Credit Suisse Sees Melt-Up Risk Two Weeks After Cutting Stocks

(Bloomberg) -- Two weeks after scrapping their overweight recommendation for equities, Credit Suisse Group AG strategists are saying that the risks are now tilted to the upside.

“On balance, we think there is more risk of a ‘melt-up’ than a meltdown, and find that we are more positive than most of the clients we meet,” analysts led by Andrew Garthwaite said in a note to clients on Monday.

To be fair, the strategists expect the MSCI All Country World Index to rise just 6% by year-end and hesitate to make a stronger call until there’s more clarity surrounding trade talks, economic data and earnings revisions. But softer monetary policy in addition to a bet that earnings growth will recover is making Credit Suisse optimistic that equities can go higher.

The analysts said that many investors may be undervaluing stocks as more than 40% of clients it surveyed in May didn’t pay attention to the appeal of valuations based on so-called equity risk premium. That’s the potential excess return for investing in shares over risk-free assets. According to the broker, equity valuations are “much more attractive” from a risk premium perspective rather than from a price-to-earnings standpoint.

Credit Suisse joins the likes of Bank of America Merrill Lynch, which on Friday said that investors’ short positioning and exodus from stocks, which has reached about $152 billion this year, is a contrarian bullish indicator. Since the Swiss broker removed its tactical overweight on stocks in early June, global equities have gained 3.7% as traders embraced the U.S. Federal Reserve’s openness to rate cuts.

Haven Search

At the same time, the rally in defensive shares has continued this month along with bond fund inflows, signaling that investors are searching for havens. This week should provide more clarity on the market’s direction as the Federal Reserve, the Bank of Japan and the Bank of England all set monetary policy.

Meanwhile, friction between the U.S. and Iran, clashes in Hong Kong and uncertainty over a G-20 meeting between President Donald Trump and China’s Xi Jinping mean that the gains in stocks stand on thin ice.

But for now, the Swiss broker recommends playing the upside risk by being overweight European non-financial cyclicals, which suffer from bearish economic growth predictions, as well as U.S. growth stocks. Both asset classes tend to outperform most of the time when the Federal Reserve cuts rates, Credit Suisse said.

--With assistance from James Cone.

To contact the reporter on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net

To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Jon Menon, Paul Jarvis

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