Financials Sector Remains Credit Suisse's Highest-Conviction Overweight

There is potential for a pullback in equities in the near term, and the strategy should be to buy the dips, since “flows and the longer term economic outlook remain constructive, ”Credit Suisse’s Lori Calvasina said in a report. Furthermore, there seems to have been a revival in buyback announcements.

The underperformance of small caps in early 2017 could persist in the near term, Calvasina mentioned, adding that any incremental weakness can be considered as a buying opportunity.

Valuations of small-cap stocks are more attractive than large-cap stocks. “Beyond valuation, we think small caps will benefit from continued protectionist leanings in Washington and are likely to benefit more from an eventual reduction in the corporate tax rate,” the analyst wrote. She also recommended focusing on value over growth.

Overweight Sectors

• Financials: “Financials remains our highest conviction overweight,” Calvasina commented, maintaining an Overweight stance on all three industry groups — Insurance, Diversified Financials and Banks. The performance of these groups has been correlated with interest rate direction, there has been an uptrend in earnings momentum, valuations are attractive, interest rate sensitivity is mostly positive and “we do not see signs of crowding risk.”
• Media: While valuations of large-cap stocks are attractive, the small-cap names have reasonable valuations. There is upside to earnings revisions and no signs of crowding yet.
• Commercial & Professional Services: There are signs of upside to earnings revisions, which had been trending lower. “Valuations remain reasonable, and the group tends to outperform when interest rates rise,” Calvasina pointed out.
• Transportation: Valuations of large caps are attractive and of small caps are reasonable. The sector seems poised for a strong earnings recovery. “Our work suggests that Air Freight & Logistics and Road & Rail are the most interesting groups within Transportation [...] We are often asked about Airlines, but find pricey valuations and a red flag on our ownership data,” the analyst stated.

Upgraded Sectors

• Pharma and Biotech: Credit Suisse upgraded this sector from Market Weight to Overweight. Although the performance of this group “has been inversely correlated with interest rate direction over the past decade,” these stocks can be used to boost defensive exposure. Valuations are slightly attractive in large cap and reasonable in small caps. Earnings may have bottomed and could trend higher. Health Care funds flows showed “signs of stabilizing in February,” after being “deeply negative” for most of the past year, Calvasina mentioned.

Market-Weight Sectors

• HC Equipment & Services, REITs, Telecom and HH & Personal Products: “[V]aluations still look reasonable or attractive on our models for small and large cap REITs, large cap Telecom, small and large cap Household & Personal Products, and small cap HC Equipment & Services,” the analyst wrote.
• Energy: Although this sector has a robust earnings profile and “lack of red flags” and there are resilient retail inflows into to Energy sector funds, “elevated valuations keep us on the sidelines,” Calvasina noted.
• Autos & Components: There is downside in earnings revisions and the small caps look overvalued.
• Semis & Semi Equipment, Software & Services and Tech Hardware & Equipment: Crowding risk and decelerating earnings momentum call for the Market-Weight rating.

Downgraded Sectors

• Retail: Credit Suisse downgraded Retail from Overweight to Market Weight. Risks of the border adjustment provision in the House corporate tax reform proposal do not seem to have been priced in completely. Within the Retail sector, there are more concerns surrounding the Internet Retail group, the performance of which “has been inversely correlated with interest rate direction,” valuations are high and there is crowding.
• Consumer Durables & Apparel: Credit Suisse downgraded this sector from Overweight to Market Weight, while noting that the sector moves in tandem with Retail.

Underweight Stocks

• Capital Goods: Although the group seems to be improving on certain metrics, a meaningful infrastructure bill is unlikely and stocks appear overvalued, Calvasina said.
• Materials: The momentum in earnings revisions, which had been in a rapid decline, is showing signs of stabilization. The analyst commented, however, that it was too early for an upgrade from Underweight.

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