Worried about the Fed’s taper tactics? Maybe Abe’s poisoned third arrow?

Andrew Garthwaite’s not. The Credit Suisse equity strategist has just hiked his S&P 500 forecast to 1,730 (from 1,640). For 2014 he’s going for 1900. Yes, Garthwaite sees another 15 per cent…

We stay overweight equities for the following reasons:

■ Relative valuation: The equity risk premium is 6.1%; our models suggest it should be 4.8%.

■ Earnings upgrades: US earnings revisions have turned positive for the first time since May 2012 (normally that is good for markets). We revise our US EPS growth forecasts up from 2% to 5.1% for 2013E and 6.1% for 2014E (we upgrade our European EPS growth estimates from 3% to 6.1% in 2013E). In our survey, two thirds of clients believe US margins will fall over the next two years. We believe margins will not fall until rates rise or labour has pricing power—neither event is likely to occur until 2015, in our view.

■ Economic momentum is troughing on many indicators; normally, this is positive for equities.

■ Too much pessimism on impact of tapering: Aggregate developed market central banks’ balance sheets will modestly expand even with Fed tapering. Markets peaked seven months after the end of QE1 and QE2 (QE could easily continue until mid-2014). Markets are pricing in the first Fed rate hike for September 2014, according to our rate strategists. This is too pessimistic, in our view. Excess liquidity is still rising at 6% (implying a 20% year-on-year re-rating of equities).

■ Funds flow is still supportive: Long-term equity weightings remain very low despite 88% of clients believing equities will be the best performing asset class over the next two years; the corporate sector is buying 3% of market cap and is set to accelerate (with optimum leverage, the corporate sector could buy c$1.7tn of equities).

■ Tactical indicators: Equity sector risk appetite is only 0.5 std above average, market breadth is good, our equity sentiment indicators is only 0.7 std above average and can stay extended for much longer periods. Since 1987, we have had three much longer periods without a 10%+ correction. Credit spreads tend to start rising three months before the peak in equities—and so far they have only moved up marginally.

We agree with our rate strategists’ forecast for government bond yields to rise to 2.7% by the end of 2014. We believe the risk/reward balance in credit looks significantly worse than that for equities.

Garthwaite also reckons the Footsie will hit 7,800 next year. A couple of tables – click to enlarge:

More in the usual place.

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