Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Our central scenario for the ongoing negotiations on the US debt
ceiling is that we will see a rise in the ceiling by August 2nd, with
the bulk of key decisions on fiscal tightening delayed until after the
2012 elections. We think there is a 50% chance of a ratings
downgrade on US sovereign debt.
● This could happen even if the debt ceiling is raised. We doubt it
will have much effect: Japan has a 1.1% yield and an AA- rating,
many US Treasury funds do not have credit-rating limitations and
national bank regulators would probably keep risk weightings for
US sovereign debt at zero.
● Alternative scenario 1 – an extended period of no rise in the debt
ceiling. As our economists point out, each month of no rise in the
ceiling could easily take 0.5%-1% off GDP. In this case, equity
markets would drop by 10%-15%, prompting Congress to find a
solution and bond yields would fall to 2.75% (according to Credit
Suisse fixed income team). Investors should focus on
defensiveness and quality growth. The dollar falls.
● Alternative scenario 2 – default. This is very unlikely, but if it
occurs, GDP could fall 5%+ and equities by 30%. Purely focus on
stocks with high FCF, low leverage.
US debt scenarios
We believe that there is a high probability that the debt ceiling is
raised, that there is a 50% probability of a credit downgrade, but only
a very tiny chance of a default. According to the US Treasury, the US
government will run out of money on August 3rd without a rise in the
debt ceiling. If the debt ceiling is not raised (from the current $14.3tn),
the government has the option of cutting government spending, selling
government assets or defaulting (missing coupon payments). We
believe that the most probable outcome is a rise in the debt ceiling.
Yet, we think little is being done to address the long term fiscal issues
until after November 2012 elections.
What if the debt ceiling is not raised within a few weeks of
the August 2nd deadline?
There would be huge fiscal tightening (11% of GDP on an annualized
basis, on our economists’ estimates, see their note Global Economy:
Monthly Review, July 22). With no agreement and with Social Security
due to be paid on August 3, our economists estimate that $134 bn of
government spending cuts will be required in August alone
The worst case: default
It is almost unthinkable to believe that the US would miss a coupon
payment ($29bn are due on August 15th). If the US does default,
there are massive ramifications. According to Credit Suisse chief
economist Neal Soss, the repo market would probably cease to work.
The inter-bank market would freeze up. The fallout would be far worse
than after the Lehman’s default.
50% probability of a US sovereign downgrade
We agree with our US rate team that the likelihood of a US sovereign
rating downgrade is around 50%. The lack of a long-term plan for
improving the public finances in combination with either no agreement
or a weak agreement on the debt ceiling clearly raises the probability
that rating agencies will downgrade the US credit rating.
Investment conclusions
No debt ceiling agreement: Equities markets down 15%. If there is
no increase in the debt ceiling for a prolonged period (say 3 months)
with no agreement in sight, we believe stock markets could easily fall
15%.
In case of default, just be overweight defensives. If there was a
default, we would simply focus on non-cyclical companies with high
FCF yield and low leverage (as we assume that funding markets
would dry up and the cost of debt would rise).
Focus on companies safer than governments. Regardless of the
outcome of the negotiations over the debt ceiling, we think investors
should focus on ultra-safe corporates (those that offer a CDS spread
below that of the average G7 sovereign in combination with a dividend
yield above the average G7 government bond yield). To the extent
that the debt ceiling negotiation in the US and the worries about
peripheral Europe drive home the uncertain outlook for government
finances, the strong financial position of these corporates will appear
increasingly attractive.
The risk/reward suggests we stay underweight of cyclicals,
especially in Europe. The price relative of cyclicals against defensive
is only 3% off its all-time high of July 2007, the P/B relative (against
defensives) is at the top end of its range, the implied CFROI on
HOLT® is above previous peaks (given our assumptions) and mutual
funds’ net long positions are close to all time highs. Furthermore, as
we have pointed out for a while, you can get defensive-led bull
markets. The areas of cyclicals we are most concerned about are
European capital goods and retailing.
Overall, however, we believe that within a week, politicians should see
sense and this would represent a buying opportunity for both markets
and for our favoured ‘beta’ sectors (infrastructure stocks and UK
REITs, luxury cars, luxury goods, software applications and
insurance).
Central scenario: equities are discounting a lot of risk. The equity risk
premium is 6.1% against our target of 4.5%. We believe that investors
tend to overdiscount the 'tail' risk. As some of these tail risks abate
(hard landing in China, default in US), markets should rally.
(This is an extract from Andrew Garthwaite’s Global Equity Strategy report,
US debt scenarios, published on 21 July. For details, please see the CS
Research and Analytics website.)
