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Zurich, 28 July 2010Global ResearchImportant disclosures are found in the Disclosure appendix
The recommendations outlined in this research report arebased on the outcome of the Investment Committee meetingof 20 July 2010.The next edition of the Research Weekly will be published onWednesday, 4 August 2010.
Positive earnings surprises support near-term outlook for equities
The Q2 2010 earnings reporting season started very well bothin the United States and in Europe. In the USA, out of thecompanies that reported until the end of last week, 78%reported a positive surprise in net earnings and – moreimportantly – 67% reported a positive surprise in revenues,indicating that the global macroeconomic recovery hastranslated into strong demand for goods and services and thusinto strong revenue growth. Most of the positive surprisescame from industrials and materials, while the surprise ratio atconsumer staples and energy was much lower, though it is tooearly to draw a complete picture for the entire earningsreporting season.
As macro concerns ebb, we take a more positiveregional stance on equities
Since May, markets have been dominated by the Eurozonecrisis. Numerous measures indicate that investors havebecome more relaxed about the Eurozone and we expect riskappetite to recover further. More importantly, with emergingmarkets in mind, there are growing signs that the Chineseauthorities will have some success in engineering a “softlanding,” and curbing some of the excesses in the Chineseproperty market for the time being. Among other recent positive factors – our sector scorecardindicators have recently become very stretched on thedownside, indicating potential for a rotation toward riskier,more economically sensitive equities. Indeed, in our lastResearch Weekly (21 July 2010), we took a more aggressivetilt towards cyclical sectors like materials and industrials andaway from defensive sectors.In this context, we make a number of changes to our regional asset allocation, upgrading emerging markets to
Research WeeklyAs macro concerns ebb, we take a more positive regionalstance for equities
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Highlights
 
Since May, markets have been dominatedby the Eurozone crisis. Numerousmeasures have made investors becomemore relaxed about the Eurozone and weexpect risk appetite to recover further. As aconsequence, we have upgraded emergingmarket equities to overweight whiledowngrading Japan and Canada.
 
We remain positive on credits that weexpect to benefit from the decline incorporate defaults. With regard toEuropean banks, we maintain our prudentinvestment strategy.
Top investment ideasEquity transaction ideas (1–6 months)BUY
MSCI Emerging Market.
page 3
 
Fixed income Trading Corner (1–6 months)
This week we are not adding any new trades to our Trading Corner portfolio.
page 4
 Fixed income Classic portfolio (6–12+ months)
This week we are not adding any new trades to our Classic portfolio. We have not transferred any bonds tothe buy-and-hold account either.
 
