Sectors
In this <i>Special Report</i>, we revisit our list of signpost economic indicators introduced two years ago to identify if the U.S. and Euro Area were falling into a "Secular Stagnation".
Economic disappointment will become the key theme in the second half of the year, driving a return to non-cyclical market leadership and a recovery in the growth vs. value ratio.
The previous Insight showed that the S&P hotel index was in a sustained downtrend, with bearish technical and valuation indications for future relative performance trends. Fundamental forces also argue for caution. Consumer spending growth at hotels is cooling in absolute terms, and plunging compared with overall personal outlays (third panel), with more downside ahead based on the persistent rise in consumer's marginal propensity to save. With travel budgets under stress, hotels are unable to lift selling prices, and are losing pricing power ground in real terms, i.e. relative to overall inflation. Against a backdrop of booming lodging construction, the odds of additional price concessions are rising. We reiterate our underweight stance. The ticker symbols for the stocks in this index are: BLBG: S5HOTL - CCL, RCL, MAR, HOT, WYN.
Despite whiffs of optimism regarding U.S. consumption trends, S&P hotel index relative performance is in a bear market. The share price ratio is well below its 40-week moving average, which itself is drifting lower, and cyclical momentum is contracting, as measured by the 52-week rate of change. Both valuations and technical momentum remain well above previous bear market troughs, warning that downside risks remain acute, particularly if profit drivers continue to sag, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HOTL - CCL, RCL, MAR, HOT, WYN.
In March we recommended doubling down on our overweight S&P consumer finance index call, because company-specific factors had caused relative performance to undershoot the bulk of our macro indicators. Since then, the share price ratio has climbed, aided by the largest monthly gain in revolving consumer credit growth in well over a decade (second panel). However, the latest consumer confidence survey showed that consumer income expectations have receded, which may forewarn of a cooling in rapid debt growth. This bears close attention, as rising credit card receivables are a major profit lever. Still, consumers are in much better financial shape than the business sector, and banks remain willing to extend consumer credit, especially relative to corporate sector loans, underscoring that revolving credit growth should remain robust. Importantly, the narrowing Treasury yield curve is not having a negative impact on industry earnings, as the credit card interest rate spread is widening anew. Against a backdrop of attractive relative valuations, we continue to recommend an overweight position, as well as a long/short position vs. the S&P bank index. The ticker symbols for the stocks in this index are: BLBG: S5CFIN - AXP, COF, SYF, DFS, NAVI.
While the financial sector relief bounce is likely to peter out as the Fed threatens to tighten monetary conditions during a profit recession, the more defensive REIT sub-component should continue to outperform. REITs are still not overvalued, despite the relentless decline in yields on competing assets. While Fed rate hikes could be construed as an impediment if they lift the cost of capital, REITs have not typically run into trouble until policy has tightened by enough to cause a trifecta of headwinds: a cresting in commercial real estate prices, a peak in occupancy rates and by extension, a downturn in the CPI for rental inflation. Once these factors turn bearish, upward pressure on cap rates materializes. None of these concerns currently exist. Keep in mind that with QE and NIRP, there is still a massive search for yield in global financial markets. Roughly $9T of global bonds trade at a negative yield, a massive increase from only two years ago, which should sustain the secular advance in REITs. Moreover, REITs are slated to become a new GICS1 sector on August 31, a new classification that has the potential to augment investor interest. Adding it up, the security, safety and yield appeal of REITs should remain intact regardless of the Fed's near-term zigs and zags, unlike the overall financials sector. Stay overweight and see yesterday's Weekly Report for more details.
The Turkish central bank has almost exhausted its foreign exchange reserve. It has been printing money to keep interest rates lower, and sustain the credit boom in the economy. Such policies are unsustainable and the currency will plunge anew. Currency depreciation will push up market-based interest rates. Stay short/underweight Turkish risk assets. A new trade: Short 2-year local currency government bonds.
Investors have embraced renewed Fed hawkishness as a vote of economic confidence and confirmation of analysts' rosy earnings forecasts, but the bounce in financials looks unsustainable, outside of REITs. Hang on to gold shares.
Consumer goods stocks enjoyed a spirited run at the end of 2015 and into 2016, but have largely consolidated that outperformance this year. However, the S&P packaged food (PF) index has bucked the trend, recently setting a new all-time relative performance high. Despite our preference for defensive groups, we are surprised by the resilience of the PF industry, and wary of its sustainability. To be sure, a surge in net earnings revisions suggests that analysts were behind the curve. However, positive profit revisions are not necessarily a sign of operating vitality, as they appear to be entirely driven by cost reductions rather than top-line strength: packaged food sales growth is contracting. PF ROE has deteriorated on the back of revenue contraction, diverging negatively from the relative valuation expansion. Typically, a sustained multiple increase can only occur within the context of a rising ROE, given the latter's direct impact on profit growth. Relative valuations may reflect an M&A premium rather than superior operating performance. Both the value and volume of deals accelerated aggressively in 2015. But 2016 has seen a sharp drop in the value of announced deals, warning that valuations may get squeezed unless growth prospects improve. We are underweight this group. The ticker symbols for the stocks in this index are: BLBG: S5PACK - MDLZ, KHC, GIS, CAG, TSN, K, MJN, SJM, HSY, MKC, CPB, HRL.VAR.
The housing market remains a bright spot within the U.S. economy, which is not yet fully reflected in relative share performance. For instance, the NAHB survey has massively outperformed the ISM composite, signaling that relative profit conditions are more favorable for housing (top panel). The latest data showed that new home sales have surged, and that homes purchased but not yet under construction are at their highest level since 2007. Importantly, while banks are tightening standards on C&I loans, they remain willing to make mortgage loans, and consumers are increasingly willing to take on residential-related debt. This is bullish from a cyclical perspective, particularly since housing starts and household formation have considerable room to run before hitting a saturation point. Stay overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOME - DHI, LEN, PHM.