Equities

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.

Our primary argument for continued EM/China growth disappointments is that their credit growth is set to decelerate further and credit impulses will remain negative, depressing economic growth. Rising LIBOR could lead to a stronger U.S. dollar versus EM currencies. In Venezuela, the economic and financial situation will continue deteriorating hindering any further rally in its sovereign and corporate credit.

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.

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.

Special Report

Commercial real estate and REITs have benefited greatly from accommodative monetary policy. Though they are approaching a peak, our analysis shows that they remain in a "goldilocks" scenario and still offer plenty of upside.

The lack of inflation makes a Fed rate hike before December unlikely. In the interim, the continued flow of liquidity could sustain the high-risk rally.

Special Report

The populist backlash, if left unchecked, could spiral out of control, leading to severe losses for investors. Concerns about lax financial regulation, rising inequality, unfettered globalization, and fiscal austerity are understandable. Addressing these grievances will hurt corporate profits short-term, but could lead to a more resilient economy longer-term. Investors should position for modestly higher inflation and steepening yield curves. Near-term, equities are technically overbought, but will benefit from the shift to more stimulative fiscal and monetary policies.

Special Report

Brazilian risk assets have rallied on the back of investor optimism about the impeachment of President Dilma Rousseff. But the political games have just begun. With all politicians looking to the October municipal elections and 2018 general elections, the Michel Temer administration is unlikely to impose fiscal and structural reforms. Debt dynamics are set to worsen, and we continue to short Brazilian equities.

The global search for yield, not an improvement in EM fundamentals, has been driving the EM rally. EM/China growth conditions have stabilized but not recovered. Barring a full-fledged cyclical profit upsurge in EM EPS, EM stocks are not cheap at all. EM/China final demand for commodities will disappoint and will likely produce a major reversal in EM risk assets.