page 6
 
Investment summary
 
page 7
 Global equity sector strategy and focus list(6–12+ months)
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 Zurich, 28 July 2010ResearchWeekly
2overweight and downgrading Canada and Japan to neutral fromoverweight. While Canada has considerable exposure to thematerials sector, we now opt for higher beta (more risky)markets. Also, Canada's banks have been seen as relativelybetter quality than those in other developed countries, but wenow feel that, in the light of the EU bank stress tests, this is lessof a concern. One negative point against Canada is earningsmomentum, which has fallen sharply in recent months. Accordingly, we are downgrading Canada to neutral fromoverweight. Japan has typically performed well in the Recovery stageof our Cycle Clock business cycle analysis, though economicmomentum in Japan itself is not strong and we areincreasingly concerned about the potentially negative effects ofthe stronger yen and the lack of clarity on the political outlook.In fact, while Japan’s price-to-book ratios are at the bottomend of their historical range, the political stalemate after theUpper House elections is likely to remain an overhang to capits performance. We are downgrading Japan from overweightto neutral. At the same time, we upgrade emerging markets to amodest overweight on the back of improving sentiment and riskappetite globally, and in anticipation of Asia performing better inthe second half of this year than market consensus expects.
Recent strength of emerging market equities isreassuring
While sensitive to risk appetite, the case for emerging marketequities is supported by decent fundamentals (such aseconomic growth and balance-sheet strength, demographics,resource richness), as well as strong earnings growth,momentum and an attractive valuation (single digit P/E 2011of 9.8). Emerging market equities are further supported bystrong investor demand looking for growth at attractive prices.In fact, investor demand for emerging markets equities hasremained strong year-to-date: emerging market equities haveso far enjoyed inflows of USD 23 bn in 2010 in spite of theEurozone headwinds, while developed market equities haveexperienced outflows at similar levels (see Figure 1). Thisclearly underpins the ongoing re-allocation of investments toemerging markets, which offer growth as well as lowindebtedness. We believe that the re-allocation trend willcontinue further, thus supporting the already attractive long-term emerging market investment case. We recommendinvesting in the MSCI Emerging Market for one full position inour Research Weekly portfolio.
We maintain our prudent investment strategy withregard to European banks
Last week, the UK benchmark yield curve was lifted significantlyhigher as the Q2 GDP reading surprised on the upside,recording an increase of 1.1% QoQ. In the Eurozone,benchmark yields also moved higher although the bankingsector stress test results caused a fair amount of volatility aheadof the release late on Friday. Riskier assets recorded relativelystrong gains. Implied volatilities receded further, complementedby strong PMI and IFO surveys in Europe.Credits have recently performed well, with spreads in atightening trend. Early last week, Greece, Spain and Ireland allsuccessfully tapped bond markets with ECB government bondpurchases almost grinding to a total halt. Markets were further supported by the generally strong Q2 earnings from bothEuropean and US companies. A main focus area for investors has been the results of theEuropean bank stress test. Seven banks – five Spanish, oneGreek, and one German – failed the test. For all of these banks,restructuring plans and capital support measures are availableand ready to be implemented. While the stress test did notcontain any major surprises, the additional disclosure regardingindividual banks’ government bond holdings should be mildlypositive for market sentiment.On the negative side, the impact on the European bankingsystem of a sovereign default scenario – which is one of themarket’s main concerns – was not tested. There is therefore arisk that the financially weaker banks may still struggle to raisemarket funding and remain dependent on the ECB for their funding in the near future. On the positive side, all our favoredissuers successfully passed the test without problems. For moreinformation on the stress tests, please see our Credit Update“European bank stress tests: Smooth sailing” published on 26 July 2010.This week, the Basel Committee on Banking Supervisionalso issued a comment on the new proposed banking regulation.In general, it appears that several of the initial strict proposalshave been put on hold, modified or delayed. While a newtougher leverage target (Tier 1 capital of 3% of total unweightedassets) was proposed, this is only to be implemented by 2018.More detailed information on issues such as hybrid capital will bepresented later this year.In our fixed-income model portfolios, we remain underweightin government bonds. We also remain positive on credits that weexpect to benefit from the decline in corporate defaults. Withregard to European banks, we maintain our prudent investmentstrategy.This week, we do not present any new trade ideas.
Figure 1
Investors continue to relocate assets to emerging marketequities
-80-60-40-2002040608010001.0902.0904.0906.0908.0910.0912.0901.1003.1005.1007.10Flows to EM equitiesFlows to US equitiesUSD bnNet fund flows since January 2009
Source:
EPFR, Credit Suisse
 
 Zurich, 28 July 2010ResearchWeekly
3
Equity transaction ideas (1–6 months)
Invest in emerging markets
Investment Committee Valuations attractive, but investors still nervous and tactical indicators indecisive. Use dips toeliminate remaining underweights and achieve at least neutral weight.Research view Since May, markets have been dominated by the Eurozone crisis. Numerous measures have madeinvestors become more relaxed about the Eurozone and we expect risk appetite to recover further. As a consequence, we have upgraded emerging market equities to overweight while downgrading Japan and Canada.TransactionsBUYMSCI Emerging Markets for one full position in the Research Weekly Portfolio.Stop-Loss: –5.0%TechnicalsBeat Grunder Technical Analyst+41 44 333 53 58The MSCI Emerging Market index has completed a new medium-term cycle bottom and the index isheading towards the key trend line resistance from end-2007 (dotted line).Given the extended short-term upcycle in the daily chart, a brief consolidation should follow intoearly August. However, a breakthrough should then follow and the index should extend its upmoveinto early fall. The next medium-term key resistances are at 1045/50 and at 1125/30.
Figure 1
MSCI EMERGING MARKET INDEX (weekly chart)
2008 2009 2010-50000500050060070080090010001100120013001400
See key to charts after the Focus list
Figure 2
MSCI EMERGING MARKET (daily chart)
 
Apr May Jun Jul Aug-1000-500050085090095010001050
Source:
Metastock, Reuters
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