with commitments to
spend a further £5.7bn on social infrastructure and R&D.
Lastly, in Japan, the secretary general of the LDP, Toshihiro Nikai, now favours
abandoning the balanced budget amendment and if Prime Minister Shinzo Abe were to
call a snap election, we think some further fiscal easing could be expected.
We feel that populism is spreading and expect this to result in more fiscal spending and
higher inflation (via protectionism, more stringent immigration and onshoring).
This again means investors are likely to buy inflation hedges.
On top of this, we believe that central banks, on the whole, will be prone to tighten too late
(and risk inflation overshooting) rather than too early (and risk deflation), and thus end up
potentially risking an asset bubble:
There are three good examples of this.
i.
The BoJ has said that it would allow inflation to overshoot and, moreover, its
focus now appears to be on institutionalising an upward-sloping yield curve to
incentivise banks to lend.
ii.
The Swedish Riksbank has continued with QE of c.6% of GDP despite nominal
GDP growth of around 4% and house price inflation of 8%.
iii.
Janet Yellen commented on 15 October that "if strong economic conditions can
partially reverse supply-side damage after it has occurred, then policymakers may
want to aim at being more accommodative during recoveries than would be called
for under the traditional view that supply is largely independent of demand".
3.
Equities are an inflation hedge…
As an inflation hedge, equities tend to re-rate to an average multiple of 20x when inflation
rises to between 2% and 3%, with this band being something of a sweet spot for
valuations; rising inflation only becomes challenging for equities beyond 3%.
This sensitivity of equities to rising inflation is of particular importance, as recently the
correlation between inflation breakevens and equity multiples has risen to a multi-year
high.
Global Equity Strategy
30
2 December 2016
Figure 34: When inflation rises from low levels,
equities tend to re-rate
22
20
12m trailing P/E
18.8
Figure 35: The correlation between equity multiples
and inflation expectations in the US is near a
decadal high
0.8
S&P 500 average P/E, 1871 to present
12m fwd P/E
17.0
18
12m rolling correlation between US 10-yr BEI and 12-m fwd PE
0.6
0.4
16
0.2
14
0
12
-0.2
10
-3% or -3 to - -2 to - -1 to
below 2%
1%
0%
0 to
+1%
+1 to +2 to +3 to +4 to +5 to 6% or
+2% +3% +4% +5% +6% above
-0.4
-0.6
2000
Inflation range shown
Source: Thomson Reuters, Credit Suisse research
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Currently, the implied 5-year, 5-year forward breakeven inflation rate is 2.0%, slightly
below core inflation of 2.2%. We believe that the 5y/5y forward breakeven rate could
easily rise to 2.5% or slightly further. However, we see little chance of inflation rising much
above 3% on a sustained basis – something that the market seems to believe as well; 3%
strike price inflation caps, which pay the holder if inflation rises above 3%, remain cheap,
whereas 1% and 2% strike price caps have recently increased substantially in price.
Figure 36: Despite having risen sharply, 5y5y
breakeven inflation rates remain below current core
inflation
Figure 37: Currently, above-3% inflation remains
seen as unlikely
US 5-yr inflation cap
3.0
700
1%
2%
3%
600
2.5
500
2.0
400
1.5
300
200
US 5y5y breakeven inflation
1.0
Core CPI, y/y
0.5
2007
2008
2009
2010
2011
2012
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2013
2014
2015
100
2016
0
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Source: The BLOOMBERG PROFESSIONAL™ service, Credit Suisse research
31
2 December 2016
Historically, equities have tended to outperform bonds at times of accelerating US CPI
inflation. We feel that, in most circumstances, equities will outperform bonds in 2017.
Figure 38: Accelerating inflation tends to support the performance of global
equities relative to bonds
60%
7
6
40%
5
4
20%
3
0%
2
1
-20%
0
-40%
Global equity to bond ratio, % chg Y/Y
-1
US CPI, % chg Y/Y
-2
-60%
-3
1992
1995
1998
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
4.
…and institutions or retail are not positioned for inflation
Since the market low in 2009, the only significant net buyer of equities has been the
corporate sector. Institutions have actually been net sellers, whereas households have
bought almost no equity on a net basis (just over 1.2% of market cap cumulatively) and
thus both retail and pension fund weightings in equities are low.
The extent of this cautious positioning becomes clear when looking at global fund flows:
since 2008, data from EPFR show $1.4trn flows into bond funds, while equity funds have
actually seen outflows.
Global Equity Strategy
32
2 December 2016
Figure 39: Since the market low, the only net buyer
in the US has been the corporate sector…
18%
Non-financial corporates
Rest of world
14%
Households
Institutions
1,430
1,500
Cumulative buying/selling of US equities, % Market Cap
16%
Figure 40: …and overall, global investors have not
been net buyers of equities
1,300
12%
1,100
10%
Flows into global funds, USD bn
900
8%
Equities
Bonds
700
6%
4%
494
500
2%
0%
300
-2%
100
308
141121
93
76 49
-4%
-6%
-100
-8%
-300
2010
2011
2012
2013
2014
2015
-50
Since Jan
2008
-10%
2009
-9
2016
Source: Thomson Reuters, Credit Suisse research
-14
-93
2012
2013
2014
2015
Last six
months
Source: EPFR Global, Credit Suisse research
On EPFR data, year-to-date we have seen $120bn of outflows from global equity funds,
the second-largest year-to-date value of outflows since 2008, against nearly $160bn of
inflows into global bond funds. It is quite astonishing to see equity mutual fund outflows at
very extreme levels – currently more extreme than even in 2008 (though some of this
reflects investors selling mutual funds to buy ETFs).
Figure 42: …and net selling of equity mutual fund
shares has surpassed 2008 levels
Figure 41: This year has seen some of the most
significant outflows from equities since 2008…
2008
2013
Cumulative flows into global equity funds, $bn
2009
2010
2011
2014
2015
2016
2012
300
30
US net new cash to all equity mutual
funds ($bn, 12mma)
25
20
15
200
10
100
5
0
0
-5
-100
-10
-200
-15
-20
-300
Jan Feb Mar Apr May Jun
Source: EPFR Global, Credit Suisse research
Global Equity Strategy
Jul
Aug Sep Oct Nov Dec
95
96
98
99
01
02
04
05
07
08
10
11
13
14
16
Source: Thomson Reuters, Credit Suisse research
33
2 December 2016
Pension fund weightings in equities are very low across many regions, and for US retail
investors equity weightings (as a share of financial assets) are close to normal levels.
Figure 44: …and households do not hold a
significant share of their wealth in equities
Figure 43: US pension funds' equity weightings
remain well below average levels…
50%
33%
US private pension funds, equities as % of invested assets
US Households directly held equities, % of
total financial assets
45%
28%
40%
23%
35%
18%
30%
13%
25%
20%
1961
8%
1970
1979
1988
Source: Thomson Reuters, Credit Suisse research
1997
2006
2016
1945
1955
1965
1975
1985
1995
2005
2015
Source: Thomson Reuters, Credit Suisse research
As a result, investors are implicitly overweight bonds (deflation hedges) and not equities
(inflation hedges) at a time when both policy and the macro environment suggest inflation
is likely to accelerate.
We see two potential catalysts for a switch in asset allocation:
First, a further rise in bond yields – reminding investors of the potential for capital losses
on their bond holdings – could catalyse something of a switch from bonds into equities. As
yields rise, equity fund flows tend to pick up relative to those into bond funds, with just over
half of all US equity fund flows over the past 10 years being explained by a combination of
equity and bond returns.
In addition, retail investors tend to follow momentum and thus buy equities when they
perform well. Households' buying of government bonds is also dominated by momentum:
buying accelerates as yields fall, and vice versa.
Global Equity Strategy
34
2 December 2016
Figure 45: Just over half of US equity fund flows are
explained by market performance relative to
bonds…
Figure 46: …meaning that equity mutual funds see
inflows when the market is expensive, and vice
versa
2%
50
1%
40
0%
30
22
20
20
10
18
0
16
-10
14
-20
12
-30
10
-1%
-2%
-3%
-4%
3m anualized flows as % of market cap
in US mutual funds, all equities
-5%
Regression (equity & bond returns;
R2=54%)
-6%
2006
2007
2008
2009
2010
2011
2012
Source: Thomson Reuters, Credit Suisse research
2013
2014
2015
2016
US net new cash to all equity mutual
funds ($bn, 3mma)
US market 12m fwd PE (rhs)
-40
26
24
8
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Source: Thomson Reuters, Credit Suisse research
Second, as bond yields rise, US actuaries allow pension funds and life companies to take
on more risk (because the value of their liabilities falls).
5.
The equity risk premium is still modestly high (and can overshoot)
The equity risk premium (the additional discount rate on top of the risk free rate that is
required to make the NPV of expected future dividends equal to the market) is still high, at
6.4%. Even on our below-consensus earnings estimates, the ERP remains high in a
historical context, at 5.3% versus a long-run average of 4.2%.
While we can debate whether the ERP is overstated because the terminal growth rate
assumed is too high, it is unambiguous that the risk-free component of the discount rate
(the long-dated bond yield) is unusually low relative to nominal GDP (the rate at which
revenues should grow) and this drives the elevated ERP.
Global Equity Strategy
35
2 December 2016
Figure 47: The gap between G4 nominal GDP growth and bond yields remains
significant
10%
G4 aggregate government bond yield
8%
G4 nominal GDP growth
6%
4%
2%
0%
-2%
-4%
1990
1994
1998
2003
2007
2011
2016
Source: Thomson Reuters, Credit Suisse research
If the bond yield is rising because inflation expectations are rising, then the long-term
growth rate should rise by as much as the discount rate and thus the ERP would be little
changed. So far, about half of the rise in the Treasury yield since its low in July has been
due to a rise in inflation expectations.
Figure 48: On our earnings forecasts, the ERP is 5.3%, versus 6.4% on
consensus numbers
12mth fwd EPS
12-24mth fwd
EPS growth
3-5yr fwd EPS
growth
ERP
ERP on 12m forward consensus EPS estimates
$129.8
11.7%
12.3%
6.4%
ERP on our EPS forecasts
$123.3
6.0%
8.0%
5.3%
$58
$49
6.4%
6.4%
5.4%
4.8%
4.2%
US ERP
$58 risk premium
Our forecast
foryear
2009average
EPS ofequity
$49
Historical
110Source: Thomson Reuters, Credit Suisse research
Our model for the warranted ERP, which depends on lead indicators and credit spreads, is
consistent with a 1.2pp fall in the ERP (using consensus numbers) and a marginal decline
if we calculate the ERP on the basis of our earnings estimates.
Global Equity Strategy
36
2 December 2016
Figure 49: The gap between the consensus and
warranted equity risk premium has narrowed
sharply
Figure 50: Our model, based on the output gap and
credit spreads, implies a warranted ERP of 5.2%
US ERP on consensus EPS
11
Model inputs
Coeff.
t-value
Current
US Warranted ERP
US lead indicator - dev. from trend
-0.38
-9.6
1.15
9
BAA Corp. bond spread
1.48
12.9
2.63
7
Model output
5
3
1
1994
1997
2000
2003
2006
2009
2012
2015
Source: Thomson Reuters, Credit Suisse research
US warranted ERP (consensus, operating)
5.2
Current ERP on consensus EPS
6.4
ERP on Credit Suisse EPS
5.3
Post-1991 average
5.3
RSQ
0.70
St. error of estimate
1.13
Intercept
1.8
Source: Thomson Reuters, Credit Suisse research
There are three main reasons why we think that the equity risk premium can end up falling
further than perhaps our models say.
i.
The equity risk premium, at 5.3% (on our earnings numbers), is still considerably
above its long run average of 4.2%.
ii.
We think that, as is the case in most bull markets, the ERP can overshoot its fair
value'. Historically, markets have peaked on a very low equity risk premium –
2.4% on average. While we do not expect the ERP to fall to such low levels again,
it is illustrative of the tendency for equities to overshoot fair value when markets
peak.
Figure 51: Markets typically peak on a far more depressed ERP
US ERP proxy until 1987 (earnings yield x 45% payout ratio - bond yields + 10-year trailing nominal GDP growth)
15%
US ERP on consensus EPS
Equity market peaks
10%
5%
0%
-5%
1871
1882
1893
1904
1915
1926
1938
1949
1960
1971
1982
1993
2005
2016
Source: Thomson Reuters, Credit Suisse research
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37
2 December 2016
iii.
Other factors suggest a lower 'warranted' ERP. Our model for the ERP largely
looks at cyclical factors to explain the riskiness of equities versus bonds (i.e.
credit spreads, ISM and PMI new orders). Below we consider other cyclical
factors and structural factors which all suggest that the 'warranted' ERP should be
lower. We discuss each in turn below.
■ Equity to bond volatility
As a proxy on the drawdown risk from equity investing, we look at the ratio of realised
equity to bond volatility. This has fallen significantly over the past quarter, reversing its
earlier rise, and suggests that the equity risk premium should fall.
■ Earnings uncertainty
As a proxy on earnings uncertainty, we look at the dispersion of analysts' earnings
estimates around their mean. Despite recent political developments having contributed to
rising macro uncertainty, perceived earnings uncertainty is still particularly low, at near the
minimum seen over the past two years, and suggests the ERP can fall further.
Figure 52: The fall in equity volatility relative to that
of bonds suggests a lower ERP
ERP on consensus EPS
15
Ratio of equity to bond volatility, 1y (rhs)
13
11
Figure 53: The level of dispersion among analysts'
earnings estimates suggests a lower ERP
10
18
9
16
8
14
7
12
6
10
5
8
4
6
3
4
2
2
1988
9
S&P 500, stdev of consensus EPS estimates / 12m fwd EPS (%)
ERP on consensus EPS
12
Warranted ERP
10
8
7
5
3
1
2004
14
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
6
4
2
0
1991
1994
1997
2000
2003
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
■ Public- to corporate-sector leverage
In the developed world, governments' leverage has risen significantly since 2008 and is
now particularly high relative to corporate sector leverage. The solution to this is to either:
default on government bonds (worse for bonds than equities); tax the creditor (worse for
equities than bonds); or tax the creditor indirectly via a sustained period of depressed real
rates (this is good for bonds until real rates fall to the required level – as they now have, as
we show in the bond section). The leaves equity returns less repressed than bond returns.
■ Minority shareholder risk
One of the highest risks of investing in equities over a very long period of time (i.e. 40
years) is minority shareholder risk. This is often overlooked but we feel that the minority
shareholder risk has been greatly reduced. This risk comes down to three elements:
Global Equity Strategy
38
2 December 2016
a. Corporate governance and whether the interests of management and shareholders are
aligned. Aggressive M&A (underperforming managements lose their jobs and are
replaced) or strong non-executive boards (who fire underperforming management) and
executive share options have all improved significantly (as we show later on in the
case of Japan), yet this reduced 'dilution' risk is not reflected in a lower ERP.
b. Accounting visibility and information flow is much better, meaning minority
shareholders today know much more about the state of the corporates that they are
buying.
c. There is now much higher liquidity in equity markets and transaction costs are far lower
than historically was the case.
Moreover, the first two of these shareholder-related factors are helped by a structural rise
in ESG-related investment mandates. Considering all these additional factors, the ERP
could indeed fall to much lower levels – around 1.5p.p. lower than currently – as we show
in the table below.
Figure 54: G4 government leverage has risen
significantly as corporates de-levered
140%
Figure 55: Our equity risk premium proxies suggest
the ERP can overshoot the warranted
G4: debt to GDP by sector
130%
Governments
120%
Non-financial corporates
110%
Risks
100%
Proxy
Implied ERP
ISM/Credit spreads
5.2%
Volatility risk
Ratio of equity to bond volatility
3.5%
Earnings uncertainty
Dispersion of earnings estimates
2.3%
Cycle risk
90%
80%
Economic uncertainty risk
Policy Uncertainty Indicator
Safety of corporate vs govt balance sheet Corporate vs government balance sheets
70%
Average 'warranted' ERP
4.7%
sub 4%
3.9%
60%
50%
40%
1980
1985
1990
1995
2000
Source: Thomson Reuters, Credit Suisse research
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
The big picture is that the cost of equity is still quite high in both the US and Europe, while
the discount rate on other assets – corporate or government debt – is low.
In our view, that leaves equities as the least expensive asset class in a world of expensive
assets and, as above, a hedge against the form of risk that we believe is most likely: that
policymakers switch to more inflationary policies.
Global Equity Strategy
39
2 December 2016
Figure 56: The cost of equity has been largely
unchanged, despite significant falls in the discount
rate on other assets
Figure 57: The cost of equity in the US is not far
below its 20-year average
US cost of
equity
20
US IG yield
US 10yr TIPS
US 10yr govt
US High yield bond yield
yield
0.00
18
US 10-year bond yield
16
US cost of equity
14
-0.20
US IG yield
12
-0.40
10
-0.60
8
6
-0.80
4
2
-1.00
0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
-1.20
Standard deviation below respective 20 year norm
Source: Thomson Reuters, Credit Suisse research
There clearly remain concerns that equities are expensive in absolute terms. As we have
shown before, the main proxies of absolute value suggest a fair value of c.1,700 for the
S&P 500, as detailed in the table below.
Figure 58: In absolute terms, equities are expensive
Current level
St.dev. from avg/trend
S&P value if indicators were
at long term levels
Upside / Downside
Value
Tobin's Q (EV/replacement value)
0.98
0.99
1,852
Downside
Market Cap to GDP
1.19
1.59
1,450
Downside
Price to trend EPS*
22.5
-0.03
2,235
Upside
Shiller PE*
26.6
1.28
1,420
Downside
0.96
1,710
Downside
Valuation indicator
Average
Source: Thomson Reuters, Credit Suisse research
However, this does not mean that the market should fall 20%. Rather, it means that the
market is c.30% expensive in absolute terms, and that long-term real returns ought to be
around 20% below their historical norm of 6.9%; i.e. in real terms returns should be
c.5.5%.
We would note that in the past 40 years, the forward P/E has had better predictive ability
over future returns than the Shiller P/E. Currently, the forward P/E ratio is consistent with
10-year real returns of c.3.5% pa.
Global Equity Strategy
40
2 December 2016
Figure 59: The current forward P/E suggests 10-year
real returns of c.3.5% pa…
Subsequent 10-yr real returns
S&P 500 12m fwd PE, rhs, inverted
17%
8
10
12%
Subsequent 5-yr real returns
Shiller PE, rhs, inverted
30%
0
5
20%
10
12
14
7%
16
2%
18
15
10%
20
0%
25
30
-10%
35
20
-3%
22
-8%
1986
Figure 60: …although the Shiller P/E, which has had
only a loose relationship with forward returns,
suggests returns will be lower than this
1991
1996
2001
2006
Source: Thomson Reuters, Credit Suisse research
2011
2016
24
40
-20%
45
-30%
1981
1986
1991
1996
2001
2006
2011
2016
50
Source: Thomson Reuters, Credit Suisse research
While the Shiller P/E (CAPE) at current levels is associated with below-average returns,
47% of the time the CAPE has been at current levels, nominal returns have been above
5% over the subsequent year (and 27% of the time over the subsequent three years).
6.
Excess liquidity suggests a re-rating
Global liquidity conditions remain supportive for equities, in our view. We look at growth in
money supply versus money demand (using the Bank of England's methodology; i.e. the
differential between nominal M1 and GDP growth) and, on this basis, excess liquidity
suggests a c.25% re-rating of equities.
The interesting dynamic, though, is that if Japanese investors buy more US bonds
(because of the higher yield and steeper curve) and the BoJ continues to target a zero
JGB yield, then the BoJ could actually accelerate its rate of QQE, potentially making the
liquidity outlook more favourable still. Indeed, at the most recent BoJ meeting, the central
bank committed to buying unlimited amounts of JGBs at a fixed yield, showing that – in
spite of rates rising globally – the BoJ is determined to cap the JGB yield at zero.
Global Equity Strategy
41
2 December 2016
7.
The ratio of equity to bond returns is not discounting an acceleration in
growth
The ratio of equity to bond returns is no longer discounting a recovery in lead indicators,
but rather a modest deceleration. However, as we discuss later, global growth is likely to
surprise positively in 2017, in our judgement.
Figure 61: Global excess liquidity is consistent with
a re-rating of global equities of around 25%
OECD excess liquidity (3m lead)
18
Global equities, 12m % change in PE (3mma, rhs)
16
95%
14
50%
Global equities vs global government
bonds, total returns (6m % chg)
40%
OECD leading indicator (6m % chg, rhs)
3%
2%
30%
1%
20%
12
65%
10
8
35%
6
10%
0%
0%
-1%
-10%
4
5%
2
0
-25%
-20%
-2%
-30%
-3%
-40%
-2
-4
1983
Figure 62: Global equity to bond returns suggest a
modest fall in macro momentum
-55%
1988
1993
1997
2002
2007
2011
2016
Source: Thomson Reuters, Credit Suisse research
-50%
1997
-4%
1999
2002
2005
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
Typically, any rise in US macro surprises – as we would expect to occur – sees the S&P
500 rally, historically.
Figure 63: A rise in US macro surprises is typically
associated with the S&P 500 rallying…
Figure 64: …and, particularly over the past 18
months, there has been a close correlation between
economic surprises and the S&P
40
30
110
20
2300
S&P 500
30
US macro surprises, rhs
20
60
10
2200
10
0
-40
0
2100
-10
-90
2000
US macro economic surprises
-190
-30
1900
-40
2009
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2014
2015
2016
-20
-40
-50
S&P 500, 3m % change, rhs
-240
2008
-10
-30
-20
-140
10
1800
-60
Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16
Source: Thomson Reuters, Credit Suisse research
42
2 December 2016
8.
No clear excess in equities
Normally the end of a bull market sees some form of excess in terms of funds flow,
valuation, or of a particular investing fad.
For example, excess valuation (e.g. the Nifty Fifty stocks peaked on 42x earnings in 1972
and the TMT stocks on 60x earnings in early 2000) or clear-cut excess leverage in the
financial sector (as in the case of 2007/08).
This time around, there is no similarly clear excess, although we would acknowledge that
corporate leverage is becoming high in the US.
Above all, there has been no excess in sentiment. If anything, quite the opposite:
sentiment toward equities – at least in recent years – has been fairly cautious, with many
investors expressing some degree of scepticism over the market's ability to make new
highs. Our most recent investor survey, conducted in October, suggests that many clients
see limited upside for equities.
Figure 65: Most investors do not see much upside for equities
2300
Where do you see the S&P 500 at the end of…?
-1%
2205
2185
2200
-3%
2132
2100
2000
1900
1800
1700
Current
2016
2017
Source: Credit Suisse Global Equity Strategy Investor Survey (October), Thomson Reuters, Credit Suisse research
9.
Could disruption actually be good for equities?
Disruptive technology's impact on certain sectors within the equity market is clearly a
negative; disruption means increased business model risk and shorter asset lives.
However, we wonder whether – at least from a macro perspective – disruption could be
positive for equities in aggregate, as it:
Global Equity Strategy
i.
Creates excess savings: the benefits of disruptive technology generally accrue
to the wealthy – or, alternatively, owners of capital – who tend to have higher
savings ratios;
ii.
Increases the marginal productivity of capital: technological advances and the
growth of the sharing economy (which raises asset utilisation rates) increase the
productivity of capital, and thus the efficiency of investment, meaning less
investment is needed. The chart below illustrates that the business investment
share of GDP in the US has remained around 'normal' levels, despite the profit
share of GDP, in 2014, having steadily risen to very elevated levels.
43
2 December 2016
Figure 66: The corporate profit share of GDP is particularly elevated, against
just 'normal' levels of business investment
Share of US GDP
Profits
Net business investment, with post-1990 avg.
12%
10%
8%
6%
4%
2%
0%
-2%
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
Both points (i) and (ii) lead to excess savings and generally that is good for financial asset
prices.
iii.
Reduces equilibrium unemployment rates: technologies such as LinkedIn and
job-switching apps mean it is now much easier to match job offers with
applications. This, combined with the reduced demand for labour as automation
becomes more widespread, should lower the full employment rate, extending the
cycle and, at the margin, reducing wage (and thus margin) pressures; and
iv.
Keeps headline inflation low: above all, disruptive technology is disinflationary,
which allows central banks to keep monetary policy loose.
10. The Trump effect: more positive for equities than not
The equity market has taken the view that the election of Donald Trump is a small net
positive (with the S&P 500 up by around 3% since the election). In general, we would
agree with this, but note that the risks remain high.
There appear to be three principal economic risks associated with a Trump presidency.
■ Immigration
The proposed deportation of 11.4 million illegal immigrants would not only sharply reduce
the US unemployment rate, it would also reduce the trend rate of growth of US GDP
growth down to c1.5%. In addition, concerns will be elevated in specialist areas such as
tech, which employs 85,000 workers on H-1B visas. However, we think the stance on
immigration will be toned down from the campaign. President Obama deported 2.7 million
illegal immigrants with criminal records and we suspect there will be a tougher pointsbased system under Trump. Moreover, both Houses of Congress are in favour of
immigration according to our Public Policy Team.
■ Protectionism
Clearly there is concern that Donald Trump's policies could lead to an all-out trade war, a
development that would be bad for growth and profits. We believe that the practicalities
will again mean that the reality is greatly toned down, however. President Obama, at one
Global Equity Strategy
44
2 December 2016
point, threatened to pull out of NAFTA and anti-dumping duties can take a very long time
to implement; we note that, in some cases, high anti-dumping duties are already in place
(222% in the case of steel).
Moreover, most of Trump's advisors are businessmen and are likely to be critical of
protectionism. The Vice President-elect, Mike Pence, who is in charge of the transition
team, is an advocate of free trade and travelled to China during his term as Governor of
Indiana. We think that the bottom line is that the interlinkages are now so great that
starting a trade war becomes much harder. For example, the US has five-times higher FDI
in China than China has in the US; as a result, corporate America potentially stands to
suffer much more directly from a trade war than in the past, with over 44% of S&P 500
revenues coming from overseas. Also, the primary consequence of reshoring would be
higher prices to the US consumer.
■ Antitrust rulings
President-elect Trump has previously stated that one of the largest tech companies in the
US has "a huge antitrust problem". The reality, however, is that in order to win an antitrust
ruling not only does one have to prove market dominance, but also abuse of market power
that results in higher prices to the consumer. The latter two might be very hard to prove in
the case of the internet-related companies.
The potential positives
■ More or less, all of Trump's policies are inflationary
These include immigration, protectionism, an increase in government spending and
potentially leaning on the Fed to raise rates less quickly than would have previously
planned (Donald Trump needs to appoint two Fed governors in 2017 and a Chair of the
FOMC by January 2018). This is happening at a time when investors are structurally very
underweight equities – the inflation hedge – and overweight bonds – the deflation hedge.
■ Improving infrastructure
Donald Trump has committed to spending $550bn on infrastructure over five years. This
should be a net positive as it boosts not only GDP but also productivity against a backdrop
where the average age of US roads is 27 years.
■ Fiscal easing
Trump's tax plans have been costed at c20% of GDP over 10 years by the Committee for
a Federally Responsible Budget. The last time there was a Republican President and
Congress was under George W. Bush when substantial fiscal easing occurred.
■ De-regulation
There have been strong hints that there will be a lower regulatory burden on energy,
pharmaceuticals, and above all financials (where Trump hints that he will repeal DoddFrank and looks to ease the new 'fiduciary duty').
■ Repatriation of overseas cash
Allowing the $750bn of offshore cash to be bought onshore with a probable tax rate of
c.10% would in all likelihood result in an increase in buybacks helping both EPS and
corporate net buying.
■ Reduce the corporate tax rate
Trump has talked about the reducing the headline tax rate from 35% to 15% (against an
effective tax rate of 30%). We suspect, as discussed, the fall in the tax rate would be much
Global Equity Strategy
45
2 December 2016
less than the headline number (with a likely loss of many tax credits). This could boost
growth and earnings. It is possible that investment tax credits could increase relative to
other credits (such as interest tax deductibility) and that would encourage more
investment.
What worries us about equities?
Despite these positives, we see a set of challenges for equities, and thus stick to our
benchmark weighting. We discuss each of the main issues in turn:
1.
The risk of government yields rising 'too high'
The biggest risk we see facing equities in 2017 is bond yields rising to a level at which: i)
the relative valuation case for equities becomes undermined; ii) rates rises impact on
profitability; or iii) rates rise to a level that significantly undermines corporate net buying.
Since 1999, the correlation between bond yields and equities has been positive, with
equities tending to benefit from any rise in bond yields.
On almost all occasions when the US 10-year yield has risen (by a median of 90bps over
a period of 4 months) the S&P 500 has pushed higher, although, generally, larger rises in
yields have been associated with lower equity returns.
Figure 68: …with equities rising on almost all
occasions since 2000 when bond yields have risen
Figure 67: Historically, a positive correlation
between yields and equities has tended to hold…
40
1.50
30
40%
2012
35%
1.00
30%
20
10
0
0.00
-10
-0.50
-20
-1.00
-30
S&P 500 % change
0.50
25%
2011
20%
2002
2009
15%
10%
2006
5%
2004
2015
-1.50
3 month % change in the S&P 500
-50
2008
3 month change in the US 10 year yield (bp, rhs)
2009
2010
2011
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
2015
2016
-2.00
-5%
2008
2004
0%
-40
2010
2001
2005
2008
2003
2001
2000
-10%
50
75
100
125
150
US 10-year yield increase (bps)
175
200
Source: Thomson Reuters, Credit Suisse research
Quantifying the level of yields at which equities become challenged is difficult, but we
examine the three potential channels in turn:
■ Relative valuations becoming challenged
On our below-consensus earnings numbers, US equities can accommodate a further
10bps rise in the US 10-year yield (i.e. to 2.5%) before the equity risk premium becomes
'fair value'. But there are three reasons for believing that the bond yield can rise closer to
3.0-3.5% before the rise in bond yields becomes a problem for equities:
i.
Global Equity Strategy
The factors that we tend not to model in our formal warranted ERP model (such
as realised equity to bond volatility, the variance in earnings estimates or minority
46
2 December 2016
shareholder rights) would imply the warranted ERP should be 1-1.5% lower than
our model suggests.
ii.
All markets tend to overshoot fair value. If this were to happen to the degree
which has occurred usually, that would imply an ability to accommodate a bond
yield of c.4%.
iii.
Although we treat consensus numbers very cautiously, on consensus earnings
forecasts, the actual ERP is much higher and suggests that a 140bps rise in
yields (to 3.7%) can be absorbed by the ERP without the cost of equity
increasing.
Another way of considering relative valuations is the yield spread of US Treasuries over
equities. As the rate of inflation rises, fixed income investors' required yield premium over
equities widens. The simple chart below suggests that, on current inflation and dividend
yield, the 10-year bond yield can rise by about 1% before it becomes a valuation
impediment. This would imply a bond yield of c.3.3%.
Figure 69: The acceleration in CPI inflation suggests a 1ppt widening of the
yield premium 10-year Treasuries offer over US equities
5.0
5.0
4.0
3.0
3.0
2.0
1.0
1.0
0.0
-1.0
-1.0
-3.0
-2.0
12 month change
-5.0
-3.0
CPI inflation
-4.0
UST yield less DY, rhs
-7.0
-5.0
1976
1979
1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
2013
2016
Source: Thomson Reuters, Credit Suisse research
Most of this analysis suggests that the time to worry is when yields hit 3.0-3.5%.
■ Higher yields damaging profitability
The main negative side-effect for equities from rising yields is a rising interest charge,
which not only dents profitability (as the interest charge rises) but can also undermine the
FCF yield enhancement of buybacks as the gap between the FCF yield and the corporate
bond yield closes.
All else equal, the chart below suggests that each 100bp rise in the BAA yield would raise
the interest burden (expressed as a percentage of sales) by 0.35pp, or, equivalently,
would reduce PBT by 4%.
Global Equity Strategy
47
2 December 2016
Figure 70: Each 100bps rise in the BAA yield suggests a 4% fall in PBT
Source: Thomson Reuters, Credit Suisse research
Turning to the impact of rising rates on the top line, the OECD's global model estimates
that a 100bps rise in US short-term rates reduces domestic nominal GDP growth by
c.0.4%, while the effect on non-US global growth is more muted, at c.0.2%.
Assuming a parallel yield curve shift, using the geographical revenue exposure for the
S&P 500 (55% domestic, 45% international), and proxying revenue growth by nominal
GDP growth, we calculate the revenue impact as minus 0.32% per 100bps increase in
interest rates. Based on the historical beta of net profit to revenue growth outside of
recessions (4x), this would imply a 1.3% decline in profits.
Thus, combining these factors gives a 5.3% hit to profits for each 100bps rise in yields
(although for sensitivity analyses within this outlook, we use purely the interest charge
impact).
■ Corporate buying slows meaningfully
We believe that the key driver of buybacks is the degree to which they are earnings
enhancing (the gap between the earnings yield and the corporate bond yield). In fact,
since 2012, buybacks have accounted for around a third of EPS growth, with the
remaining two-thirds being 'organic'.
If corporate bond yields were to rise by 150-200bps, the gap between the free cash flow
and corporate bond yield would fall to below its average 2004-2007 level, which we think
would result in a meaningful slowing of buybacks.
Below we assume uniform increases in corporate bond yields across the credit risk
spectrum (i.e. driven by an increase in the risk free rate, but not the credit risk premium)
and calculate the proportion of the market which would still have a free cash flow yield in
excess of the respective corporate bond yield.
As a rough rule of thumb, each 50bps rise in the risk free rate reduces this proportion by
6ppts, with a 200bps rise leading to a near-halving of the number of companies that can
raise their free cash flow yield by retiring shares for debt.
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48
2 December 2016
Figure 71: If corporate bond yields were to rise 200bps, the proportion of the
market with a FCF yield in excess of its corporate bond yield would nearly halve
65%
Proportion of market with FCF yield > corresponding corporate yield
60%
55%
50%
45%
40%
35%
30%
+0bps
+50bps
+100bps
Increase in corporate bond yields
+150bps
+200bps
Source: Thomson Reuters, Credit Suisse research
2.
The US profits cycle has likely peaked, even if there is a temporary rise
Although there are some near-term positives emerging for US earnings, we see the
longer-term outlook as more challenging, owing to the following factors.
■ Labour gaining pricing power
The biggest problem facing corporate profits is the growing evidence that US labour is
beginning to gain pricing power. Whether we look at the wage component of the ECI,
average hourly earnings or the Atlanta Fed wage tracker, labour market tightness is clearly
revealing itself in accelerating wage growth.
Figure 72: Wage growth is picking up on both AHE
and ECI…
5.0
Figure 73: …and the constant-cohort Atlanta Fed
wage tracker for job switchers is near previous
cycle highs
7
Atlanta Fed Wage Growth Tracker
% change Y/Y
Average hourly earnings (% chg Y/Y)
4.5
ECI wages and salaries (% chg Y/Y)
6
Job Switcher
4.0
Overall
5
3.5
4
3.0
2.5
3
2.0
2
1.5
1.0
1990
1
1993
1997
2001
2004
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2008
2012
2016
1997
1999
2001
2003
2005
2007
2009
2011
2013
2016
Source: Federal Reserve Bank of Atlanta, Credit Suisse research
49
2 December 2016
When the wage share of GDP rises – as it should do in 2017 with continuing employment
and wage growth – the profit share of GDP falls. This hit should become less in 2017 as
nominal GDP growth accelerates, but rising wage growth should still reduce the profit
share of GDP.
Using our economists' projections for nominal GDP growth and employment growth, and
assuming wage growth rises to 3.25% by end-2017, we estimate that the labour income
share of GDP could rise by 25bps in 2017 (compared to a 97bps rise in 2015 and 36bps
so far in 2016).
Figure 74: Based on our assumptions for employment and wage growth, the
rate at which the labour share of GDP increases should slow further in 2017
Year
Wage growth (y/y, annual average)
Change in labour share of GDP (bps)
2015
2.1%
+97
2016*
2.5%
+36
2017*
2.9%
+25
*estimate/partial estimate
Source: Thomson Reuters, Credit Suisse research
Based on the usual relationship between the wage and profit share of GDP, this suggests
a continued fall in the profit share of income, although a fall that is still consistent with a
modest rise in corporate profits.
Figure 75: Our projections for employment and wage growth suggest a
continued rise in the labour share of GDP
14%
52%
Share of US GDP
13%
Profits
12%
Wages, rhs (inverted)
53%
54%
11%
10%
55%
9%
56%
8%
57%
7%
58%
6%
5%
1950
59%
1955
1960
1965
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
■ The majority of the margin improvement came from one-off factors
The majority of the improvement seen in net income margins relative to the post-1990
average until their peak came from two factors that we do not think can be repeated to the
same degree: i) a fall in the interest burden; and ii) a fall in the tax burden.
Global Equity Strategy
50
2 December 2016
Figure 76: The majority of the net income margin
improvement was due to interest and tax…
Figure 77: …which, along with increased leverage,
had a positive impact on ROE
2.0%
US: Contribution to change in ROE - 10y average (0212) vs. 3yr average (13-15) ex financials & resources
1.5%
US sector margins (Ex Financials & Resources)
Component
post-1990 Latest (4Q
avg
avg)
1.0%
Contribution to change
Ch (% pt)
in net income margin
EBITDA margin
16.7
17.4
0.67
43.6%
Interest
-2.4
-2.0
0.40
25.8%
Depreciation
-5.0
-5.1
-0.17
-11.3%
Tax
-3.0
-2.4
0.64
41.3%
Net profit
6.3
7.8
1.54
0.5%
0.0%
-0.5%
-1.0%
-1.5%
Tax Burden
Source: Thomson Reuters, Credit Suisse research
Interest
Burden
EBIT margin Asset Turn
Leverage
RoE
Source: Thomson Reuters, Credit Suisse research
As discussed above, we see a risk that the interest charge continues to rise further, while,
on the tax side, clearly the election of Donald Trump helps, but we wonder whether the
positive effects have been overestimated. As noted above, a fall in the tax rate is likely to
be accompanied by a rise in corporate bond yields (given the stimulus to the economy this
would represent), serving as at least a partial offset to the boost to profitability brought
about by the tax cut.
■ Buybacks look set to slow further
As we discuss below, the outlook for share buybacks continues to deteriorate, largely
because of the extent to which corporate leverage has already risen.
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51
2 December 2016
3.
Corporate buying is set to slow, but not as quickly as previously thought
Corporate buybacks have been responsible for a third of US EPS growth since 2012.
However, after peaking at a post crisis high in the second half of 2015, buybacks have
been slowing throughout 2016. We think this slowdown is likely to continue on the back of
increased leverage (net debt to EBITDA is back above its norm) and higher bond yields
(making leverage more expensive).
Figure 78: The rate of share buybacks has slowed…
Share buybacks as a share of market cap (%)
12%
Figure 79: …on the back of increased corporate
leverage in the US
2.40
13 per. Mov. Avg. (Share buybacks as a share of market cap (%))
2.20
US net debt/EBITDA ex financials
US net debt/EBITDA ex financials and resources
10%
2.00
8%
1.80
6%
1.60
4%
1.40
2%
1.20
0%
-2%
2001
2004
2007
2010
2013
Source: TrimTabs Investment Research, Thomson Reuters, Credit Suisse research
2016
1.00
1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source: Thomson Reuters, Credit Suisse research
However, we are slightly more positive than we were earlier this year, as two hitherto
negative trends have improved:
i.
The rate of corporate net buying (which has averaged 4.2% of market cap) is
showing signs of a small pick up on the back of increased takeover activity.
ii.
Buyback as a style is starting to outperform again, indicating that – to some extent
– investors are rewarding buybacks.
Furthermore, we think corporates can still continue some of their buying albeit at a slower
rate. We see the following factors suggesting some buying power remains: i) the gap
between the FCF yield and the corporate bond yield remains attractive; ii) there is still
nearly 20% of the market with net debt-to-EBITDA below 1x; iii) there is a record $1.4trn of
private equity 'dry powder' (on Preqin data); and iv) some amount of the $750bn of US
corporates' cash held overseas will likely be used for buybacks or domestic cash-financed
M&A if repatriated.
Global Equity Strategy
52
2 December 2016
Figure 80: After falling throughout the last 12
months corporate net buying picked up recently…
Net corporate buying as a share of market cap (%)
11%
13 per. Mov. Avg. (Net corporate buying as a share of market cap
(%))
9%
Figure 81: …and the gap between the free cash flow
and junk bond yield remains attractive
0%
-5%
7%
5%
-10%
3%
1%
-15%
-1%
FCF yield ex financials* - junk bond
US
-3%
-5%
2001
* FCFE/market cap
-20%
2004
2007
2010
Source: Thomson Reuters, Credit Suisse research
2013
2016
1998
2000
2003
2006
2008
2011
2014
2016
Source: Thomson Reuters, Credit Suisse research
In addition, we would stress that even if corporate buying does remain subdued relative to
the levels seen in recent years, the issue is that the swing factor – particularly given
current asset allocations and the outlook for inflation – is likely to be retail and/or
institutional investors, not corporates.
4.
Globally, there is a clear shift under way from capital to labour
Recent years have seen capital's share of national income grow, while the wage share
has stagnated. This is at a time when, in the US, median real personal income is still
below 2007 levels and, in the UK, the median real wage fell between 2008 and 2014 by
the largest amount on record. This is leading to the following reactions, which have a
punitive impact on corporate profitability:
■ A rise in minimum wages. We have already seen this occur in the UK with the
national living wage, which is designed to raise the minimum wage to 60% of median
income by 2020. In the US, the 'Fight for $15' campaign continues to build momentum,
with 29 states now paying above the federal minimum wage of $7.25 per hour.
Meanwhile four states have existing plans to raise minimum wages to 60% of the
median wage over the next two years.
■ A rise in effective tax rates. The OECD BEPS tax initiative, which 87 tax jurisdictions
have joined, aims to close corporate tax loopholes and counter profit shifting. The
estimated cost of this to corporates is up to $240bn, or 4% of global profits.
■ The risk of a rise in protectionism. Clearly many of Trump's policies, particularly
those aimed at appeasing workers, are protectionist.
5.
One of our fair value models shows just fair value
As noted above, our valuation models, such as the ERP analysis presented above, are
increasingly signalling fair value, having pointed to equities as cheap for much of the postcrisis period. Our warranted P/E model, which is based on earnings estimate dispersion,
US lead indicators, policy uncertainty and the TIPS yield, suggests the current forward P/E
ratio is near fair value – implying very slight downside (1%).
Global Equity Strategy
53
2 December 2016
Figure 82: Our warranted P/E model suggests US
equities are at fair value on forward earnings
Figure 83: Warranted P/E model specifications
24
24
Gap Model - Actual
S&P 12m fwd PE
Model
FY3 EPS 12m fwd EPS
growth
dispersion
19
19
14
US lead indicator dev. from trend
10y TIPS Policy uncertainty,
yield
12mma
Latest
11.9
4.7
1.0
0.5
104
Coefficent
0.67
-0.90
0.19
-0.87
-0.05
t-value
16.3
-6.3
1.8
-9.3
-10.3
9
14
Intercept
4
Coefficent
19.0
Current 12m fwd P/E
t-value
23.2
Model
16.8
Upside (downside)
9
-1
4
1992
R2
69%
adj. R2
68%
17.0
-1.0%
-6
1996
2001
2006
2011
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
6.
China and technology
Essentially, the cost of corporate debt has remained low relative to the ROCE achieved.
Initially investors believed that this gap would be closed by the cost of debt rising – it did
not – and then that corporates would over-invest, bringing down the ROCE – they have
not.
Figure 84: The gap between ROCE and the cost of
debt in the developed world has been particularly
high…
22%
US non-financials ROCE
8%
9%
18%
US recessions shaded
US non-financial corporation business investment (% GDP)
10%
BAA corporate bond yield, rhs
20%
Figure 85: …and corporates are not clearly overinvested
8%
7%
6%
5%
16%
7%
14%
6%
12%
10%
5%
8%
4%
4%
3%
2%
1%
0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
-1%
1955
1965
1975
1985
1995
2005
2015
Source: Thomson Reuters, Credit Suisse research
54
2 December 2016
Instead of US corporates, where investment has been underwhelming, China is
responsible for that over-investment: China accounts for nearly 25% of global investment
but only 15% of global consumption, and thus is seeking to export the excess capacity that
it built on an artificially low cost of capital, driving down the return on equity in the
developed world. The particular issue is SOEs, which account for over half of Chinese
capex, yet achieve very low return on equity (on average 3%, but sometimes lower). We
also see clear signs that China is moving up the value added curve.
With regard to technology, while we make the argument above that disruptive technology
can lead to a higher market P/E, it does mean that individual business model risk and
asset lives are generally shortening.
7.
How much longer can bull markets really last?
Although global equities have already peaked – in the first half of 2015 – thus far we have
not seen a definitive end to the current bull market, which began in 2009.
Figure 86: Global equities peaked in May 2015 (in US dollar terms)
500
MSCI AC World (USD terms)
450
400
350
300
250
200
150
100
50
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
In a historical context, the duration of this bull market (thus far, 92 months) is fairly
unusual, at almost twice the duration of the median bull market seen since 1877.
Moreover, only 3 of the 18 bull markets over this 142-year period were of greater duration
(and two of those by at most 5 months), and the inflation-adjusted return from previous
peak is in line with that seen on average over the past 140 years.
Global Equity Strategy
55
2 December 2016
Figure 87: The current bull market in equities is near the longest duration seen
Real return
Real return from previous
bull market peak
Absolute Annualised
Bull market start date
Bull market end date
Duration
(months)
Sep 1877
Jun 1881
48
155%
26%
n/a
Jul 1884
May 1890
71
45%
6%
5%
Apr 1891
May 1892
14
31%
26%
8%
Aug 1893
Jun 1901
95
96%
9%
43%
Dec 1903
Sep 1906
34
51%
16%
4%
Dec 1907
Jun 1911
43
58%
14%
-6%
Sep 1921
Sep 1929
97
396%
22%
64%
Jul 1932
Jul 1933
13
144%
128%
-53%
Apr 1935
Feb 1937
23
109%
47%
50%
Jun 1942
Apr 1946
47
108%
21%
-21%
Jul 1949
Jul 1956
85
205%
17%
76%
Jan 1958
Dec 1961
48
68%
14%
34%
Nov 1962
Jan 1966
39
59%
15%
23%
Nov 1966
Dec 1968
26
28%
12%
2%
Aug 1970
Jan 1973
30
43%
15%
-7%
Aug 1982
Aug 1987
61
157%
20%
4%
Sep 1988
Mar 2000
139
280%
12%
193%
Mar 2003
Oct 2007
56
61%
11%
-13%
Average
54
116%
24%
24%
Feb 2009 - Now
92
187%
9%
22%
Source: Robert J Shiller, Thomson Reuters, Credit Suisse research
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56
2 December 2016
8.
Tactical indicators: no longer signalling pessimism
Bullish sentiment, as measured by the bull/bear ratio (see Figure 88), for individuals and
financial advisors have picked up quite sharply. Furthermore, option skew – which had
been fairly elevated – is now below average (Figure 89).
Figure 88: Bullish sentiment has picked up fairly
sharply
60
Individual investors
Bulls minus Bears
Financial advisors
40
Figure 89: Option skew is 1 std below neutral levels
0.15
Skew : 3-month 90-110
0.14
Average (+/- 2 stdev)
0.13
0.12
20
0.11
0
0.10
0.09
-20
0.08
0.07
-40
0.06
-60
2009
2010
2011
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
2015
2016
0.05
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Which factors could catalyse a correction in the second half?
There are three primary events that we see having the potential to cause a correction for
equities in the second half of the year:
Global Equity Strategy
i.
Bond yields: we fear that bond yields may overshoot, rising to a level above
3.5%; at this point the relative valuation case for equities becomes undermined
and the rise in corporate bond yields hits EPS to such a degree that the effective
tax rate would need to fall below 22% to bring a net positive impact.
ii.
China: after the 19th Party Congress, the Chinese leadership may choose to shift
its focus more toward reform at the expense of growth. Moreover, by the end of
2017, the loan to deposit ratio in China is likely to be close to 100%. At this level,
the risk is that the PBOC has to print money in order to roll over NPLs, which
would risk a significant and sharp devaluation of the RMB.
iii.
US wage growth: given the ambiguity around what level of unemployment is
consistent with full employment, we see risks that wage growth accelerates
meaningfully in the latter part of 2017. If the nominal wage/GDP growth gap were
to close again, this would place greater pressure on profit margins than we
envisage.
57
2 December 2016
Prefer equities over bonds
Our house view for the 10-year US Treasury yield is 2.80% mid-2017, and 3.00% at end2017, as our rates strategy team detail in Interest rates in a Trump era, 29 November
2016. We would agree with this view, and see a risk that the 10-year Bund yield ends up
at c1% by mid-2017. Indeed, even in both scenarios, we would see the risk for yields to
the upside.
Bond yields: upside risks remain
We see the following factors suggesting that the risk is that bond yields go higher:
1.
There has been an unprecedented bull market in bonds
This bond bull market has spanned 36 years, as we show in the case of UK long-dated
debt below. Moreover, real yields are still close to historical lows, as shown in the case of
US. Ordinarily, when a bull market in any asset class ends, the subsequent correction or
bear market tends to be much greater than investors anticipate (for example, after the
peak in equities in 2000 or the peak in the oil prices at $146pb). In our judgement, this
could be the case again.
Figure 90: The multi-year rally in UK debt has been
unprecedented…
18
Figure 91: …and real yields in the US are near alltime lows
15
US long term real yield,%
16
13
14
11
12
UK bond yields, %
9
10
8
7
6
5
4
3
2
0
Jan-1750
Jan-1810
Jan-1870
Source: Bank of England, Credit Suisse research
Jan-1930
Jan-1990
1
1920
1936
1952
1968
1984
2000
2016
Source: Thomson Reuters, Credit Suisse research
We have had plenty of bear markets in bonds even as part of the broader bull market.
Below we show the length of time and the magnitude of bear markets which have occurred
since 1990. The average correction has seen US 10-year bond prices decline 13% over
11 months (or a 9% total loss). On three occasions, the duration of the bear market has
been beyond a year and, on average, 10-year yields have risen by 182bp.
Global Equity Strategy
58
2 December 2016
Figure 92: Bond market corrections since 1990
10 year US bond index
Start date
End date
15/10/1993
21/11/1994
Duration (months) Chg in clean price
13.4
-19%
Chg in total returns Chg in 10 yr yield
-13%
2.86%
03/01/1996
05/07/1996
6.1
-10%
-7%
1.48%
05/10/1998
21/01/2000
15.8
-19%
-13%
2.63%
13/06/2003
07/05/2004
11.0
-12%
-9%
1.66%
01/06/2005
12/06/2007
24.7
-11%
-3%
1.34%
18/12/2008
10/06/2009
5.8
-14%
-13%
1.85%
07/10/2010
08/02/2011
4.1
-10%
-9%
1.34%
02/05/2013
08/01/2014
8.4
-11%
-9%
1.37%
08/07/2016
24/11/2016
4.6
-8%
-7%
0.99%
Av erage
11.2
-13%
-9%
1.82%
Source: Thomson Reuters, Credit Suisse research
2.
The impact of Donald Trump
Since the election of Donald Trump, there has been a c.50bps increase in nominal US 10year bond yields. Around 60% of the rise in yields has been driven by real yields, and 40%
has been driven by inflation expectations. This is very different from the 'taper tantrum'
period in 2013, where the rise in nominal bond yields was entirely due to a rise in real
bond yields. Were real yields to return to the level in the taper tantrum (or even their level
at the end of 2015), it would add another 50bps to nominal yields.
Figure 93: Inflation expectations initially moved,
followed by real yields
Figure 94: The taper tantrum of 2013 was an almost
exclusively real yield event
3.5
85
3.0
84.5
2.5
84
2.0
83.5
1.5
83
1.0
82.5
0.5
82
0.0
US 10-year real bond yields
-0.5
Implied inflation rates
-1.0
-1.5
2011
81.5
Taper Tantrum Period
US 10-year bond yields
81
80.5
Taper Tantrum
(May 2013 - Jan 2014)
Trump
(From 08 Nov 2016)
Change in nominal bond yields
1.38
0.50
Change in real bond yields
1.42
0.29
Change in implied inflation rates
-0.04
0.21
% chg in nom. yld due to chg.in real
yld.
103%
59%
% chg in nom. Yld due to chg. In
implied inflation
-3%
41%
80
2013
2014
2015
Source: Thomson Reuters, Credit Suisse research
2016
Source: Thomson Reuters, Credit Suisse research
In our view, a Trump Presidency represents a risk to the bond market in the following
respects:
■ Growth: Trump's fiscal stimulus is likely to be pro-growth: if his stimulus policies were
to be implemented, then GDP growth could easily be 1% higher above the previous
baseline, in our judgement. The last occasion when have seen a Republican Clean
Global Equity Strategy
59
2 December 2016
Sweep was under the first term of George W. Bush (which resulted in huge tax cuts in
2001 and 2003).
The multiplier on fiscal spending is estimated by our economists to be as high as 1.8x,
while McKinsey suggest that the socioeconomic rate of return on infrastructure
investment could be c.20%. The American Society of Civil Engineers suggest rates of
return on projects such as levees can be 24:1 (given the high cost of flood damage).
Donald Trump's policies are part of a bigger, global shift in policy away NIRP to fiscal
easing, at the margin. This is against a backdrop where fiscal tightening since 2011
has taken 6.4% off US GDP.
■ Inflation: Many of Trump's policies are likely to have inflationary consequences at a
time when inflationary dynamics were already turning higher. Trade protectionism
would likely increase import price inflation, and a move toward encouraging reshoring
would also serve to increase business costs. Repatriation of illegal immigrants and
stricter control on immigration could push the unemployment rate down even further
and place upward pressure on wage growth at a time when the US labour market
already appears close to full capacity.
■ Bond supply: President-elect Trump's fiscal plan could add $5.3trn to national debt
over the next 10 years, according to the Committee for a Responsible Federal Budget,
or $7.2trn according to the Tax Policy Centre. Note these numbers do not include
infrastructure spending which could range from around $550bn to $1trn over the next
decade (depending on the level of private involvement). This spending plan, were it
realised, would take US net debt to GDP up from just over 80% currently, to around
105% by 2026.
It is also worth noting that, according to the Fed's Flow of Funds data, the increase in
Treasury bonds outstanding since 2009, once we net off Fed purchases, has been
c.$5.5trn, or almost exactly that which the estimates noted above suggest Trump's
plans will add to Federal debt. That increase, however, was against the backdrop of a
financial crisis and deep recession. This also raises the question as to whether the next
decade could see the Fed unwind their Treasury holdings (currently c.$2.5trn), only
adding to net bond supply.
Figure 95: Net of Fed purchases, Treasuries outstanding rose by c.$5.5trn since
2009, not far from projections for issuance under Trump's policies over the next
decade
8000
Cumulative issuance/purchase
7000
US Treasury issuance ($m)
Fed Treasury purchases ($m)
6000
5000
4000
3000
2000
1000
0
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
■ Populism: Some of Trump's more populist policies could undermine, at the margins,
confidence in holding US debt. China and Japan own 7.7% and 7.4% of the US
Treasury market respectively, and both have faced challenges from the more populist
elements of Trump's campaign programme (relating to trade barriers in the case of
China, and NATO in the case of Japan). His criticism of Janet Yellen (for being too
political) could undermine confidence in the independence of the Fed. While his
comment that he 'would borrow, knowing that if the economy crashed, you could make
a deal' (CNBC, May 2016) suggested a willingness to buy back bonds below par under
some conditions.
3.
Populism more broadly has generally been negative for bonds
There has been a broad-based rise in populist movements globally, not just in the US.
This has occurred not least because inflation-adjusted wage growth had its worst
performance on record in the seven years to 2014. In our view, the current populist
movements seem to embody the following elements that tend to be negative for bonds:
■ Less immigration, which in turn threatens to push down unemployment rates and
therefore place further upward pressure on wage growth and inflation;
■ More protectionism and reshoring of production, pushing up prices;
■ More spending on social projects/infrastructure, which raises nominal GDP growth
and potentially increases the supply of bonds; and
■ Rising minimum wages which also add to inflation pressures.
4.
Inflation expectations look too sanguine
With the US labour market relatively tight, US wage growth appears to be on an upward
trajectory, and this is the source of c.60% of inflation. The wage component of the ECI and
average hourly earnings are now trending a little higher. Moreover, the wage component
of the manufacturing ECI is close to 15-year highs, as are the number of firms reporting
that jobs are hard to fill.
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61
2 December 2016
Figure 96: Wage pressures in the US are building…
Figure 97: …with skill shortages leading to rising
wage growth in the manufacturing sector
ECI manufacturing wages & salary, y/y % change
5.0
Average hourly earnings (% chg Y/Y)
4.5
3.0%
30%
ECI wages and salaries (% chg Y/Y)
4.0
25%
2.5%
3.5
20%
3.0
2.0%
15%
2.5
2.0
1.5%
10%
1.5
1.0
1990
1993
1997
2001
2004
Source: Thomson Reuters, Credit Suisse research
2008
2012
2016
1.0%
2004
5%
2005
2007
2009
2011
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Clearly, this is against a backdrop where no one knows what the 'true' full employment
rate is (the FOMC says it is 4.8%). All we would point out is that, on some measures, the
unemployment rate is very low (the U3 rate, which excludes those who have been
unemployed for more than six months), while on other measures there is a lot more slack
(the U6 rate, which includes people who are marginally attached to the workforce such as
part-time employees who want a full-time job). Clearly, the judge and jury of when full
employment is reached is wage growth, and that is starting to rise.
As the chart below illustrates, there has been a close relationship between services
inflation in the US (which is 65% of the CPI basket, and running currently at 3% Y/Y), and
wage inflation, suggesting that as long as the labour market remains relatively tight,
underlying inflation pressures will remain.
Just over a third of the CPI basket is accounted for by goods. This is likely to move from
deflation to inflation of c.1% thanks to the rebound in the oil price (the red dot in the figure
below assumes a flat oil price, and illustrates the Y/Y change implied in Q1 2017).
Assuming the services component remains steady at 3%, simple arithmetic would suggest
a headline CPI inflation rate of 2.5% is easily achievable by the end of Q1 next year, in line
with our economists' forecast.
Global Equity Strategy
62
2 December 2016
Figure 99: …the oil price is consistent with a pickup in goods price inflation to c.1%
Figure 98: Accelerating wage growth is leading to
service price inflation…
5.5
5.0
Oil price, % chg Y/Y
190
4.5
5.0
4.0
4.5
3.5
4.0
4
US CPI non-services inflation, % chg Y/Y, rhs
3
140
2
90
3.0
3.5
2.5
3.0
% change Y/Y
2.5
2.0
1
40
0
2.0
Atlanta Fed services wages
1.5
Services CPI, rhs
1.0
1.5
-10
-1
-60
-2
0.5
1.0
0.0
1997
1999
2001
2003
2005
2007
2009
2011
2013
-110
Source: Thomson Reuters, Credit Suisse research
-3
1998
2016
2000
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Our concern is not so much a sharp rise in headline inflation as much as a sharp upward
shift in inflation expectations. In the US, 5y/5y forward breakeven inflation is discounting
inflation of about 2.0%, i.e. no rise from the current level of core inflation at 2.2% and only
a modest rise from the current level of core PCE inflation. Headline inflation over the past
10 years has been 1.7% in spite of the most severe recession since the 1930s and a
collapse in commodity prices.
Figure 100: The recovery in commodity prices
suggests US headline inflation rising to c.2%
60%
Assuming commodity
prices unchanged
40%
Figure 101: Core inflation has risen above 5y/5y
forward breakeven inflation rates
6%
3.0
5%
2.5
4%
20%
3%
0%
2%
1%
-20%
0%
-40%
-60%
2.0
Year-on-year change
TR/CC commodities index
US CPI, lagged 2 months, rhs
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1.5
1.0
Core CPI, y/y
-1%
-2%
US 5y5y breakeven inflation
0.5
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
63
2 December 2016
Beyond the US, there are signs of global deflationary pressures easing. In China, for
example, overall PPI inflation is now positive for the first time in 55 months. The GDP
deflator is also now climbing out of negative territory and pork prices alone are up strongly
over the past 12 months.
Figure 102: Chinese deflation is now over, with PPI
positive for the first time in nearly 5 years
Figure 103: Market-implied forward inflation
expectations remain low in the euro area
15
3.0
15
China GDP deflator, y/y%
13
Europe 5y5y fwd breakeven inflation swap
PPI, rhs
Core Inflation
11
10
2.5
5
2.0
9
7
5
3
0
1.5
1
-1
-5
1.0
-3
-5
1998
-10
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
0.5
2009
2010
2011
2012
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
European core inflation – at least in the near term – is likely to remain very muted with
wage growth broadly flat at 1% with little sign of acceleration, against a backdrop of an
unemployment rate that is above its long-run average (10.1% vs 9.7%).
Figure 104: Euro area wage growth is yet to pick up
meaningfully
Figure 105: The euro area is the only major region
where the unemployment rate is above its average
3.5%
Unemployment rate, %
10
Current
3.0%
15-year average
8
2.5%
6
2.0%
4
1.5%
2
1999
2002
2005
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2008
2010
2013
2016
Japan
US
UK
GEM
0
GEM (ex
China)
0.5%
1997
Euro area labour compensation per
employee, y/y%
Euro-area
1.0%
Source: Thomson Reuters, Credit Suisse research
64
2 December 2016
The worry is that longer-term inflation expectations are too sanguine. Employment in the
euro area is growing nearly 1% above the rate of growth of the labour force (1.5% versus
0.5%, respectively), a dynamic which will eventually tighten the labour market. Moreover,
there may be some signs of a near-term cyclical upturn in core inflation, with backlogs of
work component of the PMI manufacturing release consistent with core inflation rising, as
shown below. Our economists forecast headline inflation could well move up to 1.3% in by
February from 0.5% currently. If headline inflation rises to 1.3% and nominal GDP growth
is c.3% by the middle of 2017, we believe that expectations for inflation between 20212026 (currently 1.5%) will rise.
Figure 106: Employment growth in the euro area is
now above 1.4%
Euro area employment growth y/y, %
2%
Figure 107: The backlogs of work PMI suggest that
euro area core inflation may turn up over the next
18 months
Eurozone core CPI, detrended and pushed back 18 months
PMI: backlogs of work (rhs)
0.6%
60
0.4%
55
1%
0.2%
0%
50
0.0%
-0.2%
-1%
45
-0.4%
40
-2%
-3%
2002
-0.6%
-0.8%
2004
2006
2008
2010
Source: Thomson Reuters, Credit Suisse research
2012
2014
2016
35
2003
2004
2006
2007
2009
2010
2012
2013
2015
2016
Source: Thomson Reuters, Credit Suisse research
5.
A willingness by central banks to allow inflation to overshoot and yield
curves to steepen
In our view, policy makers are now far more willing to allow an inflationary overshoot than
risk tightening too early and bringing on deflation. There are three good examples of this.
First, the BoJ has said that it would allow inflation to overshoot and, moreover, its focus
now appears to be on institutionalising an upward-sloping yield curve to incentivise banks
to lend. Second, the Swedish Riksbank has continued with QE of c.6% of GDP in spite of
nominal GDP growth of around 4% and house price inflation of 9%. And lastly, Janet
Yellen commented on 15 October that "if strong economic conditions can partially reverse
supply-side damage after it has occurred, then policymakers may want to aim at being
more accommodative during recoveries than would be called for under the traditional view
that supply is largely independent of demand.”
These developments, to us, risk creating a steeper yield curve, as markets price in this
risk. Another way of looking at this risk is to examine the term premium, which according
to the New York Fed's ACM model is still low at around zero.
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2 December 2016
Figure 108: The term premium has fallen to near
historic lows
6
Figure 109: A repricing of Fed expectations would
likely raise 10-year yields
3-month change
10 - year Treasury term premium
US 3m rate implied in 12 months' time
5
0.6
4
0.4
3
0.2
2
0
1
-0.2
0
-0.4
-1
1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016
0.8
0.6
0.4
0.2
0.0
-0.2
-0.4
-0.6
-0.6
May 15
Source: Federal Reserve Bank of New York
1.0
US 10-yr yield, rhs
-0.8
Aug 15
Dec 15
Mar 16
Jul 16
Nov 16
Source: Thomson Reuters, Credit Suisse research
Could the market be too sanguine on the Fed? Our house view is that the next Fed rate
hike is in December 2016 but critically, our economists believe there will be a total of three
rate hikes between now and end-2017, while the market is pricing in just over two. If the
market reprices short-end rates higher, the long end should rise as well.
6.
Implied volatility is still low
Implied volatility, though increased slightly in the past few days, is still low by historical
standards.
Figure 110: Implied volatility in the US bond market remains very low
MOVE Index
Current level
245
195
145
95
45
1988
1992
1996
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
7.
Could global growth surprise positively in 2017?
Global PMI new orders have risen to a two-year high and global monetary conditions
remain abnormally loose, even after the recent rise in the USD. As we highlight in the
macro overview, the drags on global growth, at least for now, seem to be diminishing
(bank de-leveraging, European crisis, the drag from the decline in commodity capex and
opex, and fiscal policy). Finally, we think China is unlikely to decelerate much ahead of the
19th Party Congress.
