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Credit suisse Two weeks ago, we sent a short note highlighting that the tactical signals gave a buy signal (sentiment was at it most depressed level for 20 years, risk appetite close to capitulation levels, percentage of stocks trading above their 10-week MA sub 20%, strong insider buying, and an improvement in economic surprises-which we have put into attachment), though the tactical signals were not as strong as on Jan 21st. Since 1973 bear market rallies have averaged 15% over 51 days (in the last bear market, we had three rallies of 20%). The market is up 9% now from its low, so arguably we have another 5% or so to go. Before the end of the bear market rally, we would normally see equity sentiment and risk appetite getting a little higher (the equity sentiment indicator and risk appetite rise on average by 0.5 std; so far they have risen by 0.2std and 0.3std respectively). We have included two additional technical charts of interest: (a) Analysis by our Private Bank chartist suggests that when gold is down 3% in a day and S&P is up 3% in a day, the market is up 19% over the next 260 days (based on the four occasions this has happened since the 1970s); (b) Similarly, on the four previous occasions when the S&P has risen 3% or more on 3 occasions in a month, that normally marks the end of the bear market (though one month returns are not so good!). Not all the news, however, is so good on the tactical signals: net short positions have been reduced sharply; earnings momentum and earnings dispersion are terrible; market breadth is poor, corporates have turned into net sellers and a liquidity premium is returning to the market (the improvement in credit spreads has been very marginal compared to CDS and critically the financing spreads such as LIBOR/OIS or mortgage repos have hardly narrowed). We think we can over-engineer some of these chart signals. Our view is, as we wrote on March 17th, the market is in a bottoming process, but it is not a V-shaped recovery. We expect the market to go moderately higher near-term and then to get close to its old low. Importantly, we believe the bottoming process will complete itself (probably in Q3) only when: (A) The ECB and MPC start to clearly target growth not inflation. The process through which this happens is probably via the Euro/US$ rising to 1.70. We believe that a new bull market requires more than just the Fed to target growth (the ECB and MPC are targeting inflation and the BoJ does not have a governor). (B) Direct Administration support for the banks along the lines of the Resolution Trust Corp. (C) Clear signs that both banks and consumers are de-leveraging. Current net asset growth on the US banks balance sheet is at a record high and despite very tight lending criteria loan growth is still very strong (slide 20). Both Greenspan and Rachael Lomax, the deputy Governor of the Bank of England, have called this financial crisis the worst since the Second World War (or in Rachael Lomax words- ' the worst peacetime liquidity crisis'). So surely banks and consumers have to de-leverage. (D) We have to rule out a US$120 oil price. If oil rise another 15%, we become deeply bearish. We think oil will fall back to $80 to $90pb, but oil remains a risk! As for fair value, bond yield to earnings ratios are closet to 50 year lows on IBES numbers but given where lead indicators and credit spreads are, the required equity risk premium is 4.8% (which is 1.4% above its average). On our earnings numbers (as opposed to IBES which is forecasting 16% EPS growth in 2008 and 12.8% p.a. from 2009-2013!), the actual equity risk premium is 4.5% and if we normalise the RoE, then the equity risk premium falls to 4.3%. Only if ISM recovers to 55 and credit spreads fall by another 20% would the required risk premium fall to warranted levels, we believe. On March 11th, we upgraded corporate bonds to overweight but since then the European itraxx index has fallen to 650bp to 520bp and at this level the imputed default rate has fallen to 27% over a 5 year period (versus previous recession peaks of 36%). So it is hard to see much more of a rally in CDS spreads. Bottom line: As we wrote on March 16th, this is the 'beginning of the end', the current market rally should last a bit longer but we would then expect equities to come close to testing their lows (we had a double bottom in Oct 2002 and March 2003) and probably in Q3 form a more sustainable base. Fair value is 1,350 S&P 500 and we think below 500, the European itraxx starts to no longer offer value. Do keep a careful eye on financing spreads and the liquidity premium (slide 19) which have so far failed to narrow in any meaningful way.