Developed Countries

The excitement surrounding steel stocks earlier this year on the back of the liquidity-driven bounce in commodity prices, whiffs of stabilization in Chinese economic growth and new steel import duties is diminishing. We used the rally to reduce positions back to underweight several months ago, as valuations overshot on the back of short covering. We remain concerned that relative performance downside risks have not abated after failing at a key trend line. New orders for steel products continue to contract, signaling that underlying steel commodity prices are at risk of sinking anew. Importantly, new vehicle sales have leveled off, and total construction spending growth has downshifted to almost nil. The implication is that steel demand is likely to stay sluggish in the coming quarters. To make matters worse, China appears likely to ramp up export activity, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S15STEL-NUE, STLD, RS, X, WOR, ATI, CMC, CRS, AKS, HAYN, SXC, TMST, ZEUS.

A Fed rate hike by December could erode the slowly evolving fundamentals favoring base metals.

Special Report

Investors are being forced into riskier asset classes by the TINA effect, but the gaping macro disequilibria makes it difficult for investors to see how we move back to equilibrium in a benign way. Monetary policy on its own is limited in its ability to soften the adjustment, but the good news is that the political pendulum is swinging toward fiscal stimulus.

Investors are being forced into riskier asset classes by the TINA effect, but the gaping macro disequilibria makes it difficult for investors to see how we move back to equilibrium in a benign way. Monetary policy on its own is limited in its ability to soften the adjustment, but the good news is that the political pendulum is swinging toward fiscal stimulus.

Special Report

Mental Accounting Bias creates an irrational attraction to yield, while The Halo Effect incentivizes companies to generate yield. Neither phenomenon is sustainable. We identify three sectors to avoid, and two to own.

The path of least resistance for the small/large cap ratio is higher. As outlined in our August 15 Weekly Report, small cap profit margins have already been crunched, while large cap margins are only just beginning to get squeezed. Wage trends between small and large companies argue for a closing of this gap, providing a catalyst for a re-rating. External factors are also supportive. Risky assets have surged around the world since expectations for additional Fed rate hikes were deferred and central banks in the rest of the world have opened the liquidity taps even wider. The small/large cap ratio typically follows the trend in our Risk Asset Composite, a mix of high beta currencies, commodities and equity markets, with a lag, and the current message is that there is catch up room ahead. We reiterate our recent shift to a small vs. large cap bias.

The budding recovery in the S&P biotech index is likely to gather steam. Big pharma is desperate to replenish its drug pipeline, putting biotech equities back into play following a drawn out de-rating phase. This phenomenon is not limited to U.S. pharmaceutical companies, as European and Japanese firms are also racing to scoop up promising biotech assets. As a result, deal premia for coveted U.S. biotech companies have skyrocketed, hitting all-time highs (middle panel). Both the relative forward P/E and P/E/G ratios are sufficiently depressed to expect a wholesale re-rating as a low cost of capital and receptive markets embolden pharmaceutical companies to buy future growth (third panel). Bottom Line: We reiterate our recent boost to an overweight stance in the S&P biotech index. The ticker symbols for the stocks in this index are: BLBG: S5BIOTX - VRTX, CELG, GILD, AMGN, REGN, BIIB, ALXN, ABBV, BXLT.

REITs have been climbing a wall of worry in recent years, as the group has had to overcome chronic concerns about potential supply growth and low cap rates. To be sure, the group typically experiences a boom/bust cycle. However, outside multifamily dwellings, REIT supply growth has been subdued globally: our proxy for global construction growth has been remarkably subdued since the Great Recession. Low cap rates have been an issue for years, but the proliferation of negative interest rates around the world and persistently high economic uncertainty argues against expecting a sudden reversal. Instead, low interest rates are spurring strong commercial real estate demand (bottom panel), which has propelled commercial property prices to new highs. In the absence of a sudden and unanticipated surge in overall inflation, the forces that have supported the REIT bull market should remain intact. Stay overweight and please see yesterday's Special Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5REITS-SPG, AMT, PSA, CCI, PLD, HCN, EQIX, VTR, AVB, EQR, WY, BXP, HCP, VNO, O, GGP, DLR, ESS, HST, KIM, SLG, FRT, MAC, EXR, VDR, IRM, AIV.

Special Report

Fed rhetoric is likely to shift in a somewhat more hawkish direction over the coming months as the FOMC starts to prep the market for a December rate hike. Against the backdrop of weak earnings growth and diminished share buyback activity, stocks have become vulnerable to a correction.

We put the odds of a Fed rate hike this year at slightly better than 50/50. But in the event of a rate hike, any sell-off in risk assets will be relatively short-lived and not as severe as the sell-off that followed the initial rate increase last December.