Credit Suisse’s bear PLUS linked to S&P 500 show contrarian bet, but timing, cap are issues

By Emma Trincal

New York, Jan. 23 – Credit Suisse AG, London Branch’s 0% bear market Performance Leveraged Upside Securities due Jan. 31, 2019 linked inversely to the S&P 500 index offer a bearish trade to investors convinced the market will be down in two years.

But the term of the notes may be too long for this type of bet, one adviser said, while another criticized the risk-adjusted return profile of the notes, saying that it is unlikely to sufficiently compensate investors in the event of a bear market for the risk they are taking on the upside.

The payout at maturity will be par of $10.00 plus triple the absolute value of any index decline, up to a maximum payout of $12.70 per note, according to an FWP filing with the Securities and Exchange Commission.

Investors will lose 1% for each 1% index gain, with a minimum payout of zero.

Two years

“It’s a pure contrarian play, and it makes sense if you’re bearish over a two-year term,” said Carl Kunhardt, wealth adviser of Quest Capital Management.

“But I wouldn’t buy it. The idea of hedging is not bad, but the timing is off.”

Kunhardt explained that for him, two years is an intermediate duration. Being bearish over the short term would be justified in his view. But over the intermediate and long terms, he tends to be more bullish.

“Emotions drive the short term. Earnings are flat. The economy has not grown at all. Capital markets are overvalued. You can certainly imagine that there is a correction around the corner,” he said.

“I can see a correction happening soon, not a correction that’s going to last two years.”

He added that he has never seen a bear market that lasted two years.

The 2001-02 bear market came close to two years, he said, but lasted only 18 months. The longest bear markets with a 21-month length were the one in 1973-74 and the other in 1980-82. On average, bear markets only last 14 months.

“To buy this note, I would have to predict that in two years, the economy will be in a recession. I don’t see it that way. I would follow the advice of Warren Buffet: don’t bet against the U.S. economy. I believe the U.S. economy will be strong two years from now and as a result, capital markets will be strong too.”

Real cap

Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management, said he likes the concept of the notes. His objection is a limited potential return in the event of a severe bear market due to the cap, making the lack of protection “on the upside” all the more risky.

“We like the credit and we like the fact that it’s a short-term note,” he said.

“But it’s a pretty big gamble given that statistically the market is up seven out of 10 years.

“I wouldn’t want to bet that the market wouldn’t be up over a two-year period.”

Just like with a note providing long exposure to the market, investors in this product have to give up the dividend yield paid by the underlying index too. The S&P 500 yields 2%, which represents for investors in the notes a 4% return to forgo over the term.

“I don’t like giving up the additional 4%,” he said.

If one looks at the cap net of dividends, its “real” value is no longer 27% but 23%, he noted.

“The fact that the cap is really low given the three times leverage limits my performance significantly.

“If we have an ugly period, the market could be a lot lower than 23%.”

In 2007-09, the S&P 500 was down almost 60%; the 2000-02 bear market led to a nearly 50% decline, he noted.

Upside risk

The cap is too low to make the risk of losing money in an up market worthwhile, he said.

“You’re only moderately participating in the downside, and your gains are considerably limited by the cap. Meanwhile you get a fair amount of risk that the market would go up,” he said.

“It’s an interesting, creative note as it relates to this administration and how the market may react.

“I just don’t think you get enough return if there is a real bear market.”

The risk of the market finishing positive at maturity could end up being costly for investors.

“You’re making a very definite bet that the market is going to be down. But if you’re wrong, you have no protection.

“It’s a hedge, but there may be better ways to do it. You could buy puts for instance. These tend to be expensive, but your risk would be limited to the cost of the option itself.”

Credit Suisse Securities (USA) LLC is the agent with Morgan Stanley Wealth Management as a dealer.

The notes will price on Friday.

The Cusip number is 22549A273.

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