Developed Countries

Special Report

The end of the Debt Supercycle will be a key theme influencing economic and financial trends for many years to come. Its hallmark will remain the inability of central banks to engineer a new credit cycle, despite extremely low interest rates. China is one of the few remaining countries where the Debt Supercycle has yet to end, and history suggests the catalyst for a turning point will be a financial crisis.

The reflation rally continues. Despite our bearish outlook for the year, we think the risks of the current rally lie to the upside given China's redoubling of stimulus at the expense of reform. Populist troubles are picking up in Europe, but we maintain our positive structural view and note that the migration crisis is slackening. Rather, the greatest risks of populism continue to flourish in the Anglo-Saxon world with Brexit and Trump.

Special Report

The U.S. dollar has fallen to almost 5% below its 2016 peak. In this <i>Special Report</i> we explore the impact of a weaker dollar on key U.S. fixed income markets.

The bright side to higher food prices is that the S&P agricultural chemical index should finally be finished a brutal bear market. This group has been savaged by the collapse in agricultural commodity prices, worries about the return of Argentine supply and China's future import growth. The good news is that these headwinds are more than discounted. The share price ratio is close to a decade low, expectations are now extremely washed out, valuations are dirt cheap and the industry has retrenched, creating an attractive reward/risk profile. Importantly, the combination of U.S. dollar softness and two years of farming financial pain are sowing the seeds for a recovery in food prices. Global grain production contracted last year, after several years of strong growth, while shipments of pesticides and fertilizers are accelerating. Typically, food prices recover after production falls, particularly if the U.S. dollar declines. A weaker U.S. dollar boosts purchasing power in the rest of the world, which bodes well for increased food consumption, and it reduces the ability of global food exporters to flood the market and keep prices depressed. Higher food prices would stop the erosion in farming real estate values after a difficult few years, a necessary step to improving capital availability. Already, cash rents are off their lows, a positive sign for underlying property valuations. In sum, current agricultural conditions are depressed, but we can envision a slow but steady improvement as food prices climb on the back of a weaker U.S. dollar and supply restraint, which would support narrower risk premiums in related equities. Boost the S&P agricultural chemicals to overweight from underweight, locking in a 34% profit on this call, and please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5FERT - MON, MOS, CF, FMC.

Last autumn we recommended using weakness in the S&P containers & packaging index to augment positions to overweight, on the basis that that global disinflation would optimize profitability at a time when excess bearishness existed. After all, the decline in global export prices would spur an increase in the volume of globally traded goods, and packaging companies benefit from the number of goods sold rather than their value. Packaging firms primarily serve the food and beverage industry. The volume of food and beverages sold is inversely correlated with prices paid. Declining food prices lead to increased spending, and vice versa. The weak U.S. dollar is helping to boost raw food prices (shown inverted, second panel), which could put a damper on the recovery in packaging demand. The contraction in intermodal rail car shipments, mostly consumer goods, is also disconcerting, and warns that non-food packaging demand is also under pressure. Thus, even though valuations are reasonably attractive, our bias is to take profits and downshift to neutral, redeploying the proceeds into a group that benefits from higher food prices. Please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5CONP - IP, WRK, BLL, SEE, AVY, OI.

Special Report

To cheaply hedge against a "Leave" vote, go long U.K. inflation protection, reduce exposure to U.K. corporate debt, and position for a steepening of the Gilt curve.

We continue to view the rally in equities and high-yield corporate bonds since February as a high-risk affair.

U.S. dollar softness has failed to lift equities of late, a tentative warning that correlations are changing as the U.S. economy cools.

While we recently downgraded financials and banks to underweight, this bearish view does not extend to each of the sector's components. REITs are a positive exception. The group is still not overvalued, despite the relentless decline in yields on competing assets. This may reflect an undercurrent of skepticism regarding the sustainability of cash flow growth and low cap rates. However, both appear sustainable. The CPI for homeowner's equivalent rent, a proxy for REIT pricing power that has a good correlation with relative performance, is still accelerating even though it is already well above the overall rate of inflation. Moreover, commercial property price inflation continues to climb. 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 cresting in commercial real estate prices, a peak in occupancy rates and by extension, a downturn in the CPI for rental inflation. None of these concerns currently exist. Consequently, we recommend maintaining an overweight position. BLBG: S5REITS

The trading action of gold is currently sending a bearish message on the dollar as the price of the precious metal has broken above critical resistance. Though the causation between the dollar and gold usually runs from the former to the latter, gold also has a tendency to sniff out broad-based moves in the greenback. We remain broadly short USD in our portfolio.