Equity rerate unlikely before second half of 2023, says Credit Suisse

Higher-rates-for-longer theme triggered significant derating this year

Most global markets have seen significant derating (term used for lowering of valuations or price-to-earnings, or P/E, multiples) this year amid hardening bond yields, following rate tightening by central banks to cool inflation.

Equity markets may once again rerate (term used for expanding of valuations or higher P/E multiples) once central banks start slacken their tight monetary stance.

However, this is unlikely to play out until the second half of 2023, says Credit Suisse in its Investment Outlook 2023 report.

“The higher-rates-for-longer theme triggered significant derating of equities in 2022. This theme will likely continue to dominate during the first half of 2023, leading to muted equity performance. Sectors and regions with stable earnings, low leverage, and pricing power should fare better in this environment,” says the report.

The Morgan Stanley Capital International World Index is down 16 per cent in the past year. Indian markets have managed to fare better with a one-year gain of 2 per cent.

“The past year has been tough for financial markets, including equities. The Ukraine war added to post-pandemic supply-chain issues and fuelled a rise in inflation to levels last seen in the 1980s. Central banks were initially slow to react, but were forced to hike aggressively,” the investment bank has said.
 

The equity markets and valuations come under pressure whenever central banks raise policy rates and bond yields spike as the risk/reward turns unfavourable. This is because an increase in the cost of funds weighs on earnings growth, further capping the valuation upside.

The biggest driver for the equity markets in 2023 will continue to be “central banks and their policies aimed at reducing inflation”, says Credit Suisse.

“Any signs that inflation is brought under control (that is close to central bank targets on a sustainable basis) will likely loosen central banks’ restrictive stance and can therefore trigger a rerating in equities. However, we do not think this will be the case in the first part of 2023 as our economists do not forecast rate cuts from major central banks, including the US Federal Reserve, in 2023,” it adds.

Economists believe the higher-for-longer policy rates will have a negative impact on the global economic outlook.

Credit Suisse economists forecast a recession in the Eurozone, the UK, and Canada, alongside very weak growth in the US.

“This will inevitably add downside risks to corporate earnings even more so, given rising costs (wages and raw materials). Ultimately, the earnings resilience will depend heavily on the length and magnitude of the economic slowdown. But we see rising risks of an earnings recession (that is negative earnings growth in 2023),” warns Credit Suisse.

However, it believes the worst of equity derating is over. But significant rerating will have to wait for some 

more time.