Figure 111: Our global monetary conditions index
shows policy remains unusually loose
Figure 112: Global PMI new orders indicate a
modest acceleration in global GDP growth
65
4.8%
Global MCI (US, Euro area, Japan,
UK), stdev from average
Tighter
1.3
60
3.8%
55
0.8
2.8%
50
0.3
1.8%
45
0.8%
40
-0.2
-0.7
35
Global manufacturing PMI new
orders
30
Global GDP growth, 6m lag, rhs
Looser
-1.2
2000
2003
2006
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
25
1999
-0.2%
-1.2%
-2.2%
2001
2003
2005
2007
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research, Markit
8.
Tactically, yields are only just beginning to price in a pick-up in growth
Financial market proxies are also consistent with higher yields, with the cyclical-todefensive ratio in both the US and Europe suggesting higher yields
Figure 114: …with the same true in Europe
Figure 113: Cyclicals relative to defensives have
rallied sharply in the US…
Eur cyclicals rel defensives
136%
US cyclicals rel defensives
3.7
US 10Y Bond yield, rhs
6 month change in bund yield, rhs
113
131%
3.2
126%
111
109
2.7
121%
107
1.7
111%
1.2
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2015
2016
0.8
0.6
0.4
0.2
0
-0.2
105
-0.4
103
-0.6
101
-0.8
2.2
116%
106%
2011
115
99
-1
97
Nov-12 May-13 Nov-13 May-14 Nov-14 May-15 Nov-15 May-16
-1.2
Source: Thomson Reuters, Credit Suisse research
67
2 December 2016
The rebound in industrial commodity prices is also consistent with a greater rise in bond
yields
Figure 115: The rally in metals prices suggests bond yields should have risen
more
30%
5.5
3m % change in metals prices
US 5y5y forward, rhs
20%
5.0
4.5
10%
4.0
0%
3.5
3.0
-10%
2.5
-20%
2.0
-30%
2010
1.5
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
9.
There is a decreasing need for financial repression
We have consistently noted that with global credit-to-GDP at all-time highs, there are three
simple ways to de-lever at the same time as stabilising unemployment: i) default on
government debt (and risk economic chaos); ii) tax the creditor (and risk losing power);
and iii) tax creditors indirectly through negative real rates. Clearly, it is the latter that is the
main focus for policy makers.
However, a combination of fiscal tightening and improving growth rates now means that
this degree of financial repression is no longer required in most developed markets. On
our calculations, with the exception of Japan, the equilibrium long term real rate is now
above the current real bond yield.
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2 December 2016
Figure 116: In many cases, the real yield required to
stabilise government debt to GDP is above current
levels…
Figure 117: …though we do acknowledge that
global leverage is at a new high
250%
Total debt to GDP (Private + Public), 4Q moving average
240%
Euro area
US
Japan
UK
Government
debt to GDP
(2014)
Cyclically
adjusted
primary
budget
2015
Trend real
GDP
growth
Real bond yield
needed to
stabilise
government debt
Current real
bond yield
96.4
105.6
245.1
92.0
1.4
-1.3
-4.7
-1.5
1.5
2.5
0.5
2.0
3.0
1.3
-1.4
0.4
-1.1
0.4
-0.8
-2.1
Global
Global Trend
230%
220%
210%
200%
*Trend calculated from Q1 1995 onwards
190%
180%
1995
Source: Thomson Reuters, Credit Suisse research
1998
2001
2005
2008
2011
2015
Source: Thomson Reuters, Credit Suisse research
10. Fair value models imply higher yields
Clearly, most fair value models have been declared redundant in the bond bull market.
However, if we look at bond yields relative to inflation, short rates and ISM new orders,
then bond yields should be higher. If the Fed raise rates three times by the end of 2017
and core inflation stays where we are, then the fair value yield of the US 10-year would
rise closer to 3.2%.
Figure 118: Our bond model indicates a fair value
10-year Treasury yield of over 2.5%
8
Figure 119: Model details
Model (+/- 1 stdev)
Fair value
7
10-year US Treasury bond yield
6
Model inputs
5
ISM new orders
US core CPI, yoy %
US 3-month T-bill rate
0.64
RSQ
0.80
4
3
Coeff.
t-value
Current
0.03
3.7
52.1
-0.33
-2.6
2.2
24.7
0.54
Model output
10Y Treasury yield
2
Fair value
2.80
latest
2.24
1
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Above all, in the developed world, nominal bond yields remain unusually depressed
relative to nominal GDP growth; ordinarily 10-year rates are above or modestly below
nominal growth, but the yield on 10-year bonds has now been significantly below GDP
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2 December 2016
growth for a sustained period of time. This is particularly extreme in the case of the euro
area.
Figure 120: Developed market bond yields remain
particularly low relative to nominal GDP growth…
10%
Figure 121: …and this gap is even more extreme in
the euro area
10%
G4 aggregate government bond yield
8%
8%
G4 nominal GDP growth
6%
6%
4%
4%
2%
2%
0%
0%
-2%
-2%
-4%
1990
1994
1998
2003
2007
2011
Source: Thomson Reuters, Credit Suisse research
2016
Germany 10-yr yield
Euro area nominal GDP growth
-4%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
Source: Thomson Reuters, Credit Suisse research
11. Globally, the policy discussion is evolving
We have already discussed in some detail the potential impact of Donald Trump's election
as President, but the shift in policy is very much a global dynamic, as we discuss in the
macro section of this piece. We believe 2017 could see a continuation of the gradual shift
away from NIRP and QE, which has characterised 2016, towards fiscal easing around the
world, and would just note the following points here in summary:
■ A move away from NIRP towards fiscal easing
As we discuss in the asset allocation section, there is a clear move from NIRP towards
fiscal easing underway. In addition to this, 2017 is likely to see growing logistical
challenges for the euro area and Japan.
■ Logistical, legal and political problems with continuing QE into 2017 or 2018
By the middle of 2017, it is likely that logistical problems start to appear in the bond-buying
programmes of both the ECB and the BoJ. Any reduction in the size of asset purchases,
were it to occur in 2017, would be different to the Fed's tapering, which began at the end
of 2013. On that occasion, the Bank of Japan and eventually the ECB stepped in to begin
buying in significant size, offsetting the Fed's taper. Any decline in purchases in 2017
would likely see no such offset. Taking the two major central banks engaged in asset
purchases in turn:
■ The ECB
The post-US election rise in government bond yields has provided the ECB's asset
purchase programme with a sense of relief. Prior to the rise in German government yields,
the prospect of the ECB running out of eligible debt to buy by the end of 2016 appeared
very real. The rise in yields may have extended their ability to buy into the middle of 2017,
however. That makes an extension of the current purchases programme for perhaps six
months from March possible, but nonetheless that could mark the beginning of the end for
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2 December 2016
the ECB's purchase programme. Extending purchases beyond the middle of 2017 will
require a relaxation of one or more of the purchase programme's constraints (following the
capital key for purchases; not buying any bonds yielding below -40bps and not owning
more than 33% of any given bond issue). All we would note is that relaxing one or more of
these constraints is potentially problematic.
Deviating from the capital key brings political problems (as clearly the ECB would be seen
to be bailing out peripheral countries and the Germans taking on disproportionate capital
risk). There is a precedent for raising the issuer limit beyond 33% (the ECB raised this to
50% from 33% for supranational bonds in June), but it does risk pushing the ECB down
the BoJ's path of owning half of the government debt market, not a comfortable position
for a central bank. There is also a potential legal hurdle with the European Court of Justice
(ECJ) if the limit is raised beyond 50%.
These difficult decisions will be discussed against a backdrop of resilient growth in real
terms (with growth of 1.6% year-on-year and if anything likely to accelerate) and
accelerating headline inflation thanks to the recent weakening of the euro.
■ The BoJ
The BoJ's programme of asset purchases is now facing a range of challenges, political
and economic. On the political side, and as noted above, MUFJ, an important supporter of
the ruling LDP, stopped being a primary dealer in the JGB market as a result of the
pressures generated by NIRP.
On the economic side, there are supply and demand challenges. On the supply side, an
IMF working paper noted that banks' and insurance companies' holdings of JGBs are likely
to reach collateral limits in late 2017 or 2018 (“We construct a realistic rebalancing
scenario, which suggests that the BoJ may need to taper its JGB purchases in 2017 or
2018, given collateral needs of banks, asset-liability management constraints of insurers,
and announced asset allocation targets of major pension funds.”), thus making them ever
more unwilling sellers. On the demand side, the BoJ currently owns 37% of the JGB
market, and the IMF estimates that it will own c.60% of the JGB market by the end of 2019
at the current purchase pace.
The critical issue is really a behavioural one. Do Japanese retail and institutional investors
believe the BoJ's inflation target (and thus realise that they are locked into a modest
capital loss, zero coupon and minus 2% real yield) and increase their rate of selling (which
the BoJ would buy), or do they read the BoJ action as a form of tapering? And will the rise
in US bond yields cause Japanese bond investors to switch into US bonds, thereby
releasing more JGBs for the BoJ to buy?
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2 December 2016
Figure 122: The BoJ's rate of JGB buying has
slowed very marginally since their policy change
Yield curve control
policy announcement
27000
Figure 123: Fed tapering was offset by BoJ and ECB
buying
Monthly central bank government bond purchases ($bn)
180
BOE
160
22000
ECB
BOJ
FED
140
120
17000
100
12000
80
7000
60
40
2000
20
-3000
-8000
Mar-14
4 week rolling average weekly JGB purchases
Jul-14
2 month rolling average weekly JGB purchases
Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16
Source: Thomson Reuters, Credit Suisse research
0
-20
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: Thomson Reuters, Credit Suisse research
■ Could the impact of QE be overstated?
There is a clear risk that investors have the mindset of "central bank buying is greater than
net supply, thus prices have to rise". We would simply highlight that in the US, under QE 1
and QE 2, bond yields rose as QE 1 and QE 2 began and fell as they finished.
More simply, if markets were only about supply and demand, then when there is a budget
surplus, yields should be low and vice versa in the pre-QE era. If anything, the correlation
– at least in the UK – has been particularly weak, and at times the other way around.
This is in an environment where, as we show in the asset allocation section, investors are
structurally very overweight bonds: since 2008, on the EPFR data, bond funds have seen
$1.4tn inflow while equity funds have experienced $42bn of outflows.
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2 December 2016
Figure 124: The correlation between the net supply of gilts and their yield has
been weak, and at times negative
4%
UK Net Lending/Borrowing, % GDP
Detrended nominal gilt yield, rhs
4
2%
3
0%
2
-2%
1
-4%
0
-6%
-1
-8%
-2
-10%
-3
1987 1988 1990 1992 1994 1996 1998 2000 2001 2003 2005 2007 2009 2011 2013 2014 2016
Source: Thomson Reuters, Credit Suisse research
12. Do investors put too much faith in demographics and productivity as an
argument for low yields?
Demographics?
Our economists highlight that the rate of growth of the US labour force has slowed to
about 0.5%, from 1.0%. Clearly this is one of the two critical determinants of the productive
potential of the economy – the other being productivity growth. Thus, worsening
demographics should – all other things being equal – mean lower real rates (with the Fed
estimating that, in the US, demographic factors alone have accounted for a 1.25
percentage point decline in the equilibrium real rate since 1980).
However, although the demographic headwinds facing productivity growth (and the
subsequent implications for real rates) are relatively well understood, we are concerned
that the impact of demographics on inflation, and thus on nominal rates, are potentially
being underestimated.
At some point, the demographic impact on inflation will reverse. As the dependency ratio
rises further, we are convinced that inflation – and thus nominal yields – will come under
upward pressure due to two key factors: first, lower labour supply is likely to result in an
increase in labour costs, and second, as the share of retirees rises, the savings rate is
likely to fall.
Low productivity?
We can't help but think productivity is being under-recorded. Goods or services that we get
for free, for example Google maps, are not being measured at all. Moreover, the quality
adjustment, particularly in technology, is not fully reflected in deflators.
What is the bull market view on bonds?
Where could the view above be wrong? There are, we think, four key aspects behind the
bond bulls' arguments.
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2 December 2016
1.
The BoJ steps up its rate of QQE via the backdoor
One emerging risk is that the BoJ continues to cap JGB yields at zero and thus as US
bond yields rise (especially in hedged terms as the yield curve steepens), the Japanese
rate of foreign buying could pick up. So perversely Trump's fiscal policies are partly funded
by the BoJ.
2.
The US is late cycle
Aspects of the US economy appear late cycle. Wage growth continues to move
moderately higher and, as the wage share of GDP rises, so the profit share falls. As the
chart below illustrates, when profits decline year-on-year, this tends to be associated with
GDP growth of at most 1%. The lines of causation are clear: when corporate margins are
squeezed, corporates spend less.
Figure 125: Profit share of GDP and wage share
move in opposite directions
% of GDP, US
14%
13%
52%
53%
Profits
12%
Figure 126: Falling NIPA profits coincide with US
GDP growth sub-1%
Wages, rhs, inverted
54%
11%
10%
55%
9%
56%
8%
57%
7%
58%
6%
5%
1950
59%
1961
1972
1983
1994
Source: Thomson Reuters, Credit Suisse research
2005
2016
55%
US NIPA post-tax profits % chg YoY
12%
45%
US real GDP y/y % 6 month lag, rhs
10%
35%
8%
25%
6%
15%
4%
5%
2%
-5%
0%
-15%
-2%
-25%
-4%
-35%
-6%
77 80 83 86 89 92 95 98 01 04 07 10 13 16
Source: Thomson Reuters, Credit Suisse research
Capex has been the high beta component of GDP (with a beta of 1.8x). While it is true that
employment growth remains resilient, it has historically been a lagging indicator, while
capex has been a leading indicator.
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2 December 2016
Figure 127: Capex tends to grow if US GDP growth
is above 1.2%
20
8
US Real fixed Investment, yoy
15
US real GDP, yoy (RHS)
6
10
4
5
2
0
0
-5
Economic indicator
C&I lending intentions
ISM manufacturing new orders
Consumer confidence
Core cap goods orders
Employment growth
Lead (+) / lag (-) with the cycle
+9 months
+4 months
+3 months
+3 months
-6 months
-2
-10
-4
-15
-20
1981
Figure 128: Investment tends to lead the cycle,
while employment tends to lag
-6
1988
1995
2002
2009
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Moreover, net debt to EBITDA of US corporates is approaching financial crisis highs, while
including resources, it has exceeded this level already.
Figure 129: Net debt-to-EBITDA is back above
normal levels
Figure 130: US corporate sector debt as a share of
GDP is close to an all-time high
2.3
80
75
2.1
US non-financial corporate sector debt, % GDP
70
1.9
65
60
1.7
55
1.5
50
1.3
45
US net debt to EBITDA
40
1.1
ex financials
35
ex financials & resources
0.9
1986
1991
1996
2001
Source: Thomson Reuters, Credit Suisse research
2006
2011
2016
30
1950 1956 1962 1968 1974 1980 1986 1992 1998 2004 2010 2016
Source: Thomson Reuters, Credit Suisse research
There are three factors that cause us to downplay this risk currently:
i) Lead indicators of capital spending are clearly turning up as nominal GDP growth
accelerates relative to nominal wage growth;
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2 December 2016
ii) Unemployment can clearly overshoot full employment levels, as it has in every previous
cycle (on average by 1% point);
Figure 132: Historically, the US unemployment rate
has fallen considerably below NAIRU as the cycle
peaks
Figure 131: Lead indicators of capex are turning
higher in the US
6
40%
30%
30
20%
Deviation of US unemployment rate
from CBO NAIRU
5
4
20
10%
3
0%
10
-10%
2
1
-20%
0
-30%
0
Core capital goods orders,
-40%
-10
3m/3m ann.
-50%
Philly Fed capex expectations
3mma, rhs
-60%
-20
2005 2006 2007 2008 2010 2011 2012 2013 2015 2016
Source: Thomson Reuters, Credit Suisse research
-1
-2
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
iii) Earnings revisions are close to a three-year high, as we show in the asset allocation
section.
3.
China starts to export deflation again after second half of 2017
In our view, China continues to pose a significant risk as discussed in our macro section. If
President Xi tries to stimulate growth in the run up to the 19th Party Congress, then in all
likelihood growth will slow after then. Moreover as we move towards the end of 2017, the
loan to deposit ratio is likely to rise above 100% (which raises the risk that the BoJ has to
print money). Thus China represents something of a downside risk to bond yields after the
second half of 2017, in our view. For now, none of the hard landing indicators is flashing
amber (yet alone red) and with net government debt to GDP at very low levels and a
current account surplus, China does have policy flexibility. The one key issue to highlight
is the degree of policy tightening (which, as we show in the macro section, seems to be
being tightened on all measures).
4.
Deflation from the disruptive economy
Globally, structural deflationary forces are at work owing to the disruptive economy. These
include: i) the move to a sharing economy implying lower demand for hotel rooms,
storage, cars and machines as existing resources are more effectively utilised; ii) the
disruptive economy creates price visibility and that forces down prices (especially in areas
such as financial services); iii) there is clearly an increase in automation – the Oxford
University Martin School believes that by the early 2020s, 47% of US jobs could be at risk
from automation.
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2 December 2016
5.
Some aspects of US inflation look overstated
We wonder if the headline inflation rate masks the breadth – or in this case, lack of – in
inflationary pressures. Calculating a diffusion index for inflation (i.e. the net balance of CPI
components exhibiting positive year-on-year inflation) suggests that CPI inflation is being
driven higher by a relatively small subset of the inflation basket; currently, the same
number of components is experiencing year-on-year price decreases as those
experiencing increases.
However, we would caveat this by noting that a similar index, measuring the momentum of
inflation (taking the net balance of CPI components with an increasing inflation rate) has
not deteriorated to the same degree as the breadth index discussed above. This may
mean a broader-based rise in inflationary pressure is imminent.
Figure 134: …but a measure of breadth in
inflationary momentum suggests this may change
Figure 133: Breadth of inflation in the CPI basket
has fallen to very low levels…
Net balance of CPI components with positive inflation
80%
US CPI inflation, rhs
6
5
70%
60%
Net balance of CPI components with increasing inflation
US CPI inflation, rhs
5
40%
4
4
60%
3
50%
2
40%
20%
3
2
0%
1
1
30%
0
20%
-1
10%
-20%
0
-1
-40%
-2
-2
0%
-3
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
6
-60%
-3
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Regional scorecards
Regional composite scorecard
Our regional composite scorecard ranks our five main investment regions based on
monetary conditions, economic momentum, valuation, earnings momentum, positioning &
sentiment, and macro factors. On this basis, UK ranks top, whereas the US ranks last.
Figure 135: Regional composite scorecard
Normalized scores
Regions
Weights
UK
Overall score
MCI
Economic
momentum
Valuation
Earnings
momentum
Positioning &
Sentiment
15%
20%
20%
15%
15%
15%
100%
1.34
1.40
0.22
1.75
0.47
-1.33
0.66
0.39
Macro factors
Europe ex UK
0.74
0.71
0.12
-0.31
1.54
-0.49
Japan
-0.35
-0.57
0.92
-0.18
-0.85
1.37
0.07
GEM
-1.01
-0.85
0.44
-0.57
-0.61
0.13
-0.39
US
-0.72
-0.70
-1.70
-0.70
-0.55
0.31
-0.73
For all the measures above, a high z score is considered as positive
Region with higher liquidity, better economic momentum, cheaper valuation, better earnings momentum and more bearish positioning
& sentiment is ranked at the top
Source: Thomson Reuters, Credit Suisse research
Regional monetary condition scorecard
Our monetary condition scorecard ranks regions based on the favourability of their
monetary environment (real policy rate, M1 relative to nominal GDP growth and the over
and undervaluation of the exchange rate). On these measures, the UK ranks top, whereas
GEM ranks bottom.
Figure 136: Regional monetary condition scorecard
Real policy rate
M1-Nominal GDP
growth
Exchange rate,
dev. from trend
MCI, st. dev.
Weight:
50%
25%
25%
100%
UK
-0.9%
8.0%
-5.0%
-1.71
Euro-area
-0.8%
5.9%
-7.3%
-1.29
Japan
-0.4%
7.4%
-7.3%
-0.52
US
-1.7%
7.8%
23%
-0.26
GEM
2.8%
12.7%
14%
-0.05
Lower value of MCI indicates higher liquidity
Region with least real policy rate, slowest M1-Nominal GDP growth and
most undervalued currency is ranked at the top
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Regional economic momentum scorecard
Our regional economic momentum scorecard ranks regions based on current levels of
PMIs, the change in PMIs and macro surprises. On this basis, the UK currently shows the
highest economic momentum, whereas GEM shows the lowest.
Figure 137: Regional economic momentum scorecard
Composite PMI
Rank Region
Macro surprises
Index, now
Index, 3m ch
Weight
33%
33%
1
UK
55.9
9.8
2
Europe ex UK
53.5
2.4
3
Japan
51.4
2.1
4
US
53.1
-1.8
5
GEM
52.1
0.4
Region having high PMIs and rank high on surprises are on top.
Level
17%
55.8
63.3
17.5
9.3
-5.6
3m change
17%
-15.0
42.1
6.7
-2.9
-3.0
Overall
score
1.1
0.5
-0.4
-0.5
-0.6
Source: Markit, Thomson Reuters, Credit Suisse research
Regional valuation scorecard
Our regional valuation scorecard assesses regions by their "cheapness" based on 12m
forward P/E, P/B, BY relative to the 12m forward earnings yield, DY and PEG ratio. On
these measures, Japan is the cheapest region, whereas the US is the most expensive.
Figure 138: Regional valuation scorecard
12m Fwd P/E
Region
Latest
Z-score
Price to Book
Latest
40%
Weight
Z-score
BY-12m fwd Earnings Yield
Latest
20%
Z-score
DY
Latest
10%
PEG
Z-score
Latest
10%
Z-score
Z-score
20%
Japan
14.1
1.1
1.3
0.5
-7.1
1.0
2.0
1.0
1.6
-0.6
0.63
GEM
11.7
-0.1
1.6
0.4
-2.3
-0.2
3.0
0.6
0.9
1.6
0.39
UK
14.3
-0.1
1.9
0.9
-5.6
0.4
3.6
0.5
1.4
0.1
0.28
Europe ex UK
14.3
0.1
1.6
1.2
-6.1
0.9
3.2
0.5
1.7
-1.0
0.23
US
17.0
-1.1
3.0
-1.4
-3.5
-0.1
2.1
0.8
1.4
-0.1
-0.67
Cheapest region, with cheaper valuation (12m fwd P/E, P/B, DY & PEG ratios) and smaller spread between bond yields and earnings yields, is ranked at the top
A higher z-score is a positive on all measures
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Regional earnings momentum scorecard
Our regional earnings momentum scorecard ranks regions based on earnings revisions as
well as changes in 12m forward EPS. On this basis, UK shows the strongest earnings
momentum, whereas the US show the weakest.
Figure 139: Earnings momentum scorecard
Net Upgrades (% tot. revisions)
12m EPS change
Total score
1m
3m
z-score
1m
3m
z-score
(50% upgrades,
50% EPS change)
UK
17%
23%
1.7
1.5%
3.0%
1.8
1.7
Japan
-1%
-3%
-0.1
-0.1%
-0.1%
-0.3
-0.2
Europe ex UK
0%
-3%
-0.1
-0.2%
-0.7%
-0.5
-0.3
GEM
-12%
-10%
-0.8
-0.1%
-0.1%
-0.3
-0.6
US
-10%
-8%
-0.7
-0.5%
-0.7%
-0.7
-0.7
Global
-7%
-6%
-0.2%
-0.3%
Regions with higher net upgrades (number of upgrades - number of downgrades)/(number of upgrades - number of
downgrades) and higher revisions to EPS are ranked as best, and shown at top
Source: Thomson Reuters, Credit Suisse research
Regional positioning and sentiment scorecard
Our regional positioning and sentiment scorecard ranks regions based on risk appetite,
fund flows, and sell side recommendations. On this basis, the Europe ex UK ranks top,
whereas Japan ranks at the bottom.
Figure 140: Regional positioning and sentiment scorecard
Region
Risk appetite, rel global
Latest
z-score
3m annualized flows, rel global
Latest
LT. average
40%
z-score
Sell side recommendations, rel global
Latest
LT. average
z-score
40%
Total z score*
Weight
Europe ex UK
20%
100%
-1.31
2.44
-8.4%
-2.6%
0.44
-1.7%
-2.7%
-0.74
1.01
UK
-0.28
0.44
-3.6%
0.3%
0.82
-2.1%
-2.3%
-0.17
0.47
US
0.08
-0.23
-1.5%
-1.5%
0.01
3.4%
3.8%
0.20
-0.05
GEM
-0.09
0.11
6.8%
2.2%
-0.40
-0.3%
0.3%
0.20
-0.08
Japan
-0.15
0.18
10.6%
3.6%
-0.26
-1.7%
-3.8%
-0.82
-0.19
Regions with lower risk appetite, most net outflows and most bearish sell-side recommendations are ranked at the top
A higher z-score is positive for all measures
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Regional macro scorecard
Our regional macro scorecard evaluates each region’s exposure to various macroeconomic factors – and then ranks them by their estimated relative performance under our
projected macro scenario. Our base case is for a small rise in economic momentum, some
upside for global equity markets and slightly higher bond yields, notable increase in
inflation and a small rise in the dollar against the euro. On this basis, Japan ranks at the
top whereas UK ranks at the bottom.
Figure 141: Regional macro scorecard
Region
Beta
PMI
BY
CPI
USD
Scenario
0.2
0.1
0.2
0.3
0.1
Score
Japan
1.59
0.37
8.23
-4.08
1.35
0.42
US
0.92
-0.04
-0.96
0.76
-0.16
0.10
GEM
0.93
0.54
-3.31
4.48
-0.49
0.04
Europe ex. UK
1.15
0.14
1.18
-2.24
0.18
-0.15
UK
0.91
-0.47
-2.32
-0.75
-0.16
-0.41
Scenario: Increase=1, Flat=0, Decrease=-1
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Continental Europe: increase overweight
Why we increase our overweight
We add to European equities for the following reasons:
1.
Europe ranks second on our regional composite scorecard
Europe currently ranks second from the top on our composite regional scorecard, scoring
particularly well on monetary conditions, positioning and economic momentum (see
above).
2.
European equities are lagging the European recovery
We highlighted in the macro overview that we expect the euro area's economic recovery to
surprise on back of pent-up domestic demand, very low SME lending rates, a clear cut
recovery in exports to Russian and China and, above all, a euro that is becoming
unusually cheap given the relative strength of European growth. In fact, on a year-on-year
basis, European GDP growth has been above that of US in real terms for the first time
since 2009 (with a one quarter exception in 2011) and we would not be surprised to see
European GDP growth of c.2% in 2017.
However, despite an ongoing economic recovery in the euro area, European equities did
not recover in line with the improvement in European economic momentum. Usually, the
growth differential between European and global growth correlates closely with the
performance of European equities relative to global equities. However, the recent
underperformance of European equities relative to global markets is consistent with euro
area GDP growth falling to be 3% below global growth. If European equities were to catch
up with our economists' forecasts of 1.5% or even our view that GDP growth could be 2%,
we should see European equities outperform global equities by c20-25%.
Figure 142: Markets move closely with growth
differentials, and are currently discounting
European GDP growth to be almost 3.0% below
global (i.e., c-0.5% growth)
Figure 143: Euro area PMI new orders are
consistent with GDP growth of c.2.0%
Eurozone manufacturing PMI: new orders, 3m lead
2
155
Cont.Europe equties relative to global, LC
terms
1
Euro area GDP growth relative to global-exeuro with 2016 CS fcst, pp gap, rhs
0
145
135
-1
125
-2
115
4%
Eurozone GDP growth, y/y rhs
60
3%
55
2%
50
1%
0%
45
-1%
40
105
-3
35
95
-4
30
-5
25
1999
-2%
-3%
-4%
85
1997
1999
2001
2003
2005
2007
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2009
2011
2014
2016
-5%
-6%
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
3.
European equities continue to face outflows and investor pessimism
Since the beginning of 2016, European equities not only underperformed their global
peers, but also experienced significant outflows, with nearly 70% of the inflows seen
throughout 2015 having flowed out again. In fact, on EPFR data, year-to-date we have
seen 39 weeks of outflows and only 7 weeks of inflows resulting in more than $34bn of net
outflows. While there are some signs that these outflows are slowing, 3 month annualised
outflows were running at -30% of AuM only three months ago. These outflows are also
reflected in the WisdomTree hedged Europe ETF, which saw nearly 50% of its inflows
since inception in early 2014 reverse.
Figure 144: Outflows from Cont. European equity
funds have bounced off their extreme lows …
Figure 145: …with around two-thirds of inflows
since Nov 14 having flowed out
60,000
50%
3m annualised net flows into Cont Europe
equity funds, as a % of assets
40%
50,000
30%
40,000
20%
10%
30,000
0%
20,000
-10%
Cumulative inflows in Continental
European equity funds since December
1st 2014, $m
10,000
-20%
-30%
2004
2006
2008
2010
2012
2014
0
Nov-14
2016
Source: EPFR Global, Credit Suisse research
Mar-15
Jun-15
Oct-15
Jan-16
May-16
Sep-16
Dec-16
Source: EPFR Global, Credit Suisse research
Furthermore, based on our most recent investor survey, only 23% of investors expect
Continental European equities to be the best performing region over the next three
months. This is the lowest value since we initiated the survey in early 2012.
Figure 146: Investors are the most negative on
European equities since we started our survey
70%
Proportion of respondents who believe Cont. Europea will be the
best-performing region over the next 3 months
Figure 147: The currency hedged WisdomTree ETF
has seen significant outflows
800
20,000
600
60%
15,000
400
50%
200
10,000
0
40%
20%
Aug-12
-200
5,000
30%
Daily inflows (rhs, $m)
-400
Cumulative inflows into WisdomTree
Europe Hedged Equity Index ($m)
Mar-13
Oct-13
May-14 Dec-14
Jul-15
Feb-16
Source: Credit Suisse Global Equity Strategy Investor Survey (October)
Global Equity Strategy
Sep-16
0
-600
Apr-14 Jul-14 Nov-14 Mar-15 Jun-15 Oct-15 Jan-16 May-16 Sep-16
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
4.
European political uncertainty the key driver of investor pessimism
European outflows and the pessimism of investors towards European equities seem to be
mainly driven by fears of a deepening political crisis in Europe. In fact, a plurality of
respondents in our October investor survey (c.31%) believe a European political crisis is
the most significant global macro risk over the next 12 months.
We would argue that this concern has increased on the back of Donald Trump's surprising
win in the US presidential election as investors will have lost even more trust in opinion
polls and the certainty of political outcomes (which was already called into question on the
back of the UK's referendum on EU membership).
Figure 148: A European political crisis is the biggest concern for investors
What is the most significant global macro risk over the next 12 months?
35%
30.8%
30%
25%
20%
18.0%
20.9%
19.0%
15%
10%
10.0%
5%
1.4%
0%
Fed rate rises
China
Geo-political
A European
political crisis
An emerging
market crisis
A US recession
Source: Credit Suisse Global Equity Strategy Investor Survey (October)
We think that investors are perhaps now too pessimistic on European politics with some
commentators and investors (e.g. Telegraph, 27 Nov) now contemplating a Le Pen win in
the French Presidential election (despite her currently polling at around 30%, as we
discuss below). We discuss the four main concerns in turn:
■ The Italian constitutional reform referendum: This is the most immediate political
test, with the referendum due on 4 December, where at the time of writing a No vote
seems highly likely (and with Italian bond spreads close to a three-year high, partly
discounted). We would agree with our economists, who argue that while the
referendum is likely to lead to increased market volatility, they don’t see any systemic
consequences.
Prime Minister Matteo Renzi has pledged his job on the success of the Italian
constitutional referendum and consequently, investors are concerned that Renzi could
be replaced by a coalition led by the 5 Star movement (which on recent polls has up to
c.27% of the vote compared to Renzi's Democratic Party on c.33%).
However, we would argue that if Renzi resigns, the most likely outcome is a
technocratic administration until the next general election in spring 2018. Even if there
are early elections, we would not expect them before the summer of 2017 as
suggested by Democratic party officials, after the constitutional court has ruled on the
Italicum election law.
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2 December 2016
Furthermore, without constitutional change, it appears very difficult for the 5 Star
Movement to get a qualified majority in the Senate (a referendum on Italy's
membership in the euro area or EU would require a qualified majority in both houses to
change the constitution). This is particularly difficult as 5 Star is coming under
considerable criticism for its running of Rome (see Reuters, 18 September) and this
could lead to a loss of its popularity in the spotlight of a general election. Moreover, we
would stress that 5 Star is much more an anti-corruption party and a referendum is
much lower on their priority list than it is for Front National in France, for example.
Even if there were a referendum on euro membership, it would most likely lead to a
remain vote. Data by the European Commission suggest a clear majority of Italians
want to remain in the euro area (see below).
■ The French Presidential election: We agree with our economists that the Presidential
election in spring 2017 is the greatest existential risk for Europe and a victory for Front
National candidate Le Pen would put the EU's future in question.
However, we would argue that while Le Pen should make it through the first round
(getting c.30% of votes based on recent polls), she is likely to lose the second round.
Francois Fillon, the candidate of the conservatives, is forecast to get slightly above
65% of the votes in a second round face off against Le Pen. While Donald Trump's
victory and Brexit can be considered as big surprises, the difference between opinion
polls and the actual result was only a few percentage points – in contrast to what would
be required in France.
If Francois Fillon won the presidential election, this would likely be a very positive outcome
for the French economy given that he plans to:
− Scrap the 35-hour week in favour of a 39-hour week;
− Lift the pension age gradually from 62 to 65;
− Scrap the wealth tax;
− Propose a €40bn tax cut for companies;
− Cut public spending by up to €100bn.
Furthermore, we would highlight that Emmanuel Macron is the most likely candidate from
the political left according to opinion polls. While his chance to proceed to the second
round is very slim (currently getting around half the votes of Fillon and Le Pen in recent
opinion polls) we would consider him a reformist and a positive for the French economy.
Macron plans to scrap the 35-hour working week for younger workers and plans to make it
easier for businesses to lay workers off.
■ Dutch general election (15 March): Recent polls suggest the eurosceptic party PVV,
headed by Geert Wilders, has been losing popularity since Brexit (with the share of the
vote slipping from 30% to c.25%). Furthermore, surveys show that Dutch people would
still overwhelmingly vote to remain in the EU if a referendum was held.
Our economists assume that at least five parties are needed to form a coalition that
holds majorities in both houses. For the next Dutch government this could prove
difficult, as just one coalition member could potentially break up the government, but
the PVV is unlikely to gain power alone.
■ Greece. Greece ended up receiving its €2.8bn payment in spite of only completing 2
out of 15 reforms. Given the refugee crisis and the upcoming German election (in
October 2017) there is little incentive for further domestic upheaval.
■ Spain: after nearly a 10-month period with no government, Mariano Rajoy was
reconfirmed as Prime Minister. While only leading a minority government, recent
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2 December 2016
opinion polls suggested that if there was another election Rajoy would be likely to win a
strong plurality. Thus there is in our opinion very little pressure on the Prime Minister to
reverse any of his previous reforms.
5.
Europe is a play on a recovering global growth and rising bond yields
Bond yields and global economic momentum are two of the two most important macro
drivers impacting the performance of European equities, and both factors are now
increasingly supportive for the reasons we discuss in the macro section of this piece.
■ Bond yields: The performance of European equities relative to global peers is closely
correlated with bond yields, with Europe outperforming c.80% of the time bond yields
rise. This is due to Europe's overweight of banks (c.10% of market cap versus 6% in
the US), which outperform as bond yields rise. We believe that by the end of next year,
the Bund yield could easily be 1%.
Figure 149: European equities usually outperform
when the Bund yield rises
German 10 year bund yield (%)
4.5
Euro area equities relative to US
in USD terms (rhs)
3.5
Figure 150: The relative performance of European
banks has been highly correlated with the relative
performance of euro area equities
21
15
8.9
European banks / Stoxx 600, lhs
19
17
2.5
0.71
Euro Stoxx 50 / MSCI AC World (local)
0.61
8.4
7.9
0.51
7.4
13
0.41
1.5
6.9
11
0.5
9
-0.5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
7
0.31
0.21
2010
6.4
5.9
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
■ Economic momentum: European equities tend to outperform as global economic
momentum picks up. European operational leverage is higher than that of US and UK,
which makes European earnings particularly sensitive to the global cycle. Recently,
European equities performance relative to global markets had lagged behind the
improvement in global PMIs.
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2 December 2016
Figure 151: Euro area equities usually outperform
when Global PMI new orders pick up…
Figure 152:… due to Europe's reasonably high
operational leverage
Euro area equities relative to global (USD terms, % chg Y/Y)
38
6
65
Global manufacturing PMI new orders (rhs)
5.7
Beta of EPS to Global IP
5
28
60
55
8
-2
3.4
3.2
3.0
3
2.4
2
50
-12
1
45
-22
-32
1998
3.9
4
18
0
Japan
40
2000
2002 2004
2006
2008
2010 2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Emerging
markets
World
Continental
Europe
US
UK
Source: Thomson Reuters, Credit Suisse research
6.
A strong macro story not offset by a strong euro
Up to 2015, a strong economic recovery (proxied by PMI new orders in Europe versus the
US) tended to be offset by a strengthening currency. With each 10% on the euro taking
directly and indirectly 6% off EPS growth (with c.45% of European earnings coming from
outside of the EU) and 1.1% of nominal GDP, this provided a powerful headwind to
earnings and economic momentum. However, this time around, as the European economy
has recovered, the euro has weakened. The reason for this has been the Treasury/Bund
spread, which is one of the key drivers determining the EURUSD exchange rate. Indeed,
our FX team believes that the euro could even weaken further, to parity against the dollar,
by the end of 2017.
Figure 153: The EUR/USD has ignored the
improvement in Eurozone relative macro
momentum
10
Figure 154: The Treasury/Bund spread suggests
only slight euro downside, and we would expect the
spread to narrow
1.60
1.20
5
1.50
EURUSD
Treasury/Bund spread, rhs, inv
1.18
1.2
1.4
1.16
0
1.40
-5
1.30
1.14
1.6
1.12
1.8
1.10
-10
-15
1.20
Euro-area vs US: manufacturing PMI new
orders
EUR USD, 6m lag, rhs
-20
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1.08
2.0
1.06
1.10
1.00
1.04
1.02
Jan-15
2.2
Jun-15
Dec-15
May-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
87
2 December 2016
A weaker euro is not only important for economic momentum but also for euro area
equities, which tend to outperform in local currency terms when the euro weakens. This
relationship is also reflected in the close correlation between European earnings revisions
and the euro trade weighted index.
Figure 155: Euro weakness is good for European
earnings momentum
Cont Europe: 13-week earnings revisions relative to global
Euro TWI, inv., rhs
83
Figure 156: Euro area equities appear to have
reassumed their pre-2005 relationship,
outperforming in local currency terms when the
euro weakens
70%
Correl. coeff:-0.9
Correl. coeff: 0.0
65%
17%
88
7%
0.7
Correl.
coeff:-0.4
0.9
60%
55%
-3%
93
-13%
98
-23%
1.1
50%
45%
1.3
40%
103
-33%
35%
Euro-area rel MSCI AC
World, local currency terms
1.5
EURO/Dollar, rhs, inverted
-43%
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
30%
1991
1994
1998
2001
2005
2009
2012
2016
Source: Thomson Reuters, Credit Suisse research
7.
GEM is not a headwind and European GEM equity exposure is
underperforming GEM
The euro area's exposure to emerging markets is the second highest of all regions
(excluding GEM), whether we consider corporate revenues or economic exposure. While
we have turned a little more cautious on GEM equities (see above), we still believe that
GEM is likely to outperform modestly in 2017 as the improvement in the aggregate
balance of payments makes GEM much more resilient to dollar strength and rising US
rates.
Figure 157: In Continental Europe and the UK, GEM
and resource exposure is about double that of the
US at c25% of sales
14%
40%
35%
Market cap energy & mining (% of total)
30%
GEM sales exposure, ex mining and oil (%)
25%
Figure 158: European economic exposure to GEM is
also nearly double that of the US
Gross exports to GEM, % GDP (on value-added basis)
Other
12%
1.6%
10%
0.8%
0.6%
LATAM
18%
NJA
7%
20%
8%
1%
4.4%
6%
15%
10%
EEMEA
2.7%
9.6%
4%
17%
18%
17%
2%
5%
7%
0%
1.4%
2.6%
1.0%
5%
2.2%
0.5%
0.7%
2.1%
3.3%
2.9%
2.6%
Euro area
UK
US
0%
FTSE 100
Euro Stoxx 50
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Nikkei
S&P 500
Japan
Source: Thomson Reuters, Credit Suisse research
88
2 December 2016
Unsurprisingly, European stocks with high GEM exposure are closely correlated to the
performance of emerging market equities. Interestingly, these stocks recently have been
underperforming emerging markets suggesting that Europe offers relative value.
Figure 159: European-listed stocks with significant GEM exposure usually track
GEM equities closely but have correctly quite sharply of late
1150
800
1100
1050
750
1000
950
700
900
850
650
800
750
600
MSCI EM USD
700
650
Jan-14
May-14
European stocks with GEM exposure, rhs
Oct-14
Mar-15
Aug-15
Jan-16
550
Nov-16
Jun-16
Source: Thomson Reuters, Credit Suisse research
8.
Valuations look reasonable
While European equities trade on a 22% discount relative to US equities on 12-month
forward P/E, this falls to a discount of just 6% on a fully sector adjusted basis. However,
Europe and US are at very different stages of the economic as well as the margin/profit
cycle.
Figure 160: Continental European equities trade on
a 6% sector adjusted PE
Figure 161: And at a 22% discount on 12m fwd P/E
1.00
145%
Europe ex UK sector adjusted 12m
fwd P/E relative to US
130%
Euro Area 12m fwd P/E rel US
Average (+/- 1sd)
0.95
Average
0.90
115%
0.85
0.80
100%
0.75
85%
0.70
70%
1995
1997
1999
2002
2004
2006
Source: Thomson Reuters, Credit Suisse research
2009
2011
2013
2016
0.65
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
In fact, if we look at normalised earnings to adjust for the different stages of the
earnings/margin cycle, Europe continues to trade nearly 20% below its norm relative to the
US.
Global Equity Strategy
89
2 December 2016
Figure 162: Europe’s Shiller P/E relative to the US is
at the bottom end of its range
Figure 163: Europe’s discount to the US on
normalized measures
160%
Shiller P/E - Cont Eur rel US
140%
Average (+/- 1SD)
120%
100%
80%
15-year
average
Now
Dev. from
average
P/B discount to US
37%
46%
-16%
Value to cost discount to US
29%
32%
-4%
CAPE discount to US
28%
55%
-37%
3-year forward P/E discount to US
14%
26%
-14%
Implied discount to US
27%
40%
-17%
60%
40%
1984
1989
1994
2000
2005
2010
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Furthermore, the equity risk premium in Europe is now 7.95% against a warranted ERP
(based on OECD lead indicators and policy uncertainty) of 7.5%.
In addition, the cost of equity has not fallen substantially despite the fall in (real and
nominal) bond yields as the ERP has risen to offset the decline in the risk free rate.
Indeed, with 52% of German pension fund weightings in bonds and just 15% in equities
(against a European average of 32%), we remain of the view that the very low equity
weightings mean that European equities should be particularly sensitive to a rise in
inflation expectations, which are still too low, with 5y/5y forward inflation expectations
1.5%.
Figure 164: The European ERP is in line with the
warranted ERP
Figure 165: The European cost of equity is not very
far below its historical average
European cost of equity
12
11
European warranted ERP
15
German 10-year nominal bond yield
European ERP
13
German 10-year real bond yield (nominal yield - 3mma inflation rate
up to 2009, inflation linked swaps since 2009)
10
11
9
9
8
7
7
5
6
3
5
1
4
-1
3
2
1998
-3
2000
2002
2004
2006
2008
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2010
2012
2014
2016
1991
1994
1997
2000
2003
2006
2009
2012
2015
Source: Thomson Reuters, Credit Suisse research
90
2 December 2016
Below we show which sectors are cheap relative to their US peers, relative to history, on
both P/E and P/B, with those in the bottom left quadrant the cheapest. These include
Energy, Industrial conglomerates, Household and Personal Products, Software, Utilities,
Insurance, Mining, Commercial services and Aerospace & Defense.
Figure 166: European sector valuations relative to the US
Relative to 10-year history, standard deviations
4
Cons Dur
European sector
trading at a discount
3
Chemicals
Cons svs
Div Fin
2
Cons Mat
Building pdts
1
Autos
0
Utilities
Insurance
Industrials
-1
Energy
(-69,-2)
-2
-40
Banks
Bev
FD Retail
Met & Min
Software
-20
-10
Media
Telecoms
Retailing
Construction
Machinery
Healthcare
Tech HD
Aero & Def
Comm svs
Oil & Gas
( -58,-2.1)
-30
Elec Equip
Pharma
App & Lux
European sector
trading cheap
relative to history
Semis
FD producers
HH & Per Prd
European vs US sectors: 12-m fwd P/E
0
10
P/E premium/discount, %
20
30
40
Source: Thomson Reuters, Credit Suisse research
9.
Earnings revisions turned positive
Earnings revisions of European equities have turned positive for only the second time in
five years and are now in line with global equities.
Figure 167: Europe Earnings momentum turned positive for only the second
time in five years
10%
MSCI Europe 3m earnings breadth
Rel world
5%
0%
-5%
-10%
-15%
-20%
1996
1999
2003
2006
2009
2013
2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
91
2 December 2016
10. We forecast c.6% EPS growth in 2017
While the expected earnings recovery in the Euro area did not materialise in 2016, our
model is pointing to significant EPS upside potential over 2017 and 2018. We forecast 6%
and 7% earnings growth in these two years.
Figure 168: We look for 14% upside to euro-area earnings over the next two
years
Expl. Variables:
Euro-area GDP yoy%
Euro-area PPI yoy%
Euro-area unit labour costs yoy%, 2Q lead
Intercept
R2
MSCI EMU EPS, yoy
IBES Consensus
Coeff.
4.0
3.1
-2.3
-0.1
0.68
Latest
1.6
-0.3
1.0
2016E
1.6
-1.0
1.0
2017E
1.5
1.0
1.3
2018E
1.5
1.5
1.5
0.9%
0.2%
6.1%
12.8%
7.2%
10.6%
Source: Thomson Reuters, Credit Suisse estimates
In our view, the earnings improvement should come from the following areas:
■ European margins tend to be very sensitive to rising nominal GDP. Weighting nominal
GDP growth based on sales exposure of European listed companies – 45% European
and 55% global – implies slight improvement in European margins.
■ The domestic profit share of GDP is very low, and should recover as the economy
recovers and the wage share of GDP falls.
Figure 169: Nominal GDP growth is consistent with
margins rising slightly
7.0%
6.0%
Global nominal GDP growth, y/y%,
weighted (45% Euro area, 55% global)
Euro area net income margins (non- 1.7%
fin), y/y pp chg, rhs
1.2%
23.0%
0.7%
22.0%
5.0%
4.0%
% GDP, Euro area
29.5%
Gross profit
22.5%
Employee
compensation, rhs,
inverted
30.0%
0.2%
3.0%
-0.3%
2.0%
-0.8%
1.0%
21.5%
30.5%
21.0%
31.0%
-1.3%
0.0%
-1.8%
-1.0%
-2.0%
2003
Figure 170: The profit share of GDP in Cont. Europe
appears to have troughed at a low level, while the
wage share has peaked
-2.3%
2005
2007
2009
2011
Source: Thomson Reuters, Credit Suisse research
2013
2015
20.5%
20.0%
31.5%
1999
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
■ The historical relationship between bond yields and the interest charge suggests that
the latter can fall by another 10%, which would serve to boost EPS by c.3.5%. This is
due to the average maturity of a corporate bank loan being c.3 years and thus the fall
in interest charges follows bond yields with a lag;
Global Equity Strategy
92
2 December 2016
We would note that euro area consensus earnings growth assumptions look reasonably
concentrated with nearly 60% of growth expected to come from financials, consumer
discretionaries and energy.
Figure 171: 60% of euro area earnings growth expected to come from three
sectors
14
6%
12
3%
3%
3%
8%
8%
10
10%
13%
8
16%
6
MSCI Euro area 2017 consensus earnings growth contribution
30%
4
2
0
Financials Cons disc. Energy Industrials Cons stap.
IT
Materials Healthcare Telecom
Utilities
Market
Source: MSCI
11. Policy setting to remain very loose
We would argue that if any of the major central banks are likely to keep rates too low for
too Iong and even risk an asset bubble, it's most likely the ECB. We note that Mario
Draghi suggested after the last ECB meeting that they had not even discussed ending
bond purchases. In fact Draghi sent a very strong signal supporting an extension of the
bond buying programme when he suggested that the Eurozone's weak economy remains
clouded by risks and heavily reliant on the ECB’s stimulus (WSJ, 18 November).
Our economists argue that the ECB is aware of the mistakes it made in 2008 and 2011
when it raised interest rates too quickly on the back of inflation concerns and will not make
the same mistake again. Draghi has consistently stated that he wants to get inflation back
to the target of 'close to but below' 2% and is willing to focus on core inflation (which has
remained range bound at 0.8%).
However, we wonder whether, with the ECB’s short-term focus on inflation, the ECB's
policy setting is now too loose. After all, the gap between nominal GDP and nominal rates
is the largest since 1990 (240bp vs 45bp in the US) and at the margin, fiscal policy is
being eased.
Global Equity Strategy
93
2 December 2016
Figure 172: In the euro area, corporate bond yields
imply the interest charge can fall by c.10% = c. 3.5%
to EPS
8
2.4
2.2
0.0
6
0.0
4
1.8
Gap between nominal GDP growth and bond yields
US
Euro area
0.0
0.0
3
2
Euro area non-financials, Interest charge /
sales (%), 4q lag
Euro area BBB corporate bond yield, rhs
1.6
1.4
1998
0.0
7
5
2.0
Figure 173: In the euro area the gap between
nominal GDP growth and 10y bond yields is
unusually high
1
0
2000
2002
2005
2007
2009
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
-0.1
-0.1
-0.1
1990
1993
1996
1999
2002
2005
2008
2011
2014
Source: Thomson Reuters, Credit Suisse research
12. Lots of spare capacity in the labour market
There remains a lot of spare capacity in the European labour market given that
unemployment is still over 10%. As a result, thus far, there has been little sign of wage
inflation accelerating. This not only allows domestic profits to accelerate (nominal GDP to
rise more than nominal wages) but also enables the ECB to keep monetary policy
abnormally loose.
Figure 174: The euro area is the only region in
which the unemployment rate is above its 15-year
average…
4.0
Unemployment rate, %
10
Current
Figure 175: ...as a result, euro-area wage growth has
yet to pick up, which should help profits
15-year average
3.5
8
3.0
6
2.5
4
2.0
2
1.5
ECB index of negotiated wages, %y/y
1.0
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Japan
US
UK
GEM
GEM (ex
China)
Euro-area
0
Euro area labour compensation per employee, y/y%
0.5
1997
1999
2001
2003
2005
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
94
2 December 2016
What are the risks?
The risks to an overweight in euro area equities are the following, in our view:
1.
Political risk will continue to weigh on investors' minds
As discussed above, the perceived political risk in Europe is likely to continue to weigh on
the performance of European equities for the foreseeable future. Trump's surprising
victory resulted in investors' trust in polls and the certainty of political outcomes to be
diminished even further.
2.
The euro area is ultimately a fragile concept
The fundamental weakness of the euro area has not been resolved: there is only a very
limited banking union (only 0.8% of bank deposits are projected to be covered under the
European Deposit Insurance Scheme by 2024) and no fiscal or political union.
This is aggravated by the lack of a meaningful fiscal redistribution mechanism with
Germany not recycling its current account surplus (which is running at 9% of GDP). This
missing fiscal transfer mechanism creates regional pockets of high unemployment with the
only solution being a painful adjustment in real effective exchange rates (an adjustment
that has not yet occurred in Italy but did occur in the rest of the periphery).
Moreover, these issues are further aggravated by worries over the loss of sovereignty and
immigration. The question remains in how far nation states are willing to sacrifice a
significant part of their sovereignty when regions (for example Catalonia or Scotland) are
demanding regional independence.
Figure 176: REER deflated by ULC has seen significant adjustments in Spain,
Greece, Ireland, but not Italy
REER deflated by ULC
130
125
Germany
Ireland
Greece
Spain
Italy
Portugal
France
120
115
110
105
100
95
90
85
80
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
95
2 December 2016
Our view remains that eventually the euro area will be severely tested and chances are
high that at some point a country will try to drop out. But we believe that this only becomes
a problem when:
i.
The majority of the electorate want to leave the euro. Currently, this is not the
case in any of the euro area countries.
Figure 177: Net support for the euro is now positive across euro area members
80%
Net % of population supporting Euro
70%
60%
2015
2016
50%
40%
30%
20%
10%
0%
-10%
-20%
CYP ITA GRC LTU ESP PRT AUT FRA DEU FIN MLT NLD BEL SVK LVA EST SVN LUX IRL
Source: European Commission, Credit Suisse research
ii.
3.
When unemployment is low. We believe that in an environment where
unemployment is high and confidence in the economic cycle is fragile, electorates
are not willing to take a risk (hence for example, Greece stayed in the euro
despite a 25% decline in GDP).
European equities have been more disrupted by technology, while offering
exposure to fewer of the beneficiaries
One of the key drivers of US equity performance has been disruptive technology (the
growth in the cloud and the internet-related networks with mobile exposure). To a large
extent this space is dominated by US names; in particular Google, Facebook, Amazon and
Microsoft. Internet software and services and internet retail account for more than 6% of
market cap in the US, but just 0.2% in the euro area.
While euro area shareholders have not particularly profited from disruptive technology,
they have certainly felt the negative impact. Retail is an obvious area where Europe, in the
absence of a company like Amazon, has been a significant relative loser from disruption,
with the euro area retail sector having underperformed its US counterpart by nearly 20%
over the last two years.
However, while this is a structural negative, we should stress that many of these disruptive
companies are long duration and long duration assets usually underperform as bond
yields rise. This is especially the case if a higher cost of funding means that disruptive
companies have to focus more on profits today than sales tomorrow.
Global Equity Strategy
96
2 December 2016
Figure 178: Internet-related stocks account for 6.7%
of US market cap, and 0.2% in Europe
Figure 179: US growth has recently been positively
correlated with bond yields
MSCI USA growth index, relative to the market
8%
MSCI Internet index (software&services and internet retail), % market
cap
1%
US 10 year government bond yield (rhs, inverted)
114
7%
2%
6%
109
US
Europe
5%
3%
104
4%
3%
99
4%
2%
94
1%
0%
2001
5%
2004
2006
2009
2011
2014
89
2003
2016
Source: Thomson Reuters, Credit Suisse research
2005
2007
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
How to play this?
One of our favourite European macro themes continues to be the recovery in European
domestic demand. We would play this through European stocks with high domestic
exposure as well as US stocks with high European exposure.
The screen below shows Continental European stocks with more than 40% of sales
coming from Continental Europe, which have been awarded a HOLT eCAP (as a proxy on
quality) and are Outperform or Neutral rated by CS analysts.
Figure 180: Continental European socks with high Continental European exposure, have been awarded a
HOLT eCAP and are OP or N rated by CS analysts
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
Exposure to Cont.
Europe (%)
eCap Award
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
Jumbo
97%
X
13.6
57%
20%
2.0
Hennes & Mauritz 'B'
70%
X
21.2
90%
-6%
7.8
Atos
57%
X
12.9
64%
-2%
Cap Gemini
57%
X
13.3
66%
Adecco 'R'
50%
X
12.9
Barry Callebaut
38%
X
Schneider Electric Se
34%
Roche Holding
HOLT
2016e Momentum, %
FCY
DY
Price, %
change to
best
10%
na
2.0
46.9
2.7
1.9
1.9
Outperform
6%
2.9
3.6
4.7
-5.7
-0.6
2.6
Neutral
2.6
84%
3.8
1.3
62.0
1.4
0.0
2.3
Neutral
-12%
1.9
48%
7.3
1.9
15.7
-0.2
-1.1
2.0
Outperform
70%
-17%
2.9
42%
6.6
3.9
8.9
-1.4
0.2
2.6
Outperform
22.8
118%
24%
3.4
27%
3.5
1.3
1.1
-1.6
0.4
3.1
Outperform
X
15.8
93%
8%
1.8
20%
6.1
3.3
10.8
-0.9
-1.9
2.5
Outperform
32%
X
14.3
99%
-11%
9.2
7%
5.4
3.8
29.4
-0.7
-0.3
2.0
Outperform
Dorma Kaba Hold
29%
X
24.1
141%
45%
7.0
108%
4.9
1.7
23.3
-14.6
-0.1
2.5
Neutral
Siemens
26%
X
14.1
83%
4%
2.5
29%
4.9
3.4
23.1
-1.2
0.1
2.2
Neutral
Temenos Group
22%
X
29.3
146%
42%
12.2
156%
3.6
0.8
10.2
2.4
2.3
2.7
Outperform
Sap
18%
X
19.1
95%
3%
4.2
10%
4.2
1.5
4.7
-0.9
0.3
2.4
Outperform
Dksh Holding
4%
X
20.3
110%
-11%
2.9
7%
3.1
2.2
2.7
0.0
0.2
2.3
Outperform
Atlas Copco 'A'
2%
X
22.6
133%
34%
7.4
56%
3.6
2.3
1.8
0.5
1.3
2.7
Neutral
Name
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Global Equity Strategy
97
2 December 2016
The screen below shows US stocks, with more than 30% of sales coming from Europe,
with upside on HOLT and rated Outperform by CS analysts.
Figure 181: US stocks with high Continental European exposure and OP rated by CS analysts
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
Pan Europe
Exposure (%)
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
Liberty Global Cl.A
67%
350.6
1928%
545%
Alexion Pharms.
51%
21.4
160%
-58%
Intercontinental Ex.
47%
17.9
120%
Priceline Group
45%
20.3
Brookfield Infr.Ptns.
Units
Owens Illinois New
42%
HOLT
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3.0
13%
4.3
0.0
3.3
-57%
na
0.0
-19%
2.2
-17%
4.7
86%
-4%
8.6
49%
21.2
168%
-44%
2.1
41%
7.4
47%
-30%
Lazard 'A'
40%
12.2
82%
Gilead Sciences
40%
6.9
Mcdonalds
40%
Electronic Arts
Name
2016e Momentum, %
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
3m EPS
3m Sales
-61.9
nm
-1.8
2.1
Outperform
59.3
-0.1
0.5
2.0
Outperform
1.2
-63.9
-1.5
-0.5
2.1
Outperform
4.4
0.0
32.1
-5.5
0.8
2.0
Outperform
59%
na
4.6
na
26.5
-1.6
2.2
Outperform
17.3
169%
9.4
0.0
-55.6
-0.8
-0.9
2.7
Outperform
-26%
3.8
-28%
na
6.1
51.2
2.9
1.1
1.8
Outperform
51%
-59%
5.8
-9%
15.6
2.5
308.7
-2.6
-1.1
2.2
Outperform
19.5
95%
5%
15.4
158%
3.5
3.0
-21.4
2.2
0.8
2.4
Outperform
39%
19.8
99%
-18%
7.0
132%
4.5
0.0
-5.7
1.9
-0.1
2.0
Outperform
Activision Blizzard
39%
16.9
85%
-16%
3.4
-39%
3.9
0.7
46.9
4.7
0.3
1.9
Outperform
Carnival
39%
13.9
68%
-14%
1.7
49%
2.8
2.6
42.4
0.7
0.2
2.3
Outperform
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Global Equity Strategy
98
2 December 2016
European countries
We show below our composite Continental European country scorecard, where Sweden,
Finland and Germany score best, while Italy, Netherlands and Belgium score worst. We
score and rank countries based on the following factors:
■ Valuation: markets that are cheap in relative terms (and relative to their own history)
score well. The valuation metrics which we assess are 12-month forward P/E, P/B (exfinancials), dividend yield and P/E on normalised margins.
■ Earnings momentum: markets that have experienced a positive change in 12-month
forward EPS estimates over the past 1-3 months, as well as those with positive
earnings breadth (calculated as net earnings upgrades expressed as a share of total
earnings revisions) are judged to have positive earnings momentum and score well.
■ Growth momentum: countries that score well are those where economic growth
momentum is judged to be positive – these are where lead indicators are low relative to
history but improving, and where forecasts for 2016 and 2017 GDP growth are high.
Those countries that are particularly exposed to the euro area domestic demand
recovery score well on growth momentum.
■ Macro fundamentals: countries that score well are those that are judged to have
robust macro fundamentals – in particular, current account and government budget
surpluses, and low government/private sector debt to GDP.
■ Euro sensitivity: given our expectation for mild euro weakness, we favour countries
with foreign sales and economic exposure. This leads us to score well those countries
that tend to outperform as the euro weakens and that have low stock market and
economic exposure to the euro area.
Figure 182: European country scorecard
Countries
Valuation
Earnings
momentum
Growth
momentum
Macro
fundamentals
Euro
sensitivity
Politics &
reform
Overall zscore
20%
10%
35%
10%
15%
15%
Sweden
-0.21
-0.19
0.34
0.33
0.99
0.71
0.35
Finland
0.28
0.03
-0.12
-0.17
0.78
0.66
0.22
Germany
-0.28
-0.18
-0.09
1.03
0.69
0.58
0.19
Ireland
-0.60
-1.50
0.79
0.05
-0.18
0.59
0.07
Switzerland
0.17
-0.61
-0.31
0.65
0.43
0.41
0.06
Norway
0.11
-0.52
-0.21
0.93
-0.46
0.66
0.02
Portugal
1.11
2.28
-0.61
-0.67
-0.97
-0.17
0.00
France
0.01
0.09
0.12
-0.52
0.39
-0.65
-0.04
Austria
0.74
0.40
-0.21
0.15
-0.80
-0.36
-0.04
Spain
-0.47
-0.24
0.13
-0.47
-0.08
0.32
-0.08
Greece
0.99
0.53
-0.07
-0.77
-0.69
-1.00
-0.10
Italy
0.71
-0.61
-0.56
-0.18
0.48
-1.16
-0.24
Netherlands
-0.59
-0.09
0.01
0.32
-0.45
-0.71
-0.27
Belgium
-1.43
0.62
-0.18
-0.68
-0.12
0.11
-0.36
Countries that have cheap equity markets, positive earnings and growth momentum, strong macro fundamentals, are internationally
oriented, have low commodity exposure, a stable political environment and positive reform momentum are scored highly
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
99
2 December 2016
Germany: remain overweight
We stick to our overweight for the following reasons:
1.
The winner from a weaker euro
Due to its export-driven economy (exports outside the euro area are c.30% of GDP) and
very high overseas exposure (40-45% of sales from outside Europe), Germany is the best
performing European region when the euro weakens. As we discuss in the FX section we
think the euro is likely to weaken from here.
Figure 183: German equities have the most negative
correlation with the euro
0.6
Figure 184: German equities tend to outperform the
European market when the euro weakens
145
Correlation with EURUSD
0.5
1.00
DAX price rel cont. Europe
135
EURUSD, rhs, inv
0.4
1.10
125
0.3
115
0.2
0.1
1.20
105
0
1.30
95
-0.1
85
-0.2
Source: Thomson Reuters, Credit Suisse research
Germany
France
Belgium
Ireland
Finland
Netherlands
Italy
Spain
Portugal
Greece
Austria
-0.3
1.40
75
1.50
65
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.
Germany scores third from the top on our European country scorecard
Germany ranks third on our European country scorecard scoring particularly well on macro
fundamentals, euro sensitivity and politics.
3.
Strong economic momentum in combination with super-loose monetary
policy
German lead indicators continue to recover and are stronger than those of the euro area.
This is due to a combination of highly supportive factors highlighted below:
■ Overly-loose monetary policy given the strength of the economy: A simple Taylor
Rule analysis suggests that the German policy rate should be around 2%. This
suggests that Germany's monetary policy (a combination of interest rates and
exchange rate) is generally too loose.
Indeed, we would expect a further acceleration in wage growth, which is already
running at 1.9% with an unemployment rate of only 4.3% — more than half of peak
levels and at levels that can be considered as full employment. This is likely to push
Global Equity Strategy
100
2 December 2016
real rates into even more negative territory (short term real rates are already at
around -2% with core German inflation currently at 1.2%).
Figure 185: German growth remains stronger than
the rest of Europe
Figure 186: German lead indicators continue to pick
up
70
1.5
65
60
0.5
55
50
-0.5
45
40
-1.5
35
German standardized lead indicators
30
Germany PMI mfg new orders
25
IFO business expectations
-2.5
PMI manufacturing new orders
Rest of Euro area PMI mfg new orders
20
2007 2008
2009 2010 2011 2012
ZEW sentiment indicator
-3.5
2007
2013 2014 2015 2016
Source: Markit, Credit Suisse research
2008
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Markit, Credit Suisse research
■ Household balance sheets are strong: German households have one of the best
combinations of low leverage and a high savings rate. Such a high savings rate and
lack of re-leveraging following the financial crisis are key supports for flows into real
assets such as residential properties and equities.
