Equities

The near-term (next month or two) market dynamics in EM risk assets remain a coin toss. Beyond that the outlook for EM risk assets remains downbeat. EM financial markets are complacent and there are many potential negative EM/China developments that could derail the current EM rally. A new trade: go long the KOSPI / short EM overall equity index.

Earlier this month we made a full shift from underweight to overweight in the S&P cable & satellite index, a sub-component of the broader media sector, in response to receding risk that cord cutting and skinnier cable packages would threaten profits. Given that the outlook for the heavyweight S&P movies & entertainment index has improved, it no longer pays to be underweight. This group has underperformed the broad market since early January, savaged by uncertainty about the outlook for key cable networks, particularly ESPN. However, if our cable read is accurate, then material and widespread deterioration in the value of high-quality specialty channels and networks is unlikely. In fact, one of the drivers of higher media spending has been recreational outlays. That improvement may reflect a delayed response to the windfall from lower fuel bills (second panel). Importantly, attendance at theme parks, movie theaters and other attractions has been sufficiently strong to generate increased ticket prices (third panel). That will buffer any advertising slippage from TV to digital. At the same time, wage inflation is non-existent. Against this backdrop, there is less risk of sustained profit margin pressure in the movies & entertainment index. Underperformance has returned valuations to an attractive level, with the relative forward P/E well below the broad market and not far above the Great Recession low (bottom panel). This warrants a lift in our underweight stance. Bottom Line: Lift the S&P movies & entertainment index to neutral, and take the S&P media group off the high-conviction underweight list. For additional details please see yesterday's Weekly publication. The ticker symbols for the stocks in this index are: BLBG: S5MOVI - DIS, TWX, FOXA, VIAB, FOX.

We turned more cautious on banks in January, but in hindsight, could have become outright bearish. Banks are headed for a triple whammy of profit trouble. Loan growth is set to cool, the credit cycle has shifted from tailwind to headwind and the yield curve continues to flatten. Moreover, following several years of downsizing, banks are no longer shedding labor. In fact, banks are adding staff, according to BLS data (middle panel). The timing of hiring is questionable, given that our measure of productivity growth, bank loans/bank employment, is now decelerating (bottom panel). That will undermine profitability, particularly against a backdrop of net interest margin compression. Expectations in the swap curve are for an ongoing yield curve flattening (top panel). It will be very difficult for long-term Treasury yields to rise sustainably as long as other global government bond yields are melting, because the divergence will cause outsized U.S. dollar appreciation which transmits deflationary pressure into the U.S. The implication is ongoing net interest margin compression. Bottom Line: Downgrade the S&P banks index to underweight. This also moves our overall financials exposure to below benchmark. For additional details please see yesterday's Weekly publication. The ticker symbols for the stocks in this index are: BLBG: S5BANK - BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION.

Like the economy, banks show no major imbalances. But the "glide path" for credit is slower than in previous cycles.

Sell the bounce in banks, which face a triple whammy of earnings threats. This will reduce our financials sector allocation to underweight, making room for last week's energy upgrade.

Last month, we highlighted that the S&P consumer finance index had far undershot bullish readings from our macro indicators, reflecting company specific issues. As the latter fade into the rearview mirror, relative performance should reengage with its upbeat outlook. For instance, the tighter U.S. labor market is pushing up wage & salary growth, supporting robust gains in revolving consumer credit (second panel). Rising income growth also suggests credit quality is unlikely to become a profit drag, paving the way for a re-rating in historically attractive relative valuations. That contrasts with the corporate sector, which is struggling with highly-indebted balance sheets and faltering profit growth (our Corporate Health Monitor is shown advanced, bottom panel). It is no wonder that personal loans are outpacing C&I credit growth (third panel) This backdrop is bullish for consumer finance stocks relative to the market, and relative to the S&P bank index. We reiterate our overweight S&P consumer finance index recommendation as well as our recently established pair trade vs. banks. The ticker symbols for the stocks in this index are: BLBG: S5CFINX - AXP, COF, SYF, DFS, NAVI.

The reflation trade will continue for a few more months on Chinese fiscal/monetary stimulus and a more dovish Fed. Despite a slightly better-than-expected start to the earnings season, Q1 S&P 500 profits are set to fall for a fourth consecutive yoy decline. Ex-energy, things aren't so bleak. Domestically-focused companies will experience flat earnings and modestly-positive revenue growth in Q1. Although margins have almost certainly peaked, their decline will be drawn-out. Remain overweight Europe/Japan/China versus the S&P 500 (currency-hedged).

While technology sector profits are disappointing on the back of the paucity of volume growth and deflation (i.e. INTC, IBM), the same is not true for health care companies. Several large cap health care firms have reported robust earnings results (i.e. JNJ, UNH), reflecting steady non-cyclical demand growth and burgeoning pricing power. Indeed, managed care companies are successfully lifting premiums, while pharmaceutical firms continue to enjoy nearly unprecedented pricing power (bottom panel). While the latter is a point of political contention in the U.S., history shows that it is an extremely difficult and drawn out process to effect change. In the meantime, the health care sector's ability to lift selling prices stands in stark contrast with the overall corporate sector. For instance, the small business sector is showing an inability to lift selling prices, as reflected by the NFIB reported price change series, (shown inverted, top panel), which is bordering on recessionary readings. As a result, health care profits should continue to outperform, and we reiterate our recent move to a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5HLTH.

The euro area's nominal GDP and wage bill are growing at 3%, suggesting that fears of deflation are overdone. But a higher wage bill has implications for profits growth.

EM/China growth improvements and the associated rally will falter on their own without tightening by policymakers. The short duration of these mini-cycles and a lack of observable catalysts make it impossible to precisely time selling out of EM positions. This makes us reluctant to chase the rally. Regardless how the impeachment process proceeds, Brazil is heading into a fiscal/public debt crisis.