Sectors

The S&P electrical equipment & components (EEC) group has comparatively less resource exposure than many other industrial sub-industries. The EEC index is comprised of mature, diversified manufacturing businesses with exposure across a broad range of end markets. This provides stability in periods of macro volatility, but limits upside potential during the initial phase of an economic expansion. The group was savaged by the relentless advance in the U.S. dollar, creating deeply oversold and undervalued conditions. To be sure, electrical equipment sales have been pressured by the global manufacturing recession. However, new orders have stabilized. Shipments are far outstripping inventories, which are contracting, and unfilled orders have held steady. Importantly, our EEC productivity proxy has been very strong throughout the general manufacturing malaise. Productivity gains will help offset the loss of competitiveness from the strong U.S. dollar, and also suggests that earnings expectations are far too bearish. If the U.S. dollar begins to soften as a consequence of U.S. economic disappointment, than a valuation normalization is probable. Upgrade to overweight. This pulls up our overall industrial sector weighting to neutral. The ticker symbols for the stocks in this index are: EMR, ETN, ROC, AME.

We recommended buying into rail weakness in November, on the view that a poor earnings outlook was already discounted and that shipment and pricing power trends would improve as 2016 progressed, allowing cost cutting efforts to shine through. However, this call was too early. Despite attractive valuations and the contrary allure of moving to overweight in the midst of recessionary conditions, the anticipated recovery in freight volumes may be more distant than we had envisioned. Domestic economic disappointment is a rising threat, owing to tightening financial conditions, exacerbated by the stubbornly hawkish Fed. Intermodal rail shipments, which account for nearly half of total freight growth, are not growing. Meanwhile, coal shipments are still a major drag. Warm North American winter weather and a manufacturing recession are keeping a lid on electricity production, which will delay any rundown in utility coal inventories. Consequently, a restocking phase, and recovery in coal shipment volumes, is not imminent. Consequently, we recommend paring back to neutral, recording a 5% loss, and shifting into another industrials group, as discussed in the next Insight. The ticker symbols for the stocks in this index are: UNP, CSX, NSC, KSU.

The defensive qualities of the S&P data processing index have served investors well in recent years, particularly given its hedge against deflation pressures (top panel). However, the index is now priced for perfection and our Indicators suggest that peak performance is in the rearview mirror. Industry sales are linked to transaction volumes. Real consumer spending growth is slipping, despite rising wage inflation, reflecting an increase in the personal savings rate. Access to credit is deteriorating, on the margin, and consumers demonstrate little appetite to re-lever. The slide in revenue is hitting profit margins, as both capital spending and SG&A expenses are accelerating as a share of turnover. Meanwhile, the ISM services index is starting to play catch up with the decline in the ISM manufacturing index. A closing of this gap has previously warned that investor appetite for the services-based data processing group may diminish, at least for a few months. As a result, we recommend taking profits of 23% and downshifting to neutral. The ticker symbols for the stocks in this index are: ADP, ADS, CSC, FIS, FISV, MA, PAYX, TSS, V, WU, XRX.

Value in the U.S. Treasury market is rapidly deteriorating, and the 10-year Treasury yield is now consistent with our fair value projections. Investors should shift from an above-benchmark to a benchmark duration stance.

Reduce portfolio duration to neutral, while also cutting exposure to European bonds (both in the core and Periphery) and Canadian government bonds.

U.S. dollar softness may be sparking a subtle shift in sub-surface dynamics, to the benefit of select deep cyclical industries. Switch from rails into electrical equipment, and take profits in data processing.

Somewhat like 1998, the dilemma for the Fed is that the labor market is approaching full employment and may justify eventual interest rate hikes.

Media stocks are undergoing a de-rating, led by the heavyweight S&P movies & entertainment index. Sales prospects have been undercut by shifting viewing habits, which is creating uncertainty surrounding the value of network assets. The ISM services index warns that recreation spending will continue to retreat, which also has implications for ad revenue. Our Advertising Indicator is already deep in negative territory, consistent with the overall profit contraction and our expectation that the corporate sector will retrench. Meanwhile, programming costs remain high, adding to profit margin stress emanating from weakening top-line performance. This toxic mix should ensure that all of the shareholder friendly activities that have supported valuation expansion since 2009 will dissipate, to the detriment of premium multiples. We have a high-conviction underweight on the overall media sector, including the S&P movie & entertainment index. The ticker symbols for the stocks in this index are: DIS, CMCSA, TWX, TWC, FOXA, CBS, OMC, VIAB, IPG, NWSA, DISCK, TGNA, CVC, SNI, DISCA, FOX, NWS.

Plunging commodities have been driven by increased supply and falling investor demand, not a major downshift in physical demand. Stay neutral global equities. The earnings outlook remains uninspiring, but bottoming oil prices and continued monetary stimulus support valuations. The selloff in global bank shares reflects NIRP-related "income statement worries", not "balance sheet concerns" linked to deteriorating credit quality. Downgrade Treasury notes to neutral. The rally in bonds has brought 10-year yields near our long-standing, out-of-consensus target of 1.5%. 

Homebuilders have been caught up in broad consumer discretionary sector weakness, but we expect differentiation to soon materialize. Housing starts are picking up steam (bottom panel) and are still trailing household formation, underscoring that structural demand for housing will remain solid. The NAHB's survey is well above the 50 boom/bust line (middle panel). Resilient housing activity is a testament to robust housing affordability. The 30-year fixed mortgage rate is near generational-low levels, and is being suppressed by the global government bond bull market and the proliferation of negative interest rate policy (NIRP) around the world. This underscores that house prices have not overshot. Importantly, the latest JOLTS survey of job openings points to a firming construction labor market. The top panel of the chart shows that job openings in the construction industry are an excellent leading indicator of homebuilding relative performance, and the current message is positive. Bottom Line: Stay overweight. The ticker symbols for the stocks in this index are: DHI, LEN, PHM.