Credit Suisse: Tactical downgrade of equities on Greek contagion risk

The Greek contagion fears continue to occupy centre stage in the global financial markets. Following its downgrade for Greece and Portugal on Tuesday, Standard & Poor's (S&P) yesterday downgraded Spain to AA from AA+ with a negative outlook. S&P warned that a further downgrade was likely if Spain's budgetary position underperformed to a greater extent than the agency's expectation. The Euro Stoxx 50 Index lost another 1.8% last night. The IMF announced that it was considering committing another EUR 10 bn to Greece's rescue package, in addition to its original commitment of EUR 15 bn. This raised some hopes that the rapidly escalating Greek debt crisis may prompt policymakers in the Eurozone to take more decisive actions to stabilize the markets. If Greece manages to reach an agreement with the EU and the IMF in the near term on conditions for a financial rescue package, this should alleviate its immediate liquidity stress before the country faces a critical EUR 8.5 bn bond maturity on 19 May.

However, our Global Fixed Income Research Team cautioned that the recent sharp widening of Greek bond spreads has materially increased the country's default risk as it has now become virtually impossible for the country to finance itself in capital markets. In Germany, the approval for distribution of funds to support Greece's rescue package is complicated by the upcoming regional elections on 9 May. Major uncertainties still exist regarding the sustainability of Greece's overall debt levels, as German opposition Green Party leader Jurgen Trittin quoted his IMF source as suggesting that the rescue package for Greece could total between EUR 100 bn and EUR 120 bn over the next three years. We believe some form of debt restructuring for Greece may still be needed, which could either be announced simultaneously with the support package or at a later stage in case the agreed austerity program does not work out as planned.

In wake of rapid deterioration of the Greek credit crisis, Credit Suisse Investment Committee decided in a special meeting yesterday to reduce the tactical (1-6 months) equity arrow to neutral after global equity markets have fallen through key technical support levels. We believe the outcome of the Greek crisis remains highly uncertain ahead of the 19 May deadline for refinancing substantial amounts of the country's debt. From a strategic (6-12+ months) perspective, the Investment Committee maintains our positive equity arrow due to robust outlook for the global recovery and corporate earnings.

To reflect the intensification of the Greek contagion risk, our Global Equity Research Team has downgraded Europe ex-UK to underweight from neutral due to deteriorated earnings outlook for the region amid the sovereign debt crisis. We believe the positive marginal effects on European exporters of the weak EUR are now peaking. We also downgraded Germany from overweight to neutral and cut Spain to underweight from neutral due to their exposure to the Greek contagion risk. Our top SELL ideas among European stocks are Commerzbank (CBK GY, HOLD, TP: EUR 5.5, -8% downside), Air France (AF FP, HOLD, TP: EUR 10.5, -10% downside), SAB Miller (SA BLN, HOLD, TP: GBp 1780, -11% downside) and EADS (EAD FP, SELL, TP: EUR 12.5, -10% downside). As part of a risk reduction strategy, we have upgraded Switzerland, which is a defensive market, to neutral from underweight. We maintain our overweight position on emerging markets and Asia given their strong domestic fundamentals, robust growth prospects and favourable structural drivers.