- Credit Suisse remains overweight equities on the back of dovish monetary policy, but analysts are eyeing three factors with the potential to trigger a sell off.
- Disappointing European growth, overheating or tapering risk, and margin squeeze on earnings could bring the bull run to a halt, Credit Suisse researchers say.
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US stocks have notched record highs in February, and with a hefty stimulus package likely on the way, the pieces are in place for further moves higher.
In a note this week, Credit Suisse analysts say that though the market is showing some signs of excess, dangerous exuberance has yet to be seen. Single stock call/put ratios are at “extremes”, for instance, though this alone is not a sign of imminent danger for the market. The researchers also note that there is currently “limited systemic risk.”
That said, the analysts flagged three catalysts they are closely watching that could trigger a sell off in stocks. Here are the risks the bank sees to an otherwise roaring stock market.
Disappointing European growth
The vaccine rollout has been haphazard in Europe. This could lead to extended lockdowns, while new strains of virus also threaten a full economic reopening.
The investment bank’s pharmaceutical team believes Europe will only have 20% of its population vaccinated by end of the first quarter, which may affect its employment rate.
The EU Recovery Fund is key but the analysts said it will be slow to disburse. Compared to the United States, the majority of corporate borrowing in Europe is from banks where lending conditions are tight.
The investment bank said the fiscal policy is less generous than it was during the first lockdown, especially in contrast to the US.
Risk of overheating or Fed tapering
Credit Suisse said there is a medium risk of a sell-off if the central bank allows inflation to overshoot to around 2.7% core CPI. The investment bank says, “not only has the Fed clearly hinted that it would allow an inflation overshoot to compensate for the undershoot but recently it has sounded even more dovish.”
In December, the Fed highlighted that even an unemployment rate of 3.7% in 2023 would still result in rates being unchanged.
The key risk for the investment bank would be the tapering being brought forward by a stronger-than-expected recovery in growth, larger pick-up inflation, and some form of financial excess.
Another crucial factor is the gross domestic product growth in the US. The investment bank said the growth of 7% would be 3% above the Fed’s 4.5% forecast. This could lead to unemployment ending close to 4% this year.
Other catalysts that could trigger overheating are the sizable fiscal package in the US as Democrats prepare to pass President Joe Biden’s COVID-19 relief package and a larger infrastructure package, and inflation expectations rising beyond the comfort zone. If this happens, the investment bank says, it could lead to the Fed tightening monetary policy.
Margin squeeze on earnings
The investment bank sees the possibility of a sharp rise in some input costs such as commodities and freight rates, which can lead to a margin squeeze.
“But markets have not fully factored in the current level of earnings revisions,” analysts said. “Only 73% of PMIs have to be above 52 to justify the current market performance.”
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