Figure 187: A Taylor rule analysis suggests that
rates are about 2-3ppt too low for the German
economy. This will end up supporting GDP growth
250%
ECB policy rate (Bundesbank before 1999), %
230%
German policy rate estimated using Taylor rule, %
9
Private sector debt, % of GDP
8
7
6
5
4
3
2
1
Belgium
Netherlands
210%
190%
France
170%
Spain
UK
150%
130%
Italy
Less saving
110%
0
Higher debt
10
Figure 188: German households have the most
attractive combination of a high savings ratio and
low leverage
Germany
90%
-1
1992
1995
1998
2001
2004
2007
2010
2013
2016
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
Household financial surplus, % of GDP
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Source: Thomson Reuters, Credit Suisse research
101
2 December 2016
■ External headwinds becoming tailwinds: German exports to Russia seem to have
troughed, while Chinese imports from Germany, in year-on-year terms, are growing
again. German exports to Russia and China make up 1.8% and 6% of total German
exports, respectively.
Figure 189: German exports to China are growing
again
80%
Figure 190: … while exports to Russia seem to have
troughed
3.6
Chinese imports from Germany (in $) y/y%, 3mma
60%
300
Russian car sales ('000s), 3mma, rhs
Germany exports to China (in EUR) y/y%, 3mma
70%
German exports to Russia (€ bn), 3mma
3.1
250
2.6
200
2.1
150
1.6
100
1.1
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
50
50%
40%
30%
20%
10%
0%
-10%
-20%
-30%
2003
2005
2007
2009
2012
Source: Thomson Reuters, Credit Suisse research
2014
2016
Source: Thomson Reuters, Credit Suisse research
■ An attractive economy for investments: Germany is the most competitive economy
in Europe in terms of the World Bank's ease of doing business index, making it one of
the most attractive European economies for foreign investments.
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2 December 2016
4.
Valuations are reasonable: mid-range on trend earnings, cheap on P/E
German equities appear cheap, trading near a 15% discount to Continental Europe on 12month forward P/E and close to 1.2 standard deviations below average levels; it is the
third cheapest market on EV/EBITDA.
Figure 191: Germany is the best ranked European
nation in regards to the World Bank's ease of doing
business index
70
World Bank ease of Doing Business 2016
Figure 192: On forward P/E relative, German
equities appear cheap, trading 1.2std below average
levels
123%
60
118%
50
113%
DAX 12m fwd PE rel Cont. Europe
Average (+/- 1SD)
108%
40
103%
30
98%
20
93%
Greece
Italy
Spain
France
Ireland
Belgium
83%
Netherlands
0
Portugal
88%
Germany
10
Source: Thomson Reuters, Credit Suisse research
78%
1996
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
On measures assuming a normalisation in earnings, German equities appear slightly less
attractive. However, they are still middling on 12-month forward P/E on normalised
margins, and have a price-to-book relative that is in line with the average.
Figure 193: Once we normalise margins, valuations
for Germany are less attractive, but are still midrange
Figure 194: Germany is among the cheapest
European markets on EV/EBITDA
14
20.0
18.7
17.7 17.4
17.0
12-m fwd P/E on normalised margins
16.1
15.0
15.3 14.8
European countries EV/EBITDA
12
10
12.7 12.4
8
9.7
10.0
9.6
8.9
6
4
5.0
2
Global Equity Strategy
Norway
Italy
Germany
France
Spain
Sweden
Netherlands
Belgium
Denmark
Portugal
Austria
Italy
Spain
Norway
France
Netherlands
Germany
Sweden
Finland
Switzerland
Ireland
Source: Thomson Reuters, Credit Suisse research
United
Kingdom
0
0.0
Source: Thomson Reuters, Credit Suisse research
103
2 December 2016
5.
Relative earnings momentum is positive and stronger than implied by the
euro
On both absolute and relative terms to European equities, earnings momentum for the
DAX remains positive, and is stronger than implied by the euro alone.
Figure 195: Earnings revisions for German equities
have been far stronger than implied by the euro
30%
20%
DAX, 13-wk earnings revisions, net upgrades
Assuming a
flat euro
Euro TWI % chg Y/Y, rhs (inverted)
Figure 196: Earnings momentum for Germany
remains much better than that for Europe
-18
DAX: 13-week earnings revisions relative to Cont. Europe
40%
-13
10%
30%
-8
0%
20%
-10%
-3
-20%
2
-30%
10%
0%
7
-40%
-50%
-60%
2011
2012
2013
2014
2015
Source: Thomson Reuters, Credit Suisse research
2016
2017
12
-10%
17
-20%
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
What are the risks to this call?
1.
Key sectors are suffering from Chinese exposure & competition
Over the past 10 years, nearly all the outperformance of the DAX has come from two
sectors, namely autos and chemicals. We are underweight both of these sectors with two
of the key concerns (amongst many others in the case of autos) being the pressure faced
from Chinese competition and the exposure to the Chinese economy.
However, this might not be of a concern in the short term, as:
■ German exposed China plays (including auto and chemicals) follow Chinese economic
momentum (proxied by PMIs) and our economists are relatively upbeat on the Chinese
economy in the run up to the 19th Party Congress.
■ The DAX, ex-chemicals and autos, has continued to outperform.
Global Equity Strategy
104
2 December 2016
Figure 197: The relative performance of the German
stocks with exposure to China plays had
disconnected from Chinese economic momentum,
but seems to be moving back in line
German autos, chemicals & China-exposed cap goods rel
market, y/y change
8%
China manufacturing PMI new orders, 1m lag (rhs)
115%
110%
52
3%
50
-2%
48
-7%
2013
2014
2015
25%
56
54
-12%
2012
Figure 198: Most of the German outperformance
since 2006 had come from autos and chemicals
95%
19%
90%
85%
44
80%
42
75%
2001
Source: Thomson Reuters, Credit Suisse research
21%
100%
46
2016
23%
105%
17%
15%
Germany rel Cont Europe
Germany ex autos and chemicals rel Europe, rhs
2004
2006
2009
2011
2014
13%
2016
Source: Thomson Reuters, Credit Suisse research
2.
On the tactical side, the sell-side is bullish and the market is overbought
Net sell-side recommendations for Germany remain elevated, and German equities are
slightly overbought.
Figure 199:The sell side is relatively bullish on the
DAX
DAX on analyst recom. rel to Cont. Europe (+=Buy; -=Sell)
2.2
Analyst recom. (1=Buy; 5=Sell)
6%
Figure 200: The DAX is slightly overbought relative
to its European peers
20%
15%
2.3
10%
4%
2.4
2%
5%
2.5
0%
2.6
-5%
0%
-2%
2.7
-4%
2.8
-6%
1999
2002
2006
2009
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2012
2016
-10%
DAX, deviation from 6mma, rel Cont. Europe
-15%
-20%
2001
Average (+/- 1SD)
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
105
2 December 2016
How to play this?
As we highlighted recently (see What to do with bond proxies, 3 November), we continue
to favour plays on domestic Germany, and especially German real estate plays, for the
following reasons: i) as real rates become more negative, household and institutional fund
flows into real estate will increase; ii) inflation-adjusted house prices remain 40% below
their peak and affordability is high (whether we look at a house price to wage ratio or rental
yield versus mortgage rate); iii) REITs are already pricing in a 30bp Bund yield; and iv)
after their recent sell off, valuations have become much more reasonable with our
analysts pointing out that the stocks now trade in line with 2016 NAV.
Figure 201: German residential are already pricing
in a 10y Bund yield of nearly 30bp
110
105
100
German Real estate cos rel
market
German bund 10y real yield,rhs
inverted
95
Figure 202: German residentials trade below their
norm on 12m fwd P/E relative to the market
-0.3
350%
German Real estate Cos 12m
fwd P/E rel German Market
-0.1
300%
Average (+/- 1SD)
0.1
250%
0.3
200%
90
85
80
150%
0.5
75
65
60
Jul 15
100%
0.7
70
50%
0.9
Sep 15
Dec 15
Mar 16
May 16
Aug 16
0%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Nov 16
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Below, we screen for German domestic plays, i.e. European stocks with high sales
exposure to Germany, which are Neutral or Outperform rated by CS analysts. Of these,
Deutsche Wohnen and TUI are Outperform rated and have positive earnings momentum.
Figure 203: Plays on domestic Germany that are rated Outperform by Credit Suisse analysts
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
Germany Sales
exposure (%)
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
Grand City Properties
100%
12.8
na
56%
1.4
25%
-6.2
3.0
-48.4
-53.5
-1.3
2.3
Neutral
Deutsche Wohnen
Br.Shs.
Vonovia
100%
23.6
na
-2%
1.4
70%
-6.0
2.7
-7.4
0.2
-3.8
2.0
Outperform
100%
20.2
na
-2%
1.3
27%
5.3
3.6
7.8
-5.8
1.1
2.3
Neutral
Hays
40%
15.9
87%
-7%
4.4
-38%
39.2
2.8
18.1
1.7
6.2
2.8
Neutral
Deutsche Telekom
40%
15.3
112%
-8%
2.3
65%
6.6
4.1
34.6
-0.1
0.8
2.3
Outperform
Tui (Lon)
28%
11.2
55%
-25%
na
na
8.9
5.0
-1.1
1.9
0.3
2.1
Outperform
Sthree
25%
14.1
77%
-18%
6.0
23%
7.1
5.1
15.5
-0.2
0.2
2.3
Outperform
Name
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Furthermore, we screen for German stocks, which are Outperform or Neutral rated by CS
analysts and have been awarded a HOLT eCAP. Of these, Dialog Semicon and
Gerresheimer have positive earnings momentum and are Outperform rated.
Global Equity Strategy
106
2 December 2016
Figure 204: German Outperform rated stocks with an eCAP
-----P/E (12m fwd) ------
HOLT
2016e, %
------ P/B -------
2016e Momentum, %
eCap Award
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
Adidas
X
25.1
151%
43%
5.1
134%
1.4
1.4
-17.5
0.5
0.3
2.9
Neutral
Beiersdorf
X
24.1
119%
-7%
4.2
20%
3.2
0.9
-3.7
1.5
-0.1
2.6
Neutral
Brenntag
X
17.7
105%
5%
2.8
28%
4.9
2.1
-13.2
-3.8
-1.2
2.3
Neutral
Deutsche Boerse
X
na
na
na
na
na
na
na
59.2
na
na
na
Neutral
Fresenius
X
20.3
123%
14%
3.3
82%
1.5
0.9
-1.7
-0.5
-0.1
2.0
Neutral
Fresenius Med.Care
X
17.4
106%
-11%
2.5
22%
3.1
1.3
-3.5
0.0
-0.3
2.0
Outperform
Prosiebensat 1 Media
X
12.7
71%
-8%
9.6
79%
4.1
5.9
-15.0
-3.0
1.2
2.1
Outperform
Sap
X
18.2
91%
-1%
4.1
8%
4.3
1.6
4.7
-0.9
0.3
2.4
Outperform
Siemens
X
14.0
83%
4%
2.5
30%
4.9
3.4
23.1
-0.6
0.0
2.2
Neutral
Dialog Semicon.
X
14.6
92%
-43%
3.1
25%
6.8
0.0
57.6
2.8
2.8
2.4
Outperform
Gerresheimer
X
15.1
81%
-4%
3.4
69%
5.3
1.5
-18.8
1.4
-2.8
2.4
Outperform
Name
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
France: upgrade to benchmark
We increase France to benchmark from underweight for four main reasons:
1.
We are seeing some change and the political situation is not as bad as
investors believe
As we argued previously in this report, we think a victory by Marine Le Pen in the 2017
presidential election is unlikely. Based on the most recent polls Francois Fillon is likely to
become the next President of France and this should be beneficial for French equities and
the economy. Fillon has stated he would:
− Scrap the 35-hour week in favour of a 39-hour week;
− Lift the pension age gradually from 62 to 65;
− Scrap the wealth tax;
− Propose a €40bn tax cut for companies;
− Cut public spending by up to €100bn;
We would however note that historically, reform plans are often met with significant
opposition – Juppe had to abandon his retirement reform plans in 1995 and many of
Hollande's reforms had to be watered down or implemented by decree.
Nevertheless, some change is already happening. We have seen a total reduction of
€41bn in costs for corporates through to 2017 thanks to: tax credit on firms’ payroll for
wages up to 2.5x minimum wage; cuts to employers’ social security contributions; and
removal of a production tax on French firms. Furthermore, Hollande's labour bill, which
bypassed parliament earlier this year, allows:
■ Companies to negotiate deals with staff to work more than 35 hours/week, provided
they are large enough to have union representatives. If such a deal is proposed but
faces difficulties being approved by unions, a referendum with employees can be held,
provided unions representing at least 30% of the workforce consent.
■ Companies with fewer than 11 employees can justify layoffs for economic reasons after
a one-month fall in revenues. Companies with up to 300 employees must show a
decrease in revenues over three consecutive quarters and even larger companies
must show a decline over a year.
Global Equity Strategy
107
2 December 2016
In addition, France has maintained its ranking on the World Bank's ease of doing business
index, despite dropping on a majority of subcomponents.
Figure 205: France's ranking on the World Bank's ease of doing business index
did not deteriorate
Topics
DB 2016 rank
DB 2015 rank
Overall
27
27
Starting a Business
32
27
Dealing with Construction Permits
40
39
Getting Electricity
20
22
Registering Property
85
82
Getting Credit
79
71
Protecting Minority Investors
29
27
Paying Taxes
87
105
Trading Across Borders
1
1
Enforcing Contracts
14
12
Resolving Insolvency
24
22
Change in
rank
No Change
-5
↓
↓
↑
↓
↓
↓
↑
-1
2
-3
-8
-2
18
No Change
-2
↓
↓
-2
Source: Thomson Reuters, Credit Suisse research
2.
Best of both worlds: large exposure to European domestic demand and
benefits from weaker euro
From an economic point of view, France has significant exposure to European domestic
demand and is therefore a great play on the European recovery.
Figure 206: France has a high exposure to euro area
domestic demand
105
Figure 207: …. But French equities have the second
most negative correlation with the euro
0.6
Exposure to euro area domestic demand, % of GDP (net exports
to EA + domestic demand)
Correlation with EURUSD
0.5
0.4
100
0.3
0.2
0.1
95
0
-0.1
90
-0.2
-0.3
Source: Thomson Reuters, Credit Suisse research
Germany
France
Belgium
Ireland
Finland
Netherlands
Italy
Spain
Portugal
Greece
-0.4
Austria
Netherlands
Germany
Sweden
Austria
Italy
Spain
Belgium
Portugal
Finland
France
Greece
85
Source: Thomson Reuters, Credit Suisse research
Moreover, the stock market is the second most sensitive market to euro weakness with
French companies generating c.40% of earnings from outside of Europe.
Global Equity Strategy
108
2 December 2016
3.
Some upside on economic momentum
French economic lead indicators are slowly starting to improve and French PMIs are now
accelerating in line with the Eurozone, having previously lagged European momentum.
The INSEE business sentiment survey is now in line with slightly above 1.5% GDP growth
(with consensus forecasting 1.2% GDP growth for France in 2017).
Figure 208: French PMI new orders started to
improve
4.0
Manufacturing PMI new orders
Denmark ( 0.96, 7.77)
3.0
Time-weighted 3 month change in z-score
Figure 209: The INSEE survey of French business
sentiment is now consistent with growth of c.1.5%
Austria
Netherlands
Italy
125
5%
4%
115
3%
Spain
2.0
105
Global
France
1.0
2%
United Kingdom
1%
Eurozone
95
-1%
Ireland
0.0
85
Germany
-1.0
-2%
Greece
-4%
France, GDP, y/y%
-2.0
-0.2
-3%
France business sentiment
75
0.0
0.2
0.4
0.6
Z-score: latest PMI
0.8
1.0
1.2
Source: Markit, Credit Suisse research
65
1998
-5%
2000
2003
2005
2008
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
4.
Valuations are reasonable
French equities are trading only slightly above with their norm on 12m forward P/E relative
to their European peers and are nearly 0.6 standard deviation cheap on P/B relative.
Figure 210: French equities are 0.5 s.d. above
average relative to history on 12-month forward P/E
Figure 211: French equities P/B relative cont.
Europe 0.6std below average
France PB rel Cont Europe ex fin
1.30
2%
France versus Continental
Europe: 12-month forward P/E
1.25
0%
Average (+/- 1 std)
1.20
Average (+/- 1SD)
1.15
-2%
-4%
1.10
1.05
1.00
-6%
-8%
0.95
0.90
0.85
-10%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
0.80
1995
1998
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
109
2 December 2016
5.
Earnings momentum is recovering
While still below the earnings momentum for the whole European market, earnings
momentum of French equities has started to recover sharply.
6.
The sell side is very bearish
French sell side recommendations are close to the most negative they have been since
the financial crisis in both absolute as well as relative terms.
Figure 212: France equities' earnings momentum
absolute and relative to the euro-area market
France 3m breadth
15%
Figure 213: France on sell side recommendations
France rel Eur x UK on sell side recommendations
Analyst Recommendations (1=BUY, 5 = SELL)
Rel Euro area mkt
2.3
7%
10%
5%
5%
2.4
0%
3%
-5%
-10%
2.5
1%
-15%
-1%
-20%
2.6
-25%
-30%
2002
2004
2006
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
-3%
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Why not overweight?
1.
The CAC has already priced in a small improvement in economic
momentum
French business sentiment relative to the euro area has picked up from its trough in 2015.
However, French growth remains c.1% below euro area GDP growth as French equities
have already outperformed the European market and have thus to some extent discounted
the pick-up in economic momentum.
Global Equity Strategy
110
2 December 2016
Figure 214: French lead indicators consistent with
French growth slightly underperforming the euro
area but by less than before
9
Figure 215: The CAC has performed better than
suggested by economic momentum
5%
3%
4
7
3%
5
2%
2
3
1%
1
1%
-1
-1%
-2
-3
-1%
-5
-3%
-4
-7
-2%
French business sentiment rel Euro area, lhs
-9
-11
1997
0
1999
2002
2005
2007
2010
2013
-5%
-6
France vs Euro area, GDP differential, y/y%, 3q
lag
-3%
2016
Source: Thomson Reuters, Credit Suisse research
-8
2009
French economic sentiment rel Euro area
CAC 40 rel to EuroStoxx, 6m % chg, rhs
2010
2011
2012
2013
2014
-7%
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.
A loss in competitiveness
We continue to worry about the loss of competitiveness (which can be proxied by the
French current account surplus relative to that of Europe), while labour costs appear
relatively high, with the share of non-labour costs the highest of any major euro area
member, as shown below. This is also reflected in France only being in 61 st place on the
World Economic Forum's ranking of labour market efficiency.
Figure 216: French current account deficit
continues to deteriorate relative to the rest of the
euro area
2%
Figure 217: France has the highest non-wage share
of labour costs of any major euro area member
45
Total labour costs, €
35%
Non-wage costs, % of total, rhs
40
1%
30%
35
30
0%
25%
25
-1%
20
20%
15
-2%
10
-3%
France
Sweden
Belgium
Italy
2016
Austria
Global Equity Strategy
2014
Euro area
Source: Thomson Reuters, Credit Suisse research
2012
Spain
2010
Netherlands
2008
Germany
2006
10%
Portugal
2004
0
United Kingdom
-5%
2001
French rel Euro area current account, 12mma, %
GDP
Ireland
-4%
15%
5
Source: Thomson Reuters, Credit Suisse research
111
2 December 2016
3.
French equities look overbought
French equities are now more than 1 standard deviation overbought relative to their
European peers.
Figure 218: French equities are overbought
30%
25%
French, deviation from 6mma, rel Cont. Europe
20%
Average (+/- 1 SD)
15%
10%
5%
0%
-5%
-10%
-15%
-20%
1985
1991
1996
2001
2006
2011
2016
Source: Thomson Reuters, Credit Suisse research
How to play this?
We believe the stocks that should benefit from reform are those where a high percentage
of labour costs is originated in France and where ideally a significant proportion of sales
are in France. The below screen show the stocks that fulfill this criteria and are Outperform
or Neutral rated by CS analysts. We would particularly highlight Orpea and Vinci, which
have more than 50% of their labour cost originating in France and are Outperform rated.
Figure 219: Outperform rated French stocks
Analysts Estimates
-----P/E (12m fwd) ------
Domestic
Exposure (%)
What % of
labour cost is
originated in
France
Abs
Eiffage
80%
79%
Orpea
67%
67%
Vinci
58%
Credit Agricole
2016e, %
------ P/B -------
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
13.3
78%
-2%
1.8
35%
6.6
21.8
133%
-4%
2.4
48%
4.7
53%
13.6
80%
-3%
2.2
31%
51%
53%
10.4
89%
25%
0.5
Remy Cointreau
4%
40%
27.9
138%
14%
Societe Generale
52%
39%
9.2
79%
Elior Group
50%
36%
16.7
Bnp Paribas
73%
31%
Kering
8%
Technip
Pernod-Ricard
Name
HOLT
2016e Momentum, %
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
2.5
-71.0
1.5
0.4
2.4
Neutral
1.4
-102.5
2.0
1.3
1.9
Outperform
7.4
3.3
-13.8
-0.4
-0.9
2.0
Outperform
4%
na
5.7
23.1
4.0
-1.6
2.6
Outperform
3.4
49%
2.1
2.1
-39.1
-0.9
-0.7
2.5
Outperform
2%
0.5
-15%
na
5.6
59.9
7.9
1.2
2.4
Neutral
81%
-11%
2.3
35%
4.3
2.0
-45.0
1.6
0.0
1.9
Outperform
9.4
80%
3%
0.7
5%
na
4.9
26.3
5.7
1.4
2.5
Neutral
20%
18.2
109%
22%
2.3
81%
3.6
2.2
-1.5
3.7
1.4
2.3
Neutral
4%
20%
17.5
71%
13%
1.7
3%
3.6
3.0
-9.8
3.5
1.2
2.5
Outperform
9%
15%
17.5
87%
1%
2.0
17%
5.2
1.9
-15.2
-0.1
-0.8
2.5
Outperform
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Global Equity Strategy
112
2 December 2016
The European periphery: upgrade to benchmark
We downgraded the European periphery on the back of the surprising Brexit referendum
at the end of June, while we regarded Italian bond yield spreads as too complacent.
However, after underperforming the core by c.4.5% since Brexit, we think it's time to raise
the periphery back to benchmark.
This is due to the following reasons:
1.
Economic upside remains as markets overreact to weakening in momentum
Economic momentum in the periphery remains strong, with PMI new orders actually higher
than those in the core. However, markets are already discounting much weaker relative
PMIs. Furthermore, GDP in most peripheral economies remains between 2-7% below its
previous peak, suggesting they can continue growing above trend for some time.
Figure 220: Manufacturing PMIs remain stronger
than those in the core
PMI mfg new orders, Periphery rel core
7
Figure 221: In most peripheral countries, GDP
remains well below its previous peak
Italy
110
Periphery rel core perf,y/y chg %, rhs
Spain
108
Portugal
106
2
Real GDP, Q3 2007 = 100
France
104
Germany
102
100
-3
98
96
-8
94
92
-13
2006
90
2007
2008
2010
2011
2012
Source: Markit, Credit Suisse research
2014
2015
2016
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.
A play on domestic demand
The peripheral European economies – with the exception of Ireland – have lower exposure
to non-euro area exports. Thus, the periphery is a reasonable expression of our positive
view on the euro area domestic demand recovery. However, we would note that because
of this, the periphery tends to underperform as the euro weakens.
Global Equity Strategy
113
2 December 2016
Figure 222: The relative performance of the
periphery is correlated with the EURUSD
Figure 223: The peripheral European economies are
more domestic than the core economies (with the
exception of Ireland)
1.6
0.74
EURUSD
Exports outside the euro area (goods&services), % of GDP
83%
60%
Peripheral Europe relative to Continental Europe (rhs) 0.72
30%
0.64
20%
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Spain
Italy
France
0.56
2012
Portugal
1.0
2011
Greece
0%
0.58
Austria
1.1
10%
Finland
0.60
Norway
0.62
Sweden
1.2
0.66
Germany
1.3
40%
Switzerland
0.68
Belgium
1.4
50%
Netherlands
0.70
Ireland
1.5
Source: Thomson Reuters, Credit Suisse research
3.
Valuations continue to look attractive
When considering valuations on measures of normalised earnings (either price-to-book or
P/E on normalised margins), the periphery still appears attractively valued on a relative
basis, trading on a P/B ratio that is 11% below the core. Given the stage of the cycle in
core versus periphery, we believe there is greater upside to earnings in the periphery as
both margins and revenues recover further.
Figure 225: Once we normalise margins, the
periphery is cheap on forward P/E, with the
exception of Ireland
Figure 224: Versus the core, the periphery is still
cheap on P/B, trading at a 10% discount
Peripheral Europe ex financials P/B rel core
130%
25.2
25
Average (+/- 1sd)
120%
12-m fwd P/E on normalised margins
22.2
20
17.9
110%
16.8 16.7 16.4
15.4
15
14.6
11.7
100%
90%
8.8
7.3
5
80%
2002
2004
2006
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2008
2010
2012
2014
2016
Portugal
Austria
Italy
Spain
France
Norway
Germany
Sweden
Finland
Netherlands
2000
Switzerland
Belgium
1998
Ireland
0
70%
60%
1996
9.8 9.7
10
Source: Thomson Reuters, Credit Suisse research
114
2 December 2016
4.
Competitiveness has improved significantly, with the exception of Italy
Since the euro area crisis, the competitiveness of the peripheral countries improved
significantly as indicated by the adjustments seen in the real effective exchange rate (with
the exception of Italy). This is also reflected in the 12-month rolling current account
balance which improved from -6.2% at the end of 2008 to 1.9% currently.
Figure 226: REER deflated by ULC has already seen
significant adjustments in most of the periphery but
Italy
130
Germany
Greece
Italy
France
125
120
Ireland
Spain
Portugal
Figure 227: The current account balance of the
periphery improved significantly
1.5%
REER deflated by ULC
European periphery 12m rolling current
accout, % of GDP
115
-0.5%
110
105
-2.5%
100
95
90
-4.5%
85
80
1999
2001
2003
2005
2007
2009
2011
2013
2015
-6.5%
2003
Source: Thomson Reuters, Credit Suisse research
2005
2007
2009
2011
2013
2015
Source: Thomson Reuters, Credit Suisse research
The below screen shows stocks in the European periphery that are Outperform rated by
CS analysts, cheap on HOLT and have positive earnings momentum.
Figure 228: Periphery OP rated stock with positive earnings momentum and cheap on HOLT
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
Name
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
Endesa
16.1
106%
88%
2.3
Enel
10.9
72%
-4%
1.1
Iberdrola
13.5
89%
2%
Jumbo
13.6
57%
Motor Oil
7.2
Green Reit
Saras
HOLT
2016e Momentum, %
FCY
DY
Price, %
change to
best
3m EPS
58%
5.1
6.7
48.0
5.7
1.1
3.1
Outperform
2%
13.9
4.8
61.1
2.3
-0.7
1.7
Outperform
1.0
1%
6.5
5.2
57.6
0.5
-1.5
2.1
Outperform
20%
2.0
10%
na
2.0
46.9
2.7
1.9
1.9
Outperform
29%
-14%
2.2
1%
na
6.2
63.5
0.2
-2.9
1.6
Outperform
22.4
na
-11%
0.8
-6%
0.0
3.1
11.5
5.5
-2.2
2.0
Outperform
9.6
39%
-66%
1.8
32%
10.2
5.9
82.6
0.5
-5.7
2.5
Outperform
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Global Equity Strategy
115
2 December 2016
Spain: increase overweight
1.
Spain is a play on European banks, where we think pessimism is overdone
Due to banks' high share of Spanish market cap (a quarter of the total market), Spain's
relative performance follows that of the European banks index. We are overweight
European banks with a particular focus on European retail banks (see Financials: tactically
long, 21 September).
Figure 229: Spain's relative performance is
correlated to the relative performance of European
banks…
110
130
100
Spain rel. Euro Area
120
Banks rel. Euro Area, rhs
110
100
90
90
Figure 230: …due partly to the fact that banks
constitute c25% of Spain's market capitalisation
30%
25.7%
Banks market cap as a % of total
25%
20%
16.1%
13.5%
15%
80
80
70
60
70
9.0%
10%
6.4%
5%
2.1%
50
60
2009
40
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
2014
2015
2016
0%
Spain
Italy
Netherlands
France
Portugal
Germany
Source: Thomson Reuters, Credit Suisse research
One of the key reasons for our overweight of European banks is the potential for loan loss
provisions to fall. We view the three key determinants of provisioning as: i) employment
growth; ii) collateral values; and iii) level of interest rates. In Spain, all three factors would
point to a fall in provisioning while proxies on loan growth, particularly on the consumer
side, look strong.
Despite these improving trends, Spanish banks are trading at all-time lows on price-tobook relative to the broader banks sector and the sell-side remains particularly bearish.
From a strategy perspective, we have consistently preferred retail banks to wholesale or
investment banks, and Spain is largely retail bank dominated.
Global Equity Strategy
116
2 December 2016
Figure 231: Credit demand in Spain, particularly for
mortgages, remains very strong
80
60
40
50%
ECB BLS, Spain mortgage credit demand
40%
Mortgage credit growth, 3mma Y/Y% 1Q
lag, rhs
30%
20%
20
10%
0
Figure 232: Relative to euro area banks, Spanish
banks are trading near an all-time low on P/B
280%
260%
Spanish Banks PB rel Euro area banks
240%
Average (+/- 1sd)
220%
0%
200%
-10%
180%
-20%
160%
-60
-30%
140%
-80
-40%
120%
-50%
100%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
-20
-40
-100
2005
2006
2008
2009
2011
2013
2014
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
2.
The ongoing recovery is solid, supported by strong economic momentum
The signs of recovery in Spain are very strong; despite weakening recently, PMIs are
consistent with GDP growth of 2%, and employment growth, which is crucial for a
continuing self-sustained domestic demand recovery, is at an 8-year high of 3% year-onyear as composite employment PMIs remain robust.
Figure 233: Spanish PMIs are consistent with GDP
growth c2%
70
8%
Figure 234: Employment growth in Spain is at an 8year high
Spain Composite PMI, employment, lhs
60
65
8
Spain employment growth, y/y%, 3-month lag
Spain Composite PMI, new orders, lhs
6
6%
GDP, q/q% , ann.
55
60
4
4%
55
2%
2
50
50
0
0%
45
-2%
40
-4%
35
30
-6%
25
2000
-8%
2002
2005
2008
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2010
2013
2016
45
-2
-4
40
-6
35
-8
1999
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
117
2 December 2016
Property prices, too, are recovering and this should support a recovery in construction
investment – something which has been a drag on domestic demand over the past few
years.
Figure 235: House prices in Spain have troughed
Figure 236: Construction investment in Spain has
begun to recover
105
Spain Investment breakdown
(2008Q1=100)
100
95
95
85
90
85
75
80
75
70
65
Construction (50%)
Spain house prices, new houses
55
Spain house prices, existing houses
Machinery/transport equipment (42%)
Spain house prices, new and existing houses
45
65
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
05
06
07
08
09
10
11
12
13
14
15
16
Source: Thomson Reuters, Credit Suisse research
3.
Competitiveness has been regained
There has been a structural improvement in Spanish competitiveness, which has not been
undermined by the economic recovery. Indeed, the current account remains in surplus,
meaning the Spanish economy is generating excess savings.
4.
Exposed to the European recovery
As we show below, among those in the euro area the Spanish economy is theoretically the
most domestically-oriented. Exports outside the euro area as a share of GDP are the
lowest among major euro area economies, giving the Spanish economy significant
exposure to the European recovery.
Global Equity Strategy
118
2 December 2016
Figure 238: Spain is one of the most domestic
European economies
10%
-10%
0%
-12%
2001
2003
2005
2007
2009
2011
2014
2016
Source: Thomson Reuters, Credit Suisse research
Spain
-8%
France
20%
Portugal
-6%
Italy
30%
Greece
-4%
Austria
40%
Finland
-2%
Norway
50%
Sweden
0%
Germany
60%
Ireland
2%
Exports outside the euro area (goods&services), % of GDP
83%
Switzerland
Spain current account 3m ann., % GDP
Belgium
4%
Netherlands
Figure 237: The Spanish current account has moved
into a surplus of 2.6% of GDP
Source: Eurostat
5.
Some elements of valuation look cheap
Spanish equities trade below their long-run average on 12m forward P/E relative to
European equities. Furthermore, Spanish equites are trading on one of the lowest 12m
forward P/E multiples across the major European countries if we normalize margins
We acknowledge that Spanish equities rank poorly on the valuation component of our
European sector scorecard, however this is mainly due to Spanish equities looking
expensive on P/B relative.
Figure 239: The Spanish equities look slightly cheap
on 12m fwd PE…
Spain 12m fwd PE rel Cont Europe
Figure 240: …. and are one of the cheapest markets
on normalized margins
25
23.9
12-m fwd P/E on normalised margins
Average (+/- 1SD)
107%
18.9
20
102%
15
97%
92%
17.9 17.4
16.8 16.2
15.5 15.0
13.1 12.8
10.2 9.6
9.3
10
87%
5
82%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2010
2013
2016
Portugal
Austria
Italy
Norway
Spain
France
Sweden
Finland
Netherlands
2007
Germany
2004
Switzerland
Belgium
72%
2001
Ireland
0
77%
Source: Thomson Reuters, Credit Suisse research
119
2 December 2016
6.
Improving political stability
As we discuss above, after 10 months without a government, Rajoy was reconfirmed as
Prime Minister and recent polls suggest the PP would be able to win a strong plurality in
the event of a snap election.
7.
Spanish equities offer some proxy Brazil exposure
The Spanish market has high exposure to Brazil, with around 20% of Spanish sales
coming from LatAm, of which the majority is from Brazil. We would highlight that the
Spanish Brazilian-exposed stocks, which typically follow the EURBRL, have recently
underperformed the strength in the Real.
Figure 241: Brazilian PMI new orders are recovering
65
Brazil PMI manufacturing new
orders
Brazil IP, y/y, rhs
60
55
50
45
40
35
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Figure 242: The recent strength of the BRL
suggests the Spanish Brazil-exposed stocks should
have performed better
20%
109
15%
107
10%
105
5%
103
0%
101
-5%
99
-10%
97
-15%
95
-20%
93
2008
Source: Thomson Reuters, Credit Suisse research
2.0
2.5
3.0
3.5
4.0
Spanish stocks exposed to Brazil price perf rel mkt
4.5
EUR/BRL, rhs, inverted
5.0
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
However, we would note that Spain ranks in the second half of our European country
scorecard, as it ranks poorly on traditional valuation measures, recent changes in short
term economic momentum and macro fundamentals.
Below we screen for Spanish stocks with significant exposure to Brazil.
Figure 243: This screen shows Spanish listed stocks with significant Brazilian exposure
-----P/E (12m fwd) ------
Name
YTD
Sales exposure
performance
to Brazil (%)
(%)
2016e, %
------ P/B -------
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
HOLT
Price, %
change to
best
2016e Momentum, %
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Banco Santander
30%
-4%
9.6
83%
-2%
0.7
-19%
na
4.7
36.1
1.3
0.2
2.7
Neutral
Prosegur
Cia.Securidad
Mapfre
29%
38%
15.6
85%
5%
5.0
64%
4.1
2.2
-25.6
-7.0
-0.2
3.2
Not Covered
24%
21%
10.8
92%
14%
1.1
6%
na
4.5
23.7
-2.1
-0.7
3.6
Not Covered
Telefonica
21%
-20%
11.5
85%
-5%
2.2
-18%
8.2
7.8
-5.5
-2.9
5.3
2.5
Neutral
Distribuidora Intnac.De
Alimentacion
Iberdrola
15%
-19%
10.9
65%
-33%
8.7
-31%
8.4
4.5
-27.7
-3.9
-0.3
2.2
Not Covered
8%
-11%
13.5
90%
2%
1.0
-1%
6.6
5.3
57.6
0.2
-1.5
2.1
Outperform
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Global Equity Strategy
120
2 December 2016
Italy: reduce underweight
We downgraded Italian equities post the Brexit vote as we perceived Italian bond spreads
as being too complacent in regard to Italian political and economic risk. However, after
widening by more than 80bps since August to a three-year high, we would argue spreads
are now looking more reasonable.
Figure 244: Italian spreads have widened significantly and equities
underperformed in line with the widening
2.7
Spreads btw Italian 10 yr and German 10 yr
2.1
MSCI Italy rel performance, rhs, inv
2.9
1.9
3.1
1.7
3.3
1.5
3.5
1.3
3.7
1.1
3.9
0.9
4.1
0.7
Nov-14
Feb-15
May-15
Aug-15
Nov-15
Feb-16
May-16
Aug-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
On the back of more realistic bond spreads, a recent rebound in macro momentum, our
more positive view on the periphery and their cheap valuation, we add slightly to
weightings.
Lead indicators of Italian economic growth, having fallen to very weak levels, are now
picking up. Italian manufacturing PMI new orders are now in line with slightly above1 %
GDP growth and suggest a stabilisation in consumer confidence.
Global Equity Strategy
121
2 December 2016
Figure 246: …and no longer indicate falling
consumer confidence
Figure 245: Italian PMIs have rebounded to be in
line with just over 1% GDP growth…
Italy manufacturing PMI, new orders
65
7%
GDP, q/q% , ann.,rhs
70
10
65
60
55
2%
50
45
-3%
40
35
-8%
Italy manufacturing PMI, new orders
5
Italian consumer confidence, rhs
0
60
-5
55
-10
-15
50
-20
45
-25
40
-30
-35
35
30
25
-13%
1999
2001
2003
2005
2007
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
-40
30
-45
1999
2001
2003
2005
2007
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Italian equities have become very cheap on almost all measures, including 12-month
forward P/E, where Italy trades close to a 20% discount to Continental Europe and more
than 1 standard deviation below average.
When we consider measures of normalised earnings, Italian equities appear even more
attractively valued; assuming margins recover to their long-run average implies over 30%
potential upside to EPS, making Italy one of the cheapest European markets on 12-month
forward P/E with normalised margins.
Average (+/- 1SD)
105%
18.7
17.7 17.4
17.0
12-m fwd P/E on normalised margins
16.1
15.0
95%
15.3 14.8
12.7 12.4
10.0
85%
9.7
9.6
8.9
5.0
75%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2010
2013
2016
Portugal
Spain
Norway
France
Sweden
Finland
Netherlands
2007
Germany
2004
Switzerland
0.0
Ireland
65%
2001
20.0
Austria
MSCI Italy 12m fwd PE rel Cont. Europe
115%
Figure 248: If we normalise margins, Italy is one of
the most attractively valued markets in Europe
(ex financials)
Italy
Figure 247: Italian equities have de-rated recently
and trade at a 20% discount to Cont. Europe, 1.4std
below average
Source: Thomson Reuters, Credit Suisse research
122
2 December 2016
On P/B relative to the European market, Italy trades at a 30% discount to the wider
European market, and nearly 1 standard deviation below average levels. In fact, of the
largest 20 markets globally, Italy is the third cheapest market on price to book.
Figure 249: On P/B relative, Italian equities look
attractive, trading at a 30% discount to Continental
Europe and over 0.8std below average
Figure 250: Italy is the cheapest of the major global
markets on P/B (ex financials)
3.5
P/B for top 20 global markets by market cap
110%
3.0
100%
2.5
90%
2.0
80%
1.5
70%
1.0
0.5
MSCI Italy PB rel Cont. Europe ex fin
50%
0.0
USA
Sweden
Switzerland
India
Netherlands
South Africa
UK
China
Spain
Australia
Europe
Taiwan
Germany
Canada
France
Hong Kong
Italy
Japan
Korea
60%
Average (+/- 1SD)
40%
1991
1996
2001
2006
2011
2016
Source Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
Italian banks have already sharply underperformed their European peers, while they trade
one standard deviation below their norm on P/B relative.
Figure 252: … and are trading 1 standard deviation
below their norm on P/B relative
Figure 251: Italian banks have already
underperformed their peers…
105
95
1.3
MSCI Italy Banks PB rel Cont. Eur Banks
1.2
Average (+/- 1sd)
1.1
1.0
85
0.9
75
0.8
65
55
45
0.7
Bank equity index,
rebased to 100 at Jan 1st
France
UK
Belgium
35
Dec-15
Feb-16
0.6
Italy
Spain
Apr-16
Source Thomson Reuters, Credit Suisse research
Global Equity Strategy
0.5
0.4
1996
Jun-16
Aug-16
1999
2001
2003
2005
2007
2009
2012
2014
2016
Oct-16
Source Thomson Reuters, Credit Suisse research
123
2 December 2016
Furthermore, we think that investors are too negative on Italian politics (see above) as well
as the risk of the Italian banking crisis leading to a sovereign risk crisis.
Our banks team highlights that Italian NPLs are c.€200bn while NPEs (Non Performing
Exposure = NPL + 'past due and unlikely to pay loans') are €360bn of which c.47% are
covered. In a very worst case scenario, if all NPEs became NPLs and coverage would
need to rise to 75%, this would amount to costs of c.€100bn or c6% of GDP, not far off
that of SAREB in Spain (c5% of GDP). Our banks research team recently discussed these
views in Italian banks: The relevance of the "soft" and the "hard" NO, 01 December.
However, there are a number of reasons for seeing this as being too pessimistic:
■ The transition from 'unlikely to pay' to NPLs has, according to our banks team, slowed
significantly and we think it is far too pessimistic to assume the coverage ratio of 'past
due and unlikely to pay loans' has to rise to 75%.
■ The coverage ratio of NPLs is already 60% and the cost of increasing the coverage of
NPLs from 60% to 75% is only 1.8% of GDP.
■ With 50% of mortgages being fixed and with the mortgage rates significantly below the
rental yield, real estate trends in Italy should improve. Real estate makes up the
majority of the collateral of Italian banks.
We think a bail-in of retail investors with no compensation is unlikely. Retail investors own
one-third of about €600bn worth of bank bonds and half of about €60bn worth of
subordinated bonds (according to the IMF) and we don't think Renzi and the established
parties are keen to alienate the electorate further especially as there are plenty of
regulations that allow room for maneuverability. Consequently, we on the Global Equity
Strategy team believe that if there is a bail in there would be some form of compensation
for the retail investors (though we raise the question of who pays for this without falling foul
of EU state aid laws).
In addition, Article 32 of the Bank Resolution and Recovery Directive suggests that state
aid can be allowed in 'exceptional circumstances to remedy a serious disturbance to the
economy' that 'endangers financial stability' and Article 23 allows viable banks to be
temporarily supported to meet capital needs identified by a shortfall in a stress test
scenario. Furthermore, we think that politically Europe will not want to risk a financial crisis
ahead of such important elections coming due in 2017, especially with the weak capital
position of Deutsche Bank.
One possible scenario is that the ECB would allow of postponement of recapitalisations in
Italy as a compromise solution until after a general election.
We would also highlight that, contrary to general belief, there have been some significant
reforms in Italy over the past couple of years. Examples include:
■ Article 18 of the 1970 workers statute has been formally abolished for new
employees, allowing firms with more than 15 workers to be able to fire for business
reasons, without the risk of having to reinstate them. This is effective even if a
dismissal is ruled unlawful, and the total payoff is limited to only two years' salary.
■ New election law: Effective since mid-2016, the new Italicum system awards an
immediate parliamentary majority to the party that achieves at least 40% of the vote.
Should no party win 40%, a run-off vote is held, with the winner guaranteed a minimum
55% of parliamentary seats. This should prevent political gridlock caused by a
succession of weak coalition governments. The constitutional court is due to rule on
this after the referendum.
■ Removal of barriers to competition through product market reform.
Global Equity Strategy
124
2 December 2016
− Insurance: introduce measures to reduce costs, fight fraud more effectively, and
give the consumer greater ability to compare policies.
− Telecoms and Banking: make switching provider easier, increase transparency of
hidden charges, and enable workers to switch freely between pension funds.
− Postal: elimination of all legal monopolies still held by Poste Italiane.
− Energy: phase out price regulation effective from 2018.
− Closed professions: remove restrictions on who may conduct certain types of
business.
■ This is in addition to other pro-competition actions by Renzi’s administration.
These include the commitment to lower energy costs, making bank accounts portable,
limiting VAT exemptions, and easing SME access to credit.
■ The most sweeping banking reform in 20 years. In 2015, Italy’s Parliament passed
legislation mandating that Popolari banks (Italy’s large cooperative banks) with assets
in excess of €8bn convert to joint-stock companies.
■ There has been important judicial reform: Specific duties previously reserved for
notaries may now be performed by lawyers; notaries are now allowed to advertise;
there has been a liberalisation of geographical regions governing where individual
notaries may practice; and the number of documents that require notarisation has been
reduced. This should speed up the time taken to enforce a contract. Italy currently
ranks 108 out of 190 countries on the ability to enforce contracts according to the
World Bank's 2016 ease of doing business index.
■ Changes to bankruptcy law: The Italian government has approved a number of
changes to existing bankruptcy laws in order to help banks rid themselves of bad debts
more quickly. The new measures are aimed at reducing current recovery times, which
can span over several years.
However, we are not yet ready to upgrade Italian equities to benchmark for the following
reasons:
1.
Competitiveness has not yet improved
While other countries in the European periphery have seen significant improvements to
their competitiveness, Italy's REER has remained flat since the start of the European
economic crisis. This suggests Italy's economy will either have to go through painful
reforms or the economy is likely to face deflation. Furthermore, Italy ranks second worst of
all European countries on the World Bank’s ease of doing business index.
2.
Political risk remains
As we argued above, we believe investors are too concerned about potential Italian
political risk. However, there is some risk with the two biggest populist parties, 5 Star
movement and Lega Nord, polling just below 30% and 13%, respectively.
3.
Italy ranks third from the bottom on our European country scorecard
Italy ranks very poorly on our European country scorecard based on weak earnings
momentum, weak growth momentum as well as significant political risk.
4.
Idiosyncratic risks not yet reflected in bond spread relative to Spain
While the spread of Italian bond yields over Spanish bond yields widened over the past
few weeks, we don’t think spreads are fully reflecting the Italian idiosyncratic risks relative
to Spain. In our opinion, the yield of Italian 10-year bonds should be 100bp above that of
Spanish 10-year yields (from c50bp now) for the following reasons:
Global Equity Strategy
125
2 December 2016
■ Weak economic momentum: Italian PMIs are only in line with just above 0% GDP
growth, while Spanish PMIs are in line with 2% growth.
■ Spain has lower government debt than Italy: Spanish government debt, at 100% of
GDP, is much lower than in Italy (government debt to GDP of 135%). While we
acknowledge that the Spanish budget deficit is clearly higher than the Italian deficit
(-3.8% vs -2.4% on the European Commission's 2017 estimates), NPLs, which might
potentially need to be shouldered by the government, are substantially higher in Italy
(17%) than in Spain (6%).
Figure 253: Italian over Spanish bond spreads have
risen but we think risks remain to the upside
Figure 254: Spain has lower government debt than
Italy
140%
120
Government debt, % GDP
120%
Italy vs Spain 10-year bond yield
spreads in bps
100%
70
80%
60%
20
40%
-30
20%
2013
2014
2015
Source: Thomson Reuters, Credit Suisse research
Norway
Switzerland
Denmark
Sweden
Netherlands
Canada
Austria
France
2016
United Kingdom
2012
Spain
Italy
2011
United States
-130
2010
Portugal
0%
-80
Source: Thomson Reuters, Credit Suisse research
■ Deteriorating competitiveness: Italy has the most expensive REER on the basis of
unit labour costs and ranks significantly worse than Spain on the World Bank’s ease of
doing business index.
Figure 255: Spain ranks significantly above Italy on the World Bank’s ease of
doing business index
World Bank ease of doing
business
Spain
Italy
Overall
33
44
Starting a Business
79
57
Dealing with Construction
Permits
111
82
Getting Electricity
71
45
Registering Property
50
24
Getting Credit
60
97
Protecting Minority Investors
30
40
Paying Taxes
45
134
Enforcing Contracts
36
106
Resolving Insolvency
25
23
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
126
2 December 2016
The below screen shows Italian stocks that are Outperform rated by Credit Suisse
analysts.
Figure 256: Italian Outperform rated stocks
-----P/E (12m fwd) -----rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
72%
-4%
88%
64%
1.1
2%
13.9
4.8
0.9
-19%
4.9
6.3
9.8
83%
-18%
0.7
5%
na
9.0
Luxottica
25.2
151%
7%
4.3
38%
3.0
Prysmian
14.2
83%
12%
3.7
23%
Azimut Holding
11.3
76%
-13%
2.9
Infrastrutture Wireless
Italiane Spa Npv
Saras
21.2
153%
-29%
9.6
39%
Yoox Net-A-Porter
43.0
Italgas
10.0
Name
Abs
rel to
Industry
Enel
10.9
Eni
21.9
Intesa Sanpaolo
HOLT
2016e, %
------ P/B -------
Price, %
change to
best
2016e Momentum, %
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
3m EPS
3m Sales
61.1
2.3
-0.7
1.7
Outperform
103.6
-283.8
-2.3
2.3
Outperform
44.5
-2.9
0.2
1.9
Outperform
1.9
-9.5
-0.6
-1.4
2.8
Outperform
8.4
2.1
-3.3
-0.9
-1.0
1.9
Outperform
2%
na
7.3
-5.1
1.5
2.2
2.3
Outperform
1.7
8%
1.5
3.5
-49.8
3.8
0.6
2.1
Outperform
-66%
1.8
32%
10.2
5.9
82.6
0.5
-5.7
2.5
Outperform
182%
-26%
12.6
58%
-1.2
0.0
-58.2
0.6
-2.4
1.9
Outperform
66%
na
na
na
5.5
6.0
na
na
na
2.2
Outperform
Source: IBES, MSCI, Thomson Reuters, Credit Suisse HOLT®, Credit Suisse estimates
Netherlands: underweight
We previously had no recommended weighting for Dutch equities, but believe that
investors should be underweight, for the following reasons.
1.
Valuations look expensive
Dutch equities are trading not far off a 20-year high on 12m forward P/E relative to the
wider European market and are trading close to a 10-year high on P/B relative.
Figure 257: Netherlands 12m fwd PE rel cont Europe
is 1.4 std above average
Figure 258: Netherlands price to book rel Cont
Europe is trading at normal level
108%
200%
103%
180%
98%
160%
93%
140%
120%
88%
Netherlands 12m fwd PE rel Cont.
Europe
83%
78%
1996
Neatherlands PB rel Cont. Europe ex fin
Average (+/- 1SD)
100%
Average (+/- 1SD)
2000
2004
2008
Source: Thomson Reuters, Credit Suisse research
2012
2016
80%
1991
1994
1997
2000
2002
2005
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
2.
Limited exposure to the European recovery
While Dutch PMIs are in line with nearly 2.5% GDP growth, we would argue that the Dutch
economy has the smallest exposure to euro area domestic demand of all major European
economies.
Global Equity Strategy
127
2 December 2016
Figure 259: Dutch PMIs are in line with strong GDP
growth….
70
Netherlands manufacturing PMI new orders, 6m lead
5
Netherlands real GDP growth (%), rhs
65
60
Figure 260: …but the economy has very little
exposure to euro area domestic demand
105
3
100
1
95
-1
90
-3
85
Exposure to euro area domestic demand, % of GDP (net exports to
EA + domestic demand)
55
50
45
2009
2011
2012
2014
Germany
Sweden
Austria
Italy
Spain
Belgium
2016
Source: Thomson Reuters, Credit Suisse research
Netherlands
2007
Portugal
-5
2005
Finland
30
2004
France
35
Greece
40
Source: Thomson Reuters, Credit Suisse research
3.
MSCI Netherlands – a play on bond yields
Consumer staples make up one-third of the MSCI Netherlands (we are underweight
staples). On the back of this overweight of bond proxies, the relative performance of Dutch
equities has been closely correlated with German 10-year bund yields.
However, we are not only expecting German bund yields to rise further but the MSCI
Netherlands has also failed to react to the recent rise in bunds, exposing Dutch equities to
significant downside risk.
Figure 261: Dutch equities are overweight staples…
Materials
7%
Telecom Con Dis Energy
1%
2%
2%
Figure 262: ….and tend to underperform as yields
rise
110
-1
105
0
100
Con Stap
32%
Industrials
18%
95
1
90
2
85
IT
18%
Financials
20%
MSCI Netherlands L1 sectors market split (%)
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
80
Netherlands price rel cont. Europe
3
10y Bund yields, rha inv
75
4
70
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
128
2 December 2016
4.
Equities decoupled from the euro
Since the beginning of 2016, Dutch equites have decoupled from the euro trade weighted
index and are already anticipating a weaker euro.
Figure 263: Dutch equities tend to underperform as
the euro strengthens
110
80
105
85
80%
Netherlands: 13-week earnings revisions
Rel Cont Europe
60%
40%
100
90
95
90
95
20%
0%
-20%
85
100
Netherlands price rel cont. Europe
80
EURTWI, rhs, inv
105
75
70
2009
Figure 264: Earnings revisions in the Netherlands
rel Continental Europe
-40%
-60%
-80%
110
2010
2011
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
2015
2016
-100%
2002
2005
2009
2013
2016
Source: Thomson Reuters, Credit Suisse research
5.
Some political risk ahead of the Dutch general election in 2017
As we highlight in our political section, the next Dutch government is likely to hold only a
slim majority on the back of a coalition potentially made up by more than five parties.
6.
The Netherlands ranks second from bottom on our European country
scorecard
The Netherlands ranks second last on our European country scorecard on the basis of
stretched valuations, limited exposure to a weaker euro as well as some political risk.
Switzerland: remain a small underweight
Despite its good rankings on our country scorecard we would be underweight Switzerland
within a Continental European portfolio, for the following reasons.
1.
A defensive market as the European recovery remains on track
Switzerland is one of the most defensive markets in Europe, with Swiss equities
underperforming relative to European equities as European lead indicators pick up. Given
our view that the European economy is likely to continue its recovery throughout 2017, we
would adopt a relatively cautious stance on Swiss equities.
Global Equity Strategy
129
2 December 2016
Figure 265: Swiss equities underperform as
European economic momentum picks up
-20%
Switzerland rel Europe, rhs, inv (lc), 6m chg %
-15%
10
-10%
5
European countries 10Y correl with PMI
0.4
0.3
0.2
-5%
0
0%
5%
-5
10%
-10
0.1
0.0
-0.1
15%
2016
Source: Thomson Reuters, Credit Suisse research
France
Spain
Sweden
Switzerland
2013
Portugal
2010
Germany
2007
Netherlands
25%
2004
Finland
-0.2
Greece
20%
Italy
-15
-20
2001
-25%
Belgium
15
European PMI manufacturing new orders, 3m chg
Austria
20
Figure 266: Swiss equities are the most negatively
correlated with European PMIs
Source: Thomson Reuters, Credit Suisse research
We would also note that Swiss equities have steadily outperformed global equities as the
bund yield has fallen (being the most negatively correlated European market with Bund
yields). Again, as noted above, we continue to see upside risks to bund yields from here
which could be a headwind for Swiss relative performance.
Figure 267: Swiss equities tend to outperform as the
bund yield falls
0.62
-0.20
Bund yield (rhs, inv)
0.3
0.2
0.56
0.30
0.54
0.52
0.80
0.1
0.0
-0.1
2013
2014
Source: Thomson Reuters, Credit Suisse research
2015
Sweden
Belgium
Portugal
2.30
2016
Switzerland
2012
Netherlands
-0.3
Finland
1.80
0.44
France
0.46
-0.2
Spain
0.48
Germany
1.30
Greece
0.50
0.42
2011
European countries 10Y correl with Bund Yield
Italy
0.58
Switzerland relative to Cont. Europe (local
terms)
0.4
Austria
0.60
-0.70
Figure 268: Swiss equities are the most negatively
correlated with Bund yields
Source: Thomson Reuters, Credit Suisse research
2.
Valuations are stretched
Swiss equities are expensive on 12m forward P/E relative to the European market, trading
nearly 1 standard deviation above their norm.
Global Equity Strategy
130
2 December 2016
3.
Earnings momentum looks weak
Earnings momentum is unimpressive, with earning momentum worse than the rest of
Europe.
Figure 269: Swiss equities are nearly 0.5std
expensive on 12m forward P/E…
140%
Figure 270: … while Swiss earnings momentum is
weak
20%
Switzerland 3m breadth
Rel Cont Europe mkt
130%
10%
120%
0%
110%
100%
-10%
90%
Switzerland rel Europe 12m fwd PE
80%
-20%
Average +/- STD
-30%
70%
60%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
-40%
1997
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
We acknowledge that, from a bottom-up perspective, we are overweight big cap drugs but
equally we are underweight consumer staples and are much more negative on
investment/universal banks than retail banks.
Global Equity Strategy
131
2 December 2016
Japan: remain overweight
We upgraded Japanese equities to overweight in our piece Japanese equities: upgrade to
overweight, 23 November 2016. Japan is the most leveraged play on a rebound in both
US growth and a rise in US bond yields. We have long found bottom-up attractions and
idiosyncratic positives for Japanese equities, but now these are allied with a more
compelling macro story, making us comfortable in taking a more positive stance for 2017.
The positives
Below, we review what has changed for the better on the macro side, before revisiting the
bottom-up arguments in favour of Japanese equities.
1) Japan has become a quintuple play on global growth
The global cycle is turning up…
Global PMI new orders have hit a 19-month high (consistent with GDP growth of 2.9%),
and many of the drags on global growth (such as bank deleveraging, the fall in commodity
opex/capex) are diminishing. This is occurring at a time when China is supporting growth
ahead of the 19th Party Congress and has the ability to continue to do so with net
government debt to GDP of c0% and a current account surplus of 3%. Added to this,
Continental European growth continues to surprise positively despite political challenges.
The big change however has been the election of Donald Trump, a development which
brings with it the prospect of meaningfully looser US fiscal policy (a prospect which is
supported by the Republican clean sweep in Congress for the first time since the sharp
fiscal easing seen in the first term of George W. Bush), following a period since 2011 in
which the IMF estimate that fiscal tightening has taken 6.4% off GDP.
This policy shift is occurring at a time when other factors are already supporting a nearterm pick in US growth, such as the inventory cycle and commodity capex, against a
backdrop of steady consumption growth. The macro consequences of this policy shift are
clear: somewhat faster nominal GDP growth in the US, dollar strength and higher bond
yields – all of these things are positive for Japanese equities.
And Japan is a quintuple play on rising US bond yields and global PMI new orders
In our October piece on Japan, we noted that Japanese equities are in a sense a triple
play on growth momentum via operational leverage, cyclicality and yen weakness as US
yields rise. Now, we would add two further elements to this leverage into the global cycle:
first, as global yields start to exert upward pressure on JGB yields, the BoJ is likely to
respond with enhanced QE to keep JGB yields low, and second, domestic inflation
expectations, which rise as the yen declines, serve to increase the attractiveness of
equities.
Taking each of these points in turn:
■ Operational leverage: The relatively low margins and high fixed cost base of
Japanese equities give them the highest operational leverage of any region, and
accordingly the market's beta to global IP is the highest of any major market, as shown
in Figure 271.
■ Cyclicality: Japan's significant weighting in industrials and technology make it the
equity market with the highest weighting in cyclicality (excluding financials) globally.
Global Equity Strategy
132
2 December 2016
Figure 271: Japan has the highest operational
leverage
70%
9.1
Share of market cap accounted for by:
Beta of EPS to Global IP
9
60%
Cyclicals
8
Defensive
Energy
50%
7
6.1
6
40%
4.9
5
4.8
4.5
4
30%
3.2
20%
3
10%
2
1
World
Continental
Europe
US
UK
Source: Credit Suisse research, Thomson Reuters
UK
US
Global
Emerging
markets
EMU
Japan
NJA
Japan
0%
0
GEM
10
Figure 272: The share of Japanese market cap in
cyclicals is highest of any region
Source: Credit Suisse research, Thomson Reuters
■ Higher US rates consistent with yen weakness: With the BoJ de facto targeting
rates of zero, rising US rates have widened out the Treasury-JGB spread in a more
pronounced way than would have been anticipated under the old monetary policy
framework. In that sense, the new policy of yield curve targeting, when combined with
the impact of 'Trumpflation', has the potential to generate further yen weakness.
Inevitably, Yen weakness tends to drive Japanese equity outperformance in local
currency terms, with each 10% off the yen adding c.15% to EPS, on the basis of a
simple correlation.
Figure 273: The real 10 year yield gap between USTs
and JGBs is likely to widen further thanks to US
policy and rising Japanese inflation
110
160
Japan/US 10-year real note yield
differential
USDJPY, rhs
6
Figure 274: Yen weakness inevitably supports the
local currency performance of Japanese equities
relative to the world
150
47
120
140
4
130
130
42
140
120
2
110
0
150
37
160
100
90
-2
Japan relative to global equities,
local currency terms
32
80
-4
1995
70
2000
2005
Source: Credit Suisse research, Thomson Reuters
Global Equity Strategy
2011
2016
Japanese Yen, TWI, inv, rhs
27
2012
170
180
190
2013
2014
2015
2016
Source: Credit Suisse research, Thomson Reuters
133
2 December 2016
■ Global upward pressure on JGB yields will be met with more monetary stimulus.
We think that there is a clear risk that with the steepening of the US yield curve and the
rise in US bond yields that Japanese investors seek to buy more US bonds (typically,
their bond buying has been hedged). There is a loose relationship between the yield
spread between USTs and JGBs and Japanese buying of foreign bonds.
With the BoJ committed to cap the JGB yield at zero, then de facto the more bonds
domestic retail or institutions sell as they move into foreign bonds, the more the BoJ is
likely to have to buy.
On November 17th, the BoJ gave their first indication as to how they intend to cap 10year JGB yields at zero when they offered to buy unlimited amounts of government
bonds with terms of between one and five years at a fixed price. The yields offered by
the BoJ were marginally above those prevailing in the market, so ultimately they ended
up not buying any bonds, but with global yields continuing to creep higher such an
operation may in future result in potential significant bond purchases. This monetary
stimulus, in turn, would place further downward pressure on the yen.
Figure 275: Japanese investors tend to switch to foreign bonds when the yield
spread widens
Japanese net buying of foreign bonds, ¥trn ,3m sum
10yr UST/JGB spread, rhs, p.p.
12
2.45
7
1.95
2
1.45
-3
0.95
-8
2008
0.45
2009
2010
2011
2012
2013
2014
2015
2016
Source: Credit Suisse research, Thomson Reuters
■ Weaker yen will eventually drive inflation expectations higher. Finally, the more
the yen weakens as a function of these macro forces, the more this creates inflation in
Japan, which could impact on the prevailing deflationary mindset and asset allocation.
Import prices generate around 80% of the change in inflation (largely because Japan
has only a 39% self-sufficiency ratio in food). And in our economist's judgement an
exchange rate of ¥110 is needed to bring Japanese core inflation (i.e. excluding fresh
food and energy) above zero.
Even three months ago when the BoJ moved toward yield curve targeting, and away
from aggressive QQE, this felt a distant prospect. US developments have now allowed
this level on the exchange rate to be achieved at a time when it seems the
US/Japanese bond spread could widen further.
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134
2 December 2016
Figure 276: Import price inflation relates closely to
the annual change in the yen…
30
-35
Import price index (manufactured goods, % chg Y/Y)
30
Japanese import price index, % change Y/Y
25
-25
Yen/USD % change Y/Y (rhs)
20
-15
15
CPI ex fresh food, % change Y/Y (3 month lag, rhs)
25
3
20
2
15
10
-5
5
5
0
1
10
5
0
0
-5
15
-10
25
-15
-20
1994
Figure 277: … with import prices now consistent
with a fall in CPI
35
1997
2000
2003
2006
2009
2013
2016
Source: Credit Suisse research, Thomson Reuters
-1
-5
-10
-2
-15
-20
-3
1994
1997
2000
2003
2006
2009
2012
2016
Source: Credit Suisse research, Thomson Reuters
The proof that Japan is a play on both rising bond yields and the global cycle is not only
the very high correlation between US TIPS yields and the relative performance of the
Nikkei but also the fact that the correlation between JGBs and Japanese equities is at an
all-time high.
Figure 278: Japan's relative performance has
historically followed the TIPS yield
300
280
260
Figure 279: Correlation between the JGB yield and
Japanese equities
3.5
Japan rel to global, lc terms
US 10-year TIPS yields, rhs
3.0
2.5
240
2.0
220
1.5
200
1.0
180
0.5
160
0.0
140
-0.5
120
-1.0
100
-1.5
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Credit Suisse research, Thomson Reuters
Global Equity Strategy
Japan 18 month correlation with 10yr Japanese bond
yields
0.9
0.6
0.3
0.0
-0.3
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Credit Suisse research, Thomson Reuters
135
2 December 2016
2) We see a clear-cut valuation discount
Japan ranks top of our composite valuation scorecard.
