Global Equity Strategy -- Another downgrade to cyclicals ::Credit Suisse,

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● The outlook for Continental Europe continues to deteriorate: Euroarea
PMIs are now the worst of any region, consistent with a mild
recession in the region. US lead indicators are also deteriorating—
and, on aggregate, are now consistent with just 0.7% GDP growth.
● Into a mid-cycle slowdown, cyclicals typically underperform
defensives by 16%, into a recession by 35%, compared with 13%
now. Valuations are not cheap and the price relative to defensives is
in line with its post-1990 average. We have been underweight
cyclicals since early March and now add to this.
● We take telecoms to overweight from benchmark, drugs to
benchmark from underweight, rather than adding to our largest
defensive overweights (consumer staples and utilities).
● We reduce our weightings in corporate spending plays. We increase
our underweight in capital goods. We take Continental European
retailing to underweight from benchmark, and take media to
benchmark.

Outlook for Continental Europe continues to deteriorate
Euro-area PMIs are now the worst of any region, consistent with a
mild recession in the region. There are also signs of a credit crunch,
the strong Euro is hurting, projected fiscal tightening for 2012 is 1.5%
of GDP and required deflation in the periphery is still under-estimated.
US lead indicators are also deteriorating—and, on aggregate, are now
consistent with just 0.7% GDP growth.
Adding to underweight on cyclicals
Into a mid-cycle slowdown, cyclicals typically underperform defensives
by 16%, into a recession by 35%, compared with 13% now.
Valuations are not cheap and the price relative to defensives is in line
with its post-1990 average. Overweight is still extreme (on the buyand
sell-side) and earnings revisions have only just turned negative.
Almost 55% of the time, cyclicals trough one to six months after the
trough in ISM. We have been underweight cyclicals since early March
and now add to this.
Overweight telecoms, drugs to benchmark
We take telecoms to overweight from benchmark and drugs to
benchmark from underweight, rather than adding to our largest
defensive overweights (consumer staples and utilities). Telecoms are
the cheapest defensive sector on our scorecard, the second best
performing sector as ISM falls below 45, have the third most resilient
earnings in a recession, and have 20% of revenue from GEM and little
government exposure (buy KPN, Telenor). Drugs are the ultimate
defensive play (high credit rating, largest inverse correlation with ISM,
highest dollar earners, but 80% of revenues come from governments).
Other changes in weightings
We reduce our weightings in corporate spending plays (when GDP is
below 1% in Europe and 1.8% in US, capex turns negative, capex has
a beta of 3x with GDP). We increase our underweight in capital goods
(expensive on P/B, over-owned, relative earnings momentum is poor,
Chinese growth is no longer investment-led; short SKF). We take
Continental European retailing to underweight from benchmark
(margins are 3 std above norm, yet P/E relatives are around 2 std
above norm; it is also a domestic sector) as well as taking media to
benchmark. Other conclusions: (1) stay underweight Continental
Europe (worst economic/earnings revisions, only 4 out of 24 sectors
are abnormally cheap). (2) Avoid expensive domestic Continental
European plays: TF1, Geberit and Accor among others (Delta 1
basket CSEREDOM). We like cheap international plays (better growth
and Euro could fall). (3) Continue to buy quality growth and stocks
with high credit rating and low leverage. (4) Within corporate spend,
we only remain overweight (albeit reduced) software.