Alternatives to the USAAA, equities edition | FT Alphaville

Alternatives to the USAAA, equities edition

The search for the elusive US-AAA alternative continues.

As Nomura’s Charles St-Arnaud and Lefteris Farmakis already pointed out on Wednesday, there’s not really all that many options left.

Though Credit Suisse’s global equity strategy team seems to have one idea. Invest in companies which are currently perceived to be safer than sovereigns.

As they wrote on Wednesday:

Worries about the US public finances, will likely bring investors to focus on ultra-safe equities: companies with a CDS spreads [sic] below that of G7 sovereigns, yet offering dividend yields above government bond yields: Centrica, Sanofi, Novartis, Compass, Pfizer, Philip Morris, Merck. In general, we would be cautious of cyclicals: valuation and positioning leaves no room for error, especially in Europe (hence our small underweight – yet, we like luxury goods, cars and software).

Regardless of the outcome of the negotiations over the debt ceiling, we think investors should focus on ultra-safe corporates (those that offer a CDS spread below that of the average G7 sovereign in combination with a dividend yield above the average G7 government bond yield). To the extent that the debt ceiling negotiation in the US and the worries about peripheral Europe drive home the uncertain outlook for government finances, the strong financial position of these corporates will appear increasingly attractive.

In Europe that means:

And in the US that means:

While a US default is definitely not their central scenario (they see a rise in the ceiling by August 2), in the unthinkable event it does happen, here’s how they see the situation playing out:

If the US does default, there are massive ramifications. According to Credit Suisse chief economist Neal Soss, the repo market would probably cease to work. It is hard to imagine money market funds operating under this scenario. The inter-bank market would freeze up. The fallout would be far worse than after the Lehman’s default. Back then, the US government could at least spend and do the ‘right thing’, while now the only back-stop would be the Fed.

Into a default, the US would have to balance its primary balance and that alone would require fiscal tightening of 8% of GDP, on IMF data. If the US defaulted, then others could follow (Portugal, Ireland, Greece). There would be a very big decline in US GDP (5% is quite possible). Lastly, it would be horrible to think of what happens to the dollar if the Fed hint that they would offset the growth damage of default and subsequent fiscal tightening with QE 3.

Yup, not so nice.

Related links:
The AAA bubble
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Buy tinned food
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What AAA corporate yields tell us
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My junk bond is better than your sovereign bond
– FT Alphaville