Figure 280: Japan scores top of our valuation scorecard
12m Fwd P/E
Region
Latest
Price to Book
Z-score
Latest
40%
Weight
BY-12m fwd Earnings Yield
Z-score
Latest
20%
Z-score
DY
Latest
10%
PEG
Z-score
Latest
10%
Z-score
Z-score
20%
Japan
14.1
1.1
1.3
0.5
-7.1
1.0
2.0
1.0
1.6
-0.6
0.63
GEM
11.7
-0.1
1.6
0.4
-2.3
-0.2
3.0
0.6
0.9
1.6
0.39
UK
14.3
-0.1
1.9
0.9
-5.6
0.4
3.6
0.5
1.4
0.1
0.28
Europe ex UK
14.3
0.1
1.6
1.2
-6.1
0.9
3.2
0.5
1.7
-1.0
0.23
US
17.0
-1.1
3.0
-1.4
-3.5
-0.1
2.1
0.8
1.4
-0.1
-0.67
Cheapest region, with cheaper valuation (12m fwd P/E, P/B, DY & PEG ratios) and smaller spread between bond yields and earnings yields, is ranked at the top
A higher z-score is a positive on all measures
Source: Thomson Reuters, Credit Suisse research
Japan trades on a 2% forward PE discount to European equities, and a 17% discount to
the US. Breaking down the PE into P/B and RoE, the Japanese RoE discount to global
markets has closed (from around a 50% discount in 2012 to around 27% now), while the
P/B discount has widened out close to a record, at around a 34% discount to global
markets currently.
Figure 281: Japanese equities are cheaper than
both the US and European equities on a 12m fwd PE
basis
Figure 282: Japan's RoE discount has closed, while
its P/B discount has not
80%
550%
PB
RoE
60%
Japan rel US: 12m fwd P/E
450%
Japan rel Europe: 12m fwd P/E
100%
Japan rel to
WORLD
40%
20%
350%
0%
250%
-20%
-40%
150%
-60%
50%
1988
1991
1995
1998
2002
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2005
2009
2012
2016
-80%
1985
1989
1993
1998
2002
2007
2011
2016
Source: Thomson Reuters, Credit Suisse research
136
2 December 2016
Below we show sectors where the P/E is abnormally cheap against the US in terms of P/E
relative, and their respective RoE premia or discounts. This approach highlights utilities,
retail and financials as sectors that trade on substantial P/E discounts to their US peers
while offering superior or almost equal profitability.
Figure 283: Utilities, retailing and financials in Japan are on significant
valuation discounts to their US peers while offering comparable profitability
2%
0%
Utilities
Div Fin
Japan sectors RoE rel US
-2%
Retailing
Insurance
Banks
-4%
-6%
Pharma
Comm svs
Media
Materials
-8%
HC & equip
Telecom
Energy
(0.3,-0.2%)
H&P prod
Semis
SW & svs
-10%
F&D Retail
Cons Dur
-12%
Auto
Fd, Bev & tobacco
-14%
Cap Goods
-16%
Tech HW
Cons svs (1.5,-35.2%)
Transport
-18%
0.6
0.7
0.8
0.9
1.0
1.1
1.2
Japan sectors 12m fwd PE rel US
1.3
1.4
1.5
1.6
Source: Thomson Reuters, Credit Suisse research
Across a wide range of valuation metrics, Japanese equities appear cheap, and on some
metrics close to their cheapest point in decades. Japan has the lowest EV/EBITDA of the
global market and nearly two-thirds of companies are trading below replacement value.
Figure 284: Nearly 61% of Japanese companies
trade below replacement value
Figure 285: Japan is the cheapest major market on
an 2016 EV/EBITDA basis
14x
80%
EV/EBITDA
12x
70%
10x
60%
8x
50%
6x
40%
4x
30%
Japan market, % of companies below replacement value
20%
2x
Average
10%
1995
0x
1998
2001
2004
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2007
2010
2013
2016
Japan
GEM
Cont. Europe
US
UK
Source: Thomson Reuters, Credit Suisse research
137
2 December 2016
Moreover, cash on the balance sheet is now 21% of market cap, the highest of any region
outside NJA. We also would note that the dividend yield of Japan is now back to a
premium to that of US equities for the first time in the Abenomics periods.
Figure 286: Cash as a percentage of market cap is
c.21%
2016 Cash, % of M Cap
25%
World = 13%
23%
125%
MSCI Japan DY rel US
115%
21%
20%
Figure 287: Japan's DY is at a premium to that of the
US for the first time in the Abenomics era
Average (+/- 1sd)
105%
18%
95%
17%
15%
13%
13%
85%
13%
75%
9%
10%
65%
55%
5%
45%
35%
0%
NJA
Japan
EMEA
LatAm Europe World
ex UK
Source: Thomson Reuters, Credit Suisse research
UK
US
25%
1996
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
This dividend premium is not just a function of a period of price underperformance.
Dividend momentum in Japan has been relatively robust thanks to reasonably resilient
earnings momentum, but also thanks to a rising payout ratio, driven by corporate
governance improvements: we discuss both elements in more detail below.
3) The most exciting funds flow story: foreign investor capitulation,
offset by BoJ and corporate buying
In some ways, international investors have been the swing investors in Japanese equities,
and currently own c.30% of market cap, as we show below. On a 12-month basis, the rate
of foreign selling has now passed its worse point but we can see that around the middle of
the year foreign selling was at its highest since 1990.
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138
2 December 2016
Figure 288: There has been substantial selling of
Japanese equities by foreigners
12m foreign buying of Japanese equities, % market cap
6%
Figure 289: Although on a 6 month basis that
foreign selling has started to slow somewhat
48
Japan relative performance (lc), % chg Y/Y, rhs
38
8%
6m annualised net foreign buying in Japanese
equities, as a % of market cap
6%
4%
28
2%
4%
18
2%
8
0%
0%
-2%
-2
-2%
-4%
Sep-13
10%
Mar-14
Sep-14
Mar-15
Sep-15
Mar-16
-4%
-12
-6%
-22
-8%
1990
Sep-16
Source: Thomson Reuters, Credit Suisse research
1993
1996
1999
2003
2006
2009
2012
2016
Source: Thomson Reuters, Credit Suisse research
The same is true when we look just at passive flows. For most of this year, investors have
aggressively rotated toward regions which benefit from falling DM rates (i.e. GEM equities)
and away from those which benefit when rates rise (Japan and Europe, to a less degree).
It's notable that flows into European and Japanese funds have just started to tick a little
higher, but if yields continue to climb, these trends seem likely to reverse.
Figure 290: The performance of European and
Japanese equities is positively correlated with bond
yields
Figure 291: Passive funds have seen sharp outflows
from Europe and Japan, and significant inflows into
GEM funds
0.32
4500
0.22
0.12
2500
Cumulative year-to-date inflows ($m)
Vanguard FTSE emerging markets
iShares MSCI eurozone
iShares MSCI Japan
0.02
500
-0.08
-1500
-0.18
Correlation of local currency relative
performance with US 10 year yields
-0.28
-3500
-0.38
-5500
-0.48
-0.58
Japan
Europe ex. UK
US
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
GEM
UK
-7500
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Source: The BLOOMBERG PROFESSIONAL™ service, Credit Suisse research
139
2 December 2016
When sentiment among foreign investors does change toward Japan, it has tended to be
extremely impactful, resulting in extended periods of buying, and substantial purchases.
Looking at the last few major turns in sentiment suggests periods of foreign buying have
tended to lasted between 1.5 and 4 years and see purchases of c.6% of market cap.
Figure 292: Periods of foreign purchasing of Japanese equities have tended to
be extended in duration and see significant purchases
Start Date
End Date
Duration
22-Feb-91
15-May-98
7 Years, 2 Months
Foreign buying of Japanese
Foreign buying of Japanese
equities USD m
equities, % market cap
178,935
6.1%
05-Mar-99
29-Sep-00
1 Years, 6 Months
59,914
1.7%
10-May-02
28-Mar-08
5 Years, 10 Months
309,368
10.7%
27-Nov-09
02-Mar-12
2 Years, 3 Months
86,423
4.0%
14-Sep-12
11-Sep-15
3 Years
182,066
6.8%
4 years
93,176
5.8%
Average
Source: Credit Suisse research, Thomson Reuters
While foreign investors might re-engage with Japanese equities against a backdrop of
rising DM yields, there remains a significant domestic funds flow story driven by the BoJ,
public pension funds and corporates themselves, with the potential for further buying from
households.
Taking each group in turn:
■ The BoJ
We discuss the outlook for policy in more detail below, but one area where the BoJ has
been proactive in recent months is in equity buying. It opted to increase its ETF purchases
from ¥3.3trn to ¥6trn on an annual basis, or c.1.2% of market cap and now owns around
2% of market cap.
Figure 293: Foreign investors own around 30% of the Japanese equity market;
the BoJ owns c.2%
% of Japanese equity market owned
Foreigners
30%
Nonfinancial
corporations
24%
Financial institutions
21%
Households
18%
Government
7%
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
■ Public pension funds
The GPIF's domestic equity weighting has fallen back as the equity market (and bond
yields) has fallen. As a result, to return to the new target allocation would require $20bn of
domestic buying, and to the top end of the range of $150bn, or around 3% of market cap.
Japan Post Bank, the second biggest holder of JGBs after the BoJ, stated last November
that it will look to increase its domestic equity holdings from less than 1% of its assets
currently.
Figure 294: If the GPIF returned to the top end of its equity weightings, it would imply buying 3% of
market cap
Potential new buying ($bn) if the
Previous
Actual realised
Estimated
New target
allocation increases to:
target
allocation (End allocation as of
upper limit for
allocation
allocation
new target
Sep 2016)
23 Nov
equities
Domestic bonds
60% (+/-8% )
36.2%
35.3%
35% (+/-10% )
-4
-143
International bonds
11% (+/-5% )
12.5%
11.4%
15% (+/-4% )
51
-5
Domestic equities
12% (+/-6% )
21.6%
23.6%
25% (+/-9% )
19
145
International equities
12% (+/-5% )
21.0%
21.1%
25% (+/-8% )
54
124
Short-term assets
5%
8.8%
8.6%
-120
-120
Source: Thomson Reuters, Credit Suisse research
■ Private pension funds
While public pension funds have moved to an equity allocation of c.20% of assets (as per
the GPIF above), equity weightings among private pension funds have actually moved
down modestly. Having been c.9% of assets for much of the past decade, domestic
equities are now around 6.5% of assets as shown below.
Private pension funds have c.¥140trn of assets, accounting for c.66% of the assets of
public pension funds, so they are substantial actors. Were private pension funds to move
to the 20% equity weighting of public pension funds (and note this number is set to rise), it
would imply c.$185bn of equity buying, or around 3.9% of market cap.
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141
2 December 2016
Figure 295: Private pension funds have not followed the allocation shift
pursued by public funds
40%
% of Japan pension funds held in domestic equities
35%
Corporate pensions
30%
Public pensions
25%
20%
15%
10%
5%
0%
1997
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
■ Japanese households
Japanese households, with their 1.7 quadrillion yen ($17trn) in financial assets, are the
biggest, but most stubborn, potential swing factor. Over 50% of these assets remain in
cash, with a further 1% or so in government bonds, i.e. an asset allocation that could be
considered 'perfect' for an environment of deflation. Despite the best efforts of the Abe
government, this allocation has barely shifted, suggesting continuing scepticism on the
part of households that a more sustained period of inflation is imminent.
A central part of the BoJ's most recent set of policy pronouncements was a commitment to
target a real bond yield of minus 2% by anchoring the 10-year JGB yield at around zero,
while aiming to push up inflation expectations via continued expansion of the monetary
base and a commitment to an inflation overshoot. Moreover, by targeting a bond yield of
zero percent, the BoJ appears to be in effect locking into zero capital gain for fixed
income. This should make JGBs relatively unattractive from a retail perspective, and
represents perhaps the boldest attempt yet by policymakers to encourage households to
move up the risk curve in terms of their asset allocation.
Were households to lift their equity weightings back to 2007 levels, it would equate to
equity buying of c.11% of market cap. There has been some modest success in replicating
the UK's tax-free Individual Savings Accounts (ISAs), with around 10 million Nippon
Individual Savings Accounts (NISAs) now active in Japan. A further more meaningful shift
into domestic equities, however, would in all likelihood require the BoJ to succeed in their
attempts to lift inflation expectations, thereby pushing down real bond yields. That remains
far from certain, as we discuss in more detail below. We note though that market-implied
inflation expectations have moved slightly higher in recent weeks, as they have done
globally.
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2 December 2016
Figure 296: Inflation expectations in Japan appear to be nudging higher
1.4
1.2
Japan Breakeven 10 year inflation (%)
1.0
0.8
0.6
0.4
0.2
0.0
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse
Corporate buying
One of the more concrete successes of Abenomics has been a renewed sense of focus
among companies on shareholders. One of the channels through which this has been
manifested is the pick-up in corporate buybacks, which are now running at around 2% of
market cap, having slowed marginally from a run rate of 3% of market cap in the first half
of the year.
Figure 297: Japan households remain positioned for
deflation
Figure 298: Corporates are buying equity worth
around 2% of market cap
4.0%
Government
bonds
1%
Other assets
8%
3.5%
Equities
8%
Share buybacks, % of market cap (6
month average annualised)
3.0%
2.5%
Currency and
deposits
53%
Insurance and
pension
reserves
30%
2.0%
1.5%
1.0%
0.5%
0.0%
2000
Source: Thomson Reuters, Credit Suisse research
2002
2004
2006
2008
2010
2012
2014
2016
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse research
If we bring together these different sources of demand, the level of equity buying under a
blue sky scenario among domestic actors could be substantial at around $500bn excluding
households (or around 10% of market cap), and a trillion dollars if we include a possible
household reallocation. These are admittedly very optimistic numbers, but there isn't
Global Equity Strategy
143
2 December 2016
another equity market globally with such a potentially compelling domestic fund flow story,
in our view.
Figure 299: Under a blue sky scenario, domestic actors could buy around 10%
of market cap and if we include households 22% of market cap
Investor
Public pension funds (upper limit)
Private pension funds
BoJ purchases (annual)
Corporate buybacks (current annual pace)
Households
Buying ex households
Buying inc. households
Equity buying
($bn)
150.0
185
59.4
95.0
539.2
489.4
1028.6
% of mkt
cap
3.1%
3.9%
1.2%
2.0%
11.3%
10.2%
21.5%
Source: Thomson Reuters, Credit Suisse research
4) Foreign investor scepticism
Moreover, scepticism towards the BoJ's ability to deliver market-moving policy change
appears to be proxied by still significant longs of the yen. In addition, data from our prime
services team suggests that although hedge fund net exposure to Japan has picked up
slightly from an Abenomics-era low reached in the summer, it remains well off highs.
Figure 300: Investors are long the yen on a net
basis, implying scepticism about the BoJ's ability to
reduce real rates via inflation expectations
100
Speculative net-positions in Yen against dollar futures contracts
Figure 301: Hedge fund exposure to Japan has
picked up a little in recent weeks, albeit from an
Abenomics-era low
100%
50
80%
0
60%
-50
40%
-100
20%
-150
0%
-200
2006
2008
2010
2012
Source: Thomson Reuters, Credit Suisse research
2014
2016
-20%
2013
Net exposure of macro/CTA funds to Japan
2014
2015
2016
Source: Credit Suisse Prime Services
5) Earnings momentum decoupling from the yen: a sign of corporate
change?
Japanese EPS in level terms proved relatively resilient to the yen strength which
characterised much of 2016 prior to the election of Donald Trump. Earnings revisions have
almost now gone positive on a breadth basis.
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2 December 2016
Figure 302: Forward EPS has been slightly more
resilient to yen strength than one might have
expected
66
61
56
51
46
Japan 12 m fwd EPS (¥, 6 week lag)
41
36
May-12
Yen TWI (rhs inv)
Dec-12
Aug-13
Apr-14
Nov-14
Jul-15
Figure 303: EPS momentum picked up even when
the yen strengthened
105
80%
115
60%
125
40%
135
20%
145
0%
-5%
155
-20%
5%
165
-40%
175
-60%
185
Mar-16
Japan earnings revisions, 4 week net upgrades (%)
JPY TWI (% change Y/Y, rhs, inv)
-25%
-15%
15%
25%
-80%
195
Nov-16
-100%
2004
Source: Thomson Reuters, Credit Suisse research
-35%
35%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
This relative strength in EPS has been driven by the more domestic sectors, with
telecoms, real estate, transport and media among the sectors to have had their 12-month
forward EPS revised higher over the past six months.
Figure 304: …with EPS in some more domestic sectors being upgraded
15
% chg in 12m fwd EPS over the last 6 months
10
5
0
-5
-10
-15
-20
Telecoms
Software
Media
Div Fins
Pharma
Food/Bev/Tobacco
HPC
Retailing
Cap Goods
Real estate
Utilities
Materials
Insurance
Transport
Healthcare Equipment
Energy
Banks
Autos
Tech hardware
Source: Thomson Reuters, Credit Suisse research
We believe that this de-coupling between EPS and the yen reflects clear signs that
corporates are cutting costs. We have long argued that apart from utilising the balance
sheet much more efficiently as we discuss below, there are two areas of low hanging fruit
for corporates to exploit:
i) A demographic dividend
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2 December 2016
There are two factors depressing aggregate wage growth. The first is ageing, with workers
over 60 paid less, and the growth of part-time employees, who are paid around a third less
than regular employees. Japan's demographics are such that there is now a peak in the
50-54-year-old wage cohort (who are on average paid c.25% more than the median
worker). Moreover, the most rapid area of employment growth has been among the over
65s (where the employment CAGR has been 6% over the past three years), who are paid
30% less than the 50-54 age cohort.
Along with this, part-time workers now account for c.23% of total employment, their share
having doubled since the late 1990s, while the broader category of non-regular workers
accounts for around 40% of the workforce. As a result of these factors, overall personnel
costs have been extremely muted, despite wage growth having picked up slightly over the
past two years.
Figure 305: The 60-64 cohort are paid c.30% less on
average than the 50-54 category…
Figure 306: …but the growth in the labour force is
among the 65+ cohort
8.0%
450
Average monthly cash earnings (¥ 000's)
3 year CAGR of employees
400
6.0%
350
4.0%
300
2.0%
250
0.0%
200
-2.0%
150
-4.0%
20-24
25-29
30-34
35-39
40-44
Source: Thomson Reuters, Credit Suisse research
45-49
50-54
55-59
60-64
20-24
25-29
30-34
35-39
40-44
45-49
50-54
55-64
65+
Source: Thomson Reuters, Credit Suisse research
A simple calculation would suggest that were the part-time share of the workforce to rise
by a further 5 percentage points, and the 55-64 cohort continue to decline by c.2%, the
total wage bill would fall by c3%.
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2 December 2016
Figure 307: Part-time work has been growing as a
share of total employment
Figure 308: Overall personnel costs have been
contained
14.5%
25%
Part time workers, % of total employment
23%
14.0%
21%
13.5%
19%
13.0%
17%
12.5%
15%
12.0%
13%
11.5%
11%
Personnel costs as a % of total sales
9%
11.0%
7%
10.5%
5%
1991
1994
1997
2000
2003
2006
2009
2012
Source: Thomson Reuters, Credit Suisse research
2015
10.0%
1991
1995
1999
2003
2007
2011
2015
Source: Thomson Reuters, Credit Suisse research
ii) Less investment
The investment share of GDP in Japan is still extremely high, as is the capex-todepreciation ratio for corporates. We believe this is relatively easy to fix as corporates
focus more on returning cash to shareholders (in theory), rather than over-investing in their
businesses.
Figure 309: Current investment share of GDP for US, UK, euro area and Japan
Investment share of GDP - Q2 2016
22%
20%
18%
16%
14%
12%
10%
Japan
Euro area
UK
US
Source: Thomson Reuters, Credit Suisse research
6) Some corporate change, although more financial than restructuring
The scope for change in Japan is significant. Productivity per hour worked is 30% below
that of France and with Japan's CFROI® more than 50% below that of Europe.
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2 December 2016
Figure 310: Japan's CFROI is significantly lower
than that of Europe and the US
12%
65
CS HOLT® CFROI (cash flow
return on investments)
Japan
Figure 311: GDP per hour worked is among the
lowest of any developed country
US
Europe
10%
GDP per hour worked (Current USD)
60
55
50
45
8%
40
6%
35
30
4%
Source: Credit Suisse HOLT®
Greece
Japan
Italy
United Kingdom
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015E
Spain
Australia
Euro area
Germany
G7 countries
0%
France
United States
25
2%
Source: Thomson Reuters, Credit Suisse research
Despite general scepticism about the achievements of the reforming third arrow of
Abenomics, we would argue that apart from the improvement in EPS relative to the yen as
shown in the point above, there have been some clear-cut signs of corporate change,
although on the whole much more from a point of view of the CFO (financial restructuring)
than the CEO (corporate restructuring).
■ A greater focus on shareholder returns
i) Buybacks
We would proxy this by the appointment of outside directors and by buybacks as a share
of market cap, both of which have been on a clear upward trend, with both the number of
companies carrying out buybacks and the average size of the buyback programmes
pursued rising. Looking ahead, Japanese corporates have cash worth 21% of market cap
(compared with c.9% of the S&P 500) suggesting that, in the absence of a sudden rise in
investment, buybacks can continue to surprise on the upside.
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2 December 2016
Figure 312: The share of independent directors on
Japanese boards has been picking up
Figure 313: The trajectory of buybacks in 2016 is
outstripping that of 2014 and 2015 thus far
7
90%
(¥ trn)
% of TSE 1st section companies with 2 or more independent directors
80%
6
2016
70%
5
2015
60%
4
2014
50%
3
40%
30%
2
20%
1
10%
2010
2011
2012
2013
2014
2015
2016
2013
2012
0
Jan
Feb
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: The BLOOMBERG PROFESSIONAL™ service, Credit Suisse research
Source: Tokyo Stock Exchange, Credit Suisse research
ii) Dividends
Another source of shareholder returns is dividends, where payments have again been
rising. The dividend payout ratio of Japanese corporates has in aggregate been moving
higher over the past year. At around 31% currently, it is around 3 percentage points higher
than in 2013, and 10 percentage points higher than in 2007. Nonetheless, it remains more
than 10 percentage points below the global norm. In the 2015 financial year, aggregate
dividends of Japan's 3,600 companies exceeded ¥10trn for the first time, and an estimated
¥11trn was paid out in dividends in the financial year ending March 2016. Dividend
momentum is clearly improving.
Figure 314: The Japanese payout ratio is on the
rise, but remains well below the global norm
Figure 315: Japanese dividend momentum has been
reasonably strong
60%
55%
50%
Topix dividend payout ratio
(%)
MSCI World dividend payout
ratio (%)
120
12 month forward DPS, rebased to
100 two years ago
110
45%
40%
100
35%
30%
25%
20%
15%
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
90
80
Euro area
Japan
USA
GEM
70
Aug-14 Nov-14
UK
Feb-15 May-15 Aug-15 Nov-15
Feb-16 May-16 Aug-16
Source: Thomson Reuters, Credit Suisse research
149
2 December 2016
■ Improving corporate governance
i) The Corporate Governance code
A new Corporate Governance code took effect on 1 June 2015, placing shareholder
interests at the core of management guidelines. For instance, it aims to facilitate
engagement with outside shareholders (by enabling electronic voting and producing
disclosures and AGM notices in English), encourages corporates to take on at least two
independent board directors (a measure which saw 58% compliance by end 2015), seeks
to improve the transparency of companies' cross holdings and ensures that anti-takeover
measures are taken only if beneficial to the shareholders. It also aims to put every type of
shareholder on a level playing field and improve transparency of disclosures.
This is already having a considerable impact on corporates. At the end of 2015, 11.6% of
companies surveyed by the Tokyo Stock Exchange were in full compliance, and an
additional 66.4% complied with >90% of the principles.
ii) Monitoring management performance
Over 100 companies (including Takeda, Calbee and Eisai) have now linked executive pay
to share price performance, and the Ministry of Economy, Trade and Industry is
considering making RoE-based compensation tax deductible. If this goes through the 2016
fiscal tax reform requests, these companies could implement this for FY17.
In February 2015, the Institutional Shareholder Services advisory firm recommended that
shareholders should vote against reappointing senior executives when the company has
generated an average RoE of less than 5% over the past five fiscal years. This is
important when, as above, 38% of firms make RoE below 5% and as below, 60% of
companies trade below replacement value (i.e. they are priced as though they will destroy
shareholder value). In 2016 for instance, it advised investors to vote against the
reappointment of executives at Kobe Steel (2015 average RoE of 2.6%) and Mitsubishi
Chemical Holdings (4.4%) among others.
iii) Shareholder activism
The GPIF last year allocated funds to Taiyo Pacific, which describes itself as a "pioneer in
friendly activist investing". As such, it invests only in companies willing to work with it to
improve returns and shuns proxy fights to force change.
The number of Japanese companies subject to activist demands this year has risen to 13
(YTD) from eight last year, according to Activist Insight of London. Moreover, Japanfocused activist funds represented 22% of activist funds started in 2015 globally, according
to data from Preqin quoted by Bloomberg.
There have recently been examples of Japanese corporates being bought by foreign as
opposed to domestic acquirers. One of the highest-profile examples of this was Sharp,
which was bought by Hon Hai Precision Industry of Taiwan. Historically the Japanese
government has tended to favour an intra-country merger, which in many cases did not
shed capacity.
iv) Cross holdings unwinding and some consolidation
The tax exemption has been reduced for cross holdings above 5%, while the corporate
governance code, which came into effect last summer, also pushes corporates to divest
their holdings. Cross holdings are unwinding slowly, with Japan's three largest banks,
Mizuho, Sumitomo Mitsui and Mitsubishi UFJ, having now set targets to sell down their
¥10trn stakes in corporate clients.
This could boost EPS for the major banks by 10% to 20% if they opt to use this cash to
pursue buybacks. Non-financial corporates hold around 22% of market cap. As these
unwind, it should serve to both free up cash to fund further buybacks, and in some cases
drive EPS higher as cross holdings are not fully consolidated, and are thus valued on the
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2 December 2016
basis of dividends rather than earnings (in theory if all cross holdings were valued on the
basis of dividend yield and then unwound and valued on the basis of earnings, then
market EPS would rise for 22% of the market and that in turn would push market EPS up
by c70%).
■ Broader economic reform
i) The Workers Dispatch Act and White Collar Exemption
Our Japan economics team discussed the changes in Updates on Labour Market Reform
Initiatives, 18 September 2015. In summary, the Workers Dispatch Act has been amended
to allow temporary workers to be employed for up to three years (and then the vacancy
can be re-filled by another temporary worker) and thus, de facto, temporary workers can
be used on a permanent basis.
Progress on the White Collar Exemption has been more disappointing, in our view. This
reform would allow for overtime pay for specialist workers with an annual salary above
¥10m. This allows professionals to be paid on performance rather than on hours worked,
which would represent an important shift. The bill, however, was delayed again earlier this
year. With the government now in possession of a fresh electoral mandate, it is possible
they will now re-focus on passing the reform.
We admit that the key element of labour reform has not been addressed: namely,
changing the 1970s' labour law, which says that companies cannot make redundancies
unless "it is in general societal interests" (and thus limits the ability to fire workers, which in
turns means loss-making operations continue to have extremely high fixed costs).
ii) Agricultural reform
Abe's Cabinet has approved a bill greatly reducing the power of the Central Union of
Agricultural Cooperatives (JA-Zenchu). Reducing this Cooperative's power is intended to
increase local autonomy and the productivity of agricultural producers. Agricultural reform
has broader significance as a key symbol of Abe's fight against vested interests within
Japan, and so his success in this area to date bodes well, in our view, for the third arrow of
Abenomics.
7) Japan is moving up our economic momentum scorecard
Japan is now moving up the economic momentum scorecard, despite the recent period of
yen strength.
Figure 316: Japan has moved up to the middle of our PMI scorecard
Rank Region
Composite PMI
Index, now
Index, 3m ch
Weight
33%
33%
1
UK
55.9
9.8
2
Europe ex UK
53.5
2.4
3
Japan
51.4
2.1
4
GEM
52.1
0.4
5
US
53.1
-1.8
Region having high PMIs and rank high on surprises are on top.
Macro surprises
Level
17%
52.6
39.3
27.1
-4.4
-2.2
3m change
17%
6.5
10.9
10.1
-4.0
-9.9
Overall
score
1.3
0.3
-0.2
-0.7
-0.8
Source: Thomson Reuters, Markit, Credit Suisse research
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2 December 2016
Moreover, PMI new orders are consistent with GDP growth picking up to almost 2% at a
time when consensus is for only 0.8% GDP growth in 2017. Moreover, Q3 saw nominal
GDP in Japan climb again, taking the aggregate gain since Abe's election to 7%.
Figure 317: PMIs and real GDP growth have both
been picking up
Japan manufacturing PMI new orders
66
Figure 318: Nominal GDP in Japan has increased by
7% since Shinzo Abe's election
8%
Japan GDP growth, 1q lag, rhs
6%
530000
Abe elected
520000
4%
56
510000
2%
46
0%
-2%
36
-4%
490000
Japanese nominal GDP, ¥bn
480000
-6%
26
-8%
16
Jan-04
500000
-10%
Feb-06
Mar-08
May-10
Jun-12
Jul-14
470000
460000
1994
Sep-16
Source: Thomson Reuters, Markit, Credit Suisse research
1997
2000
2003
2006
2009
2012
2015
Source: Thomson Reuters, Credit Suisse research
In our view, there could be two further supports for growth from here. The first of these is
that Japan already has a competitive currency, as proxied by the fact that the yen is cheap
on a PPP basis (which has been rare over recent decades) and it has a large current
account surplus. Any further yen weakness from here will help Japanese growth. As
mentioned already, rate differentials, the step up in QQE and positioning would all argue
for further yen weakness.
Figure 319: The yen, at par to PPP against the
dollar, is just off its 30-year low
Figure 320: The Japanese current account has
moved sharply into a surplus of 3.7% of GDP
5.0%
110%
90%
JPY / USD, deviation from PPP
70%
4.0%
3.0%
50%
2.0%
30%
10%
1.0%
Current account balance,
% of GDP
-10%
-30%
1986
1991
1996
2001
Source: Thomson Reuters, Credit Suisse research
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2006
2011
2016
0.0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
The second support is the prospect of fiscal easing: there is an increasing chance of a
snap Lower House election. This would not only give Prime Minister Abe more of a
mandate for reform (he then would control both the Upper and the Lower House for the
next four years), but might well lead to more fiscal easing.
8) Policy options are not exhausted, even if US growth were to weaken
We think many investors assume that Japan has run out of policy options if there were a
slowdown in US growth, or if the hopes now attached to Donald Trump (relating to a
significant fiscal boost) are disappointed. Investors fear that the BoJ appears likely to run
out of JGBs to buy in a de facto sense in 2018 because at that stage the BoJ would own
around 50% of the JGB market. To quote the IMF: “We construct a realistic rebalancing
scenario, which suggests that the BoJ may need to taper its JGB purchases in 2017 or
2018, given collateral needs of banks, asset-liability management constraints of insurers,
and announced asset allocation targets of major pension funds." Because the quality of
infrastructure is high (Japan ranks 7th of 140 countries on the WEF's infrastructure
ranking), and unskilled labour is scarce, we think there is also scepticism of Japan's ability
to pursue an infrastructure driven fiscal boost.
While the most recent round of policy innovation has moved away from a focus on the
quantity of purchases for the reasons above, we would dispute the notion that Japan is
entirely out of policy options for the following reasons:
First, Japan has net foreign assets of 62% of GDP, and thus it can always buy foreign
assets (such as equities) as the SNB is doing, given that the country in effect is short the
yen (when the yen declines, Japan becomes wealthier).
Second, although government debt to GDP is high at 250% on a gross basis, net
government debt to GDP is only 130%. This would require a real bond yield of minus 1.4%
to stabilise government debt to GDP and unemployment. The BoJ has now moved one
step closer to this by targeting a real bond yield of minus 2%.
Third, the BoJ owns c.38% of the JGB market and could retire some of the debt by de
facto converting it into a zero-coupon irredeemable, where the coupon could rise if certain
conditions (perhaps nominal GDP targets) were met.
Fourth, although on some measures Japan is close to full employment, it has significant
scope to boost productivity, as discussed above, and the U6 unemployment rate (i.e.
those part time workers who want to have a full time job but can't register as being
unemployed) is close to 6% according to our analysts.
Last, fiscal policy could take the form of spending vouchers that mature if they are not
spent within a fixed period, to push the onus onto consumption rather than investment via
infrastructure. Indeed Japan tried this approach in 1999 when 31 million 'shopping
coupons' worth ¥20,000 each were distributed to Japanese families with children and to
the elderly, which expired after 6 months.
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2 December 2016
9) Not as vulnerable to protectionism as might be feared
One of the risks attached to the election of Donald Trump is a rise in protectionist
pressures globally. Although Japan is levered into the global cycle for the reasons
discussed above, this leverage is more via yields and the USD, and less to do with trade.
Trade as a share of GDP is relatively low in Japan when compared to the US, the EU or
Germany.
Figure 321: Exports as a share of GDP are relatively low in Japan
25.0%
23.0%
Exports as a % of GDP
21.0%
19.0%
17.0%
15.0%
13.0%
11.0%
9.0%
7.0%
5.0%
Japan
Euro Area to RoW
China
Germany to non-EA
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
What are the problems?
1) Little feed-through of the weaker yen to underlying inflation
The yen-induced inflation spike of 2013/14 has simply not translated into higher inflation
expectations or materially accelerating wage growth. This is despite clear tightness in the
Japanese labour market, with the ratio of job offers per applicant now at a 20-year high of
1.4.
Figure 322: Scheduled and contracted earnings
growth has remained around zero, albeit this is an
improvement from -1% in 2013
% change Y/Y
2.0
5.0
4.0
Scheduled
1.0
1.4
Total Japanese cash earnings, % chg Y/Y, 6 mma
Total cash earnings
1.5
Figure 323: Wage growth has disconnected from the
tightness of the labour market with the ratio of job
offers per applicant at 1.4
1.3
Ratio of job offers per applicant, rhs
1.2
3.0
Contracted
1.1
0.5
2.0
0.0
1.0
-0.5
0.0
-1.0
-1.0
-1.5
-2.0
0.6
-2.0
-3.0
0.5
1.0
0.9
0.8
0.7
-4.0
-2.5
2010
2011
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
2015
2016
0.4
91
93
95
97
99
01
03
05
07
09
11
13
16
Source: Thomson Reuters, Credit Suisse research
2) The September 21st change in policy makes Japanese monetary
policy hugely dependent on US rates and GDP growth
■ Yen weakness reliant on US yields retaining upward momentum
The latest innovation from the BoJ in its statement of 21 September contained two
elements: a commitment to 'yield curve control' and an 'inflation-overshooting
commitment'. The BoJ has said it expects its purchase pace to remain 'more or less in line
with the current pace'. Thus it is critical to watch the BoJ's rate of JGB purchasing as this
will reveal if domestic institutions are selling more bonds as a result of this policy action or
if as a result of the rising US bond yield they are buying more US bonds.
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2 December 2016
Figure 324: The 2-month rolling average of JGB purchases has dipped
noticeably
27000
22000
17000
12000
7000
2000
-3000
4 week rolling average weekly JGB purchases
2 month rolling average weekly JGB purchases
-8000
Mar-14
Jun-14
Sep-14
Dec-14
Mar-15
Jun-15
Sep-15
Dec-15
Mar-16
Jun-16
Sep-16
Source: Thomson Reuters, Credit Suisse research
The second aspect of the BoJ's new policy package was to announce that they will
continue to stimulate until CPI inflation exceeds the price stability target of 2%. The BoJ's
failure to reach its 2% inflation target over the Abenomics period seems to make this
commitment somewhat lacking in credibility. Nevertheless, we would be wary of
completely ignoring the BoJ's target, as the (admittedly illiquid) market-implied inflation
expectations appear to have done.
The critical issue is that if US growth were to falter and US rate expectations fall, the yen is
likely to appreciate and this in turn would drive up Japanese real rates (owing to
accelerating deflation with the JGB yield floor at zero) with the yen backed up by a 4%
current account surplus.
■ Which leaves fiscal policy, if there is a global growth accident
As a result, from here if US growth were to falter, then fiscal easing financed if necessary
by the BoJ would likely be the solution. The usual riposte is twofold: first, the MoF will not
allow it. However, we think Abe has shown that he is able to overcome MoF objections (as
he did with QQE by eventually replacing 6 out of 9 board members with his own
appointees) and even the Secretary General of the LDP, Mr Nakai, has said that he no
longer favours a 'balanced budget'.
The second debate is over effectiveness, and we believe that fiscal spending could be
more effective than investors realise. Since 1994, fiscal easing in Japan has amounted to
¥380trn (or 76% of GDP), but the clear-water impact has been just under 24% of GDP.
This has thus added only 1% a year to GDP since 1998. If we look at the change in the
cyclically adjusted primary budget deficit, however, the fiscal easing has been less than
this. As we discuss above, we think the solution would be consumer vouchers or easing
that helps boost productivity (e.g. childcare for women to allow them to work).
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2 December 2016
3) A lingering reluctance to embrace change
Support for major policy change does not appear to run deep
Perhaps the 'problem' for Japan from a policy perspective is that there is not a sense of
crisis. Japan has net foreign assets (as a creditor nation), a very low unemployment rate
(3.1%) and a good quality of life (at least measured in terms of life expectancy or the low
crime rate).
With households net creditors, deflation actually becomes attractive, increasing real
purchasing power. In terms of GDP per capita in real terms since 2000, Japan has only
modestly underperformed the US, and in fact has outgrown the euro area. In addition,
Japan is one of the very few countries where the incumbent politicians have been reelected with an increased majority (as seen in the recent Upper House elections).
Figure 325: In terms of GDP per capita, Japan has only modestly
underperformed the US since 2000
118
GDP per capita constant prices
2000 = 100
116
Euro area
114
Japan
USA
112
110
108
106
104
102
100
98
00
01
02
03
04
05
06
07
08
09
10
11
12
13
14
15
16
Source: Thomson Reuters, Credit Suisse research
Moreover, as described above, a weak yen is politically counterproductive (as food prices
rise more than wage growth) and NIRP hurts the banking sector, which tends to support
the LDP (the trough in JGB yields occurred at a similar time when MUFG said it would
stop dealing in the primary bond market).
If the performance of the Nikkei is not going to rely largely on the US cycle, then greater
domestic change will be needed. We believe that widespread domestic economic deregulation, labour market reform or much more clear-cut fiscal stimulus to drive up inflation
expectations would all be required to make the Japanese equity story more domestically
driven.
Limits to the corporate change seen
We would argue that a full embracing of US/UK style shareholder focus would require
three factors:
■ Widespread executive share options (something still lacking).
■ Aggressive M&A to penalise underperforming managements. Again, this is very rare.
■ A change in the corporate attitude that the number of people employed remains the
key measure of corporate success, rather than a focus on profitability.
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2 December 2016
What if there is no change and US growth falters?
The key risk in Japan, in our view, is that there is no economic reform and a deceleration
in US growth momentum. Under such an outcome, Japan would slip back into deflation
and the underlying weakness of the economy would become primary once again:
■ Challenging fiscal arithmetic. Indeed, as we highlighted in our bond piece, What to
do with bond proxies, 3 November 2016, Japan needs a real bond yield of minus 1.4%
to stabilise government debt to GDP and unemployment.
■ A very low structural growth rate. The rate of growth of productivity and labour when
added together is no more than 0.5%, largely because the labour force is shrinking by
0.5% a year. The female participation rate is already quite high (for 25 to 65 year olds)
at 66%; it is just their pay which has been abnormally low.
■ Labour laws in need of reform. An economy that for political reasons has been
reluctant to change the 1970s' labour law, namely that employees cannot be fired
unless it is in 'general societal interest'.
■ Little spare capacity in the economy. The Japanese economy is close to full
capacity in the labour market with the job offer to applications ratio at a 24-year high.
■ An economy which over-invests. Japan's investment share of GDP is the highest
among major developed regions.
Figure 326: Japan's gross government debt to GDP
ratio stands at 245%
Figure 327: Corporates continue to over-save,
putting pressure on the government to borrow
12%
250
Non-financials
Government
Households
Overseas
Net surplus, % of GDP,
4Q average
9%
2016 gross government debt to GDP (%)
200
6%
3%
150
0%
100
-3%
-6%
50
-9%
0
Japan
Italy
US
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Spain
France
UK
-12%
Q1 1998
Q1 2001
Q1 2004
Q1 2007
Q1 2010
Q1 2013
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
4) Exposure to China is high
Japan has nearly five times the economic exposure of the US to China, which leaves
Japan vulnerable to any China-related economic worries. Such worries seem limited at
the moment, with CS economists having revised up their GDP forecast to 6.8% in 2017
from 6.5%. Japan was sold off aggressively by foreign investors fearing the impact of RmB
weakness in August 2015, but it has not been bought back as China recovered. We do
believe, though, that in the long run China represents a serious competitive threat to
Japan.
Figure 328: Japan is heavily exposed to China
14%
Gross exports to GEM, % GDP (on value-added basis)
12%
Rest of GEM
China
10%
8%
8.0%
9.6%
6%
7.1%
4%
2%
5.8%
4.6%
1.7%
0%
Japan
Euro area
1.0%
1.0%
UK
US
Source: Thomson Reuters, Credit Suisse research
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Stock picks
1) Japan Focus List
Our Japanese equity research team highlight the following stocks as their top picks.
Figure 329: Japan Focus List
-----P/E (12m fwd) ------
HOLT
2016e, %
------ P/B -------
2016e Momentum, %
Name
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Taisei
11.3
66%
-41%
1.8
93%
na
2.1
18.1
2.5
-3.3
2.1
Outperform
Sekisui House
10.3
61%
-36%
1.2
53%
na
3.5
43.4
0.0
0.1
1.9
Outperform
Morinaga
19.1
98%
-19%
3.1
194%
3.3
0.8
-47.4
20.0
1.7
2.0
Outperform
Toray Inds.
14.3
85%
-47%
1.6
24%
-3.2
1.5
-1.8
-0.9
-3.0
2.2
Outperform
Mitsui Chemicals
10.3
61%
-60%
1.3
76%
16.7
2.0
32.0
19.1
-1.8
2.3
Outperform
Shionogi
21.3
147%
2%
3.5
112%
na
1.3
-15.7
4.4
2.9
2.0
Outperform
Nippon Shinyaku
30.6
211%
26%
3.6
203%
na
0.6
-41.1
4.2
2.0
1.8
Outperform
Kose
22.1
109%
-6%
3.6
143%
na
1.0
-28.1
-5.3
-0.7
2.0
Outperform
Sumitomo Osaka
CementMetals
Hitachi
9.4
52%
-59%
0.9
31%
na
2.3
74.5
-4.6
-1.1
2.6
Outperform
13.3
74%
-36%
1.3
-6%
na
1.7
38.8
-0.4
-2.6
2.4
Outperform
Daikin Industries
20.2
118%
-5%
3.1
81%
6.4
1.1
-18.2
3.0
-0.3
2.2
Outperform
Toshiba
12.8
75%
-45%
5.3
178%
-1.0
0.0
-22.4
30.2
3.2
2.8
Outperform
Sony
21.0
125%
-43%
1.7
75%
4.2
0.7
39.6
-15.2
-1.0
2.0
Outperform
Aisin Seiki
12.7
137%
-39%
1.2
31%
na
2.0
71.8
6.4
0.3
2.1
Outperform
Suzuki Motor
13.0
139%
-34%
1.7
53%
na
0.9
28.3
39.4
-1.2
2.3
Outperform
Nissha Printing
21.1
115%
-45%
1.5
17%
na
1.2
-3.5
-240.9
-6.9
2.5
Outperform
Credit Saison
9.2
62%
-38%
0.8
1%
na
1.7
-11.4
-0.1
0.2
3.0
Outperform
Shinsei Bank
8.8
75%
-25%
0.6
-3%
na
0.6
-8.4
-1.4
-17.5
2.5
Outperform
Source: Credit Suisse estimates, HOLT, IBES, MSCI, Thomson Reuters
2) Cheap quality in a global context
The following Japanese stocks all have HOLT eCap awards, implying they are quality
companies, and yet they trade on valuation discounts to their global sector peers.
Figure 330: Japanese companies with eCap awards which trade at valuation discounts to their sector peers
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
eCAP Awards
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
Japan Tobacco
X
16.7
95%
-13%
2.8
38%
-0.8
3.4
-13.2
-0.2
-1.6
2.1
Outperform
Obic
X
19.2
96%
10%
2.8
82%
na
1.7
-19.0
-0.5
-0.3
2.5
Not Covered
Otsuka
X
18.8
94%
7%
3.0
49%
na
2.0
-9.9
-0.3
-0.1
2.2
Not Covered
Uss
X
20.7
88%
19%
2.9
57%
na
2.7
-17.2
-1.8
-2.7
2.7
Not Covered
Aeon Delight
X
15.3
83%
6%
2.0
16%
na
1.8
23.2
-0.9
-0.4
2.3
Not Covered
Conexio
X
10.3
77%
10%
2.1
65%
na
3.8
23.3
0.0
0.0
2.5
Not Covered
Elecom
X
12.0
89%
13%
3.3
107%
na
2.1
80.1
4.7
-1.4
2.7
Not Covered
En-Japan
X
18.1
98%
-7%
4.1
53%
na
1.3
-4.8
2.3
-2.0
2.2
Not Covered
F@N Communications
X
14.4
72%
-20%
3.9
3%
na
2.4
25.9
-1.5
-2.1
3.2
Not Covered
Obara Group
X
12.5
73%
-45%
2.4
92%
na
1.2
1.3
0.0
0.0
3.0
Not Covered
Septeni Holdings
X
13.1
72%
-32%
4.0
88%
na
1.0
-28.9
26.3
-18.1
1.7
Not Covered
Trancom
X
12.4
77%
17%
2.2
67%
na
1.4
30.1
0.0
0.0
2.3
Not Covered
Usen
X
9.7
53%
-65%
3.2
-12%
na
0.9
82.0
-26.6
3.6
1.0
Not Covered
Workman
X
19.2
81%
30%
2.8
85%
na
1.5
-39.2
0.0
0.0
3.0
Not Covered
Wowow
X
12.5
69%
10%
1.9
56%
na
2.0
77.9
0.0
0.0
3.0
Not Covered
Name
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: Credit Suisse, HOLT, IBES, MSCI, Thomson Reuters
Global Equity Strategy
160
2 December 2016
3) Companies focused on change
We highlight companies that are focusing on change, as proxied by appointing outside
directors.
Figure 331: Japanese companies which are appointing external directors
-----P/E (12m fwd) ------
2016e, %
------ P/B ------Abs
rel to mkt %
above/below
average
FCY
DY
HOLT
2016e Momentum, %
Price, %
change to
best
3m EPS
3m Sales
Consensus
recommendation Credit Suisse
(1=Buy; 5=Sell) rating
Name
% Independent
directors
Abs
rel to
Industry
rel to mkt %
above/below
average
Sony
77%
21.0
125%
-43%
1.7
75%
4.2
0.7
39.6
-15.2
-1.0
2.0
Outperform
Eisai
64%
51.6
356%
58%
3.3
51%
na
2.3
-27.3
12.2
-1.6
2.8
Underperform
Shionogi
60%
21.3
147%
2%
3.5
112%
na
1.3
-15.7
4.4
2.9
2.0
Outperform
Santen Pharm.
60%
21.5
149%
10%
2.4
36%
na
1.7
-9.7
-3.9
-0.5
2.2
Outperform
Hitachi
57%
12.0
89%
-63%
1.1
5%
4.3
2.0
52.4
-1.5
-0.3
2.2
Outperform
Astellas Pharma
57%
15.9
110%
-12%
2.7
56%
na
2.1
38.0
2.7
-0.9
2.3
Neutral
Japan Exchange Group
57%
22.8
153%
-3%
3.7
53%
na
2.5
-37.3
3.6
1.1
3.3
Underperform
Nomura Hdg.
55%
12.1
81%
-46%
0.8
-14%
na
2.5
-21.8
61.1
7.6
3.0
Neutral
Olympus
54%
23.9
145%
-14%
3.7
2%
na
0.7
-15.0
-7.4
-5.1
2.2
Outperform
Shinsei Bank
50%
8.8
75%
-25%
0.6
-3%
na
0.6
-8.4
-1.4
-17.5
2.5
Outperform
Orix
46%
8.2
55%
-28%
1.0
28%
na
2.8
-13.1
1.4
1.1
1.9
Outperform
Tdk
43%
16.8
125%
-27%
1.5
45%
-10.3
1.5
5.6
2.4
1.1
2.8
Neutral
Calbee
43%
23.4
121%
-19%
3.9
32%
3.2
1.1
-41.1
-4.0
-2.0
2.6
Neutral
Source: Credit Suisse estimates, HOLT, IBES, MSCI, Thomson Reuters
4) Japanese companies with dividend yields above 2% covered by free
cash flow, and with net cash on the balance sheet
The names below could, in our judgement, continue to increase distributions, have free
cash flow yields above their dividend yields and have cash on their balance sheets.
Figure 332: Relatively high yielding stocks with net cash
2016e, %
Name
Net Cash to
market cap
2016e
FCY
DY
-----P/E (12m fwd) ------
------ P/B -------
HOLT
2016e Momentum, %
FCY/DY
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Kuraray
3%
4.2
2.56
1.6
13.1
78%
-20%
1.1
21%
37.8
-0.1
-0.7
3.1
Neutral
Panasonic
3%
6.23
2.15
2.90
15.0
90%
-54%
1.5
39%
81.4
-1.6
-1.9
2.2
Neutral
Tokyo Electron
13%
3.91
2.75
1.42
15.6
98%
-51%
3.0
85%
2.3
10.5
4.7
2.2
Outperform
Ckd
8%
6.22
2.11
2.95
13.1
77%
-35%
1.2
50%
14.9
7.3
0.9
1.8
Not Covered
Disco
13%
5.28
2.18
2.42
21.1
132%
-19%
2.8
76%
-22.1
5.2
2.3
2.3
Neutral
Lintec
37%
4.58
2.76
1.66
13.9
83%
-5%
1.0
14%
47.0
-12.9
-3.4
2.3
Not Covered
Tsi Holdings
38%
10.27
2.66
3.86
32.4
194%
-26%
0.6
21%
32.8
-28.9
0.5
3.0
Not Covered
Source: Credit Suisse research, HOLT, IBES, MSCI, Thomson Reuters
Global Equity Strategy
161
2 December 2016
5) Companies that dominate their end markets
Japan has a number of companies which continue to dominate, or enjoy significant market
share, in their respective end markets.
Figure 333: Japanese companies that dominate their end markets
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
13.1
78%
-20%
1.1
21%
4.2
2.6
37.8
-0.1
-0.7
3.1
Neutral
30.7
192%
-8%
1.8
6%
5.4
0.8
23.3
0.9
-0.6
2.8
Underperform
28%
19.8
118%
3%
1.7
31%
2.2
1.4
-12.0
2.0
-0.8
1.9
Neutral
ArF photo-resist
30%
15.6
93%
-5%
1.0
-20%
-3.1
3.1
50.1
-1.2
-1.7
3.2
Neutral
Immersion top coat
90%
VRV
40%
20.2
118%
-5%
3.1
81%
6.4
1.1
-18.2
3.0
-0.3
2.2
Outperform
HVAC
10%
Transmission Automatic
16%
12.7
137%
-39%
1.2
31%
na
2.0
71.8
6.4
0.3
2.1
Outperform
Transmission Step -AT
22%
Torque Converter
LCD glass substrate
15%
25%
17.9
105%
-20%
0.8
-19%
na
2.5
60.4
9.7
-1.8
2.6
Not Covered
70%
12.2
72%
-78%
0.7
-2%
na
-0.1
-49.8
4.2
-0.9
2.7
Not Covered
Nippon Elec.Glass
Thin film solar cell glass
substrate
LCD glass substrate
20%
23.7
176%
5%
0.6
-39%
na
2.7
69.3
-35.3
-1.5
2.8
Not Covered
Ngk Insulators
Exhaust gas filters
40%
15.1
89%
-29%
1.8
14%
na
1.8
11.5
-12.4
-2.2
2.2
Outperform
Honeycomb
45%
Sumitomo Electric Ind.
Wire-harness
27%
12.2
131%
-31%
1.0
16%
na
2.1
82.1
-2.6
-0.1
2.2
Outperform
Nabtesco
Speed reduction gear
60%
18.4
108%
-5%
2.5
39%
-1.0
1.7
-38.5
-5.2
-0.5
2.4
Neutral
Keyence
Sensors for manufacturing
n/a
29.8
221%
18%
4.5
106%
3.0
0.2
-27.6
-0.6
-0.4
2.1
Neutral
Fanuc
CNC systems
60%
31.4
184%
17%
2.9
33%
0.4
1.7
-41.9
0.6
-1.3
2.9
Underperform
Thk
Linear motion guide
60%
20.3
119%
-30%
1.3
16%
2.5
1.5
-21.9
0.7
1.5
2.9
Neutral
Kureha
100%
9.5
57%
-40%
0.7
-2%
na
2.4
32.1
0.0
0.8
3.0
Neutral
Teijin
PGA biodegradable plastic (for
shale
extr)
carbongas
fiber
11%
10.8
64%
-62%
1.4
49%
-24.7
2.3
42.2
-0.2
-2.5
2.4
Neutral
Toray Inds.
carbon fiber
35%
14.3
85%
-47%
1.6
24%
-3.2
1.5
-1.8
-0.9
-3.0
2.2
Outperform
Mitsubishi Chm.Hdg.
carbon fiber
10%
10.0
59%
-54%
1.1
35%
16.6
2.3
86.8
17.3
-3.4
2.4
Outperform
Nidec
Spindle Motor
80-90%
27.1
159%
30%
4.0
62%
1.9
0.8
-35.6
2.5
-2.7
2.1
Outperform
Murata Manufacturing
40-50%
18.9
141%
-33%
2.7
83%
3.7
1.4
5.1
-4.7
-2.6
2.4
Outperform
Kyocera
Multilayer ceramic capacitor
(MLCC)
Ceramic package
70-80%
26.4
196%
6%
0.9
3%
6.4
1.8
49.5
-3.4
-2.5
3.1
Neutral
Ngk Spark Plug
Spark Plug, Oxygen sensor
40%
15.2
163%
-33%
1.6
34%
na
1.7
5.8
-3.7
-2.3
2.5
Outperform
Tdk
Li-ion pollymer battery
30-40%
16.8
125%
-27%
1.5
45%
-10.3
1.5
5.6
2.4
1.1
2.8
Neutral
Smc
Pneumatic equipment
33%
22.6
132%
-7%
2.3
54%
3.3
0.6
-20.4
-3.2
-0.5
2.4
Neutral
Osg
Tapping Machines
30%
18.6
109%
-32%
2.1
41%
na
2.2
-35.6
1.9
-0.8
2.8
Not Covered
Harmonic Drive Sys.
Miniature speed reducer
60%
38.0
223%
26%
7.0
174%
na
0.7
-45.8
-1.7
0.1
2.0
Not Covered
Sony
CMOS sensors
45%
21.0
125%
-43%
1.7
75%
4.2
0.7
39.6
-15.2
-1.0
2.0
Outperform
Exedy
Torque Converter
22%
11.6
125%
-23%
0.9
11%
na
2.2
37.5
0.9
0.4
3.3
Neutral
Koito Manufacturing
Headlamps
22%
17.2
184%
-6%
3.3
148%
na
0.7
13.3
0.2
-1.4
2.5
Underperform
Nifco
Auto plastic fasteners
22%
15.6
168%
-18%
2.6
105%
na
1.8
-11.3
-1.2
-0.5
2.2
Outperform
Toyota Inds.
Forklift
21%
14.0
150%
-45%
0.8
25%
na
2.2
112.2
-1.5
-0.4
2.7
Outperform
Alps Electric
Automatic Wi-Fi module
16.6
123%
-43%
2.5
113%
na
1.0
-6.0
-15.0
-3.4
1.9
Outperform
Nippon Shokubai
Super Absorb. Polymer
18%
13.4
80%
-3%
1.1
29%
-3.8
2.1
39.1
-4.6
-3.8
2.5
Neutral
Asahi Kasei
Li-ion Battery seperator
18%
14.1
84%
-14%
1.3
38%
1.0
2.0
22.4
0.9
-0.6
2.7
Neutral
Hitachi Chemical
Li-ion Battery anode
30%
13.8
82%
-23%
1.5
38%
1.1
1.9
27.5
2.1
-1.9
2.5
Outperform
Name
Product
Kuraray
Sumco
Shin-Etsu Chemical
JSR
Daikin Industries
Aisin Seiki
Asahi Glass
Nippon Sheet Glass
Market Share
Abs
Poval film
80%
300 mm wafer
26%
300 mm wafer
Consensus
recommendation Credit Suisse rating
(1=Buy; 5=Sell)
Source: Credit Suisse, HOLT, IBES, MSCI, Thomson Reuters
Global Equity Strategy
162
2 December 2016
6) Japanese banks
We believe that investors should be overweight Japanese banks. They look extremely
cheap, are essentially a play on the steeper yield curve, and asset quality should be
improving given the rise in house prices.
Figure 335: … and the same is the case with its P/B
relative
Figure 334: Japanese banks trade 2.0 standard
deviations below average on 12m fwd P/E relative…
110%
Japan banks rel mkt: P/E
Japan banks rel mkt: P/B
Average (+/- 1SD)
100%
Average (+/- 1SD)
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
35%
1995
Source: Credit Suisse research, Thomson Reuters
1998
2001
2004
2007
2010
2013
2016
Source: Credit Suisse research, Thomson Reuters
Furthermore, Japanese banks look cheap on a combination of 12-month forward RoE and
P/B.
Figure 336: Japan offers an attractive RoE/PB trade-off
1.7
Major Countries - Price to book versus ROE
Sweden
1.5
United States
Price to Book
1.3
Denmark
Netherlands
1.1
Switzerland
0.9
United Kingdom
Spain
0.7
France
Japan
0.5
Italy
Germany
0.3
-2%
0%
2%
4%
ROE
6%
8%
10%
12%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
163
2 December 2016
This is against a backdrop of rising house prices and reasonably robust loan growth.
Figure 337: House prices are stabilising
Figure 338: Japanese loan growth remains high
5%
Tokyo Metropolitan Area, house prices, %
change year-on-year
8
Japan bank loan growth, y/y%
3%
1%
3
-1%
-2
-3%
-7
-5%
-7%
1993
-12
1996
1999
2002
2006
2009
2012
2016
96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
In addition, the loan-to-deposit ratio of the banks is extremely depressed. The close
relation with JGB yields has been of particular note year-to-date given the sharp move
higher in yields, which has provided some relief to the relative performance of the sector.
Figure 339: Japan loan-to-deposit ratio is depressed
at 66%
105%
Japanese banks loan -to-deposit ratio
Figure 340: JGB yields have tended to correlate
closely with the performance of Japanese banks
0.75
2.10
Japanese banks relative to the market
100%
JGB 10 year yield (%, rhs)
0.65
95%
90%
1.60
0.55
1.10
0.45
0.60
0.35
0.10
85%
80%
75%
70%
65%
1983
1987
1992
1997
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2001
2006
2011
2016
0.25
2006
2008
2010
2012
2014
-0.40
2016
Source: Thomson Reuters, Credit Suisse research
164
2 December 2016
The critical points on the yield curve for Japanese banks are the 3 month and 5 year
points, and accordingly there has been a reasonably close relationship between this
spread and the relative performance of Japanese banks. The move by the BoJ to
institutionalise an upward sloping yield curve has helped to increase this spread.
Japanese banks, however, have not responded in the way one might have expected,
underperforming the steepening of the curve.
Figure 341: The 3 month 5 year spread is an important driver of Japanese
banks, and suggests further upside for the sector
Japanese yield curve: 5 year less 3 month
0.3
0.489
Japanese banks rel, rhs
0.2
0.439
0.1
0.389
0.0
0.339
-0.1
-0.2
2012
0.289
2013
2014
2015
2016
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse
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2 December 2016
GEM: reduce overweight
We initially upgraded GEM equities to overweight in December 2015, making the region
our largest overweight for 2016. We then modestly trimmed emerging markets to a smaller
overweight to reflect a less supportive macro backdrop in early September (see GEM:
most preferred region, slightly reduced, 2 September).
We now cut the size of our overweight even further, owing to the factors highlighted below.
However, although we think that EM equity outperformance may be muted (or indeed not
materialise) in H1 2017, we remain of the view that longer-term outperformance can be
achieved, as we discuss later, and that the relative strength of the three-year story
precludes us from taking weightings down further.
Why the modest reduction?
1.
The global macro backdrop for GEM is becoming less supportive
From a macro point of view, we see the most important drivers of emerging market
performance as: US rates; the US dollar; commodity prices; and investor perceptions of
China.
The first 10 months of the year saw a uniquely supportive set of factors come together for
emerging markets: the dollar fell by nearly 9% on a trade-weighted basis between January
and August, the oil price rallied by over 90% between February and October, the US TIPS
yield fell by 80bps between January and July, to its low of -6bps while macro momentum
in China accelerated from a low in Q1 2016. The very unusual combination seen in the
first half of the year was the sharp fall in index linked and nominal bond yields despite the
rise in the oil price: something that is very unlikely to be repeated, in our opinion.
Going forward, some of these macro tailwinds will become somewhat less supportive for
GEM equity performance. Nonetheless, we doubt these changes in the macro backdrop
will be significant enough to cause GEM to underperform over the course of 2017.
Figure 342: A number of the macro tailwinds for GEM will become headwinds in
the coming months on Credit Suisse macro forecasts (25 Oct the relative peak
in GEM performance)
Macro factor
Change: 22 Jan to 25 Oct
USD TWI
↓
-4.0%
Oil price
↑
75%
US TIPS yield (bps)
↓
-67
MSCI GEM $ rel to World
16%
12 month outlook
↑
4.2%
↑
33%
↑
40
Source: Thomson Reuters, Credit Suisse research
Below we assess each of these factors in turn.
■ US rates: rising TIPS yields
There has been a very close correlation between the TIPS yield and the performance of
emerging markets in the past three years. Thus the rise that we would project, c.50bp from
here, would – on the basis of the first chart below – take c.5% off the relative performance
of emerging markets.
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2 December 2016
However, we believe there are two reasons emerging markets can be more resilient than
they were in the 2013 'Taper Tantrum' to rising DM rates:
i.
The improvement in current account positions makes GEM less vulnerable to US rates
The aggregate emerging market current account position has improved significantly over
the past few years, reflecting a repair of external imbalances and meaning reliance on
short-term foreign capital inflows – which are undermined as DM rates rise – has
lessened. Thus emerging markets can, it seems, accommodate a rise in the TIPS yield to
c.1%.
Figure 343: There has been a clear relationship
between TIPS yields and the relative performance of
GEM equities
Figure 344: A lower TIPS yield makes it easier for
emerging markets to finance their current account
deficits
-2.0
13
GEM relative to global equities, 6m % chg
10-year TIPS yield, 6m lead, lhs
3.5
-1.5
US 10-year TIPS yields, 6m chg, rhs, inv.
8
6-month rolling GEM current account
deficits, % of GDP, rhs, inverted
2016E CS forecast
3.0
-1.0
2.5
3
-0.5
2.0
-2
0.0
Sample includes Brazil, India, Russia,
Mexico, Indonesia, Philippines, Turkey,
South Africa, Poland, Hungary
1.5
-7
1.0
-12
1.5
-17
2009
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
2014
2015
2016
-0.1%
-1.1%
0.5
-1.6%
0.0
-2.1%
-0.5
-1.0
2008
0.4%
-0.6%
1.0
0.5
0.9%
-2.6%
2009
2010
2011
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Indeed, the chart below suggests that current account positions are a determinant of EM
equity performance; since Trump's election as the next President of the US and the
subsequent sharp rise in DM yields, there has been a reasonable positive correlation
between a country's current account balance and its performance relative to GEM.
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2 December 2016
Figure 345: There has been a positive correlation between EM countries' current
account positions and their relative performance since Trump's election
Price perf rel GEM since Trump victory in $ (9th Nov,
2016)
6%
Russia
4%
Taiwan
China
2%
Korea
0%
India Philippines
Poland
Brazil
Chile
-4%
Mexico
-6%
Thailand
South Africa
-2%
Hungary
Czech
Republic
Turkey
-8%
Indonesia
-10%
-7%
-5%
-3%
-1%
1%
3%
5%
7%
Current account as % GDP (Q2, 2016)
9%
11%
13%
Source: Thomson Reuters, Credit Suisse research
ii.
An improvement in global growth (which occurs as the same time as US rates rise), is
normally good for GEM
In the pre-crisis period, GEM equities used to outperform when US bond yields rose. This
was because, during the previous cycle, a rise in bond yields occurred against a backdrop
of global reflation (i.e. rising commodity prices and stronger growth), as we are seeing
now, and that in turn helped to support emerging markets.
Indeed, as the second chart below shows, emerging markets have above-average
leverage into rising global growth because: i) in some instances, their economies are more
open; ii) they tend to be the just-in-time producers for the US consumer; iii) a rise in global
growth momentum is ordinarily associated with a rise in commodity prices; and iv) GEM
equities have above average operational leverage.
