Sectors
Unlike rails, the S&P industrial machinery index has tested prior relative performance highs even though the global manufacturing sector is still laboring under excess capacity in Asia and weak commodity prices. Relative share price performance has already diverged wildly from oil prices, a rare occurrence, and a re-convergence is probable if profits fall short. While companies have cut inventories and staff to address productivity slippage, there is little top-line relief ahead. U.S. machinery new orders continue to contract and there is no help forthcoming from abroad. Non-U.S. developed economies are struggling. Capital spending is in retreat, based on the contraction in capital goods orders and capital goods imports. Our proxy for global machinery orders, excluding the U.S., is contracting. Consequently, there is little scope for a recovery in machinery output, which is necessary to lift utilization rates and allow the industry to sustainably escape deflation. We put this group on our high-conviction underweight list on Monday. The ticker symbols for the stocks in this index are: BLBG: S5INDM - ITW, SWK, IR, PH, PNR, DOV, SNA, XYL, FLS.
Investors looking for a lower risk vehicle to participate in broad equity market strength than from chasing momentum driven areas with dubious fundamentals need look no further than the S&P rail index. Expectations have been crushed and valuations are on the cheap side of neutral. While rail freight is currently in a funk, leading indicators have perked up, particularly for the largest category, intermodal. The latter largely reflects the transportation of consumer goods. Thus, the surge in personal bank loans, strength in trucking tonnage and port traffic all bode well for a recovery in freight in the coming quarters. Against a backdrop of steep cost cutting, any stabilization in top-line performance should have an immediate positive impact on the bottom line. We upgraded to overweight in Monday's Weekly Report. The ticker symbols for the stocks in this index are: BLBG: S5RAIL: CSX, KSU, NSC, UNP.
The Chinese manufacturing sector has remained under downward pressure, but the stress level has alleviated compared to a few months ago. The Chinese labor market will likely continue to deteriorate, which will force policymakers to stay accommodative. Despite the recent rally, Chinese investable stocks remain exceptionally cheap.
The odds of an inflation "mini-scare" are rising, although deflationary tail risks from abroad cannot be dismissed.
It is dangerous to equate recent equity strength with economic vitality, as history shows that liquidity-fueled equity advances favor non-cyclicals over deep cyclicals. Take profits in gold, buy rails and sell industrial machinery.
The S&P restaurants index continues to deflate in relative performance terms and downside risks remain intact. The top panel of the chart shows that the Restaurant Performance Index (RPI, courtesy of the National Restaurant Association) has taken a turn for the worse. Historically, momentum in the RPI has been an excellent leading indicator of relative share prices. The RPI is picking up the downtrend in top-line performance, as measured by restaurant retail sales. The latter warn that relative forward earnings momentum is headed lower. To make matters worse, slow traffic is limiting pricing power gains, which are lagging badly behind a soaring wage bill (fourth panel). Bottom Line: While we have recently boosted the S&P consumer discretionary index to overweight, stick with a below benchmark allocation in the S&P restaurants sub-index. The ticker symbols for the stocks in this index are: BLBG: S5REST - MCD, SBUX, YUM, CMG, DRI.
A collection of 10 important charts to monitor closely through the summer months.
Chinese banks have been writing off impaired loans, and the pace has quickened sharply in recent years. This has been largely ignored by investors. Under a rather extreme scenario, Chinese commercial banks' NPL ratio could reach 14%, which could lead to a 30% hit to banks' net equity base. Chinese banks H shares have already priced in this scenario.
With the broad market breaking out to new highs courtesy of flush liquidity conditions and rising risk appetite, the momentum-driven biotech group stands an excellent change of reclaiming previous relative performance highs. We upgraded the S&P biotech index to overweight a month ago because value had been fully restored and underlying fundamentals remained solid. For instance, demand-driven pharmaceutical pricing power gains remain intact, which is driving productivity improvement. Increased profit potential should attract renewed capital inflows and translate into higher share prices, especially now that the supply of biotech stocks is ebbing fast: biotech IPOs have cratered. Importantly, drug industry M&A activity remains robust, suggesting that the S&P biotech index has the potential for a re-rating. We reiterate our recent upgrade to overweight. The ticker symbols for the stocks in this index are: BLBG: S5BIOT- AMGN, GILD, ABBV, CELG, BIIB, REGN, ALXN, VRTX.
In order to make room for this week's upgrade of the consumer discretionary sector, we have downgraded the utilities sector to neutral after a strong run. Overweight positions in this sector were predicated largely on external forces rather than sector-specific factors, largely that the overwhelmingly deflationary global backdrop would turbo-charge the search for yield, culminating in a re-rating in equity fixed income proxies such as utilities. Worries about a slide into recession have ebbed, because domestic consumer spending has stayed resilient, job growth has bounced back after a difficult few months, and the U.S. manufacturing sector is showing signs of life. Even the global economic surprise index has climbed into positive territory, driven mostly by an uptick in the U.S. Consequently, utility stocks may have difficulty generating additional outperformance, especially within the context of the broad market overshoot. We recommended taking profits of 17% and trimming to neutral in Monday's Weekly Report. BLBG: S5UTIL.