Most major firms on Wall Street make adjustments to their asset classes and sector weightings monthly, or at least quarterly. After all, things change and sometimes they change quite fast.
Credit Suisse’s U.S. equity strategy team has made significant changes to its underlying U.S. equity sector weightings. This has not yet been followed by waves of analyst upgrades and downgrades in each impacted sector. That said, Credit Suisse’s adjusted sector recommendations are intended to better align with the firm’s near-term cautious outlook.
At the top of the list is that the S&P 500 returns were flattish over the past month based on escalating trade concerns, as well as an inverted yield curve and a continued deceleration in the economic data. The report showed that leading indicators point to further weakness ahead and cited Bureau of Economic Analysis data showing that the 2.9% gross domestic product growth of 2018 would slow to 2.3% in 2019 and then to 1.8% in 2020, versus 1.3% international growth in 2018 slowing to 1.0% growth in 2019 and then ticking back up to 1.1% in 2020.
As far as the drivers of the sector changes, defensive groups meaningfully outperformed the broad market while energy stocks, as well as small caps and non-U.S. shares, have lagged. Contributing to the decline is the yield curve inversion, wherein the 10-year Treasury yield fell under 1.50% from 3.2% and inverted under most maturities. Credit Suisse’s view of the futures market is that the market is pricing in five rate cuts by the Federal Reserve through the end of 2020, with close to $17 trillion in debt now at negative yields around the globe and trillions more with ultra-low yields all weighing on banks and savers.
While the firm has noted that recessionary indicators have weakened, they do not yet point to a downturn. The longest recovery we have seen is also called the slowest recovery. Here are the formal sector rating changes made:
- Credit Suisse upgraded its weightings in utilities and real estate investment trusts to Market Weight from Underweight.
- Two sectors saw downgrades: Energy was cut to Underweight from Market Weight, while health care was cut to Market Weight from Overweight.
- Credit Suisse continues to favor technology, discretionary and the communications services sectors. That said, the firm noted that margin pressure is quite pronounced among the mega-cap technology companies.
Additional notes and data included by Credit Suisse:
- Many stocks provide attractive dividend yields as an alternative to bonds.
- Most groups have a dividend yield that is higher than the 10-year Treasury note, with the S&P 500 yield at 1.9% overall.
- Including share repurchases, the total return of capital (dividends and buybacks combined) is well in excess of the 10-year yield.
- Including likely revisions and beats, earnings per share growth is likely to be positive in both the third and fourth quarters, but virtually all the growth in 2019 is the result of stock buybacks rather than earnings.
- Revenues have been healthy throughout 2019, while margins have detracted value.
- Second-quarter revisions and surprises were in line with historical trends, but third-quarter estimates are lagging historical trends on trade-related concerns.
- Revenue and earnings growth have been shown to be far healthier for the typical (median) company than the benchmark.
As far as the recession front is concerned, Credit Suisse noted that a service economy (as in the United States) is less prone to recession than a manufacturing economy. That said, the industrial economy is experiencing another contraction.
Again, this has not translated into a wide swap of ratings on individual stocks moving from Outperform to Neutral and so on. If that is seen, those changes will be addressed in our daily analyst upgrades and downgrades or in individual sector pieces ahead.