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2 December 2016
Figure 346: A sustained negative correlation with
bond yields has historically been unusual for GEM
equities
0.6
GEM relative performance, 12m correlation with US 10-yr yields
6
5.7
Beta of EPS to Global IP
5
0.4
3.9
4
0.2
3.4
3.2
3
0.0
3.0
2.4
2
-0.2
1
-0.4
-0.6
2001
Figure 347: After Japan, emerging market EPS has
the greatest beta to global IP
0
2003
2005
2007
2009
Source: Thomson Reuters, Credit Suisse research
2012
2014
2016
Japan
Emerging
markets
World
Continental
Europe
US
UK
Source: Thomson Reuters, Credit Suisse research
■ The US dollar: set to strengthen…but only modestly
We acknowledge that 2017 is likely to see the dollar strengthen, in contrast to the prior
year. Ordinarily, as the chart below shows, dollar strength is a headwind for emerging
markets. There are four reasons why the dollar bull market is unlikely to be as much as a
headwind as is usually the case:
First, as we highlight in the currency section, we think that dollar strength will be relatively
muted (our FX strategists see c.4% upside to DXY) and there is unlikely to be a move from
here of the magnitude seen in 2015. The current dollar bull market has already seen the
currency gain 42% from trough to peak – greater than the previous bull market – and it has
lasted 5½ years, versus an average duration of 6 to 7 years (implying a peak in the dollar
in 2017). Thus, we struggle to see a multi-year, or greater than 10%, continuation of the
US dollar bull market.
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2 December 2016
Figure 348 The current dollar bull market has
already been of greater magnitude than the
previous
180
6 yrs
+67%
9.5 yrs
-39%
7 yrs
+40%
10 yrs
-47%
Figure 349: Visually, the correlation between GEM
relative performance and the USD is extremely
close
5 yrs
42%
75
GEM price rel. (local currency, lhs)
140
160
USD TWI (rhs, inverted)
85
120
140
95
100
120
80
105
60
115
100
80
40
60
1975
125
1980
1986
1992
1998
Trade weighted US dollar
2004
2010
2016
First Fed Rate hike
Source: Thomson Reuters, Credit Suisse research
20
1994
1997
2001
2005
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
Excluding the RmB, EM currencies – especially after the recent sell-off – are looking
particularly cheap versus the dollar, trading 30% below the valuation level suggested by
their export market share, and thus are more likely to be resilient to dollar strength.
Moreover, EM currencies have notably lagged other EM proxies, such as metals prices.
Figure 350: Against PPP, GEM currencies (ex-China)
are close to as cheap as they were in 2002…
Figure 351: …and have significantly lagged the rally
in EM proxies such as metals
GEM currency valuation (ex China) vs US on PPP
-35%
GEM export market share, ex China, rhs
15%
-40%
14%
-45%
13%
-50%
12%
-55%
49
770
47
720
45
670
43
620
570
10%
41
9%
39
Jan-14
2005
2008
Source: Thomson Reuters, Credit Suisse research
2010
2013
2016
870
820
-65%
2003
920
51
11%
2000
CRB metals index, rhs
53
-60%
-70%
1998
GEM nominal FX index (ex-China)
55
Jun-14
Dec-14
Jun-15
Dec-15
May-16
520
Nov-16
Source: Thomson Reuters, Credit Suisse research
Reflecting this, many GEM currencies, at spot exchange rates, have devalued against the
USD by a similar degree to that seen in the wake of the 1997/98 Asian financial crisis.
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2 December 2016
Figure 352: Many EM currencies have already depreciated by a similar degree to
that seen in the Asian financial crisis
GEM currency devaluations - 1997/8 vs now
TWD CNY KRW SGD THB CLP MYR INR* IDR HUF MXN* TRY ZAR* BRL
RUB ARS
0%
-10%
-20%
-30%
-40%
-50%
-60%
-70%
-80%
1997/8 (peak to trough in 4 years
centred around Asian crisis)
-90%
-100%
Now
* indicates currency was freely floating preceding the Asian crisis
Source: Thomson Reuters, Credit Suisse research
Currency is, in our view, the critical driver of equity performance: our GEM equity strategy
team estimate that 25% of total returns come from FX. Furthermore, if currencies
appreciate, then inflation and interest rates fall, and the foreign currency denominated debt
burden lessens.
As a cross check on currency cheapness, we can see that foreign exchange reserves are
rising in GEM (excluding the RMB). This is important because a rise in FX reserves in
emerging markets is often unsterilized and can thus lead to a rise in money supply growth,
supporting asset prices.
Figure 353: FX reserves in GEM ex-China have been
rising recently…
GEM ex-China M1 6-month change, rhs
China FX reserves, yoy
60%
16%
GEM Ex-China FX reserves, yoy
50%
Figure 354: …which should support domestic
money supply growth, and thus asset prices
40%
GEM ex-China rel. price perf., 6-month change,rhs
14%
40%
30%
12%
20%
30%
10%
20%
10%
8%
10%
Source: Thomson Reuters, Credit Suisse
2016
2015
2014
2013
2012
2011
2010
2009
0%
2008
-30%
2007
2%
2006
-20%
2005
4%
2004
-10%
2003
6%
2002
0%
0%
-10%
-20%
-30%
2001
2003
2005
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse
Finally, dollar strength is not explicitly a negative for GEM equities, particularly over a
shorter-term horizon. Considering five-year periods, GEM equities have only outperformed
10% of the time when the dollar strengthens, but on a quarterly view the fit is far less clear:
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2 December 2016
GEM equities have outperformed 44% of the time the dollar strengthened (and 30% of the
time GEM equities have outperformed over a one-year period when the dollar has been
strong). Moreover, recently, the correlation between the dollar and commodity prices has
broken down, reducing the negative side-effects of dollar strength on EM performance.
Figure 356: … but increases over the longer-run
Figure 355: The sensitivity between GEM and the
USD is less significant in the short term…
GEM rel performance with dollar TWI, q/q % chg
35
GEM rel, quarterly % chg ($ terms)
25
Percentage of times GEM equities outperform when…
100%
When dollar weakens, GEM
outperforms 63% of the time
Dollar weakens
90%
Dollar strengthen
80%
70%
15
60%
5
50%
-5
40%
30%
-15
20%
-25
10%
When dollar strengthens, GEM
underperforms 56% of the time
-35
10
5
0%
0
-5
Quarterly % chg in USD TWI, invert
1Q
-10
Source: Thomson Reuters, Credit Suisse research
1Y
Time horizon of change
5Y
Source: Thomson Reuters, Credit Suisse research
On a country level, when comparing currency valuations against their fundamentals, we
find that Taiwan, Hungary, Russia and Malaysia have the most attractive valuation versus
fundamental trade-offs. The worry for GEM currencies has been the risk of a significantly
weaker RmB, but we continue to believe that its decline will be orderly, for reasons
highlighted in the currency section.
Figure 357: Currency valuation versus fundamentals
Red denotes a net commodity importer, blue a net exporter
Expensive Currency
and more vulnerable
Philippines
Currency valuation (higher number = expensive)
0.9
South Korea
Brazil
0.4
Chile
-0.1
China
India
Czech
Republic
Turkey
Taiwan
Hungary
-0.6
Indonesia
South Africa
Poland
-1.1
Malaysia
Russia
Mexico
-1.6
1.2
0.7
0.2
-0.3
-0.8
-1.3
-1.8
Cheap Currency and
less vulnerable
-2.3
-2.8
External vulnerability (high number = lower vulnerability)
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
■ Commodity prices: a fading tailwind
There remains a close correlation between GEM relative performance and commodity
prices. Indeed, the correlation between the global mining sector and GEM equities has
historically been very tight, with an interesting disconnect recently. We believe that the oil
price (the critical commodity variable for GEM) will be largely range-bound, trading in a
$40-$55pb range.
Credit Suisse's energy team is more optimistic, however; their view is that the Brent oil
price will be $46 in Q1 2017, $56 in Q2 2017 and $62 by Q4 2017. For more details see
Light at the End of the Tunnel: Oil & Gas into Year-End, 24 October.
Figure 358: The relationship between the relative
performance of mining and GEM equities has
historically remained close
460
290
270
410
250
360
600
3.8
210
260
190
550
MSCI EM / MSCI AC
World
CRB spot, rhs
3.3
230
310
500
450
2.8
400
2.3
350
170
210
150
160
110
60
Nov-04
Figure 359: GEM relative performance has been
correlated with commodity prices
Nov-06
Mining, relative to global, lhs
130
GEM, relative to global
110
Nov-08
Nov-10
Source: Thomson Reuters, Credit Suisse research
Nov-12
Nov-14
90
Nov-16
300
1.8
250
1.3
0.8
1996
200
150
1999
2002
2006
2009
2012
2016
Source: Thomson Reuters, Credit Suisse research
However, the commodity sensitivity tends to be exaggerated, in our view. The direct
commodity exposure of GEM has nearly halved, with commodities now accounting for only
c.18% of market cap compared with nearly 40% in 2008. This is also the case if we look at
the indirect commodity exposure (where, for example, Mexico used to have nearly 30% of
fiscal revenues from oil compared to just 15% currently). Indeed, the majority of GEM
market cap is now accounted for by commodity importers (58%, compared to 42% in
2008). The reason that GEM tend to correlated with commodities is because they remain
more exposed to commodities directly and indirectly than developed markets.
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2 December 2016
Figure 360: Resource-related sectors account for
18% of GEM market cap, down from 37% in 2011
(they account for 11% of developed markets)
40%
Figure 361: Commodity-dependence of national
income, exports and government revenues in major
EMs
Resource-related sectors (energy&materials), % market cap
35%
30%
25%
Brazil
Indonesia
Malaysia
Mexico
Russia
20%
15%
10%
GEM
5%
0%
2001
% of total
Commodity
merchandise
exports % GDP
exports
7%
57%
13%
55%
28%
36%
7%
21%
20%
78%
% of fiscal
revenues
10%
25%
33%
15%
50%
Developed
2004
2007
2010
Source: Thomson Reuters, Credit Suisse research
2013
2016
Source: Thomson Reuters ,, Credit Suisse research
Thus, while we do not think commodities are likely to surprise to the extent they did in
2016, neither do we see them falling sharply.
■ China: stimulus boost fading
As we show in the macro section, many of the stimulus channels which had been used to
support Chinese growth through the first half of 2016 look set to slow: property turnover is
rolling over (implying a small decline in property prices), FX outflows are modestly
accelerating, state and local infrastructure investment is slowing from very high run rates
and several policy variables are being tightened.
However, none of the four hard landing indicators we look at is even 'flashing amber' (with
the key variable being the loan to deposit ratio) and China, with net government debt to
GDP of zero and a current account surplus, does have the ability to utilise its fiscal
flexibility. We suspect that, at least in the near term, policy will be geared toward
maintaining economic stability. It is only until after the 19th Party Congress (Q3/4) that we
see a risk policymakers refocus on reform, rather than growth.
2.
Trump and protectionism
The threat from President-elect Trump, as we have already seen with his commitment to
withdraw from TPP, is that there will be fewer free trade agreements made, more
encouragement for US corporates to reshore, and it may be tougher to use migrant
workers (affecting remittances to places such as Philippines, India or Mexico). Emerging
markets also tend to be much more open, and greater beneficiaries from globalisation,
than developed markets.
However, we are relatively sanguine that a lot of the protectionist rhetoric that featured in
Trump's campaign will ultimately be toned down.
■ General protectionist trade policies: it seems that President-elect Trump, in forming
his cabinet, is surrounding himself with businessmen whose businesses benefit from
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2 December 2016
free trade – and his VP, Mike Pence, is very much a free trader. Moreover, the US
consumer is far more dependent on cheap imports and corporates are far more
interlinked owing to the globalisation of supply chains (meaning the costs to corporates
and consumers from protectionism are likely to be politically untenable). Thus we think
that consumer and corporate America is better off with free trade than without it – and
we think that President-elect Trump and his team will start to realise this.
■ Tariffs on Mexican exports: we think it is unlikely a blanket tariff of 35% will be
applied to Mexican exports. US imports of final goods from Mexico contain 40% of US
value added, while the level of integration of US manufacturers' supply chains between
the US and Mexico (for example, cars built in the US are said to have their components
cross US borders – including the border with Mexico – between 8 and 11 times) would
make undoing or discouraging these trade links highly costly for US industry. It is worth
noting that, at one point, Obama threated to renegotiate NAFTA and in the video
statement outlining his plan for his first 100 days in office, President-elect Trump did
not mention NAFTA.
■ Tariffs on Chinese exports: again, we see blanket 45% tariffs on Chinese exports as
highly unlikely. In the opinion of our public policy team, such tariffs would need to be
classified as anti-dumping duties, which the US has already imposed on certain
Chinese products. It can take 12 to 18 months to impose new duties and the risk is that
a country could appeal to the WTO and if the appeal is upheld, the US would have to
abide by the ruling or withdraw from the WTO – an event we do not believe will occur.
Moreover, as is the case with Mexico, supply chain integration between the US and
China is highly advanced, with stock of US FDI in China being five times greater than
the stock of Chinese FDI in the US.
3.
Regional scorecards
Our regional composite scorecard ranks our five main investment regions based on
monetary conditions, economic momentum, valuation, earnings momentum, positioning
and sentiment, and macro factors. On this basis, and as a function of the factors
discussed above, GEM ranks second from the bottom.
GEM also ranks second from the bottom on our regional positioning and sentiment
scorecard (which scores regions based on risk appetite, fund flows, and sell side
recommendations).
Why do we avoid a downgrade to benchmark?
We see the following factors as still supportive for a longer-term overweight of GEM
equities.
1.
A structural improvement in absolute and relative profitability
One of the key drivers of emerging market underperformance since 2011 has been a
steady decline in profitability, leading to a complete erosion of the emerging market ROE
premium.
This has been reversing as emerging markets undergo a structural improvement in
profitability, in absolute and relative terms. This is in contrast to US, where we believe
profit margins have peaked as labour is gaining pricing power.
The majority of the decline in profitability was driven by a fall in margins, as the DuPont
analysis below shows (an increase in leverage has added to profitability, while the impact
of asset turns has been minimal). The key driver of this margin compression has been
wage growth in excess of productivity growth.
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2 December 2016
Figure 362: After steady deterioration, the gap
between emerging and developed markets' ROE has
now closed…
18%
6%
16%
4%
14%
2%
12%
0%
10%
-2%
8%
-4%
Figure 363: …with the decline in EM ROE largely
driven by a fall in margins
3%
2%
4%
1996
2000
2004
2008
Source: Thomson Reuters, Credit Suisse research
1%
0%
-1%
-2%
-3%
-4%
-5%
Return on equity
Spread, rhs
MSCI Developed World
MSCI Emerging Markets
6%
GEM contribution to change in ROE - 10y average vs. 2015 ex
financials
-6%
-8%
2012
2016
-6%
-7%
Tax Burden
Interest EBIT margin Asset Turn Leverage
Burden
RoE
Source: Thomson Reuters, Credit Suisse research
We think that GEM margins are now set to improve. Our Global Emerging Markets
strategists identify the three primary drivers for profit margins being: (i) commodity prices
(which our GEM equity strategy team assume will rise by 5% from current levels by the
end of 2017); (ii) EM industrial production growth (assumed to rise from to 5% by 2017
year-end); and (iii) the gap between productivity and wage growth (which our GEM
strategists estimate to increase to 1.5% by the end of 2017). Combining these factors into
a regression model suggests a 50bps increase in EM margins by end-2017.
We believe the most important of these three factors is the gap between real wage growth
and productivity growth. For the first time in over five years, wage growth is below
productivity growth, allowing unit labour costs to fall and margins to recover. This contrasts
with developed markets, where wage growth is already in excess of productivity growth.
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2 December 2016
Figure 364: EM non-financial net income margins
are forecast to improve by c.50bps by the end of
2017
Figure 365: Productivity growth in EMs is now
outpacing real wage growth, in contrast to DMs
Year on year change
EM7 real wages
EM7 productivity
Emerging markets non-financial margin (%)
11%
Predicted
10%
DM real wages
Actual
10%
DM productivity
8%
9%
6%
8%
4%
7%
6%
2%
5%
0%
4%
1995
1998
2001
2004
2007
2010
2013
-2%
2005
2016
Source: Credit Suisse Global Emerging Markets Strategy research
2.
2007
2009
2011
2013
2015
2017
Source: Credit Suisse Global Emerging Markets Strategy research
Relative economic momentum is improving in GEM versus DM
At its simplest level, there is a clear correlation between GEM relative performance and
relative growth differentials (both relative to the developed world). On both Credit Suisse
and IMF forecasts, growth in emerging markets is set to accelerate further beyond that in
developed markets.
Figure 366: GEM equity performance tracks relative growth differentials
Emerging vs Developed real GDP growth diff. (4Q rolling, LHS)
8%
MSCI EMF/World (rebased, RHS)
340
7%
310
6%
280
5%
250
4%
220
3%
190
2%
160
1%
130
IMF forecasts
0%
100
-1%
70
1989
1993
1997
2001
2005
2009
2013
2017
2021
Source: Credit Suisse Global Emerging Markets Strategy research
More timely indicators of emerging market relative economic momentum, such as the PMI
differential with developed markets, have also improved. GEM equities have normally
followed PMI new orders versus the developed world.
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2 December 2016
Figure 367: GEM relative performance versus PMI
differentials
15
Manufacturing PMI new orders, EM relative to DM,lhs
GEM, relative to global (y/y, rhs)
35%
10
5
Figure 368: GEM manufacturing PMI new orders
have continued to rise
2
GEM manufacturing PMI new orders, z-score
25%
1
15%
0
5%
-1
0
-5%
-2
-5
-10
2006
LatAm
NJA
EMEA
-15%
-25%
2007
2009
2011
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
-3
2007
2008
2010
2011
2013
2014
2016
Source: Thomson Reuters, Credit Suisse research
As relative economic momentum has picked up, so has earnings momentum. Indeed, the
right hand side chart below shows that GEM equities should have performed better given
the sharp improvement in earnings revisions.
Figure 369: GEM earnings revisions (absolute and
relative to global)
GEM: 13-week earnings revisions
40%
Figure 370: GEM earnings revisions versus GEM
equities
GEM 13w earnings revisions yoy (abs)
rel Global
GEM equity market perf, $ terms, yoy (%), rhs
100%
30%
20%
120
80%
100
60%
80
10%
40%
60
0%
20%
40
0%
20
-10%
-20%
-30%
-40%
-50%
2002
2004
2006
2009
2011
Source: Thomson Reuters, Credit Suisse research
2013
2016
-20%
0
-40%
-20
-60%
-40
-80%
-60
-100%
2002
2004
2006
2008
2010
2012
2014
-80
2016
Source: Thomson Reuters, Credit Suisse research
3.
Emerging markets have plenty of policy response potential
In the developed world, conventional monetary flexibility is largely used up. Emerging
markets, on the other hand, typically have more clear-cut policy flexibility, and in some
cases the scope for easing of monetary conditions is sizeable.
Global Equity Strategy
178
2 December 2016
We believe that investors have under-estimated the disinflationary forces within emerging
markets, which should allow rates to fall. These disinflationary forces arise from:
i.
China exporting its excess investment on an artificially low cost of capital; and
ii.
Disruptive technology (e.g. online retail sales and services, the general move
towards a sharing economy and the use of mobile banking for those people
without a bank account) brings corporates and consumers into the formal
economy and allows a much greater access to efficient financial products.
Emerging markets have a less well developed physical infrastructure and thus the
disinflationary impact of disruptive technology is likely to be higher.
Figure 371: In a number of emerging markets, there
is significant scope for central banks to cut rates…
Figure 372: …and for real government bond yields
to fall
Nominal rate less 3mma CPI inflation rate
Central bank policy rate (%), versus 10 year range
18
Real government bond yield (10-yr, %) versus 10 year range
12
16
8
14
12
4
10
8
0
6
-4
4
2
-8
Source: Thomson Reuters, Credit Suisse research
*reduced history
Chile *
Japan
India
US
China
Turkey *
Russia
Brazil
Poland
South Africa
*reduced history
-12
Mexico
Japan
US
Poland
Chile
China
Mexico
Indonesia
Turkey*
India
South Africa
Russia
Brazil
-2
Indonesia
0
Source: Thomson Reuters, Credit Suisse research
As importantly, emerging markets outperform when rates fall. A fall in real rates from high
levels signifies a risk-on environment, re-rates assets and earnings streams in general and
alleviates funding concerns.
Further, in the case of financials, there is a benefit from a fall in rates – in contrast to DM
financials. Not only does the fall in rates help improve loan growth and loan quality but it is
possible to expand NIMs as rates fall from high levels. Indeed, in the case of DM
financials, it was only when rates fell below 3% that the sector tended to suffer from a
further fall in yields.
Global Equity Strategy
179
2 December 2016
Figure 373: DM banks have only recently recorded a
positive correlation with interest rates…
Correlation coefficient
18
-0.15
15
+0.2
Figure 374: …and the correlation between banks
and rates in most GEMs remains strongly negative
0.2
Banks' relative performance, 10-yr correlation with bond yields
0.1
16
13
14
11
-0.1
12
9
-0.2
10
7
8
5
-0.5
3
-0.6
0
-0.3
1995
2000
2005
2011
Source: Thomson Reuters, Credit Suisse research
Turkey
Russia
Indonesia
India
China
2016
South Africa
1990
Poland
1
1985
Brazil
US 10-year bond yield, %, rhs
4
1980
Chile
Mexico
US banks rel market
6
-0.4
Source: Thomson Reuters, Credit Suisse research
In addition, the emerging market public sector is generally not significantly leveraged, and
government debt-to-GDP is, in most cases, still relatively low, leaving space for greater
public fiscal flexibility. Aggregate public sector debt in emerging markets is just 43% of
GDP, compared to over 100% in the developed world.
Figure 375: In the majority of emerging markets,
government debt as a share of GDP is low…
140%
GEM countries government debt to GDP
120% 233%
Figure 376: …unlike developed markets, where
public debt levels have risen significantly
120%
Public debt, % GDP
Developed
100%
GEM
100%
80%
80%
60%
EM aggregate
40%
60%
20%
Japan
United States
United Kingdom
Hungary
Brazil
Mexico
Poland
Malaysia
South Africa
India
China
Argentina
Korea
Turkey
Czech Republic
Thailand
Indonesia
Saudi Arabia
Russia
0%
Source: Thomson Reuters, Credit Suisse research
40%
20%
1990 1992 1995 1997 2000 2002 2005 2007 2010 2012 2015
Source: Thomson Reuters, Credit Suisse research
Contrary to the experience of developed markets in the wake of the financial crisis, releveraging in EMs has largely been driven by the private – not the public – sector. While
the worry is the build-up of private sector debt within GEM, aggregate leverage for the
level of GDP per capita is only particularly high in China.
Global Equity Strategy
180
2 December 2016
Figure 377: Post-crisis re-leveraging in EMs has
largely been driven by the private sector…
Figure 378: …but only China appears overleveraged
180%
450%
GEM debt
160%
Belgium
Private debt to GDP
140%
Japan
400%
Total debt to GDP
350%
Public debt to GDP
120%
Total debt, % of GDP
300%
100%
Canada
France
Netherlands
Denmark
US
Sweden
Italy HK
Singapore
Austria
Australia
UK
Finland
Spain
China
250%
Korea
200% Malaysia
Hungary
Thailand
Brazil
Poland
150%
Czech
South Africa
Turkey Republic
100% India
Mexico
Russia
50% Indonesia
80%
60%
40%
20%
0%
1995
1997
2000
2002
2005
2007
2010
2012
0%
2015
Source: Thomson Reuters, Credit Suisse research
Germany
0
10,000
20,000
30,000 40,000
GDP per capita
50,000
60,000
70,000
Source: Thomson Reuters, Credit Suisse research
4.
GEM equity valuations look attractive
On a sector-adjusted basis, GEM equities trade at around an 18% P/E discount to DM
equities, towards the lower end of their 10-year range. The following sectors trade on both
a P/E discount to their developed world peers and a larger discount than has been the
case historically (i.e. they are in the bottom left hand quadrant of the chart below):
materials, banks, diversified financials, transport, capital goods, commercial services, tech
hardware, utilities and food/beverages/tobacco.
Figure 379: GEM equities trade only slightly above
their 10-year low on sector-adjusted P/E relative to
DM
110%
Figure 380: More GEM sectors trade on a discount
to their DM peer group than a premium
GEM sector-adjusted 12m fwd P/E rel Dev.World
25%
Cons Dur/App
Average (+/- 1SD)
Retailing
EM / DM, deviation from 10-yr average
100%
90%
80%
70%
15%
5%
-5%
Semi
Auto
Pharm/Biotec
Consr Svs
H/C Eq/Svs
Materials
Fd/Bev/Tob
S/W & Svs
Transpt
Fd/Drug Rtl
H Pers Prd
-15%
Banks Tch H/W/Eq
Capital Goods
Coml Svs/Sup
-25% Utilities
60%
50%
40%
1996
Media
T/cm Svs
Div Fin
-35%
-50%
1999
2002
2005
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2008
2011
2015
-30%
-10%
Insurance
10%
30%
50%
70%
EM / DM, 12m fwd P/E
Source: Thomson Reuters, Credit Suisse research
181
2 December 2016
GEM equities look particularly cheap on trend earnings measures. On a price to book
basis, emerging market equities trade on a 29% discount to developed market equities,
close to the lower end of their 10-year range. Similarly, a Shiller P/E approach shows GEM
equities to be at financial crisis-type valuations, and at a substantial valuation discount to
the US.
Figure 381: The P/B of emerging markets is trading
at a discount of 29% relative to DM
1.4
MSCI EM P/B rel DM
Figure 382: GEM equities are very depressed on
Shiller P/E relative to the US
30
Average +/- 1 Stdev
US: Shiller's P/E = 26.1x
GEM: Shiller's P/E = 9.2x
1.3
25
1.2
1.1
20
1.0
0.9
15
0.8
0.7
10
0.6
0.5
0.4
2000
2002
2004
2006
2008
2010
2012
2014
5
2005
2016
Source: Thomson Reuters, Credit Suisse research
2006
2008
2009
2011
2013
2014
2016
Source: Thomson Reuters , Credit Suisse research
5.
Equities have lagged behind bond spreads
Not only are equities cheap, but they have also lagged behind other EM assets. The
relative performance of GEM equities typically follows the EMBI spread, but has this time
significantly lagged behind the tightening of EM bond spreads from their peak.
Figure 383: GEM equities have underperformed by more than the EMBI spread
would imply
2.7
4.8
S&P 500 / MSCI EM
EMBI spread, rhs
2.5
4.3
2.3
3.8
2.1
3.3
1.9
2.8
1.7
Sep-14
2.3
Dec-14
Mar-15
Jun-15
Oct-15
Jan-16
Apr-16
Jul-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
182
2 December 2016
6.
Still under-owned
Although inflows to emerging market equity funds have picked up from to a 2-year low
relative to developed market funds, they remain relatively muted, especially after recently
having returned to seeing outflows. Furthermore, and most importantly, investments in
GEM equity funds (at cost value) are still down over 50% from peak levels.
Figure 384: GEM relative to global equity funds:
3-month annualized flows
40%
GEM vs global equity funds: 3-month annualized inflows, relative to
net assets
30%
Figure 385: Cumulative flows into GEM equities are
down over 50% from their peak
290k
Cumulative flows into GEM equity funds, USD million
240k
20%
190k
10%
140k
0%
90k
-10%
-20%
40k
-30%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
-10k
2001
Source: EPFR Global, Credit Suisse research
2003
2005
2007
2009
2011
2013
2015
Source: EPFR Global, Credit Suisse research
Our recent investor survey highlighted that there remains a mismatch between short- and
long-term views of emerging markets. Just under a third of survey respondents expected
EM to be the best performing region on a 3-month view and 38% on a 12-month view.
However, 51% of respondents think this will be the case on a 5-year view. We think this
mismatch between shorter- and longer-term views can continue to drive further allocation
to EM equities.
Despite positive views on EM equities, respondents were not particularly bullish of EM FX,
with nearly half thinking the USD will be the best-performing currency over the next 12
months. We think currencies have significant scope to strengthen further, which should
help drive returns.
Global Equity Strategy
183
2 December 2016
Figure 386: Investors have warmed up on GEM in
the near term…
50%
Proportion of respondents who believe GEM will be the bestperforming region over the next 3 months
Figure 387: ...but despite this, there is a still a
mismatch between how investors are positioned on
a 3- or 12-month view in GEM and on a 5-year view
60%
Which equity market will show the strongest performance (in lc
terms) over the next…
12 months?
5 years?
51%
50%
40%
38%
40%
30%
30%
20%
20%
25%
24%
20%
14%
10%
10%
12%
5%
7%
4%
0%
0%
Aug-12
Mar-13
Oct-13
May-14 Dec-14
Jul-15
Source: Credit Suisse Global Equity Strategy Investor Survey (October)
7.
Feb-16
Sep-16
Continental
Europe
UK
US
Japan
Emerging
Markets
Source: Credit Suisse Global Equity Strategy Investor Survey (October)
In some instances, and in contrast to DMs, politics is becoming more stable
Some of the major emerging market countries have recently seen their political
environment improving or remaining more or less stable. In general the politics of the
emerging markets is about de-regulation (for example, in Brazil, India, Indonesia). This is
in contrast to the developed countries where domestic politics is increasingly dominated by
populist rhetoric.
The problem in developed markets is that the political debate is focusing more on
measures that appear negative for growth and profits. An increase in protectionism,
reshoring, a rise in minimum wages and limits to immigration (when immigration has
driven in the US around half the rate of growth of the labour force) are likely negative for
growth and thus earnings.
We list in the appendix some of the positive developments in specific emerging market
countries which we feel may be under-appreciated.
8.
Our GEM strategists' model gives c.8% upside potential for 2017
Our GEM equity strategists' four-factor macroeconomic regression model for emerging
market equities (based on the US dollar trade-weighted, ISM new orders, global industrial
production growth and CRB metals prices) suggests c.8% potential upside to MSCI EM by
year-end 2017.
Global Equity Strategy
184
2 December 2016
Figure 388: Multi factor regression model for MSCI
EM
Model inputs
Coeff. P-value Current Scenario Upside
from
24 Nov y/e 2017
Figure 389: Predicted versus actual MSCI EM
1500
Predicted MSCI EM
current
US$ TWI
-0.62
0.000
101.3
103.3
2.0%
ISM New orders
0.77
0.000
52.1
57.0
4.9 ppt
Global IP, % yoy
1.05
0.000
1.3%
2.7%
135 bps
CRB metals^, SDR
0.55
0.000
523
523
–
1300
Actual MSCI EM
1100
900
MSCI EMF
24 Nov
y/e 2017
Adj R square:
0.73
Current
852
852
Observations:
Intercept
250
0.00
Predicted
Upside %
983
15.4
923
8.3
700
500
300
^ Equally weighted index of Copper, Steel, Zinc, Lead and Tin
100
Jan 96 Jan 99 Jan 02 Jan 05 Jan 08 Jan 11 Jan 14 Jan 17
Source: Credit Suisse GEM Equity strategy team research, Thomson Reuters, Credit Suisse
research
Global Equity Strategy
Source: Credit Suisse GEM Equity strategy team research, Thomson Reuters, Credit Suisse
research
185
2 December 2016
How to play this?
1.
Local currency GEM debt
Below we discuss our preferred GEM country investment strategies in more detail, but we
stick to our view that, in absolute terms, one of the most attractive asset classes is local
currency denominated GEM debt. Real rates remain abnormally high in either an historical
or global context, and, as already highlighted above, for the most part GEM currencies are
cheap.
Real bond yield, standard deviations from 10 year avg
Figure 390: Local currency real bond yields are
higher than their historical average in many EM
countries
Figure 391: Emerging market real yields are
elevated relative to the US
Real 10-year bond yield gap between EM7* and the US (in pp)
Average
Poland
1.0
India
0.5
Russia
Indonesia
Mexico
3.5
Malaysia
South Africa
0.0
3.0
Hungary
China
Philippines
-0.5 Taiwan
Czech
-1.0 Republic
*simple average of respective data for Brazil, Indonesia, Mexico,
Poland, Russia, South Africa, Turkey
2.5
2.0
South Korea
-1.5
1.5
Brazil
-2.0
-1
0
1
2
3
Current real bond yield (%)
Source: Thomson Reuters, Credit Suisse research
4
5
1.0
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.
Companies that have high GEM exposure but limited exposure to China
Below we screen for European companies with high GEM sales exposure but less than
15% sales to China that are Outperform-rated by our analysts (with a market cap above
$5bn). Of these stocks, Erste, Nokia, BAT Vodafone, Reckitt, ENEL, Assa Abloy and
Sanofi are cheap on HOLT.
Global Equity Strategy
186
2 December 2016
Figure 392: European companies with high GEM sales exposure but less than 15% sales to China that are
Outperform-rated by our analysts (with a market cap above $5bn)
-----P/E (12m fwd) -----Sales
Exposure to
GEM
YTD rel
performance
(%)
Abs
rel to
Industry
Sgs 'N'
79%
14%
22.7
Technip
76%
47%
17.5
Bureau Veritas Intl.
67%
2%
Erste Group Bank
65%
Nokia
HOLT
2016e, %
------ P/B -------
2016e Momentum, %
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
123%
4%
8.0
47%
3.9
3.4
-14.7
-1.1
-0.5
3.2
Outperform
71%
13%
1.7
3%
3.6
3.0
-9.8
3.5
1.2
2.5
Outperform
17.5
95%
-9%
6.9
-4%
5.5
3.1
-21.5
-3.4
-1.3
2.8
Outperform
-4%
9.6
82%
-25%
1.0
14%
na
3.5
8.0
3.3
-0.5
2.3
Outperform
59%
-35%
16.3
121%
-40%
1.5
-34%
-5.0
4.4
72.0
-3.7
-1.7
2.2
Outperform
British American
TobaccoN
Sonova
57%
9%
15.7
90%
-2%
16.8
135%
4.0
3.7
2.8
2.0
2.7
2.1
Outperform
47%
5%
19.8
121%
-11%
4.3
0%
6.1
1.8
-5.6
-1.5
4.4
3.0
Outperform
Pernod-Ricard
45%
0%
17.5
87%
1%
2.0
17%
5.2
1.9
-15.2
-0.1
-0.8
2.5
Outperform
Vodafone Group
37%
-18%
30.3
218%
93%
0.5
-30%
6.3
6.4
42.8
-6.1
2.0
2.3
Outperform
Airbus Group
36%
4%
16.6
98%
4%
7.9
192%
1.7
2.2
-41.8
-3.1
-0.9
2.1
Outperform
Diageo
36%
0%
18.8
93%
5%
6.0
9%
4.1
3.0
-36.3
0.7
1.2
2.3
Outperform
Philips
Eltn.Koninklijke
L'Oreal
35%
23%
15.8
93%
10%
2.2
65%
5.5
2.9
-18.5
0.2
-0.2
2.3
Outperform
33%
10%
23.4
115%
0%
3.8
37%
2.8
2.0
-30.7
-0.5
0.0
2.8
Outperform
Reckitt Benckiser
Group
Vopak
32%
-1%
20.2
99%
3%
7.0
44%
3.3
2.2
14.6
0.9
1.1
2.1
Outperform
29%
18%
15.9
64%
-4%
2.8
16%
3.6
2.5
-13.3
4.8
0.4
2.6
Outperform
Casino Guichard-P
29%
7%
13.8
81%
-2%
1.1
2%
-4.1
7.1
-71.1
-10.0
0.2
2.6
Outperform
Experian
26%
15%
19.1
103%
7%
5.2
93%
5.6
2.2
-32.2
-1.7
-0.3
2.2
Outperform
Enel
26%
2%
10.9
72%
-4%
1.1
2%
13.9
4.8
61.1
2.3
-0.7
1.7
Outperform
Dassault Systemes
25%
5%
27.2
136%
14%
5.3
59%
3.4
0.7
-0.9
1.0
0.1
2.8
Outperform
Wpp
25%
1%
13.7
75%
-2%
2.9
93%
6.5
3.2
-1.3
4.2
2.0
2.1
Outperform
Prysmian
24%
15%
14.2
83%
12%
3.7
23%
8.4
2.1
-3.3
-0.9
-1.0
1.9
Outperform
Sanofi
23%
2%
13.7
95%
13%
1.7
27%
7.0
4.0
15.0
1.7
-0.7
2.5
Outperform
Assa Abloy 'B'
21%
-5%
21.1
124%
21%
5.2
85%
3.5
1.7
7.1
-2.3
-0.6
2.5
Outperform
Name
Consensus
recommendation Credit Suisse rating
(1=Buy; 5=Sell)
Source: Company data, MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
We also screen for US stocks that have significant GEM sales exposure but no more than
15% of sales to China and are Outperform- or Neutral-rated by Credit Suisse analysts
(with a market cap above $5bn). Of these stocks, Delta Air Lines, Activision Blizzard,
Pfizer, Ingredion and Citigroup look cheap on HOLT and are Outperform-rated.
Figure 393: US stocks that have significant GEM sales exposure but no more than 15% of sales to China
and are Outperform-rated by Credit Suisse analysts
-----P/E (12m fwd) -----Sales expsoure
to GEM
YTD perf rel
mkt ($)
Abs
rel to
Industry
rel to mkt %
above/below
average
Kansas City
Southern
Kla Tencor
48%
10%
17.2
106%
-22%
45%
11%
14.8
93%
-34%
Delta Air Lines
32%
-11%
9.3
57%
-37%
E I Du Pont De
Nemours
Jetblue
Airways
30%
-1%
19.1
114%
30%
-15%
10.6
Activision Blizzard
27%
-10%
Philip Morris Intl.
25%
Pfizer
2016e, %
------ P/B -------
HOLT
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
2.4
21%
2.9
1.5
18.6
234%
6.3
2.6
3.5
-74%
12.6
26%
6.3
60%
66%
-49%
2.1
16.9
85%
-16%
-5%
18.5
106%
23%
-9%
12.1
Ingredion
18%
16%
Boeing
18%
Emerson Electric
Name
Abs
2016e Momentum, %
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
3m EPS
3m Sales
-6.9
-4.3
-0.4
2.6
Neutral
-0.6
13.4
5.0
2.7
Outperform
1.4
12.2
-4.6
-1.1
1.8
Outperform
4.9
2.3
-20.1
2.0
-0.7
2.3
Neutral
90%
0.6
0.0
76.7
-1.1
0.4
2.2
Neutral
3.4
-39%
3.9
0.7
46.9
4.7
0.3
1.9
Outperform
8%
-10.5
na
5.0
4.6
-40.5
0.5
-0.7
2.2
Neutral
83%
2%
3.0
54%
5.8
3.8
12.9
-1.9
0.0
2.4
Outperform
15.8
81%
11%
4.0
124%
na
1.6
10.7
3.8
0.7
2.1
Outperform
-4%
16.3
96%
2%
15.8
16%
7.8
2.9
-0.1
12.3
0.3
2.4
Neutral
17%
6%
22.2
130%
29%
4.7
40%
5.6
3.5
-24.9
-22.0
-27.7
3.2
Neutral
Biomarin Pharm.
16%
-22%
-67.6
nm
na
6.0
4%
na
0.0
-62.0
nm
-1.2
1.8
Outperform
Citigroup
15%
0%
11.2
95%
-49%
0.8
5%
na
0.7
38.7
1.4
0.7
2.0
Outperform
Fluor
14%
6%
18.8
110%
4%
2.5
-4%
7.4
1.5
52.3
-29.3
-1.9
2.9
Neutral
Source: Company data, Credit Suisse US Equity Strategy team, MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
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2 December 2016
3.
Quality, high-yielding GEM listed stocks
With GEM government bond yields having declined, companies offering relatively low-risk
dividend yields are likely to remain in focus. Below we screen for those companies listed in
emerging markets with an eCap award from HOLT, with a full covered dividend yield
above 3% and an Outperform rating. We would highlight FGI group, TSMC, Padini and
Walmart, all of which have positive earnings revisions and are cheap on HOLT.
Figure 394: High-yielding quality GEM stocks with Outperform ratings
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
Country
eCap Award
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
Zhengzhou Yutong Bus 'A'
China
X
10.7
63%
-31%
3.6
25%
na
6.0
na
1.2
0.1
1.5
Outperform
Coca-Cola Femsa Sab De Cv
Sr.L AdrGroup
1:10
Lenovo
Mexico
X
18.2
90%
-7%
2.2
1%
na
3.4
na
-20.3
-4.7
2.8
Outperform
China
X
9.8
73%
-51%
2.3
-22%
1.6
4.4
546.3
-4.8
0.0
3.0
Outperform
Catcher Technology
Taiwan
X
8.1
60%
-34%
1.5
-21%
8.8
4.5
105.7
-4.8
-0.8
2.8
Outperform
Indonesia
X
11.0
61%
-26%
1.8
-40%
13.1
3.8
74.8
-5.3
-1.7
3.0
Outperform
Fuyao Glss.Ind.Group 'A'
China
X
13.9
149%
-9%
2.8
-8%
na
4.1
68.3
1.9
0.3
1.9
Outperform
Taiwan Semicon.Mnfg.
Taiwan
X
13.2
83%
-13%
3.9
48%
3.9
3.5
52.6
4.3
2.4
2.2
Outperform
Padini Holdings
Malaysia
X
11.3
48%
6%
4.0
86%
6.8
3.8
49.4
8.7
3.5
1.9
Outperform
Advanced Info Ser.
Thailand
X
14.1
101%
-14%
8.9
15%
3.8
7.2
41.0
-3.5
-1.4
2.2
Outperform
Novatek Microels.
Taiwan
X
12.0
75%
-5%
2.3
-5%
na
7.1
20.7
-5.6
-1.6
2.8
Outperform
Makalot Industrial
Taiwan
X
14.3
86%
11%
2.7
-5%
12.9
6.6
16.6
-12.4
-5.7
3.4
Outperform
Kt & G
Korea
X
12.2
70%
-12%
2.1
14%
na
3.5
7.8
-5.7
-0.4
2.0
Outperform
Indonesia
X
17.6
74%
-32%
37.2
45%
7.6
3.4
7.1
-2.5
-1.8
2.2
Outperform
Walmart De Mexico 'V'
Mexico
X
21.2
124%
-16%
4.3
11%
8.4
4.5
4.0
2.4
-0.6
2.2
Outperform
Bolsa Mexicana De Valores
Mexico
X
16.0
107%
-24%
3.0
39%
11.5
4.2
-1.0
0.9
0.5
2.4
Outperform
Delta Electronics
Taiwan
X
18.8
139%
4%
3.3
15%
5.3
3.2
-4.3
-1.9
-0.9
2.2
Outperform
St Shine Optical
Taiwan
X
15.8
96%
-18%
6.9
38%
na
4.1
-6.0
-0.4
0.2
2.5
Outperform
India
X
12.7
51%
-10%
5.7
24%
2.2
6.2
-7.7
-10.0
-4.5
2.2
Outperform
Taiwan
X
19.0
113%
-20%
7.0
100%
3.6
3.0
-15.3
-13.2
-7.3
2.1
Outperform
Name
Semen Gresik
Matahari Department Soe.
Coal India
Eclat Textile
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: Company data, MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
4.
Focus on DM Banks with GEM exposure
Most developed market banks with EM exposure have underperformed their emerging
market peers year-to-date.
Figure 395: GEM and GEM-related banks price relative to global banks
Relative to Global Banks, (2016 = 100), (in USD terms)
130
Santander
Standard Chartered
HSBC
GEM banks
BBVA
120
110
100
90
80
70
Jan-16
Mar-16
May-16
Jul-16
Sep-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
In addition, they appear cheap on a sum-of-the-parts basis.
Global Equity Strategy
188
2 December 2016
Figure 396: On a regional-weighted P/B basis, Standard Chartered, SAN, Citigroup, BBVA, Unicredit and
HSBC appear relatively inexpensive
Bank
Emerging market revenue exposure
Unicredit
23% Central and Eastern Europe
Standard Chartered
92% (72% NJA, 20% Africa & Mid. East)
Santander
BBVA
YTD Price perf
rel local mkt
YTD weighted price perf by
YTD Price perf
regional exposure rel to resp.
rel Global Banks
regional banks
Price to Book
PB disc/prem to
the relevant bank
sectors
Credit Suisse
rating
-49%
-64%
-32%
0.2
-58%
Neutral
3%
-9%
-5%
0.7
-33%
Underperform
37% LatAm (7% Mexico and 30% Brazil)
3%
-12%
-10%
0.7
-31%
Neutral
39% LatAm (29% Mexico)
-3%
-17%
-2%
0.8
-31%
Neutral
Citigroup
31.5% (15% Asia, 13% EMEA, 4% LatAm)
0%
4%
-3%
0.8
-28%
Outperform
HSBC
26% Hong Kong, 17% NJA, 8% LatAm
Erste Bank
68% Eastern Europe
8%
-4%
2%
1.0
-6%
Neutral
-14%
-15%
-14%
1.0
1%
Outperform
3%
1.9
34%
Neutral
Swedbank
25% Eastern Europe
11%
0%
Note: The discount/premium is calculated over the regional banks P/B ratios, weighted by the exposure of each bank to that region
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
189
2 December 2016
Country selection
The correlation between GEM equity markets has fallen to more normal levels suggesting
that country selection is becoming more important.
Figure 397: Correlation between GEM countries has fallen, suggesting country
picking is becoming more important
0.5
0.7
0.9
1.1
1.3
1.5
1.7
6-month correlation among emerging markets (proxied by
the standard deviation of performance, adjusted for
market volatility, inverted)
1.9
2.1
Nov-96
Nov-98
Nov-00
Nov-02
Nov-04
Nov-06
Nov-08
Nov-10
Nov-12
Nov-14
Nov-16
Source: Thomson Reuters, Credit Suisse research
Our GEM Equity Strategy team led by Alexander Redman are overweight China, Korea,
Brazil and Indonesia. For their broader EM equities view, please see Global EM Equity
Strategy – 2017 outlook: Staying the course, 01 December. Within Asia, Sakthi Siva is
overweight Taiwan and Korea (her biggest overweights). From our perspective, we adopt
a relatively simple quant approach to country selection, which we discuss below, before
highlighting some of the countries and regions where we think opportunities exist in more
detail in the sections that follow.
Our top down approach is built around three scorecards (all of which are shown in full in
the appendix). These assess currency valuation, equity market valuation and economic
balance sheet. We favour those GEM countries that have the following characteristics:
■ Cheap currencies: We assess this on the basis of the deviation of REER from longterm trend, real bond yields, the Economist's Big Mac index deviation from PPP, and
IMF PPP deviation from long-term average. The cheapest currencies currently belong
to Mexico, Malaysia, Poland, Russia, and South Africa.
■ Cheap equity markets: We assess this by looking at the 12-month forward P/E, P/B
and DY relatives to the world market versus their long-term averages. The cheapest
equity markets currently are Poland, Russia, China, Korea, Czech Republic and
Taiwan.
■ Good macro fundamentals: We base our macro fundamental assessment on
external balance sheets, i.e. on current account, net foreign assets, portfolio inflows,
FX reserves less financing needs (all expressed as a share of GDP) and internal
leverage (credit to GDP versus trend).
Global Equity Strategy
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2 December 2016
■ Spare capacity in the labour market: We prefer to invest in economies where there is
some spare capacity in the labour market (proxied by unemployment rate's deviation
from average).
■ Relatively low exposure to China which we proxy by looking at exports to China as a
percentage of GDP.
Until 2016, we had a bias to commodity importers; this is now neutralized given our slightly
more constructive view on commodity prices.
We bring these factors together in our composite country scorecard, and this highlights
Russia, Taiwan, Czech Republic, Poland and Malaysia.
Figure 398: Emerging markets composite scorecard
Country
Currency
Equity valuation (zvaluation (zscore)
score)
Overheating
(Unemployment dev
from average)
External/Internal
vulnerability (zscore)
Exposure to China
as % of GDP
Net commodity
imports (% of
GDP)
Weighted zscore
Weight
25%
25%
15%
25%
10%
0%
100%
Russia
0.91
0.92
-13%
0.22
2%
-17%
0.48
Taiwan
0.40
0.38
-9%
1.50
13%
8%
0.39
Czech Republic
0.44
0.14
12%
-0.28
1%
4%
0.33
Poland
1.32
0.94
-30%
-0.50
0%
0%
0.29
Malaysia
-0.04
0.97
4%
0.14
9%
-5%
0.25
Turkey
0.26
0.37
13%
-0.91
0%
2%
0.22
South Africa
-0.38
0.76
11%
-0.50
3%
-4%
0.17
Korea
0.66
-0.72
8%
0.62
10%
8%
0.15
Mexico
-0.49
1.18
-12%
-0.59
0%
0%
0.04
Hungary
-0.55
0.52
-47%
0.87
1%
3%
0.04
China
0.76
-0.29
-2%
-0.07
na
4%
0.01
India
-0.40
0.14
-10%
-0.13
0%
4%
-0.05
Chile
0.09
-0.20
-9%
-0.21
7%
-16%
-0.19
Brazil
-0.64
-0.61
-11%
-0.30
2%
-4%
-0.39
Indonesia
-1.20
0.75
-22%
-0.66
2%
-4%
-0.39
Philippines
-0.90
-0.20
-23%
-0.21
2%
3%
-0.47
High z-scores are desirable: cheap markets, cheap currency, low overheating risk, open economy, low exposure to China and a net commodity importer (All z-scores are
capped at +/- 1.5 standard deviation)
Source: Thomson Reuters, Credit Suisse research
China: selectively overweight
We recommend a selective overweight of Chinese equities (excluding financials). Our
China strategists have revised up their 2017 SHCOMP target to 3800 (c20% upside) and
HSCEI to 10,500 (c10% upside). Our GEM equity strategy colleagues are also overweight
Chinese equities as is Sakthi Siva, our Asia strategist. We like them for the following
reasons:
1.
Excess liquidity remains supportive
The key positive is that excess liquidity (which we proxy by looking at money supply
growth less nominal GDP growth) in China is highly supportive of a rise in the equity
markets. Currently, excess liquidity is increasing at 17% Y/Y, while Shanghai A's Y/Y
performance is still negative.
Global Equity Strategy
191
2 December 2016
Figure 399: Excess liquidity has now begun to rise and is now supportive
25
Chinese M1 growth - nominal GDP growth
300
Shanghai A y/y % change, rhs
20
250
15
200
10
150
5
100
0
50
-5
0
-10
-50
-15
1997
-100
1999
2002
2005
2008
2010
2013
2016
Source: Thomson Reuters, Credit Suisse
2.
There is a lack of investment alternatives beyond equities
We believe that Chinese investors alternative avenues for investment are now limited,
leaving this excess liquidity little option but to go into equities. The main alternative
avenues for investment have been:
■ Property: The government is aggressively tightening up on property regulations and
as a result property turnover is falling.
■ Wealth Management Products. In October, PBoC asked commercial banks to count
the once off-balance sheet wealth management products to be part of "broad credit" in
the Macro Prudential Assessment. While our strategists think this will not cause a
significant change in banks' behaviour in the short term, the days of very strong growth
have passed. In fact, there are already signs of slowdown: issuance of property backed
trust products is down 25% since the start of October.
■ Flows overseas. Again this has become much harder as the government has
tightened up the capital account amid worries about declining FX reserves.
Global Equity Strategy
192
2 December 2016
Figure 400: Growth in wealth management products
is slowing sharply
Figure 401: The government has tightened up on
hot money outflows
4%
2.5%
2.0%
2%
1.5%
1.0%
0%
0.5%
-2%
0.0%
-0.5%
-4%
-6%
-1.0%
-1.5%
Hot money flow as % of GDP, 4Q MA
-2.0%
Net errors & omissions as % of GDP, 4QMA, rhs
-8%
2001
Source: Credit Suisse GEM Equity strategy team research
-2.5%
2003
2005
2007
2009
2011
2013
2015
Source: : Credit Suisse GEM Equity strategy team research
■ Corporate bond yields: Not only are they close to historic lows at just 3.9%, but
issuance is also slowing (with a ban on corporate bond issuance for property
developers, for example).
3.
Some signs that inflation is rising and real rates are turning negative,
something which tends to push investors into equities or property
PPI inflation has turned positive for the first time in nearly 4.5 years, and this should
modestly drive down real rates and in turn lead individuals to seek a hedge against
inflation (i.e. normally equities or property, although we note that the latter is seeing a
strong degree of tightening). Money supply growth would imply inflation should accelerate
further still, as shown below.
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2 December 2016
Figure 402: PPI have turned positive for the first
time in 4.5 years
15
PPI, yoy %
Figure 403: Money supply growth imply a small
pick-up in inflation
10
CPI, yoy% - rhs
8
35
11
China M1 growth, 6 months
lead, yoy%
30
9
CPI, yoy% - rhs
10
6
5
4
2
0
0
-5
-2
-10
2000
-4
2001
2003
2005
2007
2009
2011
2013
2015
Source: the BLOOMBERG PROFESSIONAL™ service. Credit Suisse
4.
25
7
20
5
15
3
10
1
5
-1
0
2000
-3
2001
2003
2005
2007
2009
2011
2013
2015
Source: the BLOOMBERG PROFESSIONAL™ service. Credit Suisse
Equities look cheap relative to corporate bonds
Equities look cheap, especially when compared with corporate bonds. The ratio of the
dividend yield to the corporate bond yields is near an all-time high, as illustrated below.
5.
Margin-financed speculative positions have unwound
There seems to have been a sharp unwind from last year's excess speculation, with
margin financing now much less extreme. Total outstanding margin purchases have more
than halved from 9.75% at the peak last July to the current level of 4.7%.
Figure 404: The earnings yield is no longer low
relative to the corporate bond yield
63%
58%
Ratio of Shanghai A DY vs
corporate bond yieds
Figure 405: Margin purchases are much less
extreme, but still remain somewhat high once we
adjust for free float market cap
10%
53%
9%
48%
8%
43%
7%
38%
Total outstanding margin purchase, % of free float market cap
(Shanghai & Shenzhen)
6%
33%
5%
28%
4%
23%
18%
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2014
2015
2016
3%
Jan-14
Jul-14
Feb-15
Sep-15
Apr-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
194
2 December 2016
6.
Cash flow and earnings momentum are improving
There are some signs of a recovery recently in both operating cash flow and relative
earnings revisions, which are now just positive relative to global markets. As PPI is turning
positive and gaining momentum, we would expect earnings to rebound further still.
Figure 406: Operating cash flow has shown some
recovery…
Figure 407: …as well as 3-month relative earnings
revisions
60%
100%
Shanghai A share: 13-week earnings revisions relative to global
Operating cash flow, YoY
80%
40%
60%
20%
40%
20%
0%
0%
-20%
-20%
-40%
-40%
-60%
2010S1
2011S1
2012S1
2013S1
2014S1
Source: Credit Suisse China Equity Strategy team
2015S1
2016S1
-60%
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
7.
Some progress in supply side reform
As discussed in the macro section, China has made good progress in reducing excess
capacity in the steel and coal sectors, according to our China material analyst, Trina Chen.
8.
MSCI Index inclusion and increased accessibility
The equity market in China is becoming more open with fewer restrictions. CSRC/SFC
approved the SZ-HK stock connect in mid-2016, removed the total quota for stock
connects and expanded the existing QFII/RQFII framework making it more flexible.
With increased accessibility, we believe China's weighting in MSCI index will increase over
time. Currently, China accounts for only 26% of MSCI EM index (through stocks listed in
Hong Kong and New York) with a market cap of nearly US$12trn (China, HK and ADR
combined). MSCI is proposing a 5% partial inclusion which approximates to around 1% of
the total MSCI EM weight. A full inclusion could mean a weight of 39%. The positive fund
flow story could support the Chinese equity market in the long term. Our China strategists
estimate US$2.2bn passive funds inflow with a partial inclusion, and more than US$40bn
fund inflow with a full inclusion (The dawn of the mega market, 23 September 2016)
Vincent Chan, in his 2017 market strategy outlook, highlights that he would prefer A to H
shares and old economy to new economy areas. (China-HK Market Strategy: Outlook for
2017)
On the global equity strategy team we find ourselves structurally
underweight Chinese banks
We have held a long-standing underweight of Chinese old economy financials, and would
continue to do so for the following reasons:
Global Equity Strategy
195
2 December 2016
1.
The credit bubble
China has seen its private credit to GDP ratio increase by 93 percentage points from
2011-2016. Only Ireland has experienced a bigger increase in a five-year period. China's
debt to GDP level is now 44 percentage points above trend, way beyond the 'danger point'
of 10 percentage points above trend identified by the BIS.
120%
100%
150%
40%
100%
20%
50%
0%
0%
USA 1951-60
140%
60%
120%
100%
1995
1997
2000
2002
2005
2007
Source: Thomson Reuters, Credit Suisse research
2010
2013
2015
Ireland 2003-08
160%
200%
China 2008-16
180%
250%
Spain 1996-10
200%
300%
641% / 1156%
80%
Thailand 1986-97
220%
Japan 1985-90
20-year trend
UK 1997-09
China: Total debt to GDP
240%
Max 7-year change private sector debt
to GDP (% point)
Peak in private sector debt (% of GDP),
rhs
Korea 1988-98
260%
Figure 409: The seven-year change in private sector
debt to GDP in China has been comparable to
Thailand and Spain prior to their crises
USA 1993-09
Figure 408: Total debt to GDP is now 44 percentage
points above trend
Source: Thomson Reuters, Credit Suisse research
2.
The property developers are underperforming
Typically one of the major sources of collateral for banks has been real estate, and thus
the two sectors have tended to be quite closely correlated. The property developers are
underperforming (and real estate turnover has peaked), which could create downside risks
for the Chinese banks.
Global Equity Strategy
196
2 December 2016
Figure 410: Chinese banks vs Chinese property
developers
MSCI China real estate, relative
to market
MSCI China banks, relative to
market
14.5
Figure 411: Banking profits as a % of GDP
2.0%
4.1
4.0
Bank's net profit as %
of GDP
1.5%
3.9
13.5
3.8
1.0%
12.5
3.7
3.6
11.5
3.5
0.5%
10.5
3.4
9.5
Jan-13
Jul-13
Feb-14
Aug-14
Mar-15
Source: Thomson Reuters, Credit Suisse research
Oct-15
Apr-16
3.3
Nov-16
0.0%
China
Japan
US
European Union
Source: Thomson Reuters, Credit Suisse research
3.
Profitability is threatened by competition and regulation
Our worry is that Chinese banks' profits appear to be abnormally high with profit as a
proportion of GDP more than triple that of banks in the US and EU. Their profitability is
likely to come under threat, in our view, from the ongoing deregulation of deposit rates and
the rise of internet banking (which has a greater reach than conventional banking, better
technology and may also be more trusted).
4.
NPLs have been under-estimated…
Currently, the official NPL ratio is 1.76%. In our judgement, the market is discounting NPLs
of c.12%, assuming a 50% coverage ratio. We reach that conclusion by noting that
Chinese banks trade on 2.6x pre-provisioning operating profits compared to a norm of 4.0x
since July 2006. A year of PPOP equates to 3.7% of total gross loans and thus by trading
1.4x PPOP below the norm, the market is suggesting that c5.2% of assets have to be
written off. This means, assuming a 50% recovery rate, NPLs will rise by an extra 10.4
percentage points to around 12%. The risk may be that the amount of NPLs being
discounted is less than this because deregulation means that the PPOP for reasons
described above are likely to fall.
This risk, in our judgement, is that NPLS end up rising to more than 12%. Twice NPLs
have risen to more than 20% in the past 30 years. Given the scale of the current credit
bubble, a sharp increase in NPLs above 20% is likely eventually, in our view, but only
when the four hard landing indicators which we identify elsewhere in this report flash rednone of this is happening now.
…and with this, zombie capitalism is a problem
As our Chinese strategists point out, corporate bond defaults are just 6% of US levels and
are just 0.01% of total corporates. At some point, NPLs will not be able to be rolled over
(we suspect that this will be the case when the loan to deposit ratio including the shadow
banks rises to above 100%).
We would, however, warn that investors ignored the dividend yield attractions of US and
European banks post 2005 and thus yield is probably unlikely to provide much support.
Global Equity Strategy
197
2 December 2016
Stocks:
Below we show our China equity strategists' top stock picks.
Figure 412: Vincent Chan's top stock picks
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
Name
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
Alibaba Group
Hldg.Spn.
Adr 1:1 Sctc.
Xinjiang Goldwind
24.7
123%
-18%
6.9
7.8
46%
-53%
1.8
'H' An Insurance 'H'
Ping
10.8
92%
-47%
Geely Automobile Hdg.
10.0
109%
China Resources Land
6.5
na
FCY
DY
14%
3.1
0.0
43%
-15.4
5.2
2.1
-19%
na
1.5
-5%
3.0
104%
1.8
-58%
1.1
-13%
2.4
HOLT
Price, %
change to
best
2016e Momentum, %
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
3m EPS
3m Sales
6.7
4.0
-0.4
1.8
Outperform
-1.8
-2.7
-2.7
2.3
Outperform
18.6
2.1
-2.6
1.7
Outperform
0.8
42.1
22.3
15.9
2.1
Outperform
3.5
-19.3
0.8
0.0
1.6
Outperform
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
198
2 December 2016
Korea: reducing to a small overweight
We reduce Korean equities to a small overweight for the following main reasons:
1.
A challenging external environment, especially with the weaker Yen
Competitive threat from Japan and China: With Korean companies closely competing
with corporates in Japan in several areas (including autos, consumer electronics, semis,
shipbuilding and steel, which account for c.40% of South Korean market cap), the
Yen/Won exchange rate is one of the key drivers of Korean equity market performance
relative to global markets. As we discuss in the currency section, we think that the Yen
could weaken substantially against most other currencies including the Won.
Figure 413: Korea is an export-oriented economy
Figure 414: When the Yen weakens against the
Won, Korea underperforms Japan
80
70
Exports of goods and services (% of GDP)
60
0.67
1600
0.62
1400
50
0.57
40
30
0.52
20
0.47
10
1200
1000
0.42
0
0.37
Korea relative to World
800
KRW/JPY (rhs)
0.32
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
600
Source: Thomson Reuters, Credit Suisse research
Our economists' view is that the RmB is going to weaken further over the next year. Given
the Chinese effort to move up the value chain and building up its own technological
brands, it is increasingly posting a competitive threat to Korean exports in the world market
and also may reduce the demand for Korean intermediate goods imports further.
There is a residual Trump threat, though probably not substantial. According to our
economist, Korea fulfils two of the three key criteria of the Trade Protection and Facilitation
Act of 2015 for being labelled as a currency manipulator (as it is running a trade surplus
with US larger than US$20bn and the Korean central bank is accumulating FX reserves).
2.
Growth outlook in both the near term and medium term remain challenging
Relative economic momentum has rolled over. Additionally, Christiaan Tuntono, our
economist, expects Korea’s potential growth trend to slide further to 2-2.5% over the
medium term on the basis of an ageing population, a rigid labour structure and an
inefficient non-trade service sector (Korea: potential growth trend continue to slide, 18
October 2016).
Structural reforms are needed to tackle these problems. However, the recent corruption
scandal involving President Park has shaken the confidence in her administration and may
divert domestic attention from the much needed reforms. Our economist remains doubtful
whether the President can regain the confidence before her term ends in January 2018.
Global Equity Strategy
199
2 December 2016
Figure 415: Korean PMIs suggests a slowdown in
growth
75
Korea manufacturing PMI new orders
70
Korea real GDP growth (%), rhs
Figure 416: Korea real retail sales have rolled over
as well
11
20%
Korean real retail sales (% chg yoy), 3mma
13
9
Korean nominal retail sales (yoy chg), rhs, 3mma
15%
65
7
60
8
55
5
50
3
45
5%
3
0%
1
40
-2
-5%
-1
35
30
2004
10%
-7
2002
-3
2005
2007
2009
2011
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
-10%
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
3.
Earnings revisions have rolled over
Korea's earnings momentum has also rolled over recently and has just turned negative
relative to the global market.
Figure 417: Korea's relative earnings momentum has been deteriorating
35%
South Korea: 3-month earnings revisions relative to Global
25%
15%
5%
-5%
-15%
-25%
-35%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
However, we remain a small overweight of Korea for the following reasons:
1.
Korea is a leveraged play on the global cycle
While we expect global growth to remain generally subdued, we would not be surprised to
see a small pick-up in global economic lead indicators. Korea equities have one of the
largest overweights of cyclicals globally and the third-highest operational leverage among
the major economies, making them very sensitive to the global economic cycle.
Global Equity Strategy
200
2 December 2016
Figure 418: Korea's equity market is unusually
skewed towards cyclical sectors
Figure 419: Korea has the third-highest operational
leverage among large economies
6
100%
5.7
90%
Beta of EPS to Global IP
5
80%
4.4
% of market cap in cyclical sectors
70%
4
60%
3.4
50%
3.0
3
40%
3.0
2.5
2.4
30%
2.4
2.4
2.0
2
20%
10%
1.7
1.5
1
Spain
Brazil
India
France
UK
China
Italy
US
Germany
Korea
Russia
Belgium
Israel
China
Russian Federation
Norway
Poland
Colombia
Indonesia
Brazil
Chile
Switzerland
Italy
Australia
United Kingdom
Canada
Malaysia
Turkey
Austria
Thailand
Philippines
Netherlands
Singapore
Hong Kong
Denmark
Mexico
New Zealand
Spain
South Africa
Greece
India
France
Luxembourg
United States
Sweden
Japan
Germany
Finland
South Korea
Taiwan
Peru
Source: Thomson Reuters, Credit Suisse research
0
Japan
0%
Source: Thomson Reuters, Credit Suisse research
2.
