Andrew Garthwaite, a prominent global strategist at Credit Suisse, reiterated a timely underweight recommendation on equities on Friday while also helpfully providing a series of indicators to watch that may signal the next upturn in markets.
Mr. Garthwaite said he sees recessions in Europe and the United States as inevitable, an environment that will make life difficult for stocks. Europe is dealing with soaring Russia-related energy costs that are severely limiting consumption and industrial activity. In the U.S., leading economic indicators such as manufacturing new orders, consumer and business confidence and the price of copper are all consistent with an upcoming recession.
Central banks will be unable to respond to weaker economic activity by cutting rates – they will still be fighting persistent inflation pressures, according to the Friday research report. The strategist notes that the high worker quit rate in the U.S. is consistent with continued inflationary wage growth. Mr. Garthwaite also believes that economists’ forecasts for 2023 show too much faith that the Federal Reserve will be able to tame inflation.
The strategist believes that corporate profit margins are at risk. He estimates that 60 per cent of the improvement in profit margins since the financial crisis resulted from low taxes and low borrowing costs. Now, both those trends are reversing.
Mr. Garthwaite believes that we are entering a period of downward earnings revisions. In the past, these have lasted 19 months on average. He expects that U.S. profit estimates for 2023, roughly US$240 a share for the S&P 500, will be cut by 15 to 20 per cent, generating selling pressure on stock prices.
If his estimates prove correct, there will be more pain to come. The average bear market sees the S&P 500 fall 35 per cent over 14 months, the strategist notes. The S&P is 500 is currently 23 per cent lower than its high of January, 2022.
Credit spreads – the extent to which high-yield corporate bond yields exceed government bonds – are also an important indicator. The usual recession sees yields for these higher risk bonds at least eight percentage points higher than Treasuries. For Mr. Garthwaite, the current spread, near five percentage points, understates economic risks.
Mr. Garthwaite’s well-grounded pessimism provides some signposts for investors in search of more promising entry points. Improving new manufacturing orders and copper prices, falling worker quit rates, more realistic profit forecasts for 2023 and wider credit spreads would all signal more constructive conditions to put investment funds to work in equity markets.
-- Scott Barlow, Globe and Mail market strategist
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