Developed Countries

Utilities appear to have successfully consolidated this year's sharp relative performance run up, as the share price ratio is firming anew after holding at its 40-week moving average. The incentive to maintain an overweight exposure to this fixed income proxy is heavily influenced by whether global deflationary forces have finally ebbed. While the U.S. dollar has softened in recent months, it has not caused an upsurge in inflation expectations nor has failed to cause a sell-off in Treasurys. U.S. yields are being pinned down by persistently low global bond yields, which reflect chronic deflationary pressures. As long as the total return of bonds is beating equities, then utilities relative performance momentum should stay positive (third panel). Without any valuation barriers to further outperformance, we continue to recommend an above-benchmark weighting. BLBG: S5UTIL.

Following up from yesterday's S&P banks update, as banks go so do financials, given that they comprise the highest weight in the sector. Worrisomely, financials relative EPS momentum has more downside. Using the latest Fed Senior Loan Officer survey data, we constructed a C&I loan supply/demand indicator (middle panel). The news is grim for financial sector profits. C&I loan volumes are decelerating and banks are tightening lending standards. C&I now represents the highest lending category exposure on bank balance sheets, warning of a magnified negative impact on profitability. As long as deflationary forces prevail, as proxied by persistent weakness in our global leading economic indicator (GLEI), then credit quality will continue to erode: it is no wonder that financials relative performance and the GLEI are highly correlated. Bottom Line: We reiterate our recent downgrade to underweight. BLBG: S5FINL.

We discuss the technical and political problems with helicopter money, plus the near-term outlook for the euro area economy and markets.

At this stage of the business cycle, the bull case for banks rests on the ability of accelerating loan growth to offset the beginnings of deteriorating credit quality. However, the latest Fed Senior Bank Loan Officer Survey has poured cold water on such an outcome. Banks are tightening lending standards on their main source of asset growth, namely C&I and commercial real estate loans. These are the main sources of excess leverage. Consequently, it is logical for banks to become more discerning when doling out related credit when credit quality is eroding (bottom panel). While mortgage and consumer lending demand remains decent, it is unlikely to be sufficient to offset higher charge-offs and a slowdown in business-linked loan creation. We reiterate our recent downgrade to underweight. The ticker symbols for the stocks in this index are: BLBG: S5BANKX - WFC, JPM, BAC, C, USB, PNC, BBT, STI, MTB, FITB, CFG, RF, KEY, HBAN, CMA, ZION, PBCT.

A spate of mergers in the medical equipment space has helped propel relative performance to new cyclical highs. In our latest update, we noted our expectation for another upleg, but some niggling concerns about the future revenue outlook caused us to put the group on downgrade alert. However, recent data are supportive of a continuation of the uptrend. The medical equipment shipments-to-inventory ratio is trending steadily higher. Importantly, investment in medical equipment has reaccelerated, as has new health care facility construction. That bodes well for future equipment demand, and should keep factories operating at optimal rates. Consequently, we recommend maintaining overweight positions for a while longer, especially since value is not problematic. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, SYK, BDX, BSX, BAX, ISRG, EW, STJ, ZBH, BCR, HOLX, VAR.

The powerful short covering bounce in the S&P steel index is starting to fizzle. The latest upleg had been driven by a surge in Chinese domestic steel prices. That, combined with news that the country plans to reduce steel capacity in the coming three to five years, was enough to send shorts scrambling for cover. However, it will take time for the global steel market to rebalance. In the short run, the jump in Chinese steel prices has already encouraged domestic producers to re-ramp steel production (second panel). Persistent sluggishness in indicators of China's domestic consumption mean that steel inventories are likely to build as production picks up anew, which will put upward pressure on exports to the rest of the world. Fading construction growth and tightening lending standards in many developed countries suggest that increased steel supply from China will have a negative impact on steel prices. We reiterate our recent downgrade back to underweight. The ticker symbols for the stocks in this index are: BLBG: S15STEL - NUE, STLD, RS, X, CMC, ATI, WOR, CRS, AKS, TMST, HAYN, SXC, ZEUS.

The factors that drove the recent rally - Fed dovishness, China reflation, and a pickup in economic data - are largely over. 

Corporate earnings rarely shrink outside of economic contractions, so investors can be forgiven for worrying that we are on the brink of a global recession. Earnings-per-share (EPS) for the MSCI all-country world index are estimated to have fallen by 7% in the year to March, the fourth quarter in a row of annual decline (top panel). This is by far the worst performance since the Great Recession. EPS growth in both the U.S. and the U.K. (local currency) is deep in negative territory. Profit growth is still positive, albeit decelerating, in the Eurozone and Japan in local currencies (bottom panel). How much more downside is there? When will EPS bottom and how strong will the recovery be? These are obviously key questions for the appropriate equity weighting within balanced portfolios, especially given that stocks are not cheap, downside global growth risks abound and the FOMC is biased to lift rates. It is difficult to justify being overweight equities without seeing some profit relief on the horizon. In yesterday's Special Report, we took a top-down approach to projecting EPS for the global index, the U.S., the Eurozone and Japan. The rebound in oil prices and some positive economic signs out of China have raised hopes that the profit recession is close to the end. Indeed, the good news is that world EPS annual growth should bottom in the third quarter. However, the bad news is that the climb back into positive growth territory will take time. Barring very strong (and unrealistic) growth assumptions for the rest of 2016, investors should not expect positive year-on-year global EPS growth until early in 2017. Bottom-up earnings estimates currently are too optimistic. On a regional basis, U.S. earnings growth will likely trail both Japan and the Eurozone over the next two years, although much depends on currency movements (see the next Insight).

Financial conditions will continue to ease during the next few months, and the Fed will use its June statement to prepare the markets for a rate hike in September.

Absolute valuations on Euro Area corporates are not cheap, but there are relative value opportunities to take advantage of the ECB becoming a major buyer of corporates. Favor Euro Area High-Yield over Euro Area Investment Grade, and favor Euro Area corporates over U.S. corporates.