Corporate change might improve shareholder returns in the medium term
Korean equities have a payout ratio of below 20%, which is the lowest of all major global
equity markets.
We would, however, highlight while the scope for corporate change remains large, our
Korea strategist, Gil Kim, sees only modest follow-through after the SEC buyback
announcement.
Nevertheless, we do think it is an important signal that SEC, which is currently going
through a generational shift, has very recently committed to allocate 50% of free cash flow
to shareholder returns for 2016 and 2017, which is at the top of the 30-50% range
announced in 2015. For more details see Samsung Electronics - Quick Take: First
Impressions from shareholder return policy update, 29 November.
Figure 420: Korea has one of the lowest pay-out
ratios in the world…
Figure 421: … having risen, it has been stabilizing
80%
25%
70%
Payout Ratio
60%
50%
Korean pay-out ratio
20%
40%
30%
15%
20%
10%
10%
Brazil
Chile
Europe
South Africa
Taiwan
Thailand
Malaysia
Mexico
Indonesia
U.S.A
Poland
Philippines
Japan
China
India
Russia
Turkey
Korea
0%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
5%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
201
2 December 2016
3.
P/E relatives close to a 10-year low
In fact, Korea ranks as the fifth-cheapest equity market within EM on our traditional
valuations scorecard shown in appendix.
Figure 422: Korea is trading 0.4std below its
average P/E relative to other emerging markets
Figure 423: Korea's 12-month forward P/E relative to
global is trading 0.4std below its average
145%
120%
12m fwd P/E - Korea relative to GEM
Average (+/- 1SD)
135%
125%
100%
115%
90%
105%
80%
95%
70%
85%
60%
75%
50%
65%
40%
55%
30%
45%
1995
1998
2001
2004
2007
2010
2013
Source: Thomson Reuters, Credit Suisse research
2016
12m fwd P/E - Korea relative to global
110%
20%
1996
Average (+/- 1SD)
1998
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
4.
Korean equities continue to be unloved by investors
As we show in the Taiwan section below, Korea continues to be one of the largest
underweights of EM-focused funds.
5.
Easing of monetary and fiscal policy
Given the weak growth outlook, Christiaan Tuntono, our Korea economist, maintains his
view that the BoK will maintain loose monetary policy over the medium term. He also
expects greater government fiscal spending and subsidies in the government’s effort to
stabilize growth (Korea: Potential growth trend continues to slide, 18 October).
6.
Samsung
Samsung's recent recall of its Note 7 may have hurt investor sentiment towards Korean
equities given Samsung accounts for c.35% of MSCI Korea market cap. However, the
impact of the recent incident may be smaller than initially seems the case.
Samsung is still Outperform-rated by our analyst. The strength in Display and Memory
units has partly offset revenue lost due to the Note 7 incident (display panels, TV and
Monitors, Semiconductor devices together account for 46% of revenue), and the recall has
not seriously affected sales of other smartphone models, according to our analyst. (see
Samsung Electronics: 3Q16 review: reset for growth, 27 October 2016).
Global Equity Strategy
202
2 December 2016
Figure 424: Samsung' share of Korea equity market
cap
50%
Samsung Electronics market cap rel MSCI korea market (%)
45%
40%
Figure 425: Samsung price performance versus
KOSPI
800
Samsung price perf
700
KOSPI price perf, rhs
250
200
600
35%
500
30%
25%
400
20%
300
15%
150
100
200
50
10%
100
5%
0
1999
0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
0
2001
2003
2005
2007
2009
2011
2013
2015
Source: Thomson Reuters, Credit Suisse research
Stocks
Below we show the top stock picks chosen by our Korea equity strategist, Gil Kim, on our
aggregate scorecard.
Figure 426: Korea top stock picks by our Korea equity strategist, Gil Kim, on our aggregate scorecard
-----P/E (12m fwd) ------
Name
Abs
rel to
Industry
rel to mkt %
above/below
average
2016e, %
------ P/B -------
Abs
rel to mkt %
above/below
average
FCY
DY
HOLT
2016e Momentum, %
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Samsung Electronics
9.6
72%
-2%
1.4
24%
3.4
1.5
49.6
-7.9
-3.5
1.9
Outperform
Naver
24.4
122%
8%
11.1
34%
4.4
0.2
-21.5
1.1
-0.4
1.8
Outperform
Kb Financial Group
8.2
70%
-10%
0.6
-20%
na
2.8
36.4
17.4
3.5
2.0
Outperform
E-Mart
13.0
77%
-4%
0.7
-12%
na
0.8
-9.3
0.5
0.9
2.0
Outperform
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
203
2 December 2016
Taiwan: a small overweight
We maintain a small overweight of Taiwanese equities within a global context, although
we fully acknowledge our GEM Equity Strategy team is underweight within a global
emerging market context (and our regional strategist, Sakthi Siva, is overweight of Taiwan
within an Asian context). We agree with their view that Taiwan is the most vulnerable of all
the Asian countries to both the competitive threat from China as well as the structural
slowdown in the Chinese economy (40% of Taiwanese exports going to China). However,
we find that the following factors are still supportive, in our view:
1.
Taiwan ranks second on our GEM country scorecard
Taiwan ranks second on our GEM country scorecard and particularly well on
external/internal vulnerability.
2.
Taiwan, a hedge on a stronger dollar
One of the biggest risks to GEM is the stronger dollar. We view Taiwan as a potential
hedge of an overweight of emerging markets when dollar strengthens or a rate hike as
illustrated by its positive correlation to a rise in the dollar trade-weighted.
Taiwan tends to outperform emerging markets in aggregate as the USD strengthens. This
is because c.85% of Taiwanese revenues are USD denominated, and thus a 1%
strengthening in the USD against the TWD adds 2% to Taiwanese EPS (3-4% to
Taiwanese Tech EPS), according to Chung Hsu, Credit Suisse's Taiwan equity strategist.
Moreover, Taiwan has the best combination of current account surplus and net foreign
assets of any major country we examine (making the Taiwanese dollar less vulnerable in a
period of US dollar strength).
Figure 427: 10-year correlation of EM markets price
relative (in dollar terms) with the dollar tradeweighted
Figure 428: 24-month rolling correlation of
Taiwanese equities relative to GEM with the dollar
TWI
10Y correlation perf in $ terms, rel EM vs USD TWI
0.4
0.4
0.3
0.2
0.2
0.0
0.1
-0.2
-0.1
-0.4
-0.2
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
Brazil
Russia
Indonesia
South Korea
India
South Africa
Mexico
China
Taiwan
Philippines
-0.6
-0.3
2003
2005
2007
2009
2012
2014
2016
24m rolling correlation between Taiwan rel EM vs USD TWI
Source: Thomson Reuters, Credit Suisse research
204
2 December 2016
3.
Taiwan is a leveraged play on the global recovery
Overall, exports makeup c.62% of Taiwanese GDP and thus Taiwan is abnormally
sensitive to improvements in global growth (exports to the US are 6.3% of GDP, more than
double that found in Europe or Japan). The sensitivity to the global cycle can be seen with
the recent improvement in Taiwanese IP momentum or Taiwanese equities' high positive
correlation with ISM new orders.
Figure 429: Taiwan is one of the most correlated markets within EM to ISM new
orders
10Y Correl of rel Global perf, in LC terms with US ISM new orders
0.4
0.3
0.2
0.1
0.0
-0.1
-0.2
Malaysia
South Africa
Chile
Philippines
Mexico
Turkey
Indonesia
Poland
India
China
Brazil
Thailand
Korea
Taiwan
Russia
-0.3
Source: Thomson Reuters, Credit Suisse research
Many investors are too concerned about Taiwan's exposure to China, in our opinion. Our
Taiwan strategist, Chung Hsu, estimates that more than half of the Taiwanese exports to
China (which are 40% of GDP) are destined for end markets in the US and Europe,
aligning Taiwanese growth with the global market rather than Chinese economic
momentum.
4.
Deflation diminishing
After experiencing deflation during most of 2015, Taiwanese CPI and WPI have now
rebounded sharply.
Global Equity Strategy
205
2 December 2016
Figure 430: Taiwanese industrial production and
export orders, yoy, %
60
Figure 431: Taiwan CPI and Taiwan WPI (wholesale
price) have recovered sharply
5.7
50
Taiwan IP, yoy chg %
40
Taiwan exports orders ($), yoy % chg
Taiwan CPI, yoy %
20
Taiwan WPI, yoy %, rhs
15
4.7
10
3.7
30
5
20
2.7
10
1.7
0
0.7
-5
-0.3
-10
-1.3
-15
0
-10
-20
-30
-40
2006
-2.3
2008
2009
2010
2011
2012
2013
2015
2016
Source: Thomson Reuters, Credit Suisse research
-20
1991
1995
1998
2002
2005
2009
2012
2016
Source: Thomson Reuters, Credit Suisse research
5.
Improving earnings momentum
While Taiwanese absolute earnings revisions remain negative, they improved sharply over
the past months and are now slightly better than global earnings revisions. This is in line
with the view of our strategist who sees the Taiwan earnings downgrade cycle coming to
an end. Chung expects Taiwanese earnings growth to continue their recovery into the first
half of 2017 after an already strong third quarter. Earnings growth is normally good for
Taiwanese equities, whose performance is closely correlated to profit growth.
Figure 432: Taiwan relative earnings revisions are
now marginally positive
20%
Taiwan 3m breadth
Figure 433: Taiwanese profit growth is likely to
continue to recover into 2017
40%
Rel Global
Taiwanese equities YoY profit growth
35% 34%
34%
30%
22%
15%
12%
10%
0%
2%
2%
4Q17E
20%
3Q17E
10%
0%
-10%
-7%
-15%
-20%
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2013
2016
2Q17E
2010
1Q17E
2007
4Q16E
2004
3Q16
2001
-28%
2Q16
1998
-18%
1Q16
-40%
1995
-40%
2Q15
-30%
1Q15
-30%
3Q15
-20%
4Q15
-10%
Source: Credit Suisse Taiwan Equity strategy team research, Credit Suisse research
206
2 December 2016
Figure 434: Taiwanese equities are closely correlated to YoY profit growth
Taiwan profit growth YoY
200%
TAIEX YoY performance
90%
70%
150%
50%
100%
30%
50%
10%
0%
-10%
2Q16
1Q15
4Q13
3Q12
2Q11
1Q10
4Q08
1Q05
3Q02
3Q07
-50%
2Q06
-100%
4Q03
-30%
2Q01
-50%
Source: Credit Suisse Taiwan Equity strategy team research, Credit Suisse research
6.
Valuations look reasonable
Taiwanese equities look cheap relative the global market on 12-month forward P/E and
are trading in line with their norm relative to global equities on price-to-book.
Figure 435: The relative 12-month forward P/E for
Taiwan is 0.6std below average…
Taiwan 12m fwd PE rel
global
Average (+/- 1 SD)
200%
Figure 436: …and its P/B relative is trading around
its average
150%
Taiwan PB rel global
140%
Average (+/- 1 SD)
130%
170%
120%
110%
140%
100%
90%
110%
80%
70%
80%
60%
50%
1998
2001
2004
2007
Source: Thomson Reuters, Credit Suisse research
2010
2013
2016
50%
1998
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
Furthermore, Taiwanese net cash as a share of total market cap has reached a 15-year
high of 8%, as the market's free cash flow yield is now nearly 7%, according to our Taiwan
strategist.
As discussed below, Taiwan also has one of the largest gaps between the dividend yield
and the government bond yield - a clear reason for some degree of asset allocation shift.
Global Equity Strategy
207
2 December 2016
7.
Still an attractive fund flow story and bearish sentiment
Chung Hsu, our strategist, sees the potential for an attractive fund flow story into
Taiwanese equities to continue driven by two factors:
i.
On 2 August, the FSC (Financial Supervisory Commission) reduced the risk
weight of domestic equities for Taiwanese life insurers, with a reduction in risk
weights by 19% and 5% for domestic ETFs and individual stocks respectively.
Meanwhile they increased the risk weight for international equities, which should
result in a shift from international to domestic equities.
ii.
Chung expects Taiwanese life insurers and pension funds to increase their buying
of equities on the back of low bond yields, with the gap between the dividend yield
of Taiwanese equities and the yield of Taiwanese government bonds remaining at
a very high level.
Overall, our Taiwan strategist expects life and pension funds to buy US$25-35bn of
Taiwanese equities over the next five years with the equity holdings of Taiwanese insurers
rising to above 8% of market cap (from c.5-6% of market cap currently).
Figure 437: The Taiwanese gap between DY and the
yield of government bonds is the most attractive
among Asian economies….
8%
Dividend yield minus 10Y Bond yields
3%
Figure 438: …and this gap is near a non-crisis alltime high
2%
6%
1%
0%
Dividend Yield minus 10Y Bond yields
Taiwanese market
4%
-1%
-2%
2%
-3%
-4%
0%
-5%
-2%
Source: Credit Suisse Taiwan Equity strategy team research, Credit Suisse research
Indonesia
India
Philippines
China
South Korea
Malaysia
Thailand
Singapore
Hong Kong
Taiwan
-6%
-4%
2001 2003 2004 2006 2007 2009 2010 2012 2013 2015 2016
Source: Thomson Reuters, Credit Suisse research
Furthermore, Taiwan is one of the largest underweights within GEM funds, according to
the EPFR data from our GEM equity strategy team, and sell-side analysts continue to be
bearish on Taiwanese equities.
Global Equity Strategy
208
2 December 2016
Figure 439: GEM equity fund positioning in Taiwan
relative to the MSCI benchmark is very low
Figure 440: Relative net sell side recommendations
are bearish
2.4
Taiwan rel World on sell side recom. (+=Buy,-=Sell)
Analyst recom. (1=Buy, 5=Sell)
7%
2.0
2.2
India
2.2
2.0
2%
1.8
2.4
1.6
-3%
1.4
2.6
Russia
1.2
Brazil
1.0
China
0.8
Taiwan
3.0
S Korea
0.6
0.4
Jan 02
2.8
-8%
-13%
1995
Jan 05
Jan 08
Jan 11
Jan 14
1998
2002
2005
2009
2012
2016
Jan 17
Source: Credit Suisse GEM Equity strategy team research, EPFR, Credit Suisse research
Source: Credit Suisse GEM Equity strategy team research, EPFR, Credit Suisse research
Taiwan's exposure to semis might become a headwind
Semiconductors make up c.37% of total Taiwanese market cap. While semis are one of
the most sensitive sectors to a recovery in US growth (as proxied by their sensitivity to
ISM new orders) and have been a key driver of Taiwanese performance over the last 12
months, we wonder if the sector could now become a headwind for the reasons we
discuss below.
Figure 441: US semiconductors are one of the most positively correlated to ISM
new orders
0.6
US sectors 10Y corr with ISM
0.4
0.2
-0.1
-0.3
-0.5
Beverages
Pharmaceuticals
Food Retail
Household Products
Food Producers
Utilities
Tobacco
Telecoms
Hotels & Leisure
Healthcare Equip
Commercial Services
Software
Transport
Construction Materials
Banks
Real estate
Retailing
Consumer Durables
Media
Energy
Insurance
Chemicals
Capital Goods
Pulp & Paper
Technology Hardware
Div. financials
Semiconductors
Automobiles
Metals and Mining
-0.7
Source: Thomson Reuters, Credit Suisse research
The Taiwanese semis book/bill ratio has fallen sharply and is now in line with semis
underperforming. Furthermore, deteriorating capital discipline within global semis should
Global Equity Strategy
209
2 December 2016
be a headwind for Taiwanese semis going forward (i.e. capex to sales is high, and that
tends to lead semis underperforming).
Figure 442: Taiwanese semis tend to outperform
when the book to bill ratio picks up
Figure 443: Lower capex to sales tends to help
performance of Taiwanese semis
26%
Taiwan semis price relative, 6m %ch
Taiwan semis book / bill ratio, rhs
40%
-41%
Global semis (ex equipment makers) capex to
sales
Taiwan semis rel perf, % chg y/y, rhs, inv
1.5
23%
-31%
1.3
20%
-21%
20%
1.1
0%
0.9
-20%
0.7
-40%
-60%
1996
0.5
0.3
1998
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
-11%
17%
-1%
14%
9%
11%
19%
29%
8%
2001
2004
2006
2009
2011
2014
2016
Source: Thomson Reuters, Credit Suisse research
Stocks
Below we show top stock picks in Taiwan as selected by our equity strategist, Chung Hsu.
Figure 444: Top stock picks by our Taiwan equity strategist
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
Hon Hai Precn.Ind.
9.9
74%
-19%
1.4
-18%
9.3
4.2
54.3
2.7
1.3
2.8
Outperform
Taiwan Semicon.Mnfg.
13.2
83%
-13%
3.9
48%
3.9
3.5
52.6
4.3
2.4
2.2
Outperform
Largan Precision
15.6
116%
-6%
7.6
85%
4.8
1.8
76.3
-2.0
-1.9
2.2
Outperform
Mega Financial Holding
10.7
91%
-20%
1.1
11%
na
5.5
10.3
-16.4
-4.3
2.7
Outperform
Name
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
210
2 December 2016
India: structurally overweight, but near-term caution
We remain structural positive on Indian equities in a global context. This is more optimistic
than the view of Alex Redman or Sakthi Siva who are both underweight within a regional
context.
Some challenges have emerged in recent quarters which make us a little more cautious in
the near term, even if we think the long-term story is very much intact. The challenges
India faces are as follows, in our view:
1.
Near-term (i.e. 9-12 months) disruption from demonetisation
Cash usage in India is very much higher than the global norm (at c.14% of GDP compared
with the GEM norm of 5%). As a result, the Indian government's decision to cease usage
of R500 and R1000 notes is disruptive. Together, these two denominations account for
around 85% of the currency in circulation by value, implying that around 10.5% of GDP
has effectively been demonetised.
Our India strategist, Neelkanth Mishra, believes demonetisation will have a disruptive
impact, particularly on the asset quality impact of microfinance and non-banking financiers.
It may take many years for currency in the black market to replenish, hurting real-estate,
land transaction volumes and hence property prices (with real estate in turn accounting for
60% of cement demand, c.80% of construction jobs in rural India and c.90% of household
wealth. For more details see Ideas engine - India Market Strategy: A long winter before the
spring, 15 November).
However, long-term demonetisation should be a positive for the economy as it should
stimulate online banking, boost the formal economy (which is just 15% of GDP) and limit
corruption and fraud.
Figure 445: 85% of the currency demonetised
Figure 446: India has very high cash usage
Source: RBI, Credit Suisse India Equity Strategy team research
Source: tradingeconomics.com, Credit Suisse India Equity Strategy team research
2.
Near-term disruption from the Goods and Services Tax Bill (GST)
The GST is a value added tax to be introduced across India from April 2017 and, again,
the impact is likely to be characterised by near-term disruption. As our India strategists
highlight, Malaysia introduced its own, simpler version of the GST in 2014, and yet the
smaller economy took 3-6 months to stabilise, offering a worrying precedent.
One channel for the transmission of this volatility will be state government finances. The
R9tn or so of taxes subsumed under the GST should by design not change, and may in
fact turn out to be higher once the system stabilises as compliance improves. However,
the distribution of these between the states will change, disturbing the spending pattern at
the state level. As states now spend 65-70% more than the centre, this is likely to be
another source of volatility in the economy, in our India strategists' view.
Global Equity Strategy
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In the longer term, though, the GST allows consolidation (rather than having warehouses
in every state to exploit local tax rates), reduces the need for working capital and, above
all, allows companies to think of India as one market (in much the same way as the EU did
in Europe). Moreover, it aids and reduces the cost of revenue collection. The National
Council of Applied Economic Research estimated gains in the range of 0.9%-1.7% of GDP
for each year post the implementation of GST.
Our India economist, Deepali Bhargava, recently downgraded her growth outlook for the
next six months, cutting her FY2016-17 India GDP forecast to 6.9% from 7.8% to reflect
the demonetisation and GST disruptions discussed above. Our economists also cut their
growth forecast for FY2017-2018 to 7.4% Y/Y from 8.0% given their view that there will be
a lasting economic impact from destruction of wealth for higher income segment of the
population. For more details see India: Assessing impact on GDP from demonetization – a
J-curve effect, 22 November.
3.
Earnings revisions are weakening
India's relative earnings revisions continue to be negative relative to emerging markets,
and have been deteriorating lately.
4.
A consensus long
Equity fund positioning on Indian equities on EPFR data remains extended relative to
other GEM countries and relative to its own history. This is a concern, but should be seen
in a context where, in general, emerging markets are still relatively under-owned.
Ownership levels (relative to GEM) are back to 2002-03 levels, levels from which India
was able to historically outperform. As above, net buy recommendations have fallen to low
levels.
Figure 447: India earnings revisions relative to EM
are still negative and rolling over
50%
Figure 448: GEM equity fund positioning in India
relative to the MSCI benchmark is extended, though
it has fallen from its historical high
India: 13-week earnings revisions
2.4
rel to GEM
2.2
India
30%
2.0
1.8
10%
1.6
-10%
1.4
Russia
1.2
-30%
-50%
Brazil
1.0
China
0.8
Taiwan
S Korea
0.6
-70%
2008
2009
2010
2011
2012
2013
Source: Thomson Reuters, Credit Suisse research
2014
2015
2016
0.4
Jan 02
Jan 05
Jan 08
Jan 11
Jan 14
Jan 17
Source: Credit Suisse GEM Equity strategy team research, EPFR, Credit Suisse research
However, we remain positive structurally on Indian equities, and consider the following
longer-term positives:
Global Equity Strategy
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2 December 2016
1.
Structural positives
■ India has little economic exposure to China (the biggest long-term risk within an
overweight of GEM). India's exports to China account for just 0.5% of GDP and just
1.0% of value added exports, according to our India economics team. Moreover, if
there were a hard landing in China, India would represent something of a macro hedge
given that it is a large net commodity importer (with net commodity imports c.4.7% of
GDP). Now that China has had most of its positive growth surprise, this becomes a
support.
■ India has exceptionally good demographics. India's working age population will
grow by 1.4% p.a. between 2015-2025 according to the World Bank, the fastest of any
of the world's biggest 10 countries. Over the same period, China, Germany, Japan and
Russia are set to see their working-age populations contract.
■ India has significant catch-up potential with a very low urbanization rate at just 31%
and productivity per hour worked still only 42% of that in China. Indeed, India's
manufacturing share of GDP is just 17.5% compared to the 39% share of the industrial
sector in China. When GDP growth per capita hit 10% of US levels (India is at 11%),
China and Korea were able to grow by 11% and 8.2% a year, respectively, over the
next five years.
Figure 449: Asian economies’ GDP per capita (at PPP) as a share of US levels –
India is at just 11% of US levels
GDP per capita at PPP (as % of US)
100%
Japan (1950-)
South Korea (1965-)
Taiwan (1963-)
Malaysia (1969-)
India (1987-)
Hong Kong (1951-)
China (1978-)
80%
60%
40%
20%
0%
0
10
20
30
40
Years since acceleration
50
60
Source: Thomson Reuters, Credit Suisse research
Figure 450: GDP per capita growth after reaching 10% of US GDP per capita (India's current level)
GDP per capita at PPP
Country
<10% of US
5 years post
10 years post
20 years post
To present
Period
CAGR
Period
CAGR
Period
CAGR
Period
CAGR
Period
CAGR
India
1950-2015
2.9%
-
-
-
-
-
-
-
-
China
1950-2003
4.4%
2003-2008
10.9%
2003-2013
9.6%
-
-
2003-2015
8.4%
Korea
1950-1966
3.7%
1966-1971
8.2%
1966-1976
8.3%
1966-1986
6.9%
1966-2015
Average
3.7%
9.6%
9.0%
6.9%
5.9%
7.1%
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
■ A cheap currency: In our view, there are three indications that the rupee is still cheap:
i) India's current account deficit is forecast by our economists to be only 1.0% of GDP in
2016 (down from a deficit of 4.8% of GDP in 2012), while net FDI is 1.8% of GDP and
exceeds 2% of GDP for gross FDI inflows, according to our India economist, Deepali
Bhargava. This allows India to run a basic balance of payment surplus. Foreign direct
investment is up by 16% year on year, more than any other country.
ii) The rupee continues to look very cheap relative to its export market share (if the rupee
discount to PPP were to match its export market share then the rupee would be up by
around 31%).
iii) FX reserves are up c.$56bn over the past two years (and $15bn year to date),
according to our India economist. Indeed, such a rise in FX reserves typically helps excess
liquidity and in turn money supply growth.
Figure 451: India’s current account position has
significantly improved to a deficit of just under 1%
of GDP
4%
Figure 452: The rupee is cheaper than implied by its
export market share
1.8%
India current account balance, % of GDP, 4 qtr average
3%
1.6%
2%
-64%
India exports % of World exports
-66%
Currency deviation from PPP
1%
-68%
1.4%
-70%
0%
1.2%
-1%
-72%
1.0%
-2%
-74%
-3%
0.8%
-76%
-4%
0.6%
-5%
-6%
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
0.4%
1996
-78%
-80%
1999
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
The real bond yield at just around 1% remains reasonable (with inflation forecast to fall to
5.2% next year).
2.
Clear signs of reform
In our judgement, there have been some signs of positive progress on reform. We would
highlight the following:
The GST should be a large longer term positive (as highlighted above).
■ 99% of the population now has access to a bank account compared to 50% a year
ago. This should limit the scope for corruption and enable the efficient transmission of
subsidies and rural payments.
■ There have now been 1bn unique identification numbers (AADHAAR numbers)
issued to Indian citizens, covering c.86% of the population. These provide Indians
with a universal identity infrastructure which can be used for any identity-based
application (e.g. for social benefits, passports, etc.) and should reduce corruption.
Global Equity Strategy
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2 December 2016
Critically it also brings many more people into the formal economy (which aids
productivity and tax collection) and also allows the expansion of e-commerce which in
turn aids supply side driven deflation and efficiency gains.
■ The appointment of new RBI Governor, Urjit Patel, should help ensure continuity of
the existing monetary policy framework. Moreover, with the RBI Governor having the
casting vote, then the RBI's strong anti-inflation credentials are likely to allow real bond
yields to fall.
■ A new bankruptcy code has been established, making it possible to liquidate a
company within 180 days (with time taken to resolve insolvency having been an area
where India lagged most other economies), with management ceded to ‘insolvency
professionals’. This should help the recovery rate, which is 25% in insolvencies
(according to the World Bank).
■ Other factors that are supportive: efforts to lend at formal sector rates to the large
number of micro enterprises continue via MUDRA, and the auctioning of mining assets.
3.
Valuations are still quite reasonable
A 4% P/E premium to global equities for a 25% RoE premium looks realistic to us,
especially when we consider that India has double the trend rate of growth of the US.
Figure 453: India's PE premium is justified due to
superior ROE and not extended if adjusted for
growth
Figure 454: India's 12-month forward P/E relative to
global markets is only slightly above its five-year
average
MSCI India: 12m fwd P/E rel to MSCI
World
Average
175%
12m fwd P/E
12m fwd ROE
PEG
15.9
0.2
0.9
GEM
135%
135%
104%
Global
104%
125%
67%
India
Relative to
155%
135%
115%
95%
75%
55%
35%
2000
Source: Thomson Reuters, Credit Suisse research. *G = 3-5 year EPS growth estimate by
IBES consensus
Global Equity Strategy
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
215
2 December 2016
4.
Oil unlikely to be a headwind
As a significant oil importer, India underperforms when the oil price rises. We on the
Global Equity Strategy team think that it is unlikely that the oil price will rise much beyond
$55pb in the H1 2017.
Figure 455: India has typically underperformed GEM oil exporters when the oil
price rose
8.5
10
India rel to Oil Exporting countries (Russia, Brazil, Malaysia and
Mexico)
7.5
30
Brent price, rhs, inverted
6.5
50
5.5
70
4.5
90
3.5
110
2.5
130
1.5
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
5.
Our GEM strategy team's macro model suggests upside
Our GEM equity strategy team's macro regression model (based on India IP growth, the
Indian rupee to dollar exchange rate, ISM new orders and money supply growth) suggests
around 19% upside potential to 2017 year-end for the MSCI India.
Figure 456: Macro regression model predicted
versus actual MSCI India
Model inputs
Coeff. P-value
India IP (% yoy)
USDINR
Current Scenario
24 Nov y/e 2017
Upside
from
current
384 bps
1.5%
2.12
-2.02
0.000
0.000
-0.8%
68.5
3.0%
69.5
US ISM new orders
0.68
0.000
52.1
57.0
9.4%
M3 growth (% yoy)
0.74
0.000
10.9
12.5
1.6 ppt
Figure 457: Macro regression model predicted
versus actual MSCI India
700
600
500
400
MSCI India
24 Nov y/e 2017
Adj R square:
0.83
Current
430
430
Observations:
Intercept
167
0.00
Predicted
Upside %
463
7.6
512
19.0
300
200
100
Predicted MSCI India
Actual MSCI India
0
Jan 03 Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 Jan 15 Jan 17
Source: Credit Suisse GEM Equity strategy team research, Thomson Reuters
Global Equity Strategy
Source: Credit Suisse GEM Equity strategy team research, Thomson Reuters
216
2 December 2016
Stocks
Below we show top stock picks chosen by our India strategist, Neelkanth Mishra.
Figure 458: Top picks by our India strategist
-----P/E (12m fwd) -----rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
101%
20%
2.9
62%
-19%
4.1
12.4
62%
-12%
Cipla
23.6
163%
Tata Motors
9.0
96%
Name
Abs
rel to
Industry
Lic Housing Finance
11.9
Hcl Technologies
12.5
Tech Mahindra
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
FCY
DY
Price, %
change to
best
3m EPS
84%
na
1.2
-56.1
0.5
1.2
2.1
Outperform
22%
4.8
2.9
60.2
0.5
-1.4
2.1
Outperform
3.3
-17%
3.5
1.8
48.3
-6.4
-0.7
2.1
Outperform
3%
3.8
18%
3.7
0.4
28.9
-6.1
-1.7
2.5
Outperform
-36%
1.9
-17%
-1.7
0.3
42.6
-19.8
-2.4
2.0
Outperform
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
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2 December 2016
Russia: staying overweight
We would recommend an overweight position in Russian equities within a global portfolio
(noting that our GEM equity strategy team is benchmark within a GEM portfolio). We see
the following supports:
1.
Top of our emerging market country scorecard
Russia ranks top on our GEM country scorecard, scoring particularly highly on the
currency and equity valuation metrics. Exposure to China is also relatively low.
2.
A US détente with Russia post Donald Trump's victory?
The election of Donald Trump could lead to improved relations with Russia. In their first
phone call, President-elect Trump stated he looked forward to a 'strong and enduring
relationship' with Russia (see FT, 15 November 2016). It would seem possible that some
lifting of sanctions on Russia could follow from this change of tone in the relationship.
3.
The rouble is still one of the most undervalued currencies
The rouble is one of the most undervalued currencies, ranking fourth on our EM valuation
scorecard (see Appendix). The real effective exchange rate is below 2009 lows, despite
the oil price being at much higher levels than those seen in the financial crisis. Moreover,
using the current exchange rates, Russian GDP is only c.10% larger than that of Spain
despite having a population more than 3 times the size.
The currency is critical: if the rouble appreciates by 10%, inflation falls by about 0.75pp,
allowing monetary policy to loosen. Our economists expect inflation to fall to 4.2% in 2017
(from its peak of 13% year on year), and rates were cut for the first time in almost a year in
mid-June by 50bps to 10.5%. Our Russia economist expects 9% rates by the end of 2017,
and we think it could be lower still.
The undervaluation of the currency is reflected in the Russian current account surplus
which is expected be around 3.0% of GDP in 2016 and 2.6% of GDP in 2017, according to
our economist, despite the recovery in the rouble.
4.
Russian economic momentum is picking up
Russian manufacturing PMI new orders have been rising relative to global PMIs. Our
economists project growth of 1.5% in 2017 on the back of the expected pick-up in the
investment cycle (as companies have de-levered), lower interest rates and stronger
consumer demand.
Global Equity Strategy
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2 December 2016
Figure 459: The REER is still below 2009 lows
despite the oil price being at higher levels
Figure 460: Russian manufacturing PMI new orders
have been rising relative to global PMIs
150
65
Russia PMI mfg new orders
60
rel Global
Russia REER
120
Oil price, rhs
125
110
7
55
100
100
75
90
50
80
50
2
45
-3
40
35
25
70
60
2001
0
2003
2005
2007
2009
2011
Source: Thomson Reuters, Credit Suisse research
2014
2016
12
-8
30
25
-13
2004
2005
2007
2008
2010
2011
2013
2014
2016
Source: Thomson Reuters, Credit Suisse research
5.
Oil
Russia is clearly a play on oil, economically and from an equity market perspective. Oil
accounts for 54% of equity market capitalisation, 40% of tax revenues, 55%-60% of
exports are energy-related, and oil revenues are 13% of GDP, according to our Russia
economist. In this Outlook, we find ourselves incrementally more positive on the outlook
for the oil price, as discussed in our commodity section.
6.
Government bond yields remain too high
The local bond yield of 8.8% gives a real bond yield of 4.5% on our economists' 2017
inflation forecast (with yields up from a recent low of 8%). To us, this seems attractive
given the undervaluation of the currency and the very limited sovereign credit risk, with the
budget deficit for the past 12 months at 3.8% of GDP and government debt to GDP at just
under 10%. There has been a reasonable correlation between the Russian 10-year
government bond yield and Russian equity market price performance relative to emerging
markets.
7.
Our GEM equity strategist's fair value model points to c.9% upside by the
end of 2017
Our GEM strategist's four-factor model for Russian equities (based on the oil price,
government 10-year bond yield, M2 growth and IFO business expectations) is consistent
with c.9% upside by the end of 2017.
Global Equity Strategy
219
2 December 2016
Figure 461: Macro regression model predicted
versus actual MSCI Russia
Model inputs
Coeff. P-value
Oil (Brent)
Govt. 10 year BY %
0.37
-2.79
0.000
0.003
M2 growth % yoy
0.38
0.000
IFO business expec.
1.90
0.000
Figure 462: Macro regression model predicted
versus actual MSCI Russia
Current Scenario Upside
from
24 Nov y/e 2017
current
49.0
60.0
22.3%
8.8
8.5
-30 bps
12.0%
7.5% -4.54 ppt
106
104
1600
Predicted MSCI Russia
1400
Actual MSCI Russia
1200
-1.4%
1000
MSCI Russia
24 Nov y/e 2017
Adj R square:
0.73
Current
538
538
Observations:
Intercept
155
0.00
Predicted
Upside %
502
-6.7
588
9.3
800
600
400
200
2004
Source: Credit Suisse GEM Equity Strategy team research, Thomson Reuters, Credit Suisse
research
8.
2006
2008
2010
2012
2014
2016
2018
Source: Markit, Credit Suisse research
Russian equities look reasonably cheap
Russian equities trade slightly below their norm on P/B relative to global markets, but are
nearly 0.8 standard deviation cheap on 12-month forward P/E relative to global markets.
Figure 463: Russian equities are trading slightly
below their norm on P/B relative to global…
Figure 464: … and nearly 0.8 standard deviation
cheap on 12-month forward P/E relative to global
1.0
0.9
Russia P/B ex Financials
rel. World
0.8
MSCI Russia 12m FWD PE rel
World
Average (+/- 1 SD)
0.9
0.8
Average (+/- 1 SD)
0.7
0.7
0.6
0.5
0.6
0.4
0.5
0.3
0.4
0.2
0.3
0.1
0.0
1999
2002
2004
2006
2008
2010
Source: Thomson Reuters, Credit Suisse research
2012
2014
2016
0.2
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
9.
Earnings momentum is strong
The earnings momentum of Russian equities is strong in absolute terms as well as relative
to global equities.
Finally, we would admit that Russian equities do look overbought relative to GEM equities,
but less so relative to global equities.
Global Equity Strategy
220
2 December 2016
Figure 465: Russian earnings momentum is strong
Russia 3m breadth
22%
Figure 466: Russia equities price relative to global
market (dollar terms): only 0.4std above its 6-month
moving average
40%
Rel Global
17%
MSCI Russia % devn from
6mma rel Global mkt ($)
30%
Average (+/- 1sd)
12%
20%
7%
2%
10%
-3%
0%
-8%
-13%
-10%
-18%
-20%
-23%
-28%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
-30%
2001
2004
2006
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
Stocks
We can see that European Russia-exposed stocks are closely following the oil price.
Figure 467: Oil price versus Russia-exposed stocks price relative
180
Oil price, y/y%, lhs
Oil perf, latest
Russia exposed eur stock, y/y%
Stock perf, latest
130
110
140
90
100
70
60
50
30
20
10
-20
-10
-60
-100
1999
-30
-50
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
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2 December 2016
The screen below focuses on European stocks with high Russian exposure.
Figure 468: European stocks with high sales exposure to Russia
-----P/E (12m fwd) ------
Name
Telia Company
Russian exposure
12m Price perf
rel Cont
Europe (lc)
YTD perf rel
Cont Europe
(lc)
Abs
rel to
Industry
2016e, %
------ P/B -------
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
HOLT
2016e Momentum, %
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
19% of net income
-9%
-12%
11.4
82%
-9%
1.5
-1%
5.2
5.9
42.2
-5.8
0.4
2.6
Neutral
Adidas
10% sales
72%
64%
25.1
150%
41%
5.1
131%
1.4
1.4
-17.5
0.5
0.3
2.8
Neutral
Unilever (Uk)
3% sales
23%
15%
18.7
92%
3%
7.9
68%
na
3.4
-0.2
2.1
1.0
2.6
Neutral
Nokian Renkaat
26% sales
4%
9%
16.9
182%
5%
3.7
35%
3.9
4.6
-5.0
0.4
-0.3
2.6
Not Covered
Renault
8% sales
-12%
-15%
5.4
58%
-68%
0.8
28%
8.3
3.9
163.9
1.6
1.4
2.5
Not Covered
Henkel
6% sales
13%
13%
16.2
80%
5%
3.0
55%
na
1.8
na
1.6
0.4
1.0
Not Covered
Jcdecaux
4% sales
-22%
-25%
22.8
125%
-12%
2.2
20%
4.2
2.2
-0.8
-13.4
-2.1
2.8
Not Covered
20% of 2015E
EBITDA
18%
sales
10%
6%
19.7
130%
23%
0.9
-40%
-0.1
5.2
21.5
-1.2
2.2
3.7
Underperform
13%
4%
18.1
90%
15%
2.1
64%
5.6
1.6
-27.9
-2.6
-0.4
3.1
Underperform
7% sales
-7%
-8%
12.2
88%
-9%
3.3
53%
4.4
6.1
50.5
-14.3
-0.8
2.7
Underperform
Fortum
Carlsberg 'B'
Telenor
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Our favoured non-commodity-related Russia plays are M.Video, X5 and Magnit (all
Outperform-rated). For more details, see Ideas Engine - Russian Food Retail: Modernising
to win market share, 16 November.
Figure 469: Our favoured non-commodity-related Russia plays
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
Name
Abs
rel to
Industry
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
M Video
11.2
47%
-13%
X5 Retail Gp.Gdr Reg
'S'
Pjsc Magnit Gdr (Reg
15.2
90%
-24%
4.8
82%
10.8
1.4
-29%
-0.4
17.2
101%
-23%
na
na
2.0
HOLT
2016e Momentum, %
Price, %
change to
best
3m EPS
3m Sales
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
5.8
-7.8
18.2
9.0
2.3
Outperform
0.0
81.8
10.4
1.6
1.6
Outperform
2.2
17.4
-2.7
-1.5
2.5
Outperform
S)
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
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2 December 2016
CE3
We consider Poland, Hungary and Czech Republic to be plays on Continental Europe, a
region on which we remain positive both economically and from an equity market
perspective. We see the following positives:
1.
A European proxy trading on a discounted valuation
The performance of CE3 countries relative to the broader emerging market index tends to
match the relative performance of Europe. Accordingly, they have underperformed along
with European equities, but we think that European equities will outperform from here.
CE3 stocks trade on a significant P/B discount to DM European equities;
Figure 471: CE3 in aggregate (Poland, Hungary and
Czech Republic) are trading 0.6std below average
levels on P/B relative to the Continental European
market
Figure 470: CE3 acts a play on the European
recovery
CE3 relative to GEM
Europe relative to Global, rhs
5.0
4.5
5.2
CE3 stocks P/B rel Cont eur mkt
120%
Average
110%
4.0
4.7
3.5
100%
90%
3.0
4.2
80%
70%
2.5
3.7
2.0
1.5
2002
130%
60%
50%
3.2
2004
2006
2008
2010
2012
Source: Thomson Reuters, Credit Suisse research
2014
2016
40%
1995
1998
2002
2005
2009
2012
2016
Source: Thomson Reuters, Credit Suisse research
2.
Earnings revisions are turning higher
Earnings revisions relative to GEM have been improving, though are still marginally
negative. One of the supports for CE3 earnings is that the group tends to benefit from a
weaker euro given that they are part of the supply chain within the euro area.
3.
Hourly labour costs are among the lowest in Europe
CE3 have among the lowest labour costs in the EU, with hourly labour costs in CE3
countries is a third of the euro area level.
Global Equity Strategy
223
2 December 2016
Figure 472: Earnings revisions relative to GEM have
been improving
18%
CE3 stocks 3m breadth
Figure 473: Hourly labour costs in CE3 countries
are a third of the euro-area level
60
Rel GEM mkt
13%
50
8%
40
3%
Hourly labour costs for the whole economy (€)
30
-2%
20
-7%
10
-12%
Norway
Denmark
Belgium
Sweden
Luxembourg
France
Netherlands
Finland
Austria
Germany
Ireland
EA18
Italy
United Kingdom
Spain5
Slovenia
Cyprus
Greece5
Portugal
Malta
Estonia
Slovakia
Czech Republic
Croatia
Poland
Hungary
Latvia
Lithuania
Romania5
Bulgaria
0
-17%
-22%
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
4.
Sell-side analysts are cautious, and the group is oversold
Sell-side analysts remain bearish on the CE3 equities when we look at the consensus net
buy recommendations.
Figure 474: Sell-side analysts continue to be
negative on the CE3 equities
Figure 475: CE3 equities relative to GEM are trading
marginally below their 6-month MA
15%
2.2
10%
2.3
5%
2.4
2.5
0%
CE3 stocks %dev from 6mma, rel to GEM mkt (in $)
20%
Average
10%
2.6
-5%
2.7
-10%
0%
2.8
-15%
2.9
-20%
3.0
-25%
3.1
-30%
1997
3.2
1999
2002
2005
2008
2010
2013
2016
CE3 stocks on analyst recommendations rel to GEM mkt (+=Buy; -=Sell)
Analyst recommendations (1=Buy; 5=Sell)
Source: Eurostat, Thomson Reuters, Credit Suisse research
-10%
-20%
-30%
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
Stocks
Our EEMEA Banks analyst, Hugo Swann, highlights OTP and Erste as Outperforms given
low impairment charges and the prospect of accelerating loan growth, which should in turn
help stabilize NIM and then grow NII. As retail banks, both the stocks should also benefit
from the higher rates theme.
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224
2 December 2016
Figure 476: Our preferred plays on CE3
-----P/E (12m fwd) ------
2016e, %
------ P/B -------
HOLT
2016e Momentum, %
rel to mkt %
above/below
average
Abs
rel to mkt %
above/below
average
FCY
DY
Price, %
change to
best
3m EPS
3m Sales
92%
14%
1.8
67%
na
2.5
-5.6
12.1
-2.2
2.8
Outperform
82%
-25%
1.0
14%
na
3.5
8.0
3.3
-0.5
2.3
Outperform
Name
Abs
rel to
Industry
Otp Bank
10.8
Erste Group Bank
9.6
Consensus
Credit Suisse
recommendation
rating
(1=Buy; 5=Sell)
Source: MSCI, IBES, Thomson Reuters, Credit Suisse HOLT, Credit Suisse research
Global Equity Strategy
225
2 December 2016
UK: downgrade to underweight
In our judgement, there are four key elements to a view on UK equities in a global context:
sterling, emerging markets, commodities and the global cycle. If we look at these four
variables: the outlook for GEM has deteriorated compared to the first 8 months of the year
(as we highlight in the GEM section); two factors which had proved tailwinds through the
first half of 2016 are now neutral (oil and sterling); and OECD lead indicators are rising,
which tends to be negative for UK relative performance.
Figure 477: Macro factors which boosted UK outperformance are set to become
much less supportive, in our judgement
Macro factor
GBPUSD
Change: 1 Jan to 25 Oct
↓
-17.7%
Oil price
CRB Metals
EM relative
↑
↑
↑
42.5%
26.2%
11.6%
Macro momentum (ISM)
FTSE 100 rel to World
→
0.6
8.5%
→
→
→
↑
↑
12 month outlook
Sterling now close to trough
Likely range bound
Likely range bound
Overweight, but near-term challenges
Macro momentum now rising globally
Source: Thomson Reuters, Credit Suisse research
With the majority of macro factors now more challenging for UK equities in local currency
terms, and with a valuation which is not especially attractive, we opt to take UK weightings
down.
What are the negatives?
Sterling resilience a challenge
The UK is one of the most international equity markets globally. Around 70% of UK listed
sales are derived overseas, while 40% of dividends are dollar denominated. For the large
cap FTSE 100, the international exposure is higher still.
Figure 478: Only 25% of UK FTSE revenues come from the UK
Regional sales, % of total
FTSE 100
Euro Stoxx 50
S&P 500
Europe
23.7%
56.3%
5.7%
UK
25.4%
2.2%
0.9%
North America
20.4%
17.1%
69.7%
GEM
24.4%
19.0%
7.3%
Others
5.9%
5.3%
16.4%
Total
100%
100%
100%
Source: Thomson Reuters, Credit Suisse research
As a result, when sterling weakens, UK equities outperform in local currency terms, and
earnings in sterling terms rise. As the chart below illustrates, the trajectory of sterling has
tended to be very closely correlated with earnings momentum, which is currently strong.
While earnings revisions are stronger in the UK than any other region, this is merely a
reflection of currency weakness
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226
2 December 2016
Figure 479: The UK market tends to outperform as
sterling weakens (and vice versa)
MSCI UK rel to World (local currency)
Trade-weighted Sterling, rhs, inverted
5.5
5.3
Figure 480: Earnings momentum tracks trade
weighted sterling closely
70
40%
75
30%
5.1
80
4.9
85
UK: 13-week earnings revisions relative to global
GBP TWI, % chg Y/Y inv., rhs
-19
-14
20%
-9
10%
4.7
90
4.5
95
4.3
-4
0%
1
100
-10%
3.9
105
-20%
3.7
2002
110
4.1
-24
6
11
2004
2006
2009
2011
Source: Thomson Reuters, Credit Suisse research
2013
2016
-30%
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Having been bearish of sterling through 2016, we took the view on 12 October that the
currency was at a floor as we discussed in our Thoughts on sterling and review of UK
domestic sectors 12 October 2016). We explore the reasons in depth in our FX section,
but would just summarise briefly the key aspects of our view as follows:
■ A crisis type devaluation has occurred: Sterling has experienced most of a typical
crisis-type devaluation, having fallen at peak by c.30% against the US dollar, against
an average crisis devaluation of around 32% looking at events such as the ERM exit or
the financial crisis of 2007-08. At the time of writing, sterling is down c.28% from its
peak against the dollar, and 22% on a trade-weighted basis.
■ Valuation: Sterling is now 14% cheap against the USD on PPP, a valuation which has
represented a trough when reached in the last 20 years.
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227
2 December 2016
Figure 481: The post-Brexit sell off saw sterling
experience a typical 'crisis' devaluation
Figure 482: Sterling is now c.14% cheap against the
USD, a valuation which has represented a trough in
the last 20 years
GBP/USD
- Deviation
fromfrom
PPPPPP
GBP/USD
- Deviation
40%
30%
Event
GBP overvalued
20%
GBPUSD depreciation
Bretton Woods (1949)
-30%
10%
1980s recession (1980-1983)
-35%
0%
ERM Ex it (1992)
-29%
Financial crisis (2007-2008)
-35%
Brex it to trough (2014 - 2016)
-29%
Av erage
-32%
-10%
-20%
-30%
GBP undervalued
-40%
-50%
1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
■ Positioning: Speculators are extremely short sterling versus the USD on data from
CFTC.
Figure 483: Speculators remain extremely bearish on sterling
100
# of contracts (000's) .
80
Net long positions GBP/USD
60
40
20
0
-20
-40
-60
-80
-100
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
■ Rate differentials: Real rate differentials are consistent with a modestly stronger GBP
against the USD.
■ The current account deficit is likely to improve a little more than expected. It has
already fallen from 7% to 6% of GDP, but with 90% of assets foreign currency
denominated and 60% of liabilities foreign currency denominated, there is something of
an automatic improvement as sterling weakens.
■ Politics: Most market commentators believe that a hard Brexit is a high probability. We
think that this probability has been overstated, primarily as a function of the significant
Global Equity Strategy
228
2 December 2016
logistical hurdles which exist and the prospect of the House of Lords delaying the
passing of Article 50 (see FX section for more details).
GEM exposure – clouds on the horizon?
Around 18% of UK sales are emerging market related and, if one assumes commodities
are a play on GEM growth, then aggregate exposure of the UK to GEM via commodities
and direct exposure is c35% of market cap. The relative performance of UK equities has
tended to correlate with GEM equities and thus as GEM equities recovered through 2016,
this represented a significant tailwind.
Figure 484: UK equities have tended to track the
performance of GEM equities
150
Figure 485: The commodity weighting of UK
equities is greater than that of even GEM
5.5
EM relative - local
UK relative - local, rhs
5.3
140
40%
35%
Market cap energy & mining (% of total)
30%
GEM sales exposure, ex mining and oil (%)
5.1
130
4.9
120
4.7
110
4.5
100
90
80
2006
2008
2010
2012
Source: Thomson Reuters, Credit Suisse research
2014
2016
25%
18%
7%
20%
4.3
15%
4.1
10%
3.9
5%
3.7
0%
17%
18%
1%
17%
5%
7%
FTSE 100
Euro Stoxx 50
Nikkei
S&P 500
Source: Thomson Reuters, Credit Suisse research
As we discuss in detail in the emerging market section of this report, while emerging
market equities are still, in our judgement, an attractive multi-year investment, there are
macro challenges as we enter 2017, namely, a stronger dollar, the rise in US real bond
yields, and the increased threat of protectionism. Also, China in 2017 is unlikely to repeat
the positive surprise it provided to markets in 2016 at a time when Chinese policy is being
clearly tightened.
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229
2 December 2016
Figure 486: Real rates in the US are now moving
higher
Figure 487: The rise in TIPS yields is consistent with
GEM equities underperforming in the near-term
-2.0
10 year TIPS yield (%)
10yr breakeven inflation (%)
3.0
13
GEM relative to global equities, 6m % chg
-1.5
US 10-year TIPS yields, 6m chg, rhs, inv.
2.5
8
-1.0
2.0
1.5
1.0
3
-0.5
-2
0.0
0.5
0.5
-7
0.0
1.0
-12
-0.5
1.5
-1.0
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
-17
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
Commodities
Around 18% of UK market cap is accounted for by commodities, a share substantially in
excess of any other major equity market (higher even than GEM, and in Europe ex. UK,
the share is just 7%). In our judgement, the oil stocks need a $60pb oil price to give them
attractive free cash flow yields (and even then on 2018 numbers). We are more
constructive on the mining sector thanks to high free cash flow yields offered by the
companies (averaging 17% for the sector on spot commodity prices).
Figure 489: This commodity weighting creates a
relationship between the relative performance of the
UK and the CRB index
Figure 488: The commodity weighting of UK
equities is greater than that of even GEM
12%
12%
600
Share of market cap
Oil & Gas Mining
10%
10%
8%
5.5
CRB commodity index
UK equities relative to World, rhs
550
5.1
8%
7%
4.9
500
4.7
6%
4%
4.5
450
4%
4.3
3%
2%
0%
0%
0%
UK
Emerging
markets
US
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
5.3
Euro area
4.1
400
1%
3.9
0%
Japan
350
2011
3.7
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
230
2 December 2016
45% of expected 2017 EPS growth is coming from energy, with a further 11% from
materials. Excluding financials and resources, EPS growth expectations are 9% on
consensus forecasts. This clearly leaves the UK vulnerable to volatile commodity prices.
Figure 490: Resources are contributing more than 50% of expected EPS growth
in 2017
MSCI UK sectors
EPS grow th
Contribution to 2017 EPS
2016
2017
absolute
grow th (%)
Energy
-39.2
89.6
14.9
44.1
Materials
-19.2
35.4
6.9
11.3
Industrials
-5.6
9.7
7.4
4.1
Cons disc.
9.9
5.6
9.7
3.2
Cons stap.
12.9
13.9
14.3
10.9
Healthcare
11.4
6.9
11.6
4.7
Financials
-6.5
11.9
26.1
17.4
IT
21.6
13.6
0.6
0.5
Telecom
-1.3
14.8
4.1
3.3
Utilities
-0.9
2.7
4.3
0.7
Market
-5.5
18.9
Market ex financials
-5.2
21.8
Market ex res and fins
6.7
9.2
Market ex resources
1.9
10.1
Source: Thomson Reuters, Credit Suisse research
Outside of resources, the UK has tended to be a defensive market
The UK has historically been a defensive market outside of mining and oil given its
weighting in pharma and consumer staples (until recently, consumer staples were the
largest sector in the FTSE 100). As a result, it is not the most attractive region in which to
invest when global bond yields and global PMIs turn higher. The UK market has the lowest
operational leverage of any major market.
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2 December 2016
Figure 491: The UK’s operational leverage is low
6
5.7
Figure 492: The UK tends to outperform when
global economic lead indicators fall, and vice versa
5
3.3
3.2
3
3%
-5%
2%
0%
1%
5%
0%
10%
-1%
15%
-2%
20%
-3%
25%
-4%
2.9
2
1
0
Emerging
markets
World
Continental
Europe
US
Source: Thomson Reuters, Credit Suisse research
4%
-10%
2.4
Japan
5%
OECD composite lead indicator, 6m% ch, rhs
-15%
3.8
4
UK Ex-resorces price rel Global, lc, 6m chg, INVERTED
-20%
Beta of EPS to Global IP
UK
30%
1997
-5%
2000
2002
2005
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
These dynamics, a positive correlation with GEM equities and a relatively defensive
market construction outside resources, leave the UK market with a large negative
correlation with US 10-year yields at a time when we believe they can continue to move
higher.
Figure 493: UK equities have a significant negative correlation with US 10-year
bond yields
0.32
0.22
0.12
0.02
-0.08
-0.18
Correlation of local currency relative performance
with US 10 year yields
-0.28
-0.38
-0.48
-0.58
Japan
Europe ex. UK
US
GEM
UK
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Valuations are not especially attractive
UK valuations are not particularly attractive if we look at the PE or P/B relative., although
the recent re-rating of non-UK markets has pulled back valuations from their Brexitrecovery highs.
Figure 494: PE relative valuations are still around a
standard deviation above average
1.10
Figure 495: Excluding resources, the PB relative
valuation is around average on a relative basis
UK ex resources, 12 month forward PE relative to Global
1.05
1.25
Headline UK forward PE relative to Global
1.00
1.15
0.95
1.05
0.90
0.95
0.85
0.85
0.80
0.75
0.75
0.70
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
UK PB relative to Global
0.65
1996
Source: Thomson Reuters, Credit Suisse research
UK ex resources PB relative to Global
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
This recent de-rating has picked the UK (relative to global equities) up from the bottom of
our regional valuation scorecard, but it is still only middling.
Figure 496: UK equities are only middling on our regional valuation scorecard
12m Fwd P/E
Region
Latest
Price to Book
Z-score
Latest
40%
Weight
Z-score
BY-12m fwd Earnings Yield
Latest
20%
Z-score
DY
Latest
10%
PEG
Z-score
Latest
10%
Z-score
Z-score
20%
Japan
14.1
1.1
1.3
0.5
-7.1
1.0
2.0
1.1
1.6
-0.6
0.63
GEM
11.7
-0.1
1.6
0.4
-2.4
-0.2
3.1
0.6
0.9
1.6
0.41
UK
14.3
-0.1
1.9
0.9
-5.5
0.4
3.6
0.6
1.4
0.1
0.28
Europe ex UK
14.3
0.1
1.6
1.2
-6.1
0.9
3.2
0.6
1.7
-1.0
0.23
US
17.0
-1.1
3.0
-1.4
-3.6
0.0
2.1
0.8
1.4
-0.1
-0.67
Cheapest region, with cheaper valuation (12m fwd P/E, P/B, DY & PEG ratios) and smaller spread between bond yields and earnings yields, is ranked at the top
A higher z-score is a positive on all measures
Source: Thomson Reuters, Credit Suisse research
An uncertain outlook for the UK economy
As noted above, the UK equity market's exposure to the UK economy is not exceptionally
large, but at around 30% of sales, it is not irrelevant either. While post-Brexit caution on
the UK economy was excessive, challenges and risks remain for the UK economy in 2017.
Primary among these is a likely sharp rise in the cost of living at a time when the
consumer savings ratio is already extremely low by historic standards.
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2 December 2016
Figure 497: 12-month forward GDP growth estimates have adjusted sharply
lower but now appear to have stabilised
3
2
1
0
-1
12m fwd GDP growth estimates
UK
-2
-3
2009
2010
2011
2012
2013
2014
2015
2016
Source: the BLOOMBERG PROFESSIONAL™ service, Credit Suisse research
We would admit that PMI service new orders are consistent with growth at or around 1.5%
currently. However, we would note that a number of the lead indicators of employment
growth, such as vacancy growth, imply a slowdown in employment growth.
Figure 498: Service sector PMIs have weakened, but
are consistent with c.1.5% GDP growth
UK Services PMI new orders
10%
UK GDP % chg Q/Q annualised, 3m lag (rhs)
65
Figure 499: Vacancy growth is weakening, and that
tends to lead employment growth
3.5
40
8%
6%
60
4%
55
Employment, y/y%
2.5
30
Vacancies, y/y%, lead 3m, rhs
20
1.5
10
2%
0%
50
0.5
0
-2%
45
-4%
-20
-6%
40
-8%
35
1998
-10
-0.5
-10%
2002
2007
2011
Source: Thomson Reuters, Credit Suisse research
2016
-1.5
-30
-2.5
-40
2003
2005
2007
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
Most of the lead indicators we look at, whether PMI input prices or the ONS import price
series, are consistent with CPI heading up to at least 3% (even the Bank of England's
central projection is in excess of 3% against a current inflation rate of 0.9% with 10% off
sterling equating to 0.8% on inflation). Our economists see inflation peaking a little lower at
around c2.5%. Either this rise in inflation is passed on, in which case real wage growth will
slow to zero, or corporate margins are squeezed. Neither is positive for GDP growth.
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2 December 2016
Figure 500: IP momentum in the UK has weakened
8
50
IP, y/y%, lhs
6
CBI order book, rhs
30
2
20
0
10
-2
0
-4
-10
-6
-20
-8
-30
-10
-40
-12
-50
-60
2005
2007
2009
2011
22%
40
4
-14
2003
Figure 501: Import price inflation is consistent with
CPI picking up to 3% Y/Y
2013
2016
Source: Thomson Reuters, Credit Suisse research
17%
6%
UK import price inflation
(with GBP-implied level)
5%
UK CPI, rhs
12%
4%
7%
3%
2%
2%
-3%
1%
-8%
0%
-13%
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017
-1%
Source: Thomson Reuters, Credit Suisse research
Ordinarily, consumers have been able to cushion the impact of an unexpected rise in the
cost of living by allowing their savings ratio to decline. That remains a possibility, but a
diminished one given that the savings ratio is the UK is already close to a low at c.5%
(while savings ratios are well off their lows in the US and Europe).
Figure 502: Wage growth in the UK has stagnated at
c.2.5% chart of wage growth versus inflation with
BoE projection.
5
16
Whole economy regular pay, % chg Y/Y
4
Figure 503: While the UK saving ratio is already
close to a 40-year low
Whole economy regular pay deflated by CPI
Household sav ing ratio (%)
UK
14
3
2
12
1
10
0
-1
8
-2
Real wage growth
assuming 3% CPI
-3
-4
2008
2009
2010
2011
2012
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2013
2014
2015
2016
6
4
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: Thomson Reuters, Credit Suisse research
235
2 December 2016
What are the risks to an underweight?
What are the risks to an underweight stance in UK equities? In a sense, the risks to an
underweight would crystallise if our base case macro assumption prove incorrect:
■ Sterling falls more than expected in 2017: If Article 50 is enacted sooner than
expected, or the government's appeal to the Supreme Court succeeds in overturning
the judgement that parliament should be consulted, sterling could fall further in 2017,
supporting local currency performance.
■ A further rally in commodity prices: Creating upside risks for commodity prices
would require, we think, a further upside growth surprise in China, or an OPEC
agreement to facilitate a concrete cut in oil output.
■ A fall in US bond yields: As noted above, the relative performance of UK equities has
a large negative correlation with US bond yields. Although our base case very much
remains that US yields will rise, not fall, were President-elect Trump to fail in his
attempt to pass an ambitious infrastructure or tax cutting plans, or were the more
troubling elements of his trade proposals implemented, downside risks for the US
economy, and for US yields, could crystallise.
UK domestic sectors
Without going into any depth, we make a few observations on the outlook for the more
domestic UK sectors. We took the simple view in September 2015 that the UK sector call
was largely a sterling call. We moved to underweight UK in September 2015, and reversed
most of that in July 2016.
The dominant trade in the UK over the past seven years has been to buy dollar earners,
but we think this trade is now largely complete.
Figure 504: UK sectors relative performance:
correlation with sterling
0.4
Figure 505: Sterling and the relative performance of
retail has had a close relationship
110
UK sectors correlation with Sterling TWI, last 10y
0.3
0.2
UK Retailing price rel market
2.2
GBPUSD, rhs
100
2
90
0.1
-0.1
80
-0.2
1.8
70
-0.3
1.6
60
-0.4
-0.5
50
Energy
Capital Goods
Beverages
Met & Min
Cons spls
Chemicals
Hh prdcts
Pharmaceuticals
Tobacco
Comm svs
Semiconductors
Food Retail
Media
Software
Food Producers
Utilities
Paper prdts
Cons mat
Healthcare Equip
Cons Dur
Technology Hardware
Insurance
Telecoms
Transport
Retailing
Banks
Div. financials
Real estate
Source: Thomson Reuters, Credit Suisse research
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40
1.2
30
20
1997
1
1999
2002
2005
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
If we look at sector sensitivity, whether it is retailing or pharma, UK sector trades have
been closely related to the moves in sterling.
Figure 506: The real estate sector tends to
underperform as sterling weakens
110
Figure 507: UK pharma is a significant beneficiary
of sterling weakness
1.6
Trade-weighted sterling
1.1
1.4
UK real estate, price relative, rhs
105
1.5
1.4
1.3
1.3
100
1.2
95
1.2
1.5
1.1
1.7
90
1
0.9
85
0.8
80
0.6
75
70
2004
1.0
0.8
0.7
1.9
UK Pharma rel mkt
2.1
GBP USD, inverted, rhs
0.6
2.3
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
0.4
2006
2008
2010
2012
Source: Thomson Reuters, Credit Suisse research
2014
2016
Source: Thomson Reuters, Credit Suisse research
We revised up four areas of the UK in July and then in September 2016 (when we become
less negative on sterling). Our preferred domestic exposure is via:
■ Non-London related housebuilders
This is because, outside London and the South East, the house price to wage ratio is
attractive (and the rental yield is c5%, well above the mortgage rate). Homebuilders are
discounting a 5% fall in house prices, while the RICs survey below is implying around a
5% increase. The stock with the greatest exposure outside London and the South East is
Persimmon. We would stress that we remain negative on London related exposure, which
leave us cautious on Berkeley Group or Foxtons, especially given the technological
disruption to estate agents and the recent changes in the budget on tenant fees.
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2 December 2016
Figure 508: The sector as a whole appears to be
pricing in a 5% fall in house prices
100%
UK Home builders rel market, y/y chg (9m lead)
Figure 509: RICS sales to stocks is in line with
current house price inflation
RICS sales to stocks, rhs, lead 6 months
20%
Halifax house prices y/y%, rhs
UK house price index, y/y chg (rhs)
80%
15%
60%
10%
40%
5%
20%
30%
0.7
0.6
20%
0.5
10%
0.4
0%
0%
0.3
-20%
0%
-5%
0.2
-40%
-10%
-60%
-80%
2007 2008 2009 2010 2011 2012 2013 2015 2016 2017
-15%
Source: Thomson Reuters, Credit Suisse research
-10%
0.1
0.0
-20%
1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016
Source: Thomson Reuters, Credit Suisse research
■ UK non-food retailing
We took UK retailing up to benchmark from underweight in the summer. The key is that
the UK retailing sector is trading on a recession multiple (a 20% discount to the market)
and a 40% discount to global retailing, as we show below. Earnings revisions have also
turned positive as has growth in non-food retail sales.