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
● Our central scenario for the ongoing negotiations on the US debt
ceiling is that we will see a rise in the ceiling by August 2nd, with
the bulk of key decisions on fiscal tightening delayed until after the
2012 elections. We think there is a 50% chance of a ratings
downgrade on US sovereign debt.
● This could happen even if the debt ceiling is raised. We doubt it
will have much effect: Japan has a 1.1% yield and an AA- rating,
many US Treasury funds do not have credit-rating limitations and
national bank regulators would probably keep risk weightings for
US sovereign debt at zero.
● Alternative scenario 1 – an extended period of no rise in the debt
ceiling. As our economists point out, each month of no rise in the
ceiling could easily take 0.5%-1% off GDP. In this case, equity
markets would drop by 10%-15%, prompting Congress to find a
solution and bond yields would fall to 2.75% (according to Credit
Suisse fixed income team). Investors should focus on
defensiveness and quality growth. The dollar falls.
● Alternative scenario 2 – default. This is very unlikely, but if it
occurs, GDP could fall 5%+ and equities by 30%. Purely focus on
stocks with high FCF, low leverage.
US debt scenarios
We believe that there is a high probability that the debt ceiling is
raised, that there is a 50% probability of a credit downgrade, but only
a very tiny chance of a default. According to the US Treasury, the US
government will run out of money on August 3rd without a rise in the
debt ceiling. If the debt ceiling is not raised (from the current $14.3tn),
the government has the option of cutting government spending, selling
government assets or defaulting (missing coupon payments). We
believe that the most probable outcome is a rise in the debt ceiling.
Yet, we think little is being done to address the long term fiscal issues
until after November 2012 elections.
What if the debt ceiling is not raised within a few weeks of
the August 2nd deadline?
There would be huge fiscal tightening (11% of GDP on an annualized
basis, on our economists’ estimates, see their note Global Economy:
Monthly Review, July 22). With no agreement and with Social Security
due to be paid on August 3, our economists estimate that $134 bn of
government spending cuts will be required in August alone
The worst case: default
It is almost unthinkable to believe that the US would miss a coupon
payment ($29bn are due on August 15th). If the US does default,
there are massive ramifications. According to Credit Suisse chief
economist Neal Soss, the repo market would probably cease to work.
The inter-bank market would freeze up. The fallout would be far worse
than after the Lehman’s default.
50% probability of a US sovereign downgrade
We agree with our US rate team that the likelihood of a US sovereign
rating downgrade is around 50%. The lack of a long-term plan for
improving the public finances in combination with either no agreement
or a weak agreement on the debt ceiling clearly raises the probability
that rating agencies will downgrade the US credit rating.
Investment conclusions
No debt ceiling agreement: Equities markets down 15%. If there is
no increase in the debt ceiling for a prolonged period (say 3 months)
with no agreement in sight, we believe stock markets could easily fall
15%.
In case of default, just be overweight defensives. If there was a
default, we would simply focus on non-cyclical companies with high
FCF yield and low leverage (as we assume that funding markets
would dry up and the cost of debt would rise).
Focus on companies safer than governments. Regardless of the
outcome of the negotiations over the debt ceiling, we think investors
should focus on ultra-safe corporates (those that offer a CDS spread
below that of the average G7 sovereign in combination with a dividend
yield above the average G7 government bond yield). To the extent
that the debt ceiling negotiation in the US and the worries about
peripheral Europe drive home the uncertain outlook for government
finances, the strong financial position of these corporates will appear
increasingly attractive.
The risk/reward suggests we stay underweight of cyclicals,
especially in Europe. The price relative of cyclicals against defensive
is only 3% off its all-time high of July 2007, the P/B relative (against
defensives) is at the top end of its range, the implied CFROI on
HOLT® is above previous peaks (given our assumptions) and mutual
funds’ net long positions are close to all time highs. Furthermore, as
we have pointed out for a while, you can get defensive-led bull
markets. The areas of cyclicals we are most concerned about are
European capital goods and retailing.
Overall, however, we believe that within a week, politicians should see
sense and this would represent a buying opportunity for both markets
and for our favoured ‘beta’ sectors (infrastructure stocks and UK
REITs, luxury cars, luxury goods, software applications and
insurance).
Central scenario: equities are discounting a lot of risk. The equity risk
premium is 6.1% against our target of 4.5%. We believe that investors
tend to overdiscount the 'tail' risk. As some of these tail risks abate
(hard landing in China, default in US), markets should rally.
(This is an extract from Andrew Garthwaite’s Global Equity Strategy report,
US debt scenarios, published on 21 July. For details, please see the CS
Research and Analytics website.)
No comments:
Post a Comment