H2 2018 — that’s when equity research analysts at Credit Suisse believe the correction will arrive. In a research note published at the beginning of this month, Credit Suisse’s equity analysts layout their reasoning behind this prediction, although they’re still bullish on equities for the next eight months based on a look at the equity risk premium today.
Equity Risk Premium today implies more gains
According to the report, equities are still supported by multiple factors including, a supportive macro backdrop, profits growth, liquidity (central banks' balance sheets should continue to grow until Q4 2018), cash on the sidelines and "little sign of the usual preconditions for a market peak." Lastly, the analysts believe that, despite consensus suggesting otherwise, "relative valuations are attractive":
"The equity risk premium today is too high at c.5% in the US on our estimates, and 6% on IBES consensus; our model suggests it should be 3.6%. In the euro area, the ERP is 8.2%; our model suggests it should be 6.3%. Other factors suggest a still-lower ERP."
Considering all of these factors, the Swiss bank maintains an "overweight stance toward equities, and underweight bonds, noting a risk that the 'final hurrah' could see more of an asset bubble emerge."
The analysts go on to note that during the final stages of a bull market we often see an excess of valuation "driving the equity risk premium today down to levels below 3% on average" as well as a sharp acceleration in equity buying, "excessive optimism and often talk of 'New Paradigm.'" So far, none of these factors have emerged. Therefore the analysts think there's more risk of a "melt-up" in equities over the next six months rather than a bear market.
On the other hand, towards the end of 2018, it's likely a different scenario will unfold as the positive tailwinds gove way to negative pressures. As the report explains:
"In our view, the key risks to focus on, and why we see a more difficult second half of 2018, are: (i) an acceleration in US wage growth; (ii) China slowing down as major reforms are implemented around the Third Central Committee meeting; (iii) the Fed starting to focus on asset prices; (iv) a rise in speculative grade defaults; and (v) too much fiscal easing forcing a monetary response."