Figure 510: The sector has de-rated sharply relative
to the UK market
150%
UK 13w retail earnings revisions
rel UK
80%
140%
60%
130%
40%
120%
20%
110%
0%
100%
-20%
90%
-40%
80%
-60%
70%
60%
1995
Figure 511: UK retail sales appear to be improving
UK Retailing: 12m fwd. P/E rel. to mkt
Average (+/- 1 SD)
1998
2002
2005
Source: Thomson Reuters, Credit Suisse research
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2009
2012
2016
-80%
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Retail has tracked sterling closely, so our view that sterling has troughed should remove
this headwind for the sector.
Figure 512: Sterling has tracked the performance of
retail closely
Sterling TWI, lhs
110
UK Retailing 12m Fwd PE rel Global Retailing
Average (+/- 1sd)
130
105
100%
120
100
90%
110
95
100
90
80%
90
70%
80
85
60%
70
80
60
75
70
2002
110%
140
UK general retail relative, rhs
Figure 513: The sector now trades on c.40%
discount to the global retail sector
50%
50
40%
1996
40
2004
2006
2009
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
2000
2003
2006
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
■ UK life companies
UK life companies are not only correlated now to rising gilt yield but abnormally cheap
versus fund managers.
Figure 514: Ordinarily, when rates rise, life
companies tend to outperform
110
Figure 515: UK life insurers are almost .3std cheap
against asset managers
7
UK life insurers price relative to market
100
6
UK 10-year Gilt yield, rhs
90
5
80
130%
120%
L&G and Standard Life 12m fwd PE rel UK
asset managers
110%
Average (+/- 1 SD)
100%
70
4
90%
60
3
80%
50
2
60%
40
1
30
20
2001
70%
2004
2007
Source: Thomson Reuters, Credit Suisse research
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2010
2013
0
2016
50%
40%
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
■ UK small cap
Small cap equities have three times the domestic exposure of large cap equities and thus
tend to outperform as sterling rises. In addition, small caps are abnormally cheap versus
large cap equities.
Figure 516: A stabilisation in the sterling exchange
rate should support UK small caps relative to large
0.80
110
FTSE small cap / FTSE 100
145%
TW£, rhs
0.75
105
0.70
0.65
0.60
0.55
FTSE small cap 12m fwd PE rel large cap
135%
100
125%
95
115%
90
Average (+/- 1SD)
105%
95%
0.50
85
85%
0.45
80
0.40
0.35
0.30
1990
Figure 517: UK small caps relative to large caps is
almost 0.7std below their average P/E
1994
1998
2003
Source: Thomson Reuters, Credit Suisse research
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2007
2011
2016
75%
75
65%
70
55%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
US: remain underweight
What are the challenges?
In each of the last three years, we have been underweight US equities because we
believed – incorrectly – that global growth was poised to accelerate and US rates were set
to rise. However, although these macro forces have not played out as we thought they
would (and accordingly US equities have outperformed), we think 2017 looks different, as
we highlight in our macro overview. As a result, we retain a small underweight in US
equities for the following reasons:
1.
The US is the most defensive of the global markets
The defensiveness of US equities in a global context stems from four features:
■ The US has relatively low operational leverage. As we illustrate in other country
sections, US equities have the lowest beta of EPS to global IP of any major region, as
one would expect for the region with the highest margin;
■ The superior ability of US corporates to cut costs particularly in contrast to Japan
and Europe, where labour laws are much more restrictive;
■ The overweight the US has in growth stocks.
Hence, as the first chart below illustrates, US equities tend outperform when global PMIs
fall and when global GDP growth decelerates. Crudely, the US market appears to be
discounting a small fall in global PMIs from current levels, at a time when we think the risk
for PMIs, and indeed global growth momentum more broadly, is to the upside.
Figure 518: US equities outperform when global PMI
new orders fall
25
20
Figure 519: US equities tend to underperform when
global GDP growth accelerates
US relative to global, US$ terms, 2000 = 100
Global GDP growth, inv, rhs
35
US equities price rel. 12m
change, lhs
Global PMI composite new
orders, rhs, inverted
40
15
1.0
123
1.5
118
45
10
2.0
113
2.5
108
5
50
0
55
-5
60
-10
-15
1998
65
2000
2003
2005
2008
2010
Source: Thomson Reuters, Credit Suisse research
2013
2016
3.0
103
3.5
98
4.0
93
4.5
88
5.0
83
5.5
78
2001
6.0
2003
2005
2007
2009
2011
2014
2016
Source: Thomson Reuters, Credit Suisse research
2.
Rising bond yields should be bad for the relative performance of the US
To some extent, the US market is long of 'growth' stocks (technology and biotech are 19%
of market cap compared to 12% globally) and short of financials (banks are 6% of US
market cap compared to 9% in Europe and 8% in Japan). As a result, rising US yields tend
to be associated with US equity underperformance.
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2 December 2016
There is an investment style element to this too: when yields rise, growth as a style
globally tends to underperform (as has been apparent in recent weeks as US yields have
risen), as shown below. One disconnect to note is between growth as a style and US
equities relative to global markets: expectations surrounding the Trump fiscal package has
boosted US relative performance while undermining the performance of growth.
Figure 520: Growth as a style tends to underperform
when yields rise
0.55
0.5
MSCI AC World Growth relative to market
0.53
Figure 521: Likewise, the US tends to underperform
globally when yields rise, although the election of
Donald Trump has disrupted this relationship
0.55
5.1
1.0
US 10 year Treasury yield, rhs inverted
1.5
2.0
0.51
MSCI AC World Growth relative to market
0.53
US rel global
4.6
0.51
2.5
0.49
3.0
0.49
4.1
3.5
0.47
4.0
4.5
0.45
0.47
3.6
0.45
5.0
0.43
2002
2004
2006
2008
2010
2012
Source: Thomson Reuters, Credit Suisse research
2014
5.5
2016
0.43
2002
2004
2006
2008
2010
2012
2014
3.1
2016
Source: Thomson Reuters, Credit Suisse research
3.
Relative valuations look stretched
US equities account for 54% of the MSCI All Country World thanks to the relative rally in
the underlying equity index, combined with the move higher in the US dollar since 2011.
This period of outperformance has, however, left US equities at historically high valuations
relative to the rest of the world, which we show below in terms of HOLT P/B relative (now
around 2 standard deviations extended) as well as a simple 12-month forward P/E.
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2 December 2016
Figure 522: US equities are trading 2 s.d. above the
average on HOLT® P/B (value to cost) relative to
global
Figure 523: MSCI US 12m fwd. P/E rel global is
trading above its long-term average
115%
1.37
US HOLT P/B rel to Global
110%
1.32
105%
1.27
100%
1.22
1.17
95%
1.12
90%
1997 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
US 12m fwd PE rel world
Average (+/- 1SD)
1996
1998
2000
2002
2004
2006
2008
Source: Credit Suisse HOLT
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
4.
The dollar is strengthening
According to S&P, 44% of S&P 500 revenues come from overseas. This is nearly three
times the economic exposure of the US, with exports accounting for c.12% of GDP. As a
result, when the dollar strengthens, as it has since the election of Donald Trump, it tends
to be much more of a challenge for earnings than the economy.
As the first chart below illustrates, US earnings momentum tends to track the tradeweighted dollar reasonably closely. If we assume the dollar remains unchanged from its
current level into 2017, then the year-on-year will start to climb, which is likely to push
earnings momentum back into negative territory. In absolute terms, our US EPS model
suggests that 10% on the USD takes around 3% off US EPS. Moreover, the US overseas
earners have, thus far, proved surprisingly resilient to the move higher in the dollar.
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2 December 2016
Figure 524: Dollar strength is likely to weigh on US
earnings momentum
S&P 500
4-wk
Earnings revisions, net upgrades
13-wk
Dollar TWI, % chg Y/Y, rhs inv
80%
60%
-20
-15
Figure 525: Overseas earners have overshot what
the dollar value is suggesting
168
70
163
75
158
40%
-10
20%
-5
153
0%
0
148
-20%
5
143
-40%
10
138
-60%
15
-80%
20
80
85
90
-100%
25
05
06
07
08
09
10
11
12
13
14
15
16
Source: Thomson Reuters, Credit Suisse research
95
133
US exporters price rel to market*
US TWI (rhs, inv)
100
128
*US companies with above 60% sales
exposure outside the US
105
123
2009
110
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
5.
US labour is getting some degree of pricing power
The US economy is in a different point in the cycle compared with much of the rest of the
world – both developed and emerging markets. In Europe, the unemployment rate remains
in double digits, while across emerging markets unemployment rates are rising. In the US,
however, labour's pricing power is growing, and the wage share of GDP is increasing. This
is compressing US margins, as we highlight in the asset allocation section, and this is a
challenge almost unique to US corporates currently.
Figure 526: Profit share of GDP and wage share
move in opposite directions
14%
% of GDP, US
13%
Profits
12%
Figure 527: US wage growth is now showing signs
of meaningful acceleration
52%
5.0
53%
4.5
Wages, rhs, inverted
54%
11%
10%
55%
9%
56%
ECI wages and salaries (% chg Y/Y)
4.0
3.5
3.0
2.5
8%
57%
2.0
7%
58%
6%
5%
1950
Average hourly earnings (% chg Y/Y)
59%
1961
1972
1983
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1994
2005
2016
1.5
1.0
1990
1993
1997
2001
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
6.
Earnings and economic momentum relatively weak
The recent move higher in the US dollar has served to push the US down our earnings
momentum scorecard, leaving the US at the bottom of our regional composite scorecard.
Moreover, the US is now at second bottom of our macro momentum scorecard, not so
much because momentum is particularly weak, it should be said, but rather because of a
pick-up in growth momentum in the world excluding the US.
Figure 528: Regional earnings momentum scorecard
Normalized scores
Regions
Weights
MCI
Economic
momentum
Valuation
Earnings
momentum
Positioning &
Sentiment
Macro factors
Overall score
15%
20%
20%
15%
15%
15%
100%
UK
1.34
1.40
0.22
1.75
0.47
-1.33
0.66
Europe ex UK
0.74
0.71
0.12
-0.31
1.54
-0.49
0.39
Japan
-0.35
-0.57
0.92
-0.18
-0.85
1.37
0.07
GEM
-1.01
-0.85
0.44
-0.57
-0.61
0.13
-0.39
US
-0.72
-0.70
-1.70
-0.70
-0.55
0.31
-0.73
For all the measures above, a high z score is considered as positive
Region with higher liquidity, better economic momentum, cheaper valuation, better earnings momentum and more bearish positioning
& sentiment is ranked at the top
Source: Thomson Reuters, Credit Suisse research
7.
Outflows are no longer substantial
US equities no longer appear to be under-owned. After an extended period of significant
outflows, flows into US equity funds have picked up to more neutral levels.
Figure 529: US equities no longer appear to be under-owned
5%
0%
-5%
-10%
3m annualised net flows into US equity funds, as a % of assets, rel Global
-15%
2010
2011
2012
2013
2014
2015
2016
Source: EPFR, Credit Suisse research
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2 December 2016
Where could we be wrong?
The main positive for the US is that it is overweight of technology and, apart from the risk
of rising bond yields, we like many of the fundamentals of technology outside of hardware
(especially software and internet-related areas). The challenge for 2017 is that of rising
bond yields. While, bottom-up, the sector is likely to remain attractive, the top-down is
likely to become more challenging as yields rise, after an extended period of falling yields
re-rating longer-duration sectors.
Figure 530: When tech outperforms, the US tends to
outperform
1.70
1.30
1.60
Tech rel
1.25
US rel, rhs
15
Tech rel, 3mm % change
1.20
1.50
1.15
1.40
US rel, 3mm % change
10
1.10
1.30
1.05
1.20
1.00
1.10
5
0
0.95
1.00
0.90
0.90
0.80
2002
Figure 531: Tech relative vs. US relative, 3mm %
change
-5
0.85
0.80
2005
2007
2009
Source: Thomson Reuters, Credit Suisse research
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2011
2014
2016
-10
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
2017 macro outlook
We see the following main macro drivers for 2017:
■ A broad-based, albeit modest, acceleration in global growth: The past 4-5 years
have been characterised by a range of growth shocks emanating from multiple sources
including Europe, China and emerging markets. Tight fiscal policy, bank deleveraging
and the disruptive impact of the oil price decline on capex have also presented
significant headwinds. In our view, 2017 is likely to be a year in which the headwinds
from such shocks are diminished and growth momentum is broad-based, if
unspectacular. Our economists forecast global GDP growth of 3.0% in 2017, up from
2.5% in 2016, with leading indicators such as global manufacturing PMI new orders
(which are at a 19-month high) also suggesting reacceleration.
■ Policy shift to progress: We believe policymakers will ultimately remain supportive of
growth globally, but we think that support will continue to shift to the fiscal channel and
away from monetary policy. Indeed, QE could face growing logistical challenges in
2017 in both the euro area and Japan. The US now appears to be on a path towards
loose fiscal/tight(er) monetary policy following the election of Donald Trump.
■ Inflation back on the radar screen: After almost five years of steady disinflation, we
think 2017 is likely to see a reacceleration in headline inflation globally. The tightness
of the US labour market is now becoming apparent in accelerating wage growth,
supporting services inflation (and Trump's proposed policies on all fronts tend to be
inflationary). Goods prices inflation is likely to find support from commodities and
Chinese producer prices.
■ US growth to accelerate as headwinds diminish: In the four quarters to Q2 2016,
inventories and shale investment together subtracted c.100bps from GDP growth. With
inventories now being rebuilt in the US and commodity prices having rebounded, these
headwinds will become tailwinds, while the underlying consumption picture should
remain solid. President-elect Trump's commitment to fiscal easing and de-regulation is
likely to offset the negatives from his push for tighter immigration rules and increased
protectionism.
■ Euro area GDP growth to continue to surprise: We believe that investors
underestimate both current growth momentum (real year-on-year growth in the euro
area at the time of writing is stronger than in the US) and future prospects. Not only are
PMIs currently consistent with c.1.8% GDP growth, but we see four factors that are
particularly supportive of growth: pent-up domestic demand, a banking system that is
allocating credit, the recovery in exports to Russia and China and an abnormally loose
monetary policy (allowing the euro to weaken despite the positive growth surprise). We
think euro area GDP growth may end up being closer to 2% in 2017, a little faster than
the 1.5% our economists predict, which matters globally given that the euro area
economy is 66% the size of the US. UK growth is set to modestly disappoint, with our
economists forecasting 1.2% GDP growth in 2017 compared to consensus of 1.5%.
■ Chinese government to support growth in the run-up to next autumn's Party
Congress: China has done little to address what we have in the past referred to as the
'triple bubble' in investment, credit and housing. Indeed, the government's recent
policies have only served to exacerbate aspects of these bubbles. Nonetheless, a
combination of infrastructure spending and an export boost thanks to RMB weakness
appears set to support growth through 2017. Moreover, China appears to have large
fiscal flexibility (with net government debt to GDP very low) and the ability to use it
(with a current account surplus of 3% of GDP and net foreign assets). None of our four
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2 December 2016
hard landing indicators are flashing red, but we do see signs of policy tightening on
almost all our indicators, and this needs to be watched carefully.
■ FX – some near-term USD strength, but 2017 should be a quieter year: We see
further dollar strength, but we do not expect anything dramatic; we think the risk of a
substantial RMB depreciation is relatively small.
The three mains risks to global growth are, in our view:
■ The lack of rebalancing in China;
■ The US economy becoming late-cycle. Typically, as wage growth rises, profit
margins are squeezed and that in turn depresses corporate spending and thus GDP.
Already the US has had its fourth-longest post-war expansion. The good news is that
despite the rise in wage growth, we think full employment is likely to be closer to 4%
than the Federal Reserve's assumption of 4.8%. We think it is important to monitor the
lead indicators of capital spending;
■ Politics. The political challenges of 2016 look set to continue in 2017. But as we saw
in 2016 in the case of Brexit, or of Spain (which went without a government for almost
a year), political uncertainties do not preclude the possibility of an acceleration in GDP
growth. Indeed, they provided buying opportunities for risky assets.
Growth: a broad-based, albeit modest, acceleration in global growth
We would highlight the following positives:
1. Lead indicators finally turning higher
Global PMI manufacturing new orders have been bound in a narrow range for much of the
past two years. This PMI measure has now risen to its highest level in 19 months and is
consistent with global GDP growth of c.3%, as forecast by our economists.
Figure 532: Global PMI new orders appear to be
breaking up after 18 months to sideways trading
Figure 533: Manufacturing PMI new orders have
increased… and suggest an upturn in GDP
65
57
Global macro surprises, lhs
40
4.8%
60
3.8%
Global manufacturing PMI new orders
55
20
55
2.8%
50
53
0
-20
51
-40
49
-60
2010
1.8%
45
47
2011
2012
2013
Source: Thomson Reuters, Markit, Credit Suisse
Global Equity Strategy
2014
2015
2016
0.8%
40
35
Global manufacturing PMI
new orders
30
Global GDP growth, 6m lag,
rhs
25
1999
-0.2%
-1.2%
-2.2%
2001
2003
2005
2007
2009
2011
2013
2016
Source: Thomson Reuters, Markit, Credit Suisse
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2 December 2016
Growth weakness has not been only a real event; nominal GDP growth has also been
exceptionally weak. Indeed, on a global basis, nominal GDP growth over the past 18
months has been commensurate with rates seen in previous recessionary periods. US
nominal GDP growth in the four quarters to Q2 2016 was just 2.5% – its slowest annual
pace since 2009. However, with inflation now picking up (as we discuss below), nominal
GDP growth appears to be past an inflection point. Chinese nominal GDP growth has been
accelerating since Q4 2015, while Q2 2016 appears to have been the trough in the US.
Figure 534: Global nominal GDP growth is close to
the levels seen in previous recessions, but is set to
accelerate
Figure 535: Both US and Chinese nominal GDP
growth have turned up
6.0
10%
21
US nominal GDP y/y
5.5
8%
6%
4%
Chinese nominal GDP y/y, rhs
19
5.0
17
4.5
15
4.0
13
3.5
11
3.0
9
2.5
7
2%
0%
Real global growth, y/y%
-2%
Nominal global growth, y/y%
-4%
1985
1988
1991
1994
1998
2001
2004
2007
2010
2013
2017
2.0
5
2011
Source: Thomson Reuters, Credit Suisse
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
2. Diminishing macro shocks at a time when monetary conditions remain loose
G3 global monetary policy has been exceptionally loose for nearly three years in the face
of a steady stream of macro shocks. Now these shocks are diminishing, while monetary
conditions remain unusually loose. Among the shocks whose impact is now diminishing,
we would highlight:
■ Fiscal policy becoming much less tight. Over the past five years, fiscal policy has
been tightened by up to 6.4% of GDP in the US. Now, however, the policy tone has
shifted decisively towards easier fiscal policy going forward.
Figure 536: Advanced economies have seen significant fiscal tightening in the
post-crisis period
Post-crisis fiscal
easing
Subsequent
cumulative fiscal
tightening to 2015
Net fiscal policy
change since crisis
Euro area
2.82
3.53
Tighter
UK
4.96
5.15
Tighter
US
6.31
6.38
Tighter
Japan
5.38
3.13
Looser
% GDP
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
249
2 December 2016
■ The disruptive impact of the oil price decline: Between the summer of 2014 and
January 2016, the oil price fell by 75% – an event that proved more disruptive for the
global economy than almost anyone forecast. Our estimates, on a range of
assumptions detailed in Figure 536, suggest that the declines in oil opex and capex
have reduced global GDP by c.2% and US GDP by 1% over the past year. Now,
however, with the oil price up 64% from its low, capex in this sector should soon make
a positive contribution to growth.
Figure 537: Total commodity capex cuts have hit
global GDP growth by c.1.8% since the oil price
peak in mid 2014
Scale of capex cut
Capex assumption
Figure 538: The rise in the oil price suggests that oil
capex will soon start to make a positive contribution
to growth once again
150
$ billion
% GDP
-249.4
-0.3%
130
-498.8
-0.7%
110
Associated opex and second round effects
-498.8
-0.7%
90
Total energy capex cut impact on global GDP
-1246.9
-1.3%
-87.2
-0.1%
Global listed energy sector capex cut from peak
Total energy sector capex cut (assuming listed sector
1/3 total, non-listed cuts capex by half as much)
Global listed mining sector capex cut from peak
Total mining sector capex cut (assuming listed sector
-174.4
-0.2%
Associated opex and second round effects
-174.4
-0.2%
Total mining sector capex cut on global GDP
-436.0
-0.5%
Total commodity capex cut impact
-1682.9
-1.8%
1/2, non-listed cuts capex by half as much)
Source: Thomson Reuters, Credit Suisse
1.2%
1.0%
0.8%
70
0.6%
50
10
2000
0.4%
WTI oil price
30
Investment in mining, exploration and wells
& oilfield machinery, % GDP, rhs
2002
2004
2006
2009
2011
2013
0.2%
2016
Source: Thomson Reuters, Credit Suisse
In the US, c.180,000 jobs have been lost in the oil sector since 2014, but employment in
the sector is now no longer declining, while oil sector wages are also falling less rapidly.
The Baker Hughes rig count is up 40% from its low.
Figure 539: c180,000 jobs have been lost in the US
oil sector since the peak…
20
Figure 540: …but payroll income per employee in oil
is now falling more slowly
25%
Employment in the oil sector, monthly chg
15
20%
10
15%
5
10%
0
5%
-5
0%
-10
-5%
-15
-10%
-20
2001
2004
2007
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2010
2013
2016
Payroll income per employee
in oil sector, y/y%
-15%
2001 2002 2004 2005 2007 2008 2010 2011 2013 2014 2016
Source: Thomson Reuters, Credit Suisse research
250
2 December 2016
■ A series of European crises, and only a belated fall in SME-related lending rates:
For much of the period between 2011 and 2013, the euro area represented a drag on
global growth and posed systemic financial risks given fears of a disorderly Greek exit
from the euro area. Subsequently, following the ECB's decision to backstop the euro
area sovereign debt market, sovereign spreads have remained contained and the euro
area is now delivering steady growth of c.1.5% Y/Y.
We would also note that it was really only at the start of this year that SME-related
lending rates in the periphery fell to low levels. This is critical because SMEs account
for c.58% of GDP and banks are their only source of funds as they are too small to
access credit markets.
Figure 541: Lending rates to Spanish and Italian SMEs have only recently
declined to German and French levels
6.8
Lending rates to non-financial
SMEs, 1-5yrs, up to €1m, %
6.3
5.8
5.3
4.8
4.3
3.8
3.3
2.8
Germany
2.3
Spain
France
Italy
1.8
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
■ Bank de-leveraging: An extended period of bank de-leveraging in the US and, in
particular, Europe, was a significant headwind for growth. Now, however, bank
deleveraging appears advanced, with assets-to-equity in both the US and Europe at
lows. This in turn has allowed lending growth to pick up, allowing the banking system to
become a positive, rather than a negative, for growth.
■ A re-basing of Chinese growth expectations: Much of the past five years has seen a
steady decline in Chinese GDP growth expectations, from close to 10% in 2010 to
around 6.5% now. In nominal terms, we have seen Chinese GDP growth slow by two
thirds from peak levels. What is notable is that 12-month forward Chinese GDP growth
expectations have started to inflect higher, as we discuss in more detail below. Our
judgement is that the Chinese government will support growth until the National
Congress to be held next autumn.
Global Equity Strategy
251
2 December 2016
Figure 542: Banks in the US and Europe have now
de-levered
Figure 543: Chinese growth expectations are
starting to stabilise
42
12m fwd GDP growth estimates
Banks' tangible assets/ tangible equity
37
9
Europe
7
US
32
5
27
3
22
1
17
-1
12
1994
1997
2000
2002
Source: Thomson Reuters, Credit Suisse
2005
2007
2010
2013
2015
-3
2009
Global
2010
2011
2012
2013
2014
China
2015
2016
Source: Thomson Reuters, Credit Suisse
■ Dollar strength: From its 2011 trough, the trade-weighted dollar rose by around 40%
to its 2015 peak, climbing by over 20% in the 12 months to July 2015. This was a
contributing factor to dislocation in emerging markets (given their $4.4trn of dollardenominated debt), a fall in commodity prices and a decline in the US net export
contribution to growth. More broadly, global GDP declined by 5% in USD terms in
2015. While the dollar might strengthen modestly, we struggle to see very substantial
dollar strength.
3. The euro area recovery continues to slowly build and surprise positively
The euro area is often overlooked as a driver of global GDP, but the euro area economy is
around 66% of the size of the US. Our economists remain of the view that the euro area
economy will continue to grow by around 1.5% year-on-year, with PMIs consistent with a
run-rate in the near term a little higher than this. The euro area growth story continues to
be supported by the following factors:
■ Domestic demand: Domestic demand in the euro area has lagged that of Japan and
the US by 4% and 10%, respectively, since 2011, and nearly all of the growth achieved
in Europe over recent quarters has been domestic-demand related.
Global Equity Strategy
252
2 December 2016
Figure 544: Euro area GDP growth remains steady
at around 1.6%...
Eurozone manufacturing PMI: new orders, 3m lead
4%
Eurozone GDP growth, y/y rhs
60
Figure 545: Domestic demand in Europe has lagged
Japan and the US by 4% and 10%, respectively,
since 2008
111
3%
109
55
2%
107
50
1%
105
0%
45
-1%
40
-2%
-3%
35
30
25
1999
2001
2004
2007
2010
2013
101
99
97
-5%
95
-6%
93
Source: Markit, Thomson Reuters, Credit Suisse research
Euro area
US
Japan
103
-4%
2016
Domestic demand
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
To some extent, the potential for domestic demand to continue to climb is illustrated by the
size of the private sector financial surplus in the euro area, which remains high at c.4.5%
of GDP (with a household saving ratio of 12.8%), almost back to its financial-crisis peak.
Figure 546: Euro area GDP growth has been driven
solely by domestic demand growth
4%
Figure 547: The euro area private sector financial
surplus is near an all-time high
6%
Contribution to Euro area GDP growth
Euro area private sector net lending/borrowing (% GDP)
5%
2%
4%
3%
0%
2%
-2%
1%
Net exports
-4%
0%
Domestic demand
GDP
-6%
2009
2010
2011
2012
2013
2014
2015
2016
-1%
-2%
2000
Source: Thomson Reuters, Credit Suisse research
2002
2004
2006
2008
2010
2012
2014
2016
Source: Eurostat, Thomson Reuters, Credit Suisse research
■ A recovering banking system: Crucial to the sustainability of this recovery are banks,
which are responsible for c.75% of lending flows to the economy. Loans to both
households and the non-financial corporate sector are both up 2% year-on-year, lead
indicators of loan growth look good and, in general, lending conditions are relatively
easy. As discussed above, critically only at the turn of the year did SME-related lending
rates in Spain and Italy fall to low levels.
Global Equity Strategy
253
2 December 2016
■ Less of an external drag: As an example, German exports to Russia and China are
now recovering, having acted as a large drag in 2015. German exports to Russia and
China are 2% and 6% of total German exports, respectively.
Figure 548: Euro area banks' loan growth to nonfinancial corporates and households
Figure 549: German exports to Russia and China
are now stabilising, having been a drag
16
Germany exports to China (in EUR) y/y, 3mma
70%
14
Germany exports to Russia (in EUR) y/y, 3mma
Euro area private sector loan growth
(adj. for securitization), Y/Y
12
10
50%
NFCs
30%
8
Households
6
10%
4
-10%
2
0
-30%
-2
-4
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
-50%
2002
Source: Thomson Reuters, Credit Suisse research
2005
2007
2009
2011
2014
2016
Source: Eurostat, Thomson Reuters, Credit Suisse research
■ A euro that remains unusually weak: In the past, the problem has been that when
European PMIs are strong, the euro appreciates and that in turn hits European GDP
growth (with c10% off the euro taking, with a lag, around 0.6% off real GDP growth and
0.5% off inflation). The current PMI differential would historically have been consistent
with a much stronger euro. However, ECB QE is keeping the bund yield low relative to
the Treasury yield and preventing euro appreciation.
Figure 550: The EUR/USD has ignored the
improvement in Eurozone relative macro
momentum, owing to QE
Figure 551: The Treasury/Bund spread suggests
euro downside
10
1.54
5
1.44
0
1.20
EURUSD
Treasury/Bund spread, rhs, inv
1.18
1.4
1.16
1.14
1.34
-5
1.6
1.12
1.8
1.10
1.24
-10
-15
Euro-area vs US: manufacturing PMI new
orders
EUR USD, 6m lag, rhs
-20
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1.14
1.2
1.08
2.0
1.06
1.04
1.04
1.02
Jan-15
2.2
Jun-15
Dec-15
May-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
254
2 December 2016
4. Some near-term positives for US GDP growth
Over the past 12 months, US nominal GDP has grown by only 2.8%, with investment,
inventory and net trade weighing on activity. In our view, each of these drags looks set to
improve, with some of these headwinds becoming tailwinds.
■ Inventories to become less of a drag
Inventory declines subtracted an average of 60bps from growth between Q1 15 and Q3
16, in what was the longest period of negative growth contributions from inventories since
1955. We have now seen the end of this destocking, with inventories adding 0.6
percentage points to GDP growth in Q3, and we think this positive contribution can last for
two to three quarters.
We also wonder whether some corporates may have postponed their decision-making
ahead of the US presidential election in much the same way as happened prior to Brexit,
with many of the capital goods lead indicators having been weak. In the case of the UK,
the BoE estimated that GDP was hit by 0.7% ahead of the referendum as corporates
postponed decision-making.
Figure 552: ISM new orders less inventories is
consistent with IP growth picking up
35
US ISM Manufacturing new orders less inventories
30
Industrial Production, % chg Y/Y, 6m lag, rhs
Figure 553: Inventories have taken a cumulative
3ppts off growth
5
10
25
3
20
5
15
2
1
10
5
0
0
0
-1
-5
-5
-10
-2
Inventories have subtracted a
cumulative 3p.p. off growth
since Q2 2015
-3
-15
-20
1986
Inventory % point contribution to growth each quarter
4
-10
1991
1996
2001
2006
Source: Thomson Reuters, Credit Suisse research
2011
2016
-4
1990
1996
2003
2009
2016
Source: Thomson Reuters, Credit Suisse research
■ Investment picking up more broadly
Investment more broadly is also likely to prove less of a drag: investment in mining
exploration – a proxy for the shale industry – has subtracted an average of 50bps from
growth each quarter since the start of 2015. Beyond the oil industry, our economists note
that residential investment, which has been weak recently, subtracting 30bps from GDP
growth in each of the last two quarters, is also in a position to prove a durable source of
growth for the US. Construction as a share of GDP is still depressed relative to both
history and lead indicators, such as the NAHB index.
Against that backdrop, there is a triple tailwind of demographics (as the millennial cohort
enters their 30s); vacancy rates that appear to be troughing, removing a headwind for new
construction; and improving access to credit. We would also note that non-residential real
estate investment tends to follow residential investment with a lag of 12 months (and we
remain positive on the outlook for non-residential real estate investment).
Global Equity Strategy
255
2 December 2016
Figure 554: The residential construction share of
GDP is still c.1 percentage point below the long-run
average
90
7.0%
80
6.5%
6.0%
70
5.5%
60
5.0%
50
4.5%
40
30
20
US NAHB index
10
0
1985
US residential construction (% GDP rhs)
1989
1993
1998
2002
2007
2011
Figure 555: Non-residential investments lag
residential investments by 12 months
Current prices, y/y%
Non-residential private investment, structures (12
month lag)
Residential private investment
60%
50%
40%
30%
20%
10%
4.0%
0%
3.5%
-10%
3.0%
-20%
2.5%
-30%
2.0%
-40%
1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
At a time when the non-residential investment share of GDP is low, the lead indicators of
capex are starting to rise. The C&I loan survey, CEO business confidence index and Philly
Fed capex expectations are all ticking higher, while US new truck sales have started to
improve too.
Figure 556: The C&I loan survey has ticked higher
-40
Figure 557: …so does the CEO business confidence
index
80
10%
-20
5%
US CEO confidence Index (lhs, 2q lead)
25%
US Capex yoy (rhs)
20%
70
15%
0
0%
10%
60
5%
20
US C&I loan survey
(large & medium)
40
60
-5%
50
-10%
40
Nonresidential fixed
investments (y/y%), -15%
3Q lag rhs
80
0%
-5%
-10%
-15%
30
-20%
-20%
2001
2004
2007
2010
Source: Thomson Reuters, Credit Suisse research
2013
2016
20
1978
-25%
1983
1989
1994
2000
2005
2010
2016
Source: Thomson Reuters, Credit Suisse research
These lead indicators are ticking higher at a time when the non-residential investment
share of GDP is still well below previous peaks.
Global Equity Strategy
256
2 December 2016
Figure 558:… so does Philly Fed capex expectations
survey
Figure 559: The US non-residential investment
share of GDP is still well below previous highs
40%
30%
30
20%
15%
14%
20
10%
13%
0%
10
-10%
-20%
0
-30%
Core capital goods orders,
-10
3m/3m ann.
-50%
Philly Fed capex expectations
3mma, rhs
-60%
-20
2005 2006 2007 2008 2010 2011 2012 2013 2015 2016
-40%
Source: Thomson Reuters, Credit Suisse research
12%
11%
US non-residential investment share of GDP
10%
9%
1955
1963
1972
1981
1989
1998
2007
2016
Source: Thomson Reuters, Credit Suisse research
■ The underlying driver of US growth – employment growth – has remained very steady
With c60% of GDP being accounted for by consumption, the underlying driver of US
growth has been employment and wages. Year-on-year employment growth has remained
very steady in a range of 1.7% to 2.0% despite the oscillation in the Kansas City Fed
diffusion indicator. As we highlight later on, wage growth has risen to a 7-year high of
c.2.5%. This leaves underlying nominal income growth at around 4.5% and, with a PCE
deflator of 1.7%, underlying consumption growth of 2.2%.
Figure 560: Employment growth has been steady
5%
Figure 561: The Kansas City Fed composite labour
market conditions indicator has rebounded
2
2004-07 avg +1.4%
3%
4%
3%
1
2%
0
1%
0%
-1
-1%
Last 12
months avg
+1.7%
Clinton years
avg +2.4%
-3%
-4
Employment growth, % 3m annualised
1992
1996
2000
2004
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
-1%
-2
-2%
-3%
-3
-5%
-7%
1988
1%
2008
2012
2016
-5
1992
-4%
Kansas City Fed Labor Market Conditions
Indicators (LMCI) Momentum
US employment growth, y/y%, 6m lag, rhs
-5%
-6%
1994
1997
2000
2002
2005
2008
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
257
2 December 2016
■ Trumpflation
The election of Donald Trump as US President presents both upside and downside risks
to US growth. On the upside, his commitment to increased fiscal spending and lower
corporate and personal taxes, if implemented, could have a significant impact on growth.
The scale of his proposals is large: his tax cuts have been costed at c.20% of GDP over
10 years by the Committee for a Responsible Federal Budget, while his infrastructure
spending plan (on which his transition website places a number of $550bn) is worth a
further 3% of GDP. Moreover, any attempt to enhance investment tax credits at the
expense of reducing interest tax deductibility would be a positive for growth, as would be
the lighter regulatory burden on banks. It might even be the case that some of the US
c.$750bn of US cash (c.$2.5trn in retained earnings) potentially repatriated from overseas
finds its way into GDP (via buybacks and consumption or via investment).
On the downside, there is likely to be a period of significant policy uncertainty ahead, while
some of Trump's campaign pledges on trade and immigration clearly present downside
risks both to US and indeed global GDP growth. There has been some moderation of
language (a commitment to remove all undocumented migrants, estimated at around 11.4
million people by the Department of Homeland Security, has become a commitment to
remove or incarcerate 2-3 million 'criminal' undocumented migrants, with President Obama
having already removed 2.7 million illegal immigrants with a criminal record). We believe, as
we highlight in the asset allocation section, that his policies on protectionism will be toned
down in the much the same way as Obama's threat to leave NAFTA never materialised.
5. China, in some areas, might not be as bad as we feared but remains the major
risk
The most recent major move by our EM economists has been to increase their GDP
growth expectations for China, raising their 2017 growth forecast to 6.8% from 6.6%. This
move was predicated on two factors: first, a recognition that the government appears likely
to remain supportive of growth in the run-up to next autumn's Party Congress. It is doing
this via the infrastructure channel, which continues to grow at c.15%, even as real estate
and manufacturing investment slow. Second, the historical weakness of the RMB is
consistent with a significant acceleration in Chinese export growth (our economists believe
to 9.4% in 2017E, from -2.3% this year).
Global Equity Strategy
258
2 December 2016
Figure 562: Infrastructure investment is growing
substantially faster than real estate or
manufacturing
60%
Fixed Asset Investment growth (% chg Y/Y, 3 m.m..a.)
Figure 563: The weaker renminbi suggests Chinese
export growth should reaccelerate
-12%
60
Manufacturing, 38%
50%
Real estate, 29%
Infrastructure, 17%
40%
-8%
40
-4%
0%
30%
20
4%
20%
0
8%
10%
-20
0%
-10%
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
-40
Chinese export growth,
% change year-on-year
Chinese yuan, TWI,
inverted, rhs
12%
16%
20%
01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Source: Thomson Reuters, Credit Suisse research
On the Global Equity Strategy team, we are structurally more bearish than the consensus
on China. Nevertheless, we acknowledge the following fundamental factors likely
postpone any hard landing beyond 2017.
■ There is a lot of fiscal firepower. The IMF claims that government assets are 100%
to 150% of GDP and thus even in the event of a worst-case bank bailout, net
government debt to GDP would be very low. The IMF estimates that local government
debt is 45% of GDP, central government debt was last estimated to be 32% of GDP
and if NPLs were to rise to above 20% (the levels they went to in the two previous
banking crises), then the cost of a bank bail-out could be 40% of GDP. As a result, total
government debt in a worst-case scenario would be c.120% of GDP. With nominal
bond yields of 2.88% and nominal GDP growth of 6.7%, net government debt to GDP
is financeable even if it rises to c.150%.
■ Limited external vulnerability: A typical emerging market crisis occurs when a
country ends up with a current account deficit financed by foreign portfolio flows, which
in turn leads to a country becoming a net debtor. At that point, a country's only option is
to protect the currency by raising rates sharply to cause a collapse in imports.
Otherwise it risks a worse recession by devaluing as this would lead to a sharp
increase in defaults as the value of foreign currency denominated debt rises. China has
a current account surplus of 3% of GDP, net foreign assets of 15.8% of GDP and is
thus in a position to be able to use its fiscal flexibility.
■ The impact of a real estate decline is less bad that we had previously thought:
One of the critical issues in China has been real estate (which accounts for half of
household wealth, a quarter of local government revenue, 40% of banks' collateral and
15% of GDP). Our economists highlight that there are three mitigating factors:
Global Equity Strategy
i.
The house price to wage ratio, which they believe is still reasonable. The team
calculate that the average house price to income ratio is 5.5x in China, actually
slightly below its average over the last 15 years of around 6x – see their piece
China: A correction, not a collapse in the property market, November 7 2016;
ii.
Housing supply has slowed relative to housing demand;
259
2 December 2016
Figure 564: Sales have surpassed housing starts in
China for the first time in over a decade…
Figure 565: …which has led to a substantial decline
in inventory levels, especially in Tier 3 cities
70
China residential construction, 12m mav, 1m sqm
1,600
1,400
Inventory, months of sales
60
Tier 1 - 9
Completed
1,200
50
Sold
1,000
Tier 2 - 11
Tier 3 - 38
Starts
40
800
30
600
20
400
10
200
1998
2000
2003
2006
2009
2012
0
Jan-07 Feb-08 Mar-09 Apr-10 May-11 Jun-12 Jul-13 Aug-14 Sep-15
2015
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
iii.
Mortgage debt to GDP is only 25%, a third of US levels at peak (not least
because some individuals were given houses in 1991). This combined with low
LTVs means that even a 30% fall in real estate prices would only leave 5% of
homes in negative equity.
None of the hard landing indicators are flashing even amber:
We continue to believe that a hard landing in China would be preceded by four factors:
■ Loan-to-deposit ratio rises above 100%. At that point it becomes much harder to roll
over the NPLs without printing money. Currently the loan-to-deposit ratio is around
90%.
■ Deflation. Producer prices need to fall sharply, which would depress corporate
margins and accelerate NPLs. Recently, PPI deflation has turned positive (though less
so if we just look at PPI ex commodities).
■ A 40%+ fall in property prices.
■ When the authorities need to raise rates to protect the RmB.
Figure 566: Hard landing indicator
Indicator
Direction
Level of concern
Past 2 years'
(0-5)
progression
Latest
Loan to deposit ratio
↑
3
91%
Corporate bond y ield (bps)
↓
1
368
2-y r gov ernment bond y ield (bps)
↓
0
240
PPI, Y/Y
↑
2
1.2%
House prices, Y/Y
↑
2.5
12.3%
Total score (out of 25)
8.5
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
260
2 December 2016
We do acknowledge that the clear risk is that policy is starting to be tightened in China,
there has been little rebalancing and real estate, which has been a key growth driver, is
clearly rolling over. That is why, as we discuss later we continue to characterise China as
a key risk for 2017, even if a hard landing over the next 12 months is not our base case.
In emerging markets beyond China, there are now clear signs of a recovery under way in
Brazil, India and Russia, with rates falling in all three (although so far just at the long end
in Brazil) and PMIs recovering.
Figure 567: Year-to-date, manufacturing PMI new orders have improved steadily
in Brazil, India and Russia
65
Manufacturing PMI new orders
Brazil
India
Russia
60
55
50
45
40
2012
2013
2014
2015
2016
Source: Markit, Credit Suisse research
The critical problem in emerging markets had been that they were operating on a negative
output gap (i.e. they were overheating, especially in the case of Brazil in early 2014) and
then in some instances they were disproportionately affected by the decline in commodity
prices. Now, however, GEM countries are operating back below full capacity (according to
estimates by the ECB), reducing overheating pressures.
Figure 568: The ECB estimates that GEM economies moved from operating at
above full capacity in 2014 to below in 2015
4
8
GEM output gap (% of potential output)
Potential GEM output growth (% chg Y/Y, rhs)
3
7
2
6
1
5
0
4
-1
3
-2
2
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
Source: ECB
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2 December 2016
What are our concerns for 2017?
1. The US economy could increasingly be considered late-cycle
The current US recovery has been the fourth-longest since the Second World War. Its
pace has been tepid, however, with the trough-to-peak increase in GDP and employment
relatively small compared to the historical average.
Figure 569: The US GDP growth recovery has lasted
more than two years longer than the average, but
has been shallower
Start date
End Date
Duration (No of
Quarters)
Trough to peak
(%) - GDP
Trough to peak (%) employment
Mar-50
Jun-53
13
24.4%
15.8%
Mar-54
Jun-57
13
12.7%
7.7%
Mar-58
Mar-60
8
12.6%
5.4%
Dec-60
Sep-69
35
53.7%
31.4%
Sep-70
Sep-73
12
13.8%
8.7%
Dec-74
Dec-79
20
21.4%
15.9%
Jun-80
Jun-81
4
3.0%
1.0%
Sep-82
Jun-90
31
38.5%
22.9%
Dec-90
Dec-00
40
42.3%
21.3%
Sep-01
Sep-07
24
17.9%
4.6%
Mar-09
Latest
30
16.2%
8.5%
Average
02-Nov-16
20
24.0%
13.5%
Figure 570: As the wage share of GDP rises, the
profit share falls
14%
13%
53%
Profits
12%
Wages, rhs, inverted
54%
11%
10%
55%
9%
56%
8%
57%
7%
58%
6%
5%
1950
Source: Thomson Reuters, Credit Suisse research
52%
% of GDP, US
59%
1961
1972
1983
1994
2005
2016
Source: Thomson Reuters, Credit Suisse research
The worry we have is that labour, with the unemployment rate edging lower, is getting
more pricing power. This is evident in the recent wage component of ECI data, average
hourly earnings and the Atlanta Fed's wage tracker for job switchers.
Ordinarily, as the wage share of GDP rises, the profit share of GDP falls. A fall in profits
normally coincides with decelerating GDP growth (as corporates reconsider capex and
employment decisions), especially against the current backdrop of relatively high
corporate leverage.
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2 December 2016
Figure 571: Falling profitability tends to coincide
with decelerating GDP growth
40%
6%
5%
30%
2.3
2.1
4%
20%
3%
10%
2%
0%
1.9
1.7
1%
0%
-10%
-1%
-20%
-30%
Figure 572: Net debt to EBITDA is above its norm
US y/y% chg in 12m fwd EPS
US real GDP, y/y%, rhs
-2%
-3%
-40%
-4%
1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016
Source: Thomson Reuters, Credit Suisse research
1.5
1.3
US net debt to EBITDA
1.1
0.9
1986
ex financials
ex financials & resources
1991
1996
2001
2006
2011
2016
Source: Thomson Reuters, Credit Suisse research
Historically capex has not only been the high-beta component of GDP (with a beta of
1.8x), but also it has tended to lead GDP. While it is true that employment growth has
remained remarkably steady at 1.7% year-on-year, that has tended to lag, not lead, GDP
growth.
Figure 573: Capex tends to lead GDP while employment lags GDP
Economic indicator
C&I lending intentions
ISM manufacturing new orders
Consumer confidence
Core cap goods orders
Employment growth
Lead (+) / lag (-) with the cycle
+9 months
+4 months
+3 months
+3 months
-6 months
Source: Thomson Reuters, Credit Suisse research
Steady employment growth can therefore create a degree of complacency on the part of
investors. To us, there are three key trends to watch:
■ Profit growth: the latest trends here, as we discuss elsewhere, are actually
incrementally positive thanks to rising commodity prices;
■ The gap between nominal GDP and wage growth, which we discuss in the asset
allocation section of this Outlook, could improve in the near term;
■ The near term indicators of corporate spending, which as we show earlier have
picked up.
Perhaps the most important issue to monitor is the extent to which the US is – or isn't – at
full employment. Ultimately, the judge and jury is wage growth, which as mentioned above
is trending higher as the duration of unemployment falls. The debate is whether full
employment is 4.8% (as the Fed believes), or something lower.
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2 December 2016
If we look at two different measures of unemployment, we get two very different views: the
unemployment rate for those unemployed for less than 6 months is close to historical lows.
The U6 unemployment rate, which adjusts for those workers who are partially attached to
the workforce (e.g. a part-time worker who wants a full-time job) remains much higher
(although it is falling). Our view is that some of the decline in the participation rate is
cyclical (with roughly half being demographic) and that ultimately the full employment rate
is likely to be lower than 4.8% – probably closer to 4%.
Figure 574: U6 has declined to 9.5%, but remains
around its previous cycle peak while short-term
unemployment is close to its historic low
18
16
14
U6 Unemployment: marginally attached,
and part-time for economic reasons (%)
Unemployment rate for those unemployed
for less than 6 months (%)
Figure 575: Around half of the decline in the
participation rate is cyclical
68%
US labour force participation rate
67%
66%
65%
12
64%
10
63%
8
62%
6
61%
Adjusted for demographics (keeping the population
ratio by age cohort constant at 2009 levels)
4
60%
Actual
2
98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16
Source: Thomson Reuters, Credit Suisse research
59%
1970
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
This is partly because with better technology it is easier to match job offers to
applications. Also, the experience of the UK and Japan would back this up. In the UK
the participation rate hit an all-time high but wage growth has not accelerated much and
in Japan there are 40% more job offers than applications and again wage growth has
been flat. We should also note that historically we have seen that unemployment rates
can fall c1% below full employment.
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264
2 December 2016
Figure 576: In the UK, an employment ratio in
excess of its pre-crisis level has not led to
particularly rapid wage growth
75%
Figure 577: Historically, the US unemployment rate
has fallen considerably below NAIRU as the cycle
peaks
6%
UK working age employment ratio
Private sector regular pay growth, 3mma
6
Deviation of US unemployment rate
from CBO NAIRU
5
74%
5%
4
73%
4%
3
72%
3%
2
71%
2%
1
0
70%
69%
2000
1%
0%
2002
2004
2006
2008
2010
Source: Thomson Reuters, Credit Suisse research
2012
2014
2016
-1
-2
1975
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
2. China – stabilised, but it remains a source of risk
China was perceived to be the biggest risk a year ago, including by ourselves. Instead, it
turned out to be perhaps the biggest source of positive surprises in 2016 owing to its
growth resilience. Despite China’s economic momentum improving recently, significant
risks remain. We would agree with our economists that social stability and steady growth
will remain the focus of the government ahead of the Party Congress in the autumn of
2017. What are the risks?
■ Credit-to-GDP has stayed at an unsustainably high level, and most of the new credit
growth is driven by the real estate sector
Credit to GDP versus trend is more extended than ever. Total debt to GDP is now 42 ppts
above trend and the increase in private debt to GDP is higher than in nearly every other
banking crisis apart from Ireland ahead of 2008.
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2 December 2016
Figure 578: Total debt to GDP in China is now 42
percentage points above trend
260%
Figure 579: The five-year change in private sector
debt to GDP in China has been comparable to
previous changes in Thailand and Spain prior to
their crises
120%
China: Total debt to GDP
240%
100%
20-year trend
220%
Max 5-year change private sector debt
to GDP (% point)
300%
641% / 1156%
Peak in private sector debt (% of GDP),
rhs
250%
50%
140%
0%
0%
USA 1951-60
120%
100%
1995
1997
2000
2002
2005
Source: Thomson Reuters, Credit Suisse research
2007
2010
2013
2015
Ireland 2003-08
20%
China 2008-16
160%
Spain 1996-10
100%
Thailand 1986-97
40%
180%
Japan 1985-90
150%
UK 1997-09
60%
200%
Korea 1988-98
200%
USA 1993-09
80%
Source: Thomson Reuters, Credit Suisse research
The ratio of credit to GDP in China is now above that of the US: total credit to the nonfinancial sector is 255% of GDP in China compared to 252% the US. The problem is the
credit multiplier (i.e. the impact of each marginal unit of credit on GDP), which has fallen
by a factor of 4 compared with a decade ago. What makes the continued credit growth
even more concerning is that 40% of new loans are to the real estate sector. Given the
questionable fundamentals of the sector, this is clearly problematic, in our view.
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2 December 2016
Figure 580: Nominal GDP per incremental unit of
total social financing has been declining
Figure 581: 42% of new bank loans are for real
estate
45%
1.0
Change in GDP per unit of new TSF
0.9
40%
0.8
35%
0.7
30%
0.6
25%
0.5
20%
0.4
15%
0.3
10%
0.2
0.1
2004
Real estate loan as % total new bank
loan (4 quarter rolling)
5%
2006
2008
2010
2012
2014
2016
Source: Thomson Reuters, Credit Suisse research
0%
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Credit Suisse China Economics Research
■ The housing market is rolling over
The biggest surprise this year has been the recovery in the real estate sector, with prices
having risen sharply. Now we can see signs that real estate turnover is falling, and is now
at levels consistent with a 5% decline in house prices. We would also note that the listed
property developers are now underperforming.
While we acknowledge as above that the house price to wage ratio looks reasonable and
there has been some inventory rundown, we find it worrying that the rental yield is 1.7% to
2.4%, which is well below the mortgage rate of 4.5%.
Figure 582: Property transactions suggest a fall in
house price inflation
China property transactions (floorspace), y/y%, 3mma
100%
House price inflation, rhs, lag 6m
Figure 583: Chinese property developers have
stopped outperforming
14.0
13%
MSCI China real estate, relative to market
13.5
80%
13.0
60%
8%
12.0
40%
20%
12.5
3%
11.5
11.0
0%
-2%
-20%
-40%
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
10.5
10.0
-7%
9.5
Sep-13
Apr-14
Nov-14
Jun-15
Jan-16
Sep-16
Source: Thomson Reuters, Credit Suisse research
267
2 December 2016
■ There has been no rebalancing away from the investment-driven growth model, and
private FAI growth has dropped to nearly zero
The investment share of GDP, while slightly reduced at 42% of GDP, is still significantly
higher than it ever was in Japan and Korea at similar points in their industrialisation. More
worrying is the over-reliance on state-driven investment. SOE and central government FAI
has increased by in excess of 25% Y/Y, while private-sector investment growth dropped to
nearly zero.
Figure 584: China’s investment share of GDP,
though decreasing, is still higher than it ever was in
Japan and Korea
50%
Figure 585: FAI-state and local government is at a 6year high, but is rolling over. Private sector
investment growth has improved a little recently
65%
Investment, % of GDP
FAI, % chg Y/Y 3 m.m.a.
China: latest 42%
SOE & Central government
FAI
Private sector FAI
55%
45%
40%
Korea peak in
1991 at 38%
Japan peak in
1973 at 36%
45%
35%
35%
30%
25%
25%
15%
20%
5%
15%
Japan
Korea
China
10%
1954
1964
1974
1984
Source: Thomson Reuters, Credit Suisse research
1994
2004
2014
-5%
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
■ The degree of supply-side reform in certain areas (steel, oil refining and coking coal)
has fallen short of expectations
■ There are clear signs of attempts at supply-side reform, especially in cutting excess
capacity. By the end of October, China had already achieved its annual target of
closing down 45m tonnes of steel capacity and is well on track to achieve its annual
target of cutting 250m tonnes capacity in coal, according to the NDRC (Reuters, 10
Nov).
However, we remain somewhat sceptical of the commitment to reform. To start with steel,
the proposed production cuts might not be enough. China plans to cut 100 to 150 million
tonnes of steel production by 2020. However, according to Luo Tiejun, an official at the
Chinese Steel and Iron Ore Federation, steel consumption is estimated to stay between
630 and 700 million tonnes in the coming 5 years and if exports remain at around 100
million tonnes, production would stay around 800 million tonnes compared to 1.13 billion
tonnes of current capacity. Thus, China has to reduce capacity by 223m tonnes, a much
bigger cut than has been achieved to date.
Credit Suisse's Head of China Economics, Vincent Chan, is sceptical of widespread SOE
reform given that:
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2 December 2016
■ The job offer-to-application ratio has fallen to 1.05, potentially signalling a rise in
unemployment. As SOEs account for c.15% of total urban employment (with c.60m
employees), the government is likely to be extra cautious in shutting down capacity.
■ 60% of the top Chinese Communist Party officials, and 40% of leaders, are due to
retire before the 19th Party Congress to be held in autumn 2017. As a result, we would
expect only limited policy changes to take place prior to this.
Thus, the risk is that SOE reform will be more focused on consolidation rather than
ownership change or capacity reductions. Nevertheless, on the Global Equity Strategy
team, we have to admit to being surprised by the degree of capacity reductions so far this
year.
■ China's policy setting is incrementally less loose
Some policy indicators we look at have shown recent tightening. We look at four proxies
on policy: LGFV, project approvals, Macao casino stocks (as a proxy for the anticorruption drive) and stance of monetary policy (by looking at a combination of total social
financing and interest rates). These proxies suggest some moderate tightening of policy in
recent months.
Figure 586: China policy scorecard
1m chg.
3m chg.
Momentum score
(0-5)
Latest
Macau stocks relative
↑
↑
3
0.66
Total social financing (RMB bn)
↓
↑
2.5
896
Infrastructure spend (Y/Y % chg)
↑
↓
2.5
15.7%
Local government bond issuance (RMB bn)
↓
↓
2
273.5
Policy scorecard
Total score (out of 20)
10
Source: Thomson Reuters, Credit Suisse research
Infrastructure spend has slowed moderately and local government bond issuance has
declined. Moreover, the value of project approvals is down 40% compared to last year.
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2 December 2016
Figure 587: LGFV debt is rising more rapidly this
year than 2015, but slowing
350
Figure 588: Project approvals are slowing Y/Y
1000
Local government financing vehicles debt market net financing
(RMB bn)
300
2015
Headline project approvals released by NDRC (RMB bn)
900
2016
2014
2015
2016
800
250
700
200
600
150
500
400
100
300
50
200
0
100
-50
0
Jan
Feb Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Source: Credit Suisse China Economics team
Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
Source: Credit Suisse China Economics team
Growth in total social financing has slowed to a near 13-year low, and we have seen a
modest recent rise in the government and corporate bond yields. Regulation on property
has tightened across 20+ major cities recently in response to the sharp price increases.
Figure 589: Chinese total social financing growth is
near a 13-year low
40%
Figure 590: Government yields are inching higher,
from historical lows
5.0
Total social financing, y/y%
China government bond yields
2-year, rhs
35%
4.5
30%
4.0
25%
3.5
20%
3.0
2.5
15%
10%
2003
10-year
2004
2006
2007
2009
2010
2012
2013
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.0
Jan 14
May 14
Oct 14
Mar 15
Aug 15
Jan 16
Jun 16
Nov 16
Source: Thomson Reuters, Credit Suisse research
FX: fewer fireworks
Our FX strategists believe next 12 months will be characterised by USD strength (see their
piece FX Compass: Big League Changes, 16 November 2016), and have the following
range of forecasts.
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2 December 2016
Figure 591: Credit Suisse FX forecasts
EURUSD
CS FX forecasts
3 month
12 month
1.03
1.00
USDJPY
111
108
GBPUSD
EURGBP
USDCAD
EURCHF
USDCHF
1.20
0.86
1.38
1.05
1.02
1.20
0.83
1.40
1.04
1.04
USDMXN
USDCNY
23.00
7.01
25.00
7.33
Source: Credit Suisse FX Research team
We would make the following observations on the major FX markets:
US dollar – some upside risks
Our FX strategists' forecasts imply DXY will rise by c.2.5% over the next 3 months, and by
c.4% over the next 12 months. We would broadly agree with this judgement, and would
note the following factors in support of the USD.
■ In the US, a move toward loose fiscal policy… : The post-crisis policy orthodoxy
globally has been one of loose monetary combined with tight fiscal policy. International
institutions, such as the IMF, have been campaigning for some time for governments to
reconsider their policy mix against a backdrop of very low borrowing costs. The
election of Donald Trump arguably has the potential to dramatically change the policy
mix being pursued in the US, and suggests a move toward loose fiscal and tighter
monetary policy is likely, with his fiscal plans costed at $5.3trn by the Committee for a
Responsible Federal Budget, even before infrastructure spending. To some extent this
can be compared to the dollar bull market of Reagan (which ended up seeing a troughto-peak rise in the dollar of 67% tradeweighted) against a comparable policy backdrop.
■ …and tighter monetary policy: Even without significant fiscal easing, our economists
expect US rates to be increased three times by the end of 2017 compared to market
expectations for two.
■ The return of divergence: The US appears set to embrace a loose fiscal/tight(er)
monetary stance at a time when this remains well off the agenda in both Europe and
Japan, suggesting the divergence theme so prevalent in 2015 is re-emerging in a way
that is likely to remain USD-supportive. The BoJ is likely to retain a very loose
monetary policy until the Yen weakens to a level consistent with their 2% inflation
target (and that, according to our economists, is a level well beyond Yen/$120). The
ECB's rhetoric has been dovish with Draghi focusing explicitly on core inflation and
also being acutely aware of the mistaken rise in rates in 2008 and 2011.
■ Populism: Protectionism and repatriation of $750bn of overseas cash are dollar
positive, we think. Protectionism is arguably least bad for the economy whose export
share of GDP is the lowest (and exports are only c.12% of US GDP, compared to
c.19% in the euro area).
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2 December 2016
Why only relatively modest dollar upside?
■ The Bank of England's trade-weighted dollar is already up 41% from the 2011
low. It is also the case that normally a dollar bull market lasts 6 to 7 years. History
would simplistically suggest there that the dollar bull market should peter out in the
middle of next year.
■ History tells us Fed rate hikes represent near-term USD peaks. With the Fed
having reset its policy path in Q1 2016, the expected rate increase in December 2016
is in a sense the first rate rise of a new tightening cycle. As we have noted historically,
USD strength tends to be most acute in the period immediately preceding a rate rise,
before diminishing following the reality of an increase.
Figure 592: The US dollar has tracked a typical postfirst rate hike performance pattern this year
Figure 593: From trough to peak, the USD gained
42%, in line with the last full bull market in the 1990s
180
103
Trade weighted dollar, rate rise = 100
6 yrs
+67%
10 yrs
-47%
9.5 yrs
-39%
7 yrs
+40%
5 yrs
42%
160
98
140
120
93
100
88 Date of rate hike
80
Aug-1977
Dec-1986
Feb-1994
Jun-1999
Jun-2004
Dec-2015
Days
83
-80 -60 -40 -20 0 20 40 60 80 100 120 140 160 180 200 220 240 260
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
60
1975
1980
1986
1992
Trade weighted US dollar
1998
2004
2010
2016
First Fed Rate hike
Source: Thomson Reuters, Credit Suisse research
272
2 December 2016
The euro – down but not necessarily out
Our FX strategists forecast modest downside for the euro over the next 3 and 12 months,
with a forecast of parity. We have sympathy with this view in the near term as the principal
driver of this cross rate has been the spread of Bunds versus US Treasuries, as the chart
below illustrates. While near term we could see Treasury yields rising more than the Bund
yield, we would be a little more doubtful that such a differential will be sustained on a 12to 18-month view (unless there is a political shock in the euro area).
Figure 594: The widening Treasury/Bund spread has been placing downward
pressure on EURUSD
EURUSD
1.20
1.2
Treasury/Bund spread, rhs, inv
1.18
1.4
1.16
1.14
1.6
1.12
1.8
1.10
1.08
2.0
1.06
1.04
2.2
1.02
Jan-15
Jun-15
Dec-15
May-16
Nov-16
Source: Thomson Reuters, Credit Suisse research
We struggle to be too bearish of the euro over the medium term, and would look at any
near term sell-off as more of a buying than selling opportunity for the following reasons:
■ Valuation: The euro is now around 15% cheap on a PPP approach;
Figure 595: Real rate differentials are not consistent
with a weaker euro
Euro vs US 2-year real rates, gap, bps
EUR/USD, rhs
1.6
Figure 596: The Euro is now 15.3% undervalued
against the dollar on PPP
Euro/$ - Deviation from PPP exchange rate
30%
170
120
1.5
70
1.4
20
10%
1.3
-30
0%
1.2
-80
-130
1.1
-180
-230
-280
2003
20%
2005
2007
2009
2010
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2012
2014
2016
-10%
1.0
-20%
0.9
-30%
1996
1998
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
273
2 December 2016
■ Macro momentum: Relative macro momentum appears consistent with a stronger
euro relative to the US dollar;
■ Current account surplus: The euro area is running a current account surplus of 3% of
GDP;
■ ECB policy: The ECB will be a critical variable. The issue is that the if the euro
weakens too far, the ECB would have to alter their view of growth, with 10% off the
euro adding c.0.6% to real GDP and 0.5% to inflation, at a time when growth
momentum is already reasonable. We wonder whether the market has become a bit
complacent on ECB actions in the 2H 2017, with the risk of tapering perhaps higher
than priced;
Figure 597: The EUR/USD has ignored the
improvement in Eurozone relative macro
momentum, owing to QE
Figure 598: The euro area is running a current
account surplus of c.3% of GDP
10
4%
1.54
5
1.44
0
1.34
-5
Euro area current account balance, % GDP
3%
2%
1%
0%
1.24
-10
-15
-1%
Euro-area vs US: manufacturing PMI new
orders
EUR USD, 6m lag, rhs
-20
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Thomson Reuters, Markit, Credit Suisse research
Global Equity Strategy
1.14
1.04
-2%
-3%
2000
2003
2006
2009
2013
2016
Source: Thomson Reuters, Credit Suisse research
274
2 December 2016
■ Speculators are still cautious: Finally, we would note that speculators remain short
the euro at a time when the currency is oversold.
Figure 599: Speculators remain short the euro
against the dollar…
150
Figure 600: …and the euro is oversold
Speculative net-positions in Euros against dollar futures contracts
100
EUR/USD deviation from 6mma
Average (+/- 1SD)
9%
50
4%
0
-1%
-50
-100
-6%
-150
-11%
-200
-250
2001
2004
2007
2010
Source: Thomson Reuters, Credit Suisse research
2013
2016
-16%
2001
2004
2007
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
The Japanese yen – a leveraged play on US rates
The yen has appreciated strongly this year as investors came to the view that the BoJ's
ability to pursue aggressive monetary easing was diminished. Our FX strategists forecast
a USD/Yen of ¥110 and ¥108 on a 3- and 12-month view respectively. If anything we find
ourselves a little more bearish, but struggle over 2017 to see ¥125 to ¥130. We see the
following reasons to remain cautious on the yen:
■ Increasing rate differentials: With the BoJ de facto targeting rates of zero, rising US
rates have widened out the Treasury-JGB spread in a more pronounced way than
would have been anticipated under the old monetary policy framework. Given our view
that US rates will rise further, this source of downward pressure on the yen will persist,
we think.
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275
2 December 2016
Figure 601: Real rate differentials are likely to widen further, and have been
driving the yen down
160
6
150
Japan/US 10-year real yield differential
USDJPY, rhs
140
4
130
120
2
110
0
100
90
-2
80
-4
1995
70
1997
2000
2003
2005
2008
2011
2014
2016
Source: Thomson Reuters, Credit Suisse research
■ A double play on rates: not only has the BoJ committed to cap rates at zero, but if
Japanese institutions or retail investors respond to higher US bond yields and a
steeper yield curve by increasing their purchases of US bonds, then the BOJ would
have to step up its rate of QQE. Indeed on 17 November, the BoJ committed to an
open-ended purchase of 1 to 5 year bonds at a fixed price.
