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The reasons why stock exchanges still have upside potential

Many investors have been disillusioned with 2018. Nothing seems to be as easy as it was last year. While many investors are already in a pessimistic mindset, however, we prefer to swim against the current. Read six reasons why the equity bull market could persist.

1. The tortoise and the hare: Slow and steady wins the race

Some investors expect to have gains every quarter. However, that is not how effective asset management works. Investment risks can yield return through diversification and patience.

For example, the SMI has fallen 5% year to date, and Swiss equities are down 0.5%. A 50/50 portfolio with investments in both would thus be 2.75% percent in the red for the year to date. Our balanced Swiss franc investment portfolios have achieved gains, however. What is behind this difference? It is based on the unassuming secret of diversification. Once again, the patient, diversified investor (the tortoise) has beaten the hare.

2. Global economy underestimated

Do not underestimate the economic weight of 6 billion consumers and a billion companies that are fighting to advance their businesses day in and day out. This is stronger than many a geopolitical storm. The recent slump in the Purchasing Managers Index is not the precursor of a recession. Instead, it reflects a healthy global economy in which inventories are being managed as cost-effectively as possible.

We project that the Swiss and global economies will accelerate slightly in the second half of the year. This development is becoming apparent in the rising interest rates, steeper yield curves, and escalating commodity prices.

We are unlikely to witness the peak oil scenario.

Burkhard Varnholt, CIO Credit Suisse (Switzerland) Ltd.

3. The possibility of an oil shortage

A question I often hear about energy is, "When will we run out of readily extractable oil?" My answer: little by little. We are unlikely to witness this peak oil scenario. The era of fossil fuels will end when other sources satisfy our hunger for energy. This is one reason why we prefer to invest in energy stocks over energy futures. The second reason: The likely scenario of a shortage in the supply of oil from Iran, Venezuela, and potentially Iraq could be a financial boon for the holders of energy stocks.

4. Increasing interest rate volatility is good for equities

It is not inflation, but a rise in real interest rates that places upward pressure on interest rates. This difference is an important one. Eight times out of ten, increases in real interest rates precede rises in equity markets by three to six months. One reason for this is that increases in real interest rates detract from the relative appeal of bonds. Another is that they indicate healthy economic growth, unlike rising inflation forecasts.

400

billion US dollars coming up in US dividends in 2018.

5. Share buybacks and dividends at record highs

According to the US Federal Reserve, US companies have just under USD 3 billion in foreign-held liquidity. Thanks to the US tax reform, a large portion of this may soon be repatriated and subsequently return to the equity market through share buybacks or dividends. Based on the current annual reports, 2018 is gearing up for a record year with over USD 600 billion in share buybacks and over USD 400 billion in dividends. Considering that this record amount (equivalent to a billion Swiss francs) will be invested almost entirely in treasury shares, it is clear why investors should not bet against such waves of buying.

6. Earnings ahead of valuations

Many investors are surprised that price-earnings ratios (P/E ratios) are lower now than at the start of the year. The reason for this is simple, however. In the US, for instance, corporate earnings in the S&P 500 rose an impressive 25% to USD 1.2 billion in the first quarter. Nevertheless, the S&P 500 is only up 2%.

In Switzerland, most earnings also rose in the first quarter of 2018 – yet the SMI is still 5% below its level at the start of the year. This difference in prices and earnings has made the risk premiums on equities far more attractive.

Geopolitical risks overestimated

So, what is behind the reversal in this year's market sentiment? Aside from interest rates and the normalization of the economy, many investors are primarily unsettled by geopolitics. To name but a few keywords: trade war, debt spiral, and Italexit.

Yet as much as each of these risks would be a veritable black swan with global, negative consequences, it is also easy to overestimate the likelihood that they will occur. This is particularly true since fear is known to sell. Until these risks subside again, diversification and patience will be the most effective method of handling even such uncertainty.