Developed Countries
Among the myriad of troubling signs for the global economy, some developments on the inventory and deflationary fronts could point to a brighter future. While still not our base case, those factors need to be monitored. With Brexit over and done with, we are reshuffling our GBP portfolio. Remain bullish EUR/USD. Go short CAD/NOK.
The health care sector is slowly reclaiming ground lost on the back of the dip in the U.S. dollar and temporary rebound in inflation expectations (second panel). We expect this rebound to gather pace. Now that both the currency and inflation expectations are headed in a direction that suggests disinflation/deflation have not been overwhelmed by policy efforts and/or stronger global final demand, flows into the non-cyclical health care sector are likely to resume. Technically, the sector is improving. Participation is broadening following last year's wholesale flight out, as the number of groups trading above their 40-week moving average has climbed decisively above 50%. Our sector advance/decline (A/D) line, shown compared with our overall S&P 500 A/D line, is flirting with new cyclical highs. Strong breadth is essential to revitalizing the bull phase. Importantly, our Technical Indicator is rebounding, but remains in deeply oversold territory, underscoring that there is plenty of room for momentum to accelerate. Stick with a high conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5HLTH.
Transportation stocks are weak, reflecting profit warnings in both the trucking and rail industries. Air freight equities have been slightly more resilient, but the outlook for profits remains bearish. Global revenue ton miles are contracting, with weakness spread across all the major regions. High inventory-to-sales ratios in both developed and developing markets warn that demand for rapid delivery services will stay soft. The implication is that deflationary pricing power will persist, just as fuel costs have climbed anew. To make matters worse, FedEx stated that it was raising its capital spending outlook to better compete, continuing a trend of rising investment and growing capacity. Consequently, it will take a major resurgence in top-line growth to reverse deflationary tendencies and pressure on operating margins. Despite increasingly low valuations, we recommend staying underweight. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD.
Global oil demand will continue to surprise to the upside over the balance of the year - growing at a rate of 1.6 MMb/d - following an unexpected surge over the first five months of 2016.
There are not two possibilities in today's vote, but four: Clear Remain; Narrow Remain; Narrow Leave; Clear Leave. We discuss the distinct repercussions from each.
The previous Insight showed that mortgage demand was rising steadily, courtesy of the decline in mortgage rates and willingness of banks to extend mortgage credit. We expect this to translate into steady sales increases for the homebuilding industry. New home sales are gaining as a share of total home sales, flirting with their highest level in the post-crisis era. Importantly, the supply of new homes is now falling relative to total supply, underscoring that meeting this new demand will require faster new home construction. Single family housing starts are rising relative to total starts, a significant change since the financial crisis ended when multifamily dwellings dominated construction activity, as commercial/financial developers were the only ones with easy access to financing. The upshot is that good value in the S&P homebuilding index should be realized. Stay overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOME - DHI, LEN, PHM.
The decline in global bond yields and negative interest rates abroad represents a windfall for U.S. housing, to the extent that U.S. mortgage rates are lower than they otherwise would be. The latest plunge in yields is translating into a clear acceleration in mortgage demand, as proxied by the advance in mortgage purchase applications. That is a leading indicator for home sales, the lifeblood of the homebuilding industry. Importantly, the financial incentive to buy a home is high and rising, given the attractiveness of owning vs. renting, and the growing gap between house price inflation and mortgage rates. It is no wonder that the latest National Homebuilder's Survey recorded a sharp jump in sales expectations, heralding faster top-line growth ahead. That should be sustainable, as discussed in the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HOME - DHI, LEN, PHM.
The secular stagnation narrative is gaining traction amongst the FOMC. Expect further downward revisions to longer run FOMC interest rates forecasts, toward levels already discounted in the Treasury curve.
The financials sector led the recent pullback in the broad market. Rather than view this as a buying opportunity, it is symptomatic of the relentless plunge in global bond yields and an increasing scarcity of financial sector pricing power. For instance, the asset management & custody bank (AMCB) index will struggle to overcome profit margin pressure. Punitively low running yields represent a major challenge for the AMCB industry. Anything that can be capitalized has been re-rated. High valuations mean that prospective long-term equity returns are slim. Against this backdrop, management expense ratios look high in both the equity and bond universes. Fees have already been under structural pressure due to the shift into passive equity products (bottom panel), and outperformance of bonds, which garner even lower margins than equity products. Index funds generate much lower fees than actively managed pools of capital. If bonds continue to outperform stocks as global economic sentiment sours, then performance chasing investors are likely to continue putting more capital into lower margin bond products relative to equity funds. In other words, as the equity risk premium climbs, AMCB profit potential will decline. Stay underweight.
For the broad market, capital appreciation potential will be levered to profit trends rather than liquidity/multiple expansion at the current stage of the cycle. The fuel to drive up global aggregate demand remains absent. According to BIS data, global credit growth is contracting. That is significant, because credit greases the wheels of the global economy. The message is that it is too soon to expect profit relief from overseas. Corporate profit margins are already narrowing, but bottom up forecasts discount an aggressive move out to new highs in the coming quarters (middle panel). The growth backdrop is not conducive to such a development. The yield curve, which is an excellent business cycle indicator and a leading signal for profit margins, continues to narrow relentlessly. Fewer than 50% of the non-financial and non-utility industry groups are currently expanding profit margins. Yet 8 out of 10 sectors are expected to grow margins, according to analyst earnings estimates. Specifically, cyclical sectors such as industrials, materials, energy and technology are slated to show broad-based improvement in profitability. That would not be farfetched if the world were on the cusp of a V-shaped, post-recession type of acceleration and the U.S. dollar were set to weaken significantly. However, deleveraging and the global credit contraction warn that global growth is not about to rebound. As such, we remain skeptical that the macro backdrop will validate upbeat analyst forecasts, rendering deep cyclical sectors vulnerable to underperformance.