Given that the BoJ targets a zero rate, domestic investors are faced with an asset
giving zero capital gain, zero yield and, inflation-adjusted, a clear loss. If there is a
widespread flight out of JGB into US bonds, then the rate of QQE could step up very
rapidly.
■ A Yen/$ below 110 is needed to generate inflation. We have consistently found that
c80% of inflation comes from import prices. In the opinion of our economists, an
exchange rate of ¥110 is needed to get core inflation back to zero and perhaps as low
as ¥140 to get inflation towards the BoJ's target of 2%.
What are the supports for the yen from here?
■ Current account surplus: On the positive side, we would note that Japan's current
account surplus has expanded significantly in recent quarters almost back to a preAbenomics high, at around 4% of GDP.
■ Already a quite cheap currency. From a valuation perspective, the yen is around fair
value on a PPP basis, having been overvalued for much of the past 30 years.
Global Equity Strategy
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2 December 2016
Figure 602: The yen, at just below par to PPP
against the dollar, is just off its 30-year low
Figure 603: The Japanese current account surplus
has widened to 3.8% of GDP
5.0%
110%
90%
4.0%
JPY / USD, deviation from PPP
70%
3.0%
50%
2.0%
30%
10%
1.0%
Current account balance,
% of GDP
-10%
-30%
1986
1991
1996
2001
2006
2011
2016
Source: Thomson Reuters, Credit Suisse research
0.0%
1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Thomson Reuters, Credit Suisse research
■ A political risk: Finally, we think politically it would be hard for the yen to depreciate
much beyond ¥120 because ultimately it is pushing down inflation-adjusted wages
(with, for example, only 39% of food produced domestically). The feed-through
mechanism of higher inflation leading to higher wages (via the semi-annual shunto) did
not work when the yen weakened from ¥80 to ¥125, and thus is unlikely to work now.
Sterling – close to lows?
We discussed our view on sterling at some length in our piece Thoughts on sterling and
review of UK domestic sectors (12 October 2016), but to summarise here, our judgement
is that most of the weakness in sterling has now been seen, although it remains too early
to position for significant appreciation. Our FX team forecast GBPUSD at 1.20 in 3 months'
and 12 months' time. Why do we think that we have seen the lows in sterling?
■ A crisis-type devaluation has occurred: Sterling has experienced most of a typical
crisis-type devaluation, having fallen at peak by c.30% against the US dollar, against
an average crisis devaluation of around 32% looking at events such as the ERM exit or
the financial crisis of 2007-08. At the time of writing, sterling is down c.28% from its
peak against the dollar, and 22% on a trade-weighted basis.
■ Valuation: Sterling is now 14% cheap against the USD on PPP, a valuation that has
represented a trough when it was reached previously in the last 20 years.
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2 December 2016
Figure 604: The post-Brexit sell off saw sterling
experience a typical 'crisis' devaluation
Figure 605: Sterling is now c.14% cheap against the
USD, a valuation that has represented a trough in
the last 20 years
40%
30%
Event
GBPUSD depreciation
GBP/USD
- Deviation
fromfrom
PPPPPP
GBP/USD
- Deviation
GBP overvalued
20%
Bretton Woods (1949)
-30%
10%
1980s recession (1980-1983)
-35%
0%
ERM Ex it (1992)
-29%
Financial crisis (2007-2008)
-35%
Brex it to trough (2014 - 2016)
-29%
Av erage
-32%
-10%
-20%
-30%
-40%
GBP undervalued
-50%
1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 2012 2016
Source: Thomson Reuters, Credit Suisse research
Source: Thomson Reuters, Credit Suisse research
■ Positioning: Speculators are extremely short sterling versus the USD on data from
CFTC.
■ Rate differentials: rate differentials are consistent with a modestly stronger GBP
against the USD.
■ The current account deficit is likely to improve a bit more than expected. It has
already fallen from 7% to 6% of GDP, but with 90% of assets foreign currency
denominated and 60% of liabilities foreign currency denominated, there is something of
an automatic improvement as sterling weakens. Moreover, much of the UK's overseas
assets are commodity-related (and thus the recovery in commodity prices helps). We
also wonder whether the sharp fall in real wage growth (with inflation set to rise above
wage growth) will slow down import growth more than expected.
■ Politics: Most market commentators believe that there is a very high probability of a
hard Brexit. We think that this probability has been overstated, primarily as a function
of the significant logistical hurdles, including:
Global Equity Strategy
i.
The current system for imports and exports is only fit to process 100m
transactions a year, and yet capacity for some 350m transactions will be
required. Moreover, according to the Treasury and OECD, the cost of crossborder checks will increase transaction costs by c.24% and the only way to
mitigate these is to have a new process on digitalisation. Clearly, setting up
and completing new IT systems always takes longer than expected;
ii.
The UK may have to increase its number of customs officers to levels
comparable with Germany (which would entail an eightfold increase);
iii.
The UK will have to negotiate treaties with the 52 countries that the EU
currently has agreements with, a process that could take a very long time.
Moreover, the UK will have to replicate the 30 EU agencies that check
products;
278
2 December 2016
iv.
It could take a long time to negotiate a financial services treaty with the EU (it
has taken Switzerland 11 years to try to negotiate one);
v.
The cost of a divorce from the EU has been estimated to be between £20bn to
£60bn. In the Autumn Statement the direct and indirect cost of Brexit was put
at £58.7bn over the next 5 years;
vi.
If, as seems likely, the Supreme Court backs up the judgement of the High
Court that Parliament must be consulted prior to the activation of Article 50 at
January's appeal, then there is a chance that the House of Lords will be able
to temporarily block the passing of Article 50 (which of course was not in the
Conservative manifesto).
Many of the arguments above suggest that there could be a long transition period between
enacting Article 50 and leaving the EU (which would occur, at the very earliest, in March
2019). During that period, the UK will trade with the EU, accept some movement of people
and contribute to the EU budget. The longer the interim period, however, the greater the
chance of a second referendum on the outcome of exit negotiations, in our judgement. It is
also possible that the House of Lords could postpone the passing of Article 50 for a
sufficiently long period that it will not be implemented until the next parliament.
We do, however, struggle to be sterling bulls, as: i) consensus is now probably too
optimistic on UK growth for 2017 (at 1.5% versus our house view of 1.2%); ii) Unless there
are more special deals (as with Nissan), FDI into the UK of 2.5% of GDP could fall sharply;
iii) the twin deficits, budget and current account, remain exceptionally large.
Figure 606: A deterioration in investment income
has led to a widening of the UK current account
deficit
Figure 607: Almost half of the UK's stock of inward
FDI is from the EU
5.0%
Stock of UK FDI
3.0%
Asia
7%
1.0%
Other
21%
-1.0%
EU
48%
-3.0%
-5.0%
Balance, % GDP
Goods and services
Investment income
Current account balance
-7.0%
-9.0%
1960
1968
1976
1984
1992
Source: Thomson Reuters, Credit Suisse research
2000
2008
US
24%
2016
Source: Thomson Reuters, Credit Suisse research
GEM FX (ex the RMB): still cheap, but rising DM rates a challenge
In our judgement, GEM currencies (excluding the RMB) remain abnormally cheap, with
their discount to PPP not close to the lows seen in the last financial crisis, despite the
GEM share of global trade being higher now than it was then. We would note that GEM FX
has in aggregate underperformed its historical relationship with both commodities prices
and with GEM fixed income.
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2 December 2016
Figure 609: …and have underperformed the
rebound in commodity prices
Figure 608: GEM currencies are cheap on a PPP
basis relative to history
GEM currency valuation (ex China) vs US on PPP
-35%
GEM export market share, ex China, rhs
-40%
-45%
13%
12%
-55%
CRB metals index, rhs
53
14%
-50%
GEM nominal FX index (ex-China)
55
15%
820
49
770
47
720
45
670
43
620
570
11%
-65%
10%
41
9%
39
Jan-14
2000
2003
2005
2008
2010
2013
2016
Source: Thomson Reuters, Credit Suisse research
870
51
-60%
-70%
1998
920
Jun-14
Dec-14
Jun-15
Dec-15
May-16
520
Nov-16
Source: Thomson Reuters, Credit Suisse research
In general, the very sharp improvements made in the basic balance of payment deficits
(especially in India and Brazil), the fall in unit labour costs (for the first time in 6 years), deregulation and the likely-underestimated fall in inflation are all supportive for GEM
currencies, and could increase resilience in the face of rising DM yields.
We show more detailed analysis of GEM currencies in our emerging market equity section
below, but we would note here that the rouble, forint, TWD and ringgit are among the
currencies offering an attractive combination of cheap valuation and attractive
fundamentals.
Figure 610: The rouble, forint, TWD and ringgit are among the GEM currencies
which offer cheap valuations and attractive fundamentals
Expensive Currency
and more vulnerable
Philippines
Currency valuation (higher number = expensive)
0.9
South Korea
Brazil
0.4
Chile
-0.1
China
India
Czech
Republic
Turkey
Taiwan
Hungary
-0.6
Indonesia
South Africa
Poland
-1.1
Malaysia
Russia
Mexico
-1.6
1.2
0.7
0.2
-0.3
-0.8
-1.3
-1.8
Cheap Currency and
less vulnerable
-2.3
-2.8
External vulnerability (high number = lower vulnerability)
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Below, we highlight our FX team's Asian FX forecasts.
Figure 611: Our FX team's Asian FX forecasts
USDCNY
USDCNH
USDINR
USDIDR
USDKRW
USDMYR
USDPHP
USDSGD
USDTWD
USDTHB
3 month forecast
7.01
7.03
68.5
13500
1190
4.5
50
1.455
32.4
35.7
12 month forecast
7.33
7.34
69.5
13900
1225
4.55
50.5
1.48
33.6
35.9
Source: Credit Suisse FX research team
Clearly, one of the key risks to GEM FX is the RMB, where our FX team forecasts
USDCNY of 7.33 by end-2017 (from around 6.90 currently). The critical issue is whether
the decline is orderly (a slow adjustment) or disorderly (i.e. threatening a much larger
decline). We see it more likely to be the former outcome for the following reasons:
■ China has a current account surplus of 3% of GDP and it has already unwound much
of its short-term external debt (our economists believe that, excluding trade credit,
short-term external debt is $270bn, and net external debt is $800bn);
■ China is clearly in a position to impose capital controls (especially given that Chinese
companies have spent substantially on foreign corporates this year);
■ Above all else, the RMB appreciation over the last decade has followed China's rising
share of global exports higher, and that remains a support, in our view.
The issue in our opinion is that China is pursuing market share at the expense of margin,
but this is sustainable until the banking system's loan to deposit ratio rises significantly
above 100%. Thus we believe that the decline in the RMB is orderly until the loan to
deposit ratio rises much above 100%, or the PBOC is forced to raise rates to protect the
currency. For now, the RMB tradeweighted has been stable, while it has weakened
against the dollar in periods of dollar strength.
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2 December 2016
Figure 612: The de factor dollar peg led to
substantial RmB appreciation
16%
130
125
120
Figure 613: Simplistically charted against export
market share, the RmB looks fairly valued
-40%
China exports % of World exports
CNY CFETS basket
Chinese RmB/US Dollar
14%
rebased, Jan 2011=100
-45%
RmB Currency deviation from
PPP, rhs
12%
115
-50%
10%
-55%
110
8%
105
100
-65%
4%
95
90
2011
-60%
6%
2012
2013
2014
Source: Thomson Reuters, Credit Suisse research
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2015
2016
2%
1996
-70%
1999
2001
2003
2006
2008
2011
2013
2016
Source: Thomson Reuters, Credit Suisse research
282
2 December 2016
Commodity prices
Gold: remain cautious
We, on the global equity strategy team, highlighted our concerns about gold in Some
tactical concerns on gold, 12 August, and we remain cautious, but would acknowledge that
the house view remains more constructive. There are four key macro drivers of the gold
price, in our view, and all look to be problematic in the near term:
1.
Real rates are likely to rise
Though often cited as an inflation hedge, we think the most important driver of gold is the
real interest rate; the gold price moves inversely to real bond yields (in a sense, the
opportunity cost of holding gold), rather than being correlated with inflation expectations.
This is due to gold not offering a coupon or yield of any kind, it is implicitly a hedge on
inflation rising more than nominal yields, i.e. falling real yields.
Figure 614: Gold is highly correlated with the TIPS
yield
Figure 615: …but not inflation breakevens
3.5
4
3
3.5
R² = 0.7513
R² = 0.0072
2.5
3
2.5
1.5
Inflation breakeven
TIPS yield
2
1
0.5
0
2
1.5
1
0.5
-0.5
-1
300
600
900
1200
Gold, $/oz
Source: Thomson Reuters, Credit Suisse research
1500
1800
0
300
600
900
1200
Gold, $/oz
1500
1800
Source: Thomson Reuters, Credit Suisse research
We believe that the real bond yield is set to rise further. As we highlight in the bond
section, the US TIPS yield can rise to c.80bp, in our judgement.
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283
2 December 2016
Figure 616: As real rates rise, the gold price tends to fall
2000
-1.5
1800
-1.0
-0.5
1600
0.0
1400
0.5
1200
1.0
1000
1.5
2.0
800
Gold bullion
600
400
2006
10-year TIPS yield, rhs (inverted)
2.5
3.0
3.5
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: Thomson Reuters, Credit Suisse research
2.
Gold is a play on confidence in the financial system
Historically, gold has always been a proxy on the confidence in the financial system, acting
as a 'safe haven' when banks came under pressure. During the financial crisis, this used
to be proxied by the close correlation between the gold price and the CDS of banks.
However, nowadays, we would highlight the close correlation between the relative
performance of bank equities and gold. If banks outperform, the gold price typically
weakens. We think banks outperform as rates rise, and, moreover, we remain overweight
European banks; in our view, investors remain too pessimistic on the outlook for the sector
(see Financials: tactically long, 21 September).
Figure 618: …however, recently this correlation has
been with bank equities
Figure 617: The gold price has historically been
correlated with financial CDS spreads…
2100
Gold bullion
iTraxx senior financial, rhs
1900
0.029
400
350
1700
300
1500
250
1300
200
1400
Gold bullion $
0.031
US banks rel market, inv,
rhs
0.033
1300
0.035
1200
1100
150
900
100
700
50
500
2008 2009 2010 2011 2012 2013 2014 2015 2016
0
0.037
0.039
1100
0.041
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1000
Sep 14
Feb 15
Jul 15
Dec 15
May 16
Oct 16
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
3.
The dollar is unlikely to weaken
Gold tends to do well when the dollar weakens. However, we struggle to see any
significant downside to the USD from here. In fact, as we discuss in the FX section, both
we and our FX strategists expect dollar strength in 2017.
Figure 619: Periods of dollar weakness tend to see the gold price rise
Y/Y change
25%
-40%
-30%
20%
-20%
15%
-10%
10%
0%
5%
10%
0%
20%
30%
-5%
40%
-10%
50%
-15%
-20%
2006
USD TWI, %
2007
2008
2009
2010
2011
2012
Gold bullion, $, inv, %, rhs
2013
2014
2015
60%
70%
2016
Source: Thomson Reuters, Credit Suisse research
4.
Gold looks quite expensive
Gold looks expensive relative to other inflation hedges. As we argue above, gold is a
hedge against lower real bond yields. The two other assets classes with similar
characteristics are real estate and equities. We would argue gold looks expensive against
both of these.
Figure 620: Gold looks expensive relative to
equities…
Figure 621: …and relative to housing
-4
Gold to US house price ratio
1.7
Gold to US equities ratio, log scale
-6
1.5
1.3
-8
1.1
-10
0.9
0.7
-12
0.5
-14
-16
1854
0.3
1874
1894
1914
1934
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
1954
1974
1994
2014
0.1
1890
1905
1920
1935
1950
1965
1980
1995
2010
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
As another proxy on valuation, we look at the price of gold in real terms or the price of gold
relative to other precious metals, such as silver – where the relative price is not far off
post-2000 highs – or platinum – where the relative price is near an all-time high. On both
of these metrics, we think gold appears expensive.
Figure 622: The inflation-adjusted gold price
remains well above its long-term average
Figure 623: The ratio of gold to silver is not far from
post-2000 highs
110
2600
Gold price, inflation adjusted $/oz
Average
2200
100
Gold to silver ratio
90
Average since 2006
80
1800
70
60
1400
50
1000
40
30
600
20
200
1968
1973
1978
1984
1989
1994
2000
2005
2010
2016
Source: Thomson Reuters, Credit Suisse research
10
1980
1985
1990
1995
2000
2005
2010
2015
Source: Thomson Reuters, Credit Suisse research
Our fair value model, which is based on the macro drivers identified above, shows gold to
be c.8% overvalued.
Figure 624: Our model suggests the gold price is
modestly above fair value
2000
Figure 625: Model specifications
Gold price, $/oz
1800
1600
1400
1200
Model inputs
Coeff.
t-value
Current
US dollar index
-12.6
-20.7
106
TIPS yield
-248
-39.1
0.44
MSCI USA banks / MSCI USA ratio
-351
-11.7
0.39
R2
93%
Fair value
1,095
Model output
1000
Gold price, $/oz
Model +/- 1 stdev
800
Actual
600
400
2006
Fair value
2008
2010
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2012
2014
Std. error
95.7
Intercept
2668
Latest
1,186
Upside (downside)
-7.7%
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
However, there are also supportive factors for gold…
We would argue there are also some supportive factors for the gold price. We would
particularly highlight the following:
1.
The inflation-adjusted Fed funds rate is still very low and consistent with a rising
gold prices. However, this relationship has recently been weak
Figure 626: The gold price has also tended to rise when the real Fed funds rate
is below 1%, though this relationship has recently been weak
60
-4
Gold, us$/oz y/y%, lhs
50
-3
Real fed funds rate, %, rhs, inverted
40
-2
30
-1
20
0
10
1
0
2
-10
-20
3
-30
4
-40
1988
5
1992
1996
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
2.
Central banks, in many instances, have a low proportion of their reserves in gold.
If those central banks that have less than 20% of their reserves in gold were to
raise their reserves to 20%, the gold demand would rise six fold.
Figure 627: Central banks could create significant additional gold demand
World Official Gold Holdings as of June 2016
Assuming an increase to 20% of Additional demand,
reserves, tonnes
tonnes
Tonnes
% of reserves
US
8,133
75%
-
-
Germany
3,381
69%
-
-
Italy
2,452
69%
-
-
France
2,436
65%
-
-
Spain
282
20%
-
-
Russia
1,477
16%
1,897
420
UK
310
9%
691
380
1,040
7%
3,149
2,109
558
6%
1,762
1,205
Japan
765
3%
6,108
5,343
China
1,808
2%
16,043
14,234
Brazil
67
1%
1,752
1,685
Switzerland
India
Total additional demand, tonnes
25,377
Total additional demand, multiple of yearly demand
6.1x
Source: Thomson Reuters, World Gold Council, Credit Suisse research
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2 December 2016
We would note, however, that we do not think ETF demand is important as it tends to lag
behind the gold price, suggesting these flows are momentum-driven and not price-setters.
Figure 629: …although these flows seem largely
momentum driven, and lag behind gold
Figure 628: ETF gold demand is positively
correlated with the gold price…
100
1900
90
1700
80
1-month % change in gold price
10%
4-week flows into gold ETFs, % holdings, 1
week lag (rhs)
8%
10
6%
1500
70
1300
60
4%
5
50
1100
40
900
Total ETF holdings,
million oz, rhs
2008
2010
2012
2014
0%
-5
-4%
10
0
2006
0
-2%
20
500
2%
30
Gold, $/oz
700
300
2004
15
2016
Source: Thomson Reuters, Credit Suisse research
-10
-6%
Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 Oct-16
Source: Thomson Reuters, Credit Suisse research
On a positive note, gold stocks are now looking cheap on a P/E basis and are no longer
overbought – relative to the market or relative to the gold price, as had been the case
before.
Figure 630: Gold stocks are no longer clearly cheap
on P/E relative…
280%
Gold stocks 12m fwd P/E rel World mkt
Average (+/- 1sd)
Figure 631: Gold stocks are no longer overbought
50%
40%
240%
30%
20%
200%
10%
0%
160%
-10%
120%
-20%
-30%
80%
-40%
40%
1990
1993
1997
2001
Source: Thomson Reuters, Credit Suisse research
Global Equity Strategy
2004
2008
2012
2016
-50%
1996
Gold stocks %dev from 6mma, rel to World mkt
Average (+/- 1SD)
2000
2004
2008
2012
2016
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Appendices
Appendix 1: political developments
Brazil: The new president and economic team have correctly diagnosed the country’s
need for a thorough fiscal reform, which will require strong support from the Congress.
President Temer’s government coalition accounts for more than three-fifths of Congress
members. His strength was already proven in the first rounds of voting of a Constitutional
amendment that caps public expenditure growth, which was approved by a comfortable
margin at both the Chamber of Deputies and the Senate. The biggest challenge of this
administration, nevertheless, will be the approval a social security reform, expected to be
discussed throughout 2017, in the opinion of our Brazil economists.
India: There have been positive developments in the following key areas as highlighted by
our India economist, Deepali Bhargava: (i) GST: the GST (Goods and Services tax)
constitution amendment Bill finally got the nod of the parliament in August. It is a
breakthrough on indirect tax reform given India has been on the verge of implementing
GST for nearly a decade. We think GST would help boost economic growth, improve ease
of doing business, lower inflation and budget deficits in the medium term. Estimates
suggest gains to GDP in the range of 0.9%-1.7% of GDP for each year post the
implementation of GST. (ii) Bankruptcy law: one of the binding constraints for business in
India has been the inefficiency of its insolvency framework. With the passing of the
insolvency and bankruptcy bill by the Parliament early this year this should change. Time
bound process, along with single-unified law, to deal with all aspects of insolvency should
mean speedy resolution and higher recovery. (iii) FDI: the government significantly
liberalised FDI norms in sectors like retail, tourism, construction, banking. While gains to
the services sector are already evident, the government’s push to ‘Make in India’ should
help manufacturing as well. (iv) Financial market reforms: the RBI recently took significant
measures to develop the corporate bond market. This should diversify sources of funding
of growth away from banks. We see this as a long term positive for infrastructure
financing, bank balance sheet risks and overall growth. The key areas to focus on are land
acquisition bill, labour law – these haven’t been passed yet.
South Africa: As highlighted by our South Africa economist, Carlos Teixeira, political
headlines were generally negative in the country in 2016, which unfortunately
overshadowed some of the country’s well-established institutional strengths: (i) South
Africa conducted another well-organized, well-conducted, free and fair election – the Local
Government Election – which resulted in a further move towards a re-balancing of power.
(ii) The judicial system proved its independence and sophistication during a number of
important legal hearings. (iii) Some of the countries independent institutions (established in
terms of Chapter 9 of the Constitution) – such as the Public Protector proved their
importance in holding the government and individuals to account for their actions. (iv)
Non-government organizations and the media continued to be very active in trying to
correct wrongs in society, in particular holding state officials to account. In the opinion of
our South Africa economist, these strengths bode well for the country if they are
supplemented with structural economic reforms.
Indonesia: As our economist, Santitarn Sathirathai highlights, Indonesian President Joko
Widodo in July reshuffled his cabinet, the move that was very well received by the market.
He brought in reformist, business and investor friendly Sri Mulyani Indrawati who was MD
at the World Bank and also ex Finance Minister while rotating another reformist minister of
trade to the board of investment promotion to oversee measures to boost FDI. Additionally
the Tax amnesty law was finally passed in September and have so far proven to be one of
the most successful amnesty programs in the world on terms of revenue raised as a share
of GDP. With 3 months into the program it has raised over 0.8% of GDP and also
generating around US$10bn in terms of asset repatriation
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Appendix 2: Currency valuation scorecard
Figure 632: GEM currency valuation scorecard (all factors equal weighted)
Deviation of
REER from long
term trend
Real bond yield
Big mac deviation
from PPP (%)
Big mac, std
from 10y avg
IMF PPP
deviation (%)
Mexico
-21.4%
3.3%
-52.9
-2.0
-59.5
-2.4
-1.2
1
Malaysia
-10.2%
2.1%
-60.6
-1.4
-67.7
-1.5
-1.0
2
Poland
-15.2%
3.6%
-52.0
-1.5
-57.8
-1.7
-0.9
3
Russia
-21.0%
1.2%
-59.3
-1.4
-64.8
-1.4
-0.9
4
South Africa
-0.4%
2.4%
-58.3
-1.6
-59.0
-1.6
-0.8
5
Indonesia
-4.8%
3.9%
-53.1
-1.2
-69.3
-0.5
-0.7
6
Hungary
-14.0%
2.8%
-37.5
-1.5
-55.1
-1.5
-0.5
7
Taiwan
12.2%
-0.3%
-57.3
-1.9
-52.9
-1.7
-0.4
8
Turkey
-15.4%
1.8%
-29.9
-1.8
-61.8
-1.4
-0.4
9
Colombia
-15.5%
-0.7%
-39.7
-1.7
-60.7
-1.2
-0.2
10
Czech Republic
IMF PPP, std from
Avg Z-score
10y avg
Rank
-13.6%
-0.2%
-39.4
-1.2
-47.5
-1.6
-0.1
11
India
5.7%
1.2%
-52.2
1.4
-74.8
-1.4
-0.1
12
Philippines
17.9%
1.7%
-44.0
-0.3
-63.9
-0.1
0.2
13
Chile
-4.9%
0.6%
-29.9
-1.4
-44.3
-0.9
0.2
14
China
4.6%
2.5%
-44.7
0.7
-49.0
0.3
0.3
15
Brazil
-12.8%
2.8%
-5.1
-0.4
-42.4
-0.6
0.6
16
9.5%
0.5%
-23.5
-0.7
-29.0
-0.6
0.7
17
South Korea
Source: Thomson Reuters, Credit Suisse research
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Appendix 3: Equity valuation scorecard
Figure 633: GEM equity markets valuation scorecard
12m fwd P/E
Price to book
DY
Absolute
Relative
Z-Score
Absolute
Relative
Z-Score
Absolute
Relative
Z-Score
Valuation
Score
Singapore
12.5
81%
1.63
1.2
58%
1.64
3.44
135%
1.55
2.04
Poland
11.3
74%
1.33
1.2
60%
1.75
3.29
129%
0.20
1.32
Russia
6.5
46%
0.70
1.6
81%
1.06
4.54
178%
0.68
0.91
China
11.5
75%
0.36
1.0
49%
1.13
4.15
162%
0.63
0.76
Korea
9.6
63%
0.38
1.3
67%
0.50
2.01
79%
1.07
0.66
Hong Kong
15.3
100%
0.73
1.3
66%
1.23
2.94
115%
-0.35
0.51
Czech Republic
14.3
94%
-0.24
1.2
62%
0.84
6.90
270%
0.81
0.44
Taiwan
12.8
83%
0.63
1.8
92%
0.33
3.93
154%
0.49
0.40
Turkey
7.6
50%
1.25
1.4
71%
0.00
2.68
105%
0.00
0.26
Chile
15.6
102%
0.55
1.6
81%
0.57
3.10
121%
-0.35
0.09
Malaysia
15.6
102%
0.14
1.7
83%
0.59
3.14
123%
-0.25
-0.04
Colombia
11.7
76%
0.81
1.3
66%
0.43
2.77
108%
-1.06
-0.22
South Africa
13.6
89%
-0.40
2.3
117%
0.20
3.41
134%
-0.04
-0.38
India
15.9
104%
0.13
2.6
129%
-0.19
1.55
61%
-0.14
-0.40
Mexico
16.6
109%
-0.24
2.7
136%
-0.34
1.95
76%
0.18
-0.49
Hungary
11.4
74%
-0.59
1.2
61%
0.53
2.44
96%
-0.58
-0.55
Brazil
14.6
95%
-0.79
1.4
73%
0.00
4.11
161%
0.00
-0.64
Thailand
13.8
90%
-0.86
2.1
105%
0.10
3.18
124%
-0.43
-0.83
US
17.0
111%
-1.27
3.0
151%
0.00
2.06
81%
0.00
-0.85
Egypt
12.2
80%
-0.35
1.9
94%
0.08
2.69
105%
-1.00
-0.89
Philippines
16.4
107%
0.07
2.3
116%
-0.53
1.79
70%
-0.74
-0.90
Indonesia
14.7
96%
-0.38
3.4
169%
-0.43
2.02
79%
-1.07
-1.20
Country
A high z-score indicates the country is trading cheap on 12m fwd, P/B & DY relative to the world market, compared to its long term average
Cheapest countries are ranked at the top
Source: Thomson Reuters, Credit Suisse research
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2 December 2016
Appendix 4: External vulnerability scorecard
Figure 634: External vulnerability scorecard
2016&17F avg current
Net foreign assets,
Portfolio inflows
FX reserves less
Private sector debt to GDP
account, % GDP
% GDP
2016e avg, % GDP
financing needs, % GDP
deviation from trend (in pp)
Country
Weighted zscore
30% weight
17.5% weight
17.5% weight
17.5% weight
17.5% weight
Taiwan
14.4
198.8
-11.0
63.2
1%
-2.5
Hungary
5.3
79.9
0.7
9.3
-32%
-0.9
South Korea
7.5
-2.7
-3.6
20.4
8%
-0.6
Russia
2.9
11.6
0.4
22.0
4%
-0.2
Malaysia
1.7
5.3
-3.4
19.7
17%
-0.1
China
2.3
15.9
-0.7
23.2
30%
0.1
India
-1.2
-17.0
0.5
8.3
-6%
0.1
Philippines
1.1
-11.7
0.3
15.0
18%
0.2
Chile
-1.7
-22.3
-2.1
2.2
3%
0.2
Czech Republic
0.6
-44.8
0.4
3.0
5%
0.3
Brazil
-0.4
-44.4
1.0
13.7
8%
0.3
Poland
-1.9
-79.2
0.3
-3.0
-2%
0.5
South Africa
-4.0
-8.9
1.4
-3.0
-2%
0.5
Mexico
-3.5
-35.5
1.7
11.3
12%
0.6
Indonesia
-2.4
-42.1
0.2
-4.5
15%
0.7
Turkey
-4.6
-54.8
1.5
-10.8
11%
0.9
Source: Thomson Reuters, Credit Suisse research
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Companies Mentioned (Price as of 30-Nov-2016)
Activision Blizzard, Inc (ATVI.OQ, $36.61)
Adecco (ADEN.S, SFr62.65)
Adidas AG (ADSGn.F, €138.62)
Advanced Info Service PCL (ADVANC.BK, Bt144.5)
Aeon Delight (9787.T, ¥3,140)
Airbus Group (AIR.PA, €60.27)
Aisin Seiki (7259.T, ¥4,890)
Alexion Pharmaceuticals Incorporated (ALXN.OQ, $122.59)
Alibaba Group Holding Limited (BABA.N, $94.02)
Alphabet (GOOGL.OQ, $775.88)
Alps Electric (6770.T, ¥2,873)
Amazon com Inc. (AMZN.OQ, $750.57)
Asahi Glass (5201.T, ¥743)
Asahi Kasei (3407.T, ¥1,018)
Assa Abloy (ASSAb.ST, Skr174.4)
Astellas Pharma (4503.T, ¥1,580)
Atlas Copco (ATCOa.ST, Skr279.0)
Atos (ATOS.PA, €97.53)
Azimut (AZMT.MI, €14.08)
BBVA (BBVA.MC, €5.83)
BNP Paribas (BNPP.PA, €54.78)
Barry Callebaut (BARN.S, SFr1207.0)
Beiersdorf (BEIG.DE, €77.08)
Berkeley Group Holdings Plc (BKGH.L, 2477.0p)
BioMarin Pharmaceuticals, Inc. (BMRN.OQ, $85.63)
Boeing (BA.N, $150.56)
Bolsa Mexicana de Valores (BOLSAA.MX, MXN27.23)
Brenntag (BNRGn.DE, €49.66)
British American Tobacco (BATS.L, 4393.5p)
Brookfield Infrastructure Partners LP (BIP.N, $31.5)
Bureau Veritas (BVI.PA, €17.76)
CKD (6407.T, ¥1,376)
COLI (0688.HK, HK$22.4)
Calbee (2229.T, ¥3,565)
Capgemini (CAPP.PA, €74.5)
Carlsberg (CARLb.CO, Dkr597.0)
Carnival (CCL.N, $51.41)
Casino Guichard (CASP.PA, €42.93)
Catcher Technology (2474.TW, NT$231.5)
China Resources Land (1109.HK, HK$18.84)
Cipla Limited (CIPL.BO, Rs566.55)
Citigroup Inc. (C.N, $56.39)
Coal India Limited (COAL.BO, Rs308.2)
Coca-Cola Femsa (KOF.N, $62.9)
Conexio (9422.T, ¥1,400)
Credit Agricole SA (CAGR.PA, €10.65)
Credit Saison (8253.T, ¥2,051)
DIA (DIDA.MC, €4.306)
DISCO (6146.T, ¥13,560)
DKSH Holdings (DKSH.S, SFr67.75)
Daikin Industries (6367.T, ¥10,715)
Dassault Systemes (DAST.PA, €72.02)
Delta Air Lines, Inc. (DAL.N, $48.18)
Delta Electronics (2308.TW, NT$160.0)
Deutsche Bank (DBKGn.F, €14.85)
Deutsche Boerse (DB1Gn.F, €73.54)
Deutsche Telekom (DTEGn.F, €14.83)
Deutsche Wohnen (DWNG.DE, €29.06)
Diageo (DGE.L, 2005.0p)
Dialog Semiconductor (DLGS.DE, €37.4)
DuPont de Nemours and Co. (DD.N, $73.61)
E-MART Co. Ltd (139480.KS, W188,000)
ENI (ENI.MI, €13.14)
Eclat Textile Co., Ltd. (1476.TW, NT$330.0)
Eiffage (FOUG.PA, €62.28)
Eisai (4523.T, ¥6,609)
Elecom (6750.T, ¥1,961)
Electronic Arts, Inc (EA.OQ, $79.24)
Elior (ELIOR.PA, €19.58)
Emerson (EMR.N, $56.44)
En-Japan (4849.T, ¥1,917)
Endesa (ELE.MC, €19.5)
Enel (ENEI.MI, €3.81)
Erste Bank (ERST.VI, €26.24)
Exedy (7278.T, ¥3,145)
Experian (EXPN.L, 1510.0p)
Global Equity Strategy
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2 December 2016
Facebook Inc. (FB.OQ, $118.42)
Fanuc (6954.T, ¥19,305)
Fluor (FLR.N, $53.51)
Fortum (FUM1V.HE, €13.7)
Foxtons (FOXT.L, 105.25p)
Fresenius (FREG.DE, €67.75)
Fresenius Medical Care AG & Co. (FMEG.DE, €73.6)
Fuyao Glass Industry Group Co., Ltd. (600660.SS, Rmb18.89)
Geely Automobile Holdings Ltd (0175.HK, HK$8.02)
Gerresheimer AG (GXIG.DE, €68.85)
Gilead Sciences, Incorporated (GILD.OQ, $73.7)
Grand City Properties (GYC.DE, €15.76)
Green REIT PLC (GN1.I, €1.28)
HCL Technologies (HCLT.BO, Rs802.8)
HSBC (HSBA.L, 635.2p)
Harmonic Drive (6324.T, ¥3,015)
Hays (HAYS.L, 138.9p)
Henkel (HNKG_p.F, €109.1)
Hennes & Mauritz (HMb.ST, Skr267.9)
Hitachi (6501.T, ¥609)
Hitachi Chemical (4217.T, ¥2,510)
Hitachi Metals (5486.T, ¥1,495)
Hon Hai Precision (2317.TW, NT$82.0)
INWIT (INWT.MI, €4.0)
Iberdrola (IBE.MC, €5.68)
Ingredion Inc (INGR.N, $117.38)
IntercontinentalExchange, Inc. (ICE.N, $55.4)
Intesa-Sanpaolo (ISP.MI, €2.1)
Italgas (IG.MI, €3.38)
JCDecaux (JCDX.PA, €24.6)
JSR (4185.T, ¥1,646)
Japan Exchange Group (8697.T, ¥1,694)
Japan Tobacco (2914.T, ¥3,946)
JetBlue Airways Corporation (JBLU.OQ, $20.09)
Jumbo SA (BABr.AT, €13.42)
K Laser (2461.TW, NT$17.15)
KB Financial Group (105560.KS, W42,100)
KLA-Tencor Corp. (KLAC.OQ, $79.84)
KOSE (4922.T, ¥9,170)
KT&G Corp (033780.KS, W105,000)
Kansas City Southern (KSU.N, $88.71)
Kering (PRTP.PA, €205.0)
Keyence (6861.T, ¥78,230)
Kobe Steel (5406.T, ¥1,079)
Koito Manufacturing (7276.T, ¥5,960)
Kuraray (3405.T, ¥1,618)
Kureha (4023.T, ¥4,670)
Kyocera (6971.T, ¥5,436)
L'Oreal (OREP.PA, €161.05)
LIC Housing Finance Ltd (LICH.BO, Rs563.8)
Largan Precision (3008.TW, NT$3690.0)
Lazard Ltd. (LAZ.N, $38.85)
Lenovo Group Ltd (0992.HK, HK$4.81)
Liberty Global (LBTYA.OQ, $31.32)
Lintec (7966.T, ¥2,425)
Luxottica Group (LUX.MI, €49.1)
M.Video (MVID.MM, Rbl373.0)
Magnit (MGNTq.L, $40.28)
Makalot Industrial Co., Ltd. (1477.TW, NT$125.5)
Mapfre SA (MAP.MC, €2.83)
Matahari Department Store (LPPF.JK, Rp14,400)
McDonald's Corp (MCD.N, $119.27)
Mega Financial Holding Co Ltd (2886.TW, NT$22.75)
Microsoft Corporation (MSFT.OQ, $60.26)
Mitsubishi Chemical (4188.T, ¥720)
Mitsubishi UFJ Financial Group (8306.T, ¥670)
Mitsui Chemicals (4183.T, ¥529)
Mizuho Financial Group (8411.T, ¥203)
Morinaga & Co (2201.T, ¥4,525)
Motor Oil (MORr.AT, €12.22)
Murata Manufacturing (6981.T, ¥15,425)
NGK Insulators (5333.T, ¥2,186)
NGK Spark Plug (5334.T, ¥2,346)
Nabtesco Corp (6268.T, ¥2,908)
Naver Corp (035420.KS, W798,000)
Nidec (6594.T, ¥10,240)
Nien Made Enterprise Co., Ltd. (8464.TW, NT$357.0)
Nifco (7988.T, ¥6,280)
Nippon Electric Glass (5214.T, ¥610)
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2 December 2016
Nippon Shinyaku (4516.T, ¥5,320)
Nippon Shokubai (4114.T, ¥7,010)
Nissan Motor (7201.T, ¥1,056)
Nissha Printing (7915.T, ¥2,423)
Nokia (NOKIA.HE, €4.06)
Nokian Tyres (NRE1V.HE, €34.08)
Nomura Holdings (8604.T, ¥614)
Novatek Microelectronics Corp Ltd (3034.TW, NT$106.0)
OBIC (4684.T, ¥5,030)
OSG Corp (6136.T, ¥2,261)
OTP (OTPB.BU, Ft7956.0)
Obara Group (6877.T, ¥5,280)
Olympus (7733.T, ¥4,020)
Orix (8591.T, ¥1,782)
Orpea (ORP.PA, €72.9)
Otsuka (4768.T, ¥5,570)
Owens Illinois (OI.N, $18.37)
Padini Holdings Berhad (PDNI.KL, RM2.64)
Panasonic (6752.T, ¥1,164)
Pernod-Ricard (PERP.PA, €99.0)
Pfizer (PFE.N, $32.14)
Philip Morris International (PM.N, $88.28)
Philips (PHG.AS, €27.14)
Ping An (2318.HK, HK$42.9)
ProSieben (PSMGn.DE, €32.34)
Prosegur (PSG.MC, €5.86)
Prysmian (PRY.MI, €22.57)
Reckitt Benckiser (RB.L, 6763.0p)
Remy Cointreau (RCOP.PA, €79.23)
Renault (RENA.PA, €74.34)
Roche (ROG.S, SFr226.7)
SAP (SAPG.F, €78.7)
SGS Surveillance (SGSN.S, SFr2043.0)
SMC (6273.T, ¥32,520)
SThree (STHR.L, 276.5p)
SUMCO (3436.T, ¥1,253)
Samsung Electronics (005930.KS, W1,746,000)
Sanofi (SASY.PA, €76.11)
Santander (SAN.MC, €4.31)
Santen Pharmaceutical (4536.T, ¥1,396)
Saras (SRS.MI, €1.67)
Schneider Electric (SCHN.PA, €62.82)
Sekisui House (1928.T, ¥1,870)
Semen Indonesia (SMGR.JK, Rp8,875)
Septeni Holdings (4293.T, ¥345)
Sharp (6753.T, ¥189)
Shin-Etsu Chemical (4063.T, ¥8,460)
Shinsei Bank (8303.T, ¥183)
Shionogi (4507.T, ¥5,410)
Siemens (SIEGn.DE, €106.6)
Societe Generale (SOGN.PA, €40.58)
Sonova Holding (SOON.S, SFr122.9)
Sony (6758.T, ¥3,288)
St.Shine Optical Co.,Ltd (1565.TWO, NT$610.0)
Standard Chartered (STAN.L, 641.1p)
Sumitomo Electric Industries (5802.T, ¥1,602)
Sumitomo Mitsui Financial Group (8316.T, ¥4,206)
Sumitomo Osaka Cement (5232.T, ¥404)
Suzuki Motor (7269.T, ¥3,680)
Swedbank (SWEDa.ST, Skr212.9)
TDK (6762.T, ¥7,690)
THK (6481.T, ¥2,461)
TSI Holdings (3608.T, ¥657)
TUI (TUIT.L, 1054.0p)
Taisei Corp (1801.T, ¥828)
Taiwan Semiconductor Manufacturing (2330.TW, NT$183.0)
Takeda Pharmaceutical (4502.T, ¥4,685)
Tata Motors Ltd. (TAMO.BO, Rs459.35)
Tech Mahindra Limited (TEML.BO, Rs485.4)
Technip (TECF.PA, €65.36)
Teijin (3401.T, ¥2,118)
Telefonica (TEF.MC, €7.85)
Telenor (TEL.OL, Nkr125.8)
Telia Company (TELIA.ST, Skr34.66)
Temenos Group (TEMN.S, SFr70.4)
The Priceline Group Inc (PCLN.OQ, $1503.68)
Tokyo Electron (8035.T, ¥10,475)
Toray Industries (3402.T, ¥929)
Toshiba (6502.T, ¥425)
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2 December 2016
Toyota Industries (6201.T, ¥5,360)
Trancom (9058.T, ¥5,570)
USS (4732.T, ¥1,831)
Unicredit (CRDI.MI, €2.02)
Unilever (ULVR.L, 3196.0p)
Usen (4842.T, ¥344)
VINCI (SGEF.PA, €61.23)
Vodafone Group (VOD.L, 193.9p)
Vonovia (VNAn.DE, €30.43)
Vopak (VOPA.AS, €44.1)
WPP (WPP.L, 1709.0p)
Walmex (WALMEX.MX, MXN37.75)
Workman (7564.T, ¥3,375)
Wowow (4839.T, ¥2,994)
X5 Retail Group (PJPq.L, $30.0)
Xinjiang Goldwind Science & Technology Co., Ltd. (2208.HK, HK$12.24)
Yoox Net-A-Porter Group (YNAP.MI, €25.52)
Zhengzhou Yutong Bus Co., Ltd (600066.SS, Rmb21.05)
dorma+kaba (DOKA.S, SFr734.5)
Disclosure Appendix
Analyst Certification
The analysts identified in this report each certify, with respect to the companies or securities that the individual analyzes, that (1) the views
expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her
compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.
The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's
total revenues, a portion of which are generated by Credit Suisse's investment banking activities
As of December 10, 2012 Analysts’ stock rating are defined as follows:
Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months.
Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months.
Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months.
*Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which
consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and
Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total
return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperfor ms representing the
most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities . For Latin American and non-Japan Asia stocks, ratings
are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian
ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return pote ntial within
an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation inc ludes 12-month rolling dividend yield. An
Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned
where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18
May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, wh ich was in operation from 7 July
2011.
Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications,
including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other
circumstances.
Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the
company at this time.
Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment
view on the equity security of the company or related products.
Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24
months or the analyst expects significant volatility going forward.
Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or
valuation of the sector* relative to the group’s historic fundamentals and/or valuation:
Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months.
Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.
Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months.
*An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.
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Credit Suisse's distribution of stock ratings (and banking clients) is:
Global Ratings Distribution
Rating
Versus universe (%)
Of which banking clients (%)
Outperform/Buy*
44%
(63% banking clients)
Neutral/Hold*
38%
(59% banking clients)
Underperform/Sell*
15%
(55% banking clients)
Restricted
3%
*For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely
correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to
definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individ ual factors.
Important Global Disclosures
Credit Suisse’s research reports are made available to clients through our proprietary research portal on CS PLUS. Credit Suisse research products
may also be made available through third-party vendors or alternate electronic means as a convenience. Certain research products are only made
available through CS PLUS. The services provided by Credit Suisse’s analysts to clients may depend on a specific client’s preferences regarding the
frequency and manner of receiving communications, the client’s risk profile and investment, the size and scope of the overall client relationship with
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manner, please contact your sales representative or go to https://plus.credit-suisse.com .
Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the
market that may have a material impact on the research views or opinions stated herein.
Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer
to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research-andanalytics/disclaimer/managing_conflicts_disclaimer.html .
Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer
to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research:
See the Companies Mentioned section for full company names
The subject company (2208.HK, 035420.KS, 005930.KS, 8464.TW, 2330.TW, PJPq.L, TELIA.ST, TEL.OL, MVID.MM, MGNTq.L, 105560.KS,
CARLb.CO, ULVR.L, ERST.VI, FUM1V.HE, 1109.HK, 0688.HK, 139480.KS, 2317.TW, 2318.HK, BABA.N, PRY.MI, RB.L, EXPN.L, SOON.S,
OREP.PA, BBVA.MC, ASSAb.ST, EMR.N, HSBA.L, KSU.N, SAN.MC, CRDI.MI, ATVI.OQ, DGE.L, BMRN.OQ, BVI.PA, FLR.N, PM.N, WPP.L,
PFE.N, KOF.N, LPPF.JK, ADVANC.BK, DD.N, TECF.PA, ENEI.MI, JBLU.OQ, SGSN.S, SMGR.JK, PERP.PA, NOKIA.HE, 3034.TW, PHG.AS,
WALMEX.MX, SWEDa.ST, C.N, CASP.PA, VOD.L, 0992.HK, STAN.L, SASY.PA, BA.N, KLAC.OQ, AIR.PA, DAL.N, INGR.N, FB.OQ, GOOGL.OQ,
FOXT.L, AMZN.OQ, LBTYA.OQ, DOKA.S, SCHN.PA, FMEG.DE, GXIG.DE, CAPP.PA, MORr.AT, GYC.DE, LAZ.N, DWNG.DE, BIP.N, LUX.MI,
ATCOa.ST, AZMT.MI, TEMN.S, SIEGn.DE, CCL.N, SGEF.PA, PSMGn.DE, ISP.MI, IG.MI, ALXN.OQ, BARN.S, ELIOR.PA, ELE.MC, MCD.N,
EA.OQ, FREG.DE, TEF.MC, BNPP.PA, SRS.MI, ATOS.PA, ADEN.S, PCLN.OQ, BABr.AT, ICE.N, TUIT.L, RCOP.PA, IBE.MC, CAGR.PA, ROG.S,
GILD.OQ, YNAP.MI, SOGN.PA, BEIG.DE, VNAn.DE, PRTP.PA, BNRGn.DE, ENI.MI, 2914.T, 8591.T, 6753.T, 5232.T, 7733.T, 6762.T, 5486.T,
8303.T, 6758.T, 4217.T, 8411.T, TAMO.BO, COAL.BO, SAPG.F, HCLT.BO, ADSGn.F, DB1Gn.F, DBKGn.F, DTEGn.F, HNKG_p.F, TEML.BO,
6501.T, 5333.T, 8604.T, 6752.T, 8306.T, 1928.T, 8316.T, 6502.T, 4502.T, DAST.PA) currently is, or was during the 12-month period preceding the
date of distribution of this report, a client of Credit Suisse.
Credit Suisse provided investment banking services to the subject company (035420.KS, 005930.KS, 8464.TW, PJPq.L, TEL.OL, 105560.KS,
ULVR.L, ERST.VI, 2317.TW, 2318.HK, BABA.N, SOON.S, BBVA.MC, HSBA.L, KSU.N, SAN.MC, CRDI.MI, ATVI.OQ, DGE.L, BVI.PA, PM.N,
PFE.N, KOF.N, LPPF.JK, ADVANC.BK, DD.N, ENEI.MI, SMGR.JK, WALMEX.MX, SWEDa.ST, C.N, CASP.PA, 0992.HK, STAN.L, DAL.N, FB.OQ,
GOOGL.OQ, FOXT.L, LBTYA.OQ, SCHN.PA, DWNG.DE, BIP.N, ISP.MI, IG.MI, BARN.S, ELE.MC, MCD.N, TEF.MC, BNPP.PA, ADEN.S, ICE.N,
CAGR.PA, ROG.S, SOGN.PA, BEIG.DE, VNAn.DE, ENI.MI, 2914.T, 8411.T, HCLT.BO, DBKGn.F, DTEGn.F, HNKG_p.F, 8306.T) within the past 12
months.
Credit Suisse provided non-investment banking services to the subject company (ERST.VI, BBVA.MC, HSBA.L, SAN.MC, CRDI.MI, SWEDa.ST,
C.N, CASP.PA, STAN.L, LAZ.N, AZMT.MI, SIEGn.DE, ISP.MI, BNPP.PA, CAGR.PA, GILD.OQ, SOGN.PA, 8303.T, 8411.T, DBKGn.F, 8604.T,
8306.T, 8316.T) within the past 12 months
Credit Suisse has managed or co-managed a public offering of securities for the subject company (035420.KS, 8464.TW, TEL.OL, 105560.KS,
BBVA.MC, HSBA.L, SAN.MC, CRDI.MI, BVI.PA, PM.N, PFE.N, LPPF.JK, SMGR.JK, C.N, STAN.L, GOOGL.OQ, SCHN.PA, BARN.S, MCD.N,
BNPP.PA, ADEN.S, CAGR.PA, SOGN.PA, VNAn.DE, 2914.T, 8411.T, DBKGn.F, DTEGn.F, 8306.T) within the past 12 months.
Credit Suisse has received investment banking related compensation from the subject company (035420.KS, 005930.KS, 8464.TW, PJPq.L,
TEL.OL, 105560.KS, ULVR.L, ERST.VI, 2317.TW, 2318.HK, BABA.N, SOON.S, BBVA.MC, HSBA.L, KSU.N, SAN.MC, CRDI.MI, ATVI.OQ, DGE.L,
BVI.PA, PM.N, PFE.N, KOF.N, LPPF.JK, ADVANC.BK, DD.N, ENEI.MI, SMGR.JK, WALMEX.MX, SWEDa.ST, C.N, CASP.PA, 0992.HK, STAN.L,
DAL.N, FB.OQ, GOOGL.OQ, FOXT.L, LBTYA.OQ, SCHN.PA, DWNG.DE, BIP.N, ISP.MI, IG.MI, BARN.S, ELE.MC, MCD.N, TEF.MC, BNPP.PA,
ADEN.S, ICE.N, CAGR.PA, ROG.S, SOGN.PA, BEIG.DE, VNAn.DE, ENI.MI, 2914.T, 8411.T, HCLT.BO, DBKGn.F, DTEGn.F, HNKG_p.F, 8306.T)
within the past 12 months
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Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (2208.HK, 035420.KS,
005930.KS, 8464.TW, 2330.TW, PJPq.L, TELIA.ST, TEL.OL, MVID.MM, MGNTq.L, 105560.KS, 2886.TW, 3008.TW, CARLb.CO, 0175.HK, ULVR.L,
ERST.VI, FUM1V.HE, 1109.HK, 0688.HK, 139480.KS, 2317.TW, 2318.HK, BABA.N, PRY.MI, RB.L, 033780.KS, EXPN.L, SOON.S, OREP.PA,
BBVA.MC, ASSAb.ST, EMR.N, HSBA.L, KSU.N, SAN.MC, 2308.TW, CRDI.MI, PDNI.KL, ATVI.OQ, BOLSAA.MX, DGE.L, BMRN.OQ, BVI.PA,
FLR.N, PM.N, WPP.L, 2474.TW, PFE.N, BATS.L, KOF.N, LPPF.JK, ADVANC.BK, DD.N, TECF.PA, ENEI.MI, JBLU.OQ, SGSN.S, SMGR.JK,
PERP.PA, NOKIA.HE, 3034.TW, PHG.AS, WALMEX.MX, SWEDa.ST, C.N, CASP.PA, VOD.L, 0992.HK, STAN.L, SASY.PA, BA.N, KLAC.OQ,
AIR.PA, DAL.N, INGR.N, FB.OQ, GOOGL.OQ, FOXT.L, AMZN.OQ, 7201.T, LBTYA.OQ, DOKA.S, FOUG.PA, SCHN.PA, FMEG.DE, GXIG.DE,
CAPP.PA, MORr.AT, GYC.DE, LAZ.N, DWNG.DE, BIP.N, LUX.MI, ATCOa.ST, TEMN.S, SIEGn.DE, CCL.N, SGEF.PA, PSMGn.DE, ISP.MI, IG.MI,
ALXN.OQ, BARN.S, ELIOR.PA, ELE.MC, MCD.N, EA.OQ, FREG.DE, TEF.MC, BNPP.PA, SRS.MI, ATOS.PA, ADEN.S, PCLN.OQ, BABr.AT,
ICE.N, TUIT.L, OI.N, RCOP.PA, IBE.MC, CAGR.PA, ROG.S, GILD.OQ, YNAP.MI, SOGN.PA, BEIG.DE, VNAn.DE, PRTP.PA, BNRGn.DE, ENI.MI,
3401.T, 7988.T, 2914.T, 8591.T, 6753.T, 6268.T, 4507.T, 7733.T, 6762.T, 4185.T, 5486.T, 6367.T, 6981.T, 6273.T, 8303.T, 6594.T, 2229.T, 3407.T,
6758.T, 6971.T, 4217.T, 3405.T, 3402.T, 4114.T, 4183.T, 4188.T, 4503.T, 4523.T, 4922.T, 8411.T, TAMO.BO, COAL.BO, LICH.BO, SAPG.F,
HCLT.BO, ADSGn.F, DB1Gn.F, CIPL.BO, DBKGn.F, DTEGn.F, HNKG_p.F, TEML.BO, 6501.T, 8604.T, 6752.T, 4063.T, 8306.T, 1928.T, 8316.T,
5406.T, 6502.T, 4502.T, DAST.PA) within the next 3 months.
Credit Suisse has received compensation for products and services other than investment banking services from the subject company (ERST.VI,
BBVA.MC, HSBA.L, SAN.MC, CRDI.MI, SWEDa.ST, C.N, CASP.PA, STAN.L, LAZ.N, AZMT.MI, SIEGn.DE, ISP.MI, BNPP.PA, CAGR.PA,
GILD.OQ, SOGN.PA, 8303.T, 8411.T, DBKGn.F, 8604.T, 8306.T, 8316.T) within the past 12 months
As of the date of this report, Credit Suisse makes a market in the following subject companies (ATVI.OQ).
Credit Suisse may have interest in (PDNI.KL)
Please visit https://credit-suisse.com/in/researchdisclosure for additional disclosures mandated vide Securities And Exchange Board of India
(Research Analysts) Regulations, 2014
Credit Suisse may have interest in (TAMO.BO, COAL.BO, LICH.BO, HCLT.BO, CIPL.BO, TEML.BO)
As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (2330.TW, 2886.TW,
2317.TW, 2318.HK, EXPN.L, HSBA.L, 2308.TW, CRDI.MI, 1476.TW, 2474.TW, SGSN.S, 1477.TW, 3034.TW, 0992.HK, STAN.L, DKSH.S,
DOKA.S, TEMN.S, ISP.MI, FREG.DE, TEF.MC, ADEN.S, BNRGn.DE, 3401.T, 8303.T, DBKGn.F).
As of the end of the preceding month, Credit Suisse beneficially own between 1-3% of a class of common equity securities of (SOON.S, BARN.S).
Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (035420.KS, 005930.KS, 105560.KS,
3008.TW, 139480.KS, 033780.KS, GOOGL.OQ, FREG.DE).
Credit Suisse beneficially holds >0.5% short position of the total issued share capital of the subject company (ERST.VI, 7988.T, 6861.T, 6981.T,
6273.T, 6954.T).
Credit Suisse has a material conflict of interest with the subject company (SOON.S) . Credit Suisse AG is acting as an agent in relation to the
company’s announced share buy-back program for the purpose of capital reduction
Credit Suisse has a material conflict of interest with the subject company (SGSN.S) . Credit Suisse AG is acting as an agent in relation to the
company's announced share buy-back program.
Credit Suisse has a material conflict of interest with the subject company (C.N) . Credit Suisse is acting as a financial advisor for Springleaf in
relation to the acquisition of OneMain Financial from CitiFinancial Credit Company, a wholly-owned subsidiary of Citigroup.
Credit Suisse has a material conflict of interest with the subject company (FB.OQ) . Credit Suisse has been named as a defendant in various
putative shareholder class-action lawsuits relating to Facebook, Inc.’s May 2012 initial public offering. Credit Suisse’s practice is not to comment in
research reports on pending litigations to which it is a party. Nothing in this report should be construed as an opinion on the merits or potential
outcome of the lawsuits.
Credit Suisse has a material conflict of interest with the subject company (LBTYA.OQ) . Credit Suisse International is acting as financial advisor to
Liberty Global plc in relation to the announced acquisition of Multimedia Polska S.A. through its subsidiary UPC Poland.
Credit Suisse has a material conflict of interest with the subject company (BIP.N) . Credit Suisse is advisor to Global Infrastructure Partners and
Canada Pension Plan Investment Board in relation to the acquisition of an interest in the shares of Asciano Limited.
Credit Suisse has a material conflict of interest with the subject company (ICE.N) . Credit Suisse acted as a principal advisor to Interactive Data
Corporation in Intercontinental Exchange's acquisition of Interactive Data Corporation.
Credit Suisse has a material conflict of interest with the subject company (VNAn.DE) . Wulf Bernotat, a Senior Advisor of Credit Suisse, is a
supervisory board member of Deutsche Annington Immobilien SE (now renamed Vonovia)
Credit Suisse has a material conflict of interest with the subject company (DTEGn.F) . Detusche Telekom AG - Wulf Bernotat, a Senior Advisor of
Credit Suisse, is a supervisory board member of Deutsche Telekom AG (DTE)
As of the date of this report, an analyst involved in the preparation of this report has the following material conflict of interest with the subject
company (PFE.N). As of the date of this report, an analyst involved in the preparation of this report, Vamil Divan, has following material conflicts of
interest with the subject company. The analyst or a member of the analyst's household has a long position in the common stock Pfizer (PFE.N). A
member of the analyst's household is an employee of Pfizer (PFE.N).
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As of the date of this report, an analyst involved in the preparation of this report has the following material conflict of interest with the subject
company (C.N). As of the date of this report, an analyst involved in the preparation of this report, Susan Katzke, has following material conflicts of
interest with the subject company. The analyst or a member of the analyst's household has a long position in the common and preferred stock
Citigroup (C).
For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683.
For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated
within the past 12 months, please refer to the link: https://rave.credit-suisse.com/disclosures/view/report?i=273465&v=5w3krcegf6u5locrzmhqfiela .
Important Regional Disclosures
Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report.
The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse
does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events.
Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares;
SVS--Subordinate Voting Shares.
Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not
contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report.
For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit https://www.creditsuisse.com/sites/disclaimers-ib/en/canada-research-policy.html.
Credit Suisse Securities (Europe) Limited (Credit Suisse) acts as broker to (HSBA.L, FOXT.L).
The following disclosed European company/ies have estimates that comply with IFRS: (PJPq.L, TELIA.ST, TEL.OL, MGNTq.L, OTPB.BU,
CARLb.CO, ERST.VI, RB.L, EXPN.L, SOON.S, OREP.PA, BBVA.MC, ASSAb.ST, HSBA.L, SAN.MC, CRDI.MI, DGE.L, WPP.L, BATS.L, TECF.PA,
ENEI.MI, SGSN.S, PERP.PA, NOKIA.HE, PHG.AS, SWEDa.ST, CASP.PA, VOD.L, STAN.L, SASY.PA, AIR.PA, BKGH.L, 7201.T, SCHN.PA,
FMEG.DE, CAPP.PA, MORr.AT, ATCOa.ST, AZMT.MI, TEMN.S, SIEGn.DE, PSMGn.DE, ISP.MI, FREG.DE, TEF.MC, HMb.ST, BNPP.PA,
HAYS.L, ATOS.PA, ADEN.S, RCOP.PA, IBE.MC, CAGR.PA, SOGN.PA, BEIG.DE, PRTP.PA, ENI.MI, 3407.T, SAPG.F, ADSGn.F, DB1Gn.F,
DBKGn.F, DTEGn.F, HNKG_p.F, DAST.PA).
Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (035420.KS, 8464.TW,
TEL.OL, 105560.KS, ERST.VI, BABA.N, BBVA.MC, HSBA.L, SAN.MC, CRDI.MI, ATVI.OQ, DGE.L, BVI.PA, PM.N, PFE.N, BATS.L, LPPF.JK,
DD.N, ENEI.MI, SGSN.S, SMGR.JK, WALMEX.MX, SWEDa.ST, C.N, 0992.HK, STAN.L, BA.N, DAL.N, FB.OQ, GOOGL.OQ, FOXT.L, LBTYA.OQ,
SCHN.PA, MORr.AT, BIP.N, AZMT.MI, ISP.MI, BARN.S, ELIOR.PA, ELE.MC, MCD.N, FREG.DE, TEF.MC, BNPP.PA, ADEN.S, OI.N, IBE.MC,
CAGR.PA, SOGN.PA, VNAn.DE, 2914.T, 8411.T, TAMO.BO, COAL.BO, DBKGn.F, DTEGn.F, 8306.T) within the past 3 years.
Principal is not guaranteed in the case of equities because equity prices are variable.
Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that.
For Thai listed companies mentioned in this report, the independent 2014 Corporate Governance Report survey results published by the Thai
Institute of Directors Association are being disclosed pursuant to the policy of the Office of the Securities and Exchange Commission: Advanced Info
Service PCL (Excellent)
This research report is authored by:
Credit Suisse InternationalAndrew Garthwaite ; Marina Pronina ; Robert Griffiths ; Nicolas Wylenzek ; Alex Hymers ; Mengyuan Yuan ; Alexander
Evans
To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important
disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research
analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the
NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a
research analyst account.
Credit Suisse InternationalAndrew Garthwaite ; Marina Pronina ; Robert Griffiths ; Nicolas Wylenzek ; Alex Hymers ; Mengyuan Yuan ; Alexander
Evans
Important MSCI Disclosures
The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of
MSCI, this information and any other MSCI intellectual property may not be reproduced, re-disseminated or used to create and financial products,
including any indices. This information is provided on an "as is" basis. The user assumes the entire risk of any use made of this information. MSCI,
its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of
originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of
the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any
liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are services marks of MSCI and its affiliates.
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The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. and
Standard & Poor’s. GICS is a service mark of MSCI and S&P and has been licensed for use by Credit Suisse.
Important Credit Suisse HOLT Disclosures
With respect to the analysis in this report based on the Credit Suisse HOLT methodology, Credit Suisse certifies that (1) the views expressed in this
report accurately reflect the Credit Suisse HOLT methodology and (2) no part of the Firm’s compensation was, is, or will be directly related to the
specific views disclosed in this report.
The Credit Suisse HOLT methodology does not assign ratings to a security. It is an analytical tool that involves use of a set of proprietary quantitative
algorithms and warranted value calculations, collectively called the Credit Suisse HOLT valuation model, that are consistently applied to all the
companies included in its database. Third-party data (including consensus earnings estimates) are systematically translated into a number of default
algorithms available in the Credit Suisse HOLT valuation model. The source financial statement, pricing, and earnings data provided by outside data
vendors are subject to quality control and may also be adjusted to more closely measure the underlying economics of firm performance. The
adjustments provide consistency when analyzing a single company across time, or analyzing multiple companies across industries or national
borders. The default scenario that is produced by the Credit Suisse HOLT valuation model establishes the baseline valuation for a security, and a
user then may adjust the default variables to produce alternative scenarios, any of which could occur.
Additional information about the Credit Suisse HOLT methodology is available on request.
The Credit Suisse HOLT methodology does not assign a price target to a security. The default scenario that is produced by the Credit Suisse HOLT
valuation model establishes a warranted price for a security, and as the third-party data are updated, the warranted price may also change. The
default variable may also be adjusted to produce alternative warranted prices, any of which could occur.
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and valuation advisory service of Credit Suisse.
For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683.
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