Bulls versus bears: Who will win the second half of 2018?

The opportunities and risks of the financial markets can already be calibrated based on the first half of the year. How the first two quarters stack up and an outlook for the stock exchange in the second half of 2018.

Bear market wins out in the first half of the year

The halfway point of the calendar year is a good opportunity to pause and take stock. One thing is certain: The global struggle between bears and bulls was fairly balanced in the first half of the year. But towards the end the bears gained ground, as increasing trade tensions, Europe's internal political differences, a strong franc, and financial crises in Argentina and Turkey gave them the upper hand. Below is a summary of the main points (all figures in US dollars, as of June 30, 2018).

  1. The MSCI (World) Index for equities has lost 1.6 percent since the start of the year, while the World Bond Index (Citigroup) has lost 1.2 percent. 
  2. Among the European exchanges (FTSE Euro 100: -5 percent), Switzerland was one of the biggest losers, down -10 percent. Only Poland (-17.8 percent) and Hungary (-16.5 percent) have fared worse. Norway's exchange is leading with a clear increase of +12 percent. 
  3. In the US, the Nasdaq technology index with +7.8 percent is ahead of the Dow Jones Industrial index DJIA (-2.4 percent). 
  4. Japan's Nikkei 225 share index is slightly ahead with +0.3 percent. 
  5. Emerging markets came under pressure in the first half of the year. Argentina's MERV index (-40 percent) and the Turkish BIST index (-31 percent) suffered the biggest falls. The global MSCI Emerging Markets Index lost 7.8 percent. 
  6. The half-time leader: Of the stock exchanges, this year it's Saudi Arabia that's out in front, thanks to the price of petroleum. Its Tadawul index is up 15.1 percent.

Eleven key factors in the bear market

In the past, turning points in the stock markets were regularly signaled by up to 11 indicators. They generally reflect different aspects of recession and/or inflation. Where do these indicators stand today in historical comparison? Eleven factors that could come to the aid of both the bears and the bulls.

Eleven indicators that regularly precede the bear market

Indicator  Current score
(0=low, 3=high)
1. High corporate leverage 2.5
2. Decreasing economic momentum 2.0
3. Buybacks start to perform worse 1.5
4. Excessive optimism in tactical indicators 1.5
5. Broad downward revisions of corporate profits 1.5
6. Unemployment > 1 percent below full employment and wage inflation 1.5
7. Extreme overvaluation of equities 1
8. Excessive business investments 1
9. Significant chance of recession 1
10. Loss of market breadth 1
11. Sharp increase in credit spread 0

Source: Credit Suisse

Not included in this table are external factors such as politics, society, environment, and technology. They are currently unsettling both the bear market and the bull market. This is because the tense global situation clearly increases the risk of a negative chain reaction. Rightly or wrongly, fear can be just as contagious as greed. Individual events are therefore difficult to gauge, because the media attention alone can trigger their occurrence.

There are three key potential hazards in this regard: first, the global increase in overall debt; second, the risk of another euro-zone crisis; and third, the economic policy risks of a trade war, especially for emerging markets.

Eleven important factors in the bull market

1.    Risk premiums: In the absence of a recession or inflation, equities usually offer higher risk premiums than bonds. Despite all the setbacks, patient investors have seen above average earnings on equities since the start of the global economic expansion in 2009. And the risk premiums on equities are still currently twice as high as they should be. A continuation of the low-inflation moderate growth could help the bull market in the second half of the year.


A moderate, low-inflation economic expansion has been driving a global bull market since 2009

Source: Credit Suisse
Past performance and financial market scenarios are not reliable indicators of future results.

2.    Equities are cheap: Worldwide, equities trade at a Shiller PE ratio of 14. However, the average since 1984 is 17.

3.    Price margins: In addition to productivity increases and fiscal support, large US companies in particular benefit from a seemingly defensive pricing power. Of course, a large part of this development is due to the monopoly of technology companies such as Microsoft and FANG.

4.    Buybacks and dividends: In recent years they supported the market in a way that could offset the characteristic restraint of institutional investors. As long as borrowing costs are below the earnings yield, which seems to remain plausible, executive boards have strong incentives to use these means to maintain their return on capital and market price.


Buybacks and dividends create constant demand

Source: Standard & Poor's, Yardeni Research

5.    Deferred institutional demand: Pension funds have reduced their equity holdings by around 30 percent since the financial crisis compared to the period before 2008. The equity holding of German pension funds is at 11 percent. In Denmark it is only 8 percent, whereas in Switzerland it is nonetheless 27 percent. Historically, these were significantly higher in the last 50 years. Sooner or later, patient investors will benefit from this deferred demand.

6.    Falling unemployment is supporting consumption: The latest OECD statistics illustrate that companies are still hiring more people than they are letting go. This development perpetuates economic expansion.


Unemployment continues to fall

Source: Employment statistics, OECD

7.    Increasing corporate turnover: According to estimates from analysts and companies, corporate turnover should be higher in the second half of 2018 than in the last semester. Growth rates may be reducing, but that is no surprise. Moderate growth is more sustainable than overheating.

8.    Profits: Analysts expect average earnings per share of USD 170 for companies in the S&P 500 in 2018. Multiplied by a price-earnings ratio of e.g. 16, 18, or 19, this results in potential year-end closes of 2,720, 3,060, or 3,230. By the same logic, in Switzerland an SMI of 9,100 seems fair.

9.    Confidence indicators: Despite all the turbulence, the results of confidence surveys among managing directors, companies, and consumers in Switzerland, the EU, the US, and worldwide are still close to their historic maximum values. These results are positive indicators for investment activity.


US dollars in earnings per share are expected for S&P 500 companies in 2018.

10.    Strong balance sheets: Even the four trillion Swiss francs worth of cheap debt that companies have taken on in the last ten years are put into perspective by their balance sheets. The average ratio of net debt to EBITDA is far below the limit factor of six that is considered critical.

11.    Tactical indicators: Finally, most tactical indicators suggest that the equity markets are oversold, especially in emerging markets and in Switzerland. The ratio of bull markets to bear markets, investor sentiment, and technical indicators suggest that at least a summer rally seems likely.