Developed Countries

While the financial sector relief bounce is likely to peter out as the Fed threatens to tighten monetary conditions during a profit recession, the more defensive REIT sub-component should continue to outperform. REITs are still not overvalued, despite the relentless decline in yields on competing assets. While Fed rate hikes could be construed as an impediment if they lift the cost of capital, REITs have not typically run into trouble until policy has tightened by enough to cause a trifecta of headwinds: a cresting in commercial real estate prices, a peak in occupancy rates and by extension, a downturn in the CPI for rental inflation. Once these factors turn bearish, upward pressure on cap rates materializes. None of these concerns currently exist. Keep in mind that with QE and NIRP, there is still a massive search for yield in global financial markets. Roughly $9T of global bonds trade at a negative yield, a massive increase from only two years ago, which should sustain the secular advance in REITs. Moreover, REITs are slated to become a new GICS1 sector on August 31, a new classification that has the potential to augment investor interest. Adding it up, the security, safety and yield appeal of REITs should remain intact regardless of the Fed's near-term zigs and zags, unlike the overall financials sector. Stay overweight and see yesterday's Weekly Report for more details.

A Fed rate hike in June, July or September is likely to send our 12-month fed funds discounter toward 70bps by the date of the next hike. This re-rating of rate expectations will cause significant flattening at the long-end of the curve. Investors should enter a 5/30 flattener to profit.

There is a risk that global bond yields move higher in the near term, although we prefer to position for that move <i>via</i> cross-market spread, yield curve and inflation trades.

Markets will remain stuck in a trading range, driven by two policy feedback loops: the Fed's and China's.

Both hawks and doves at the Federal Reserve, including Chair Yellen, have stepped up efforts to condition financial markets for a rate hike as early as June.

Special Report

Long-term fundamentals are often poor predictors of the outlook for currencies over the subsequent 12 months. For shorter time horizons, investors should focus on the medium- and short-term currency determinates introduced in this <i>Special Report</i>.

The BoC will continue to watch from the sidelines. Our short-term model shows that the Canadian dollar is modestly cheap after having reached technically overbought levels earlier this month.

Special Report

While it is impossible to time the stock market, even a system whose results are slightly better than a coin-flip can still generate significant <i>alpha</i>. Overweight equities when valuations are favorable, growth is advancing, and financial conditions are easing. Stocks tend to do best when sentiment is bearish but improving, and the market has started trending higher without yet going parabolic. The outlook for U.S. stocks is rather mixed; Europe, Japan and China should outperform (currency-hedged).

For the month of May, the model underperformed both global equities and the S&P 500. For the month of June, the model is further paring back its risk exposure.

Consumer goods stocks enjoyed a spirited run at the end of 2015 and into 2016, but have largely consolidated that outperformance this year. However, the S&P packaged food (PF) index has bucked the trend, recently setting a new all-time relative performance high. Despite our preference for defensive groups, we are surprised by the resilience of the PF industry, and wary of its sustainability. To be sure, a surge in net earnings revisions suggests that analysts were behind the curve. However, positive profit revisions are not necessarily a sign of operating vitality, as they appear to be entirely driven by cost reductions rather than top-line strength: packaged food sales growth is contracting. PF ROE has deteriorated on the back of revenue contraction, diverging negatively from the relative valuation expansion. Typically, a sustained multiple increase can only occur within the context of a rising ROE, given the latter's direct impact on profit growth. Relative valuations may reflect an M&A premium rather than superior operating performance. Both the value and volume of deals accelerated aggressively in 2015. But 2016 has seen a sharp drop in the value of announced deals, warning that valuations may get squeezed unless growth prospects improve. We are underweight this group. The ticker symbols for the stocks in this index are: BLBG: S5PACK - MDLZ, KHC, GIS, CAG, TSN, K, MJN, SJM, HSY, MKC, CPB, HRL.VAR.