Equities
Earlier this month we made a rare shift from underweight to overweight in the S&P cable & satellite index, because fears of cord cutting and skinnier cable packages undermining profitability were no longer justified. In fact, in real terms, consumer outlays on cable have jumped to new highs. Unsurprisingly, the latest consumer price report showed that cable TV inflation is following in the footsteps of spending: the rate of pricing power growth is accelerating (bottom panel). That implies low subscriber churn, reducing the likelihood that capital spending will need to materially increase to maintain competitiveness. Importantly, cyclical share price momentum is still well below levels that have marked previous interim relative performance peaks, and should continue to climb based on the uptrend in real consumer spending (middle panel). We reiterate our upgrade to overweight. The ticker symbols for the stocks in this index are: BLBG: S5CBST - CMCSA, CVC, TWC.
Monday's upgrade of the energy sector to neutral and the exploration & production index to overweight does not mean that refiners are out of the woods. In fact, the opposite is true, because the crude oil supply glut will morph into a refined product glut. Refiners are still running full out, likely in response to strong gasoline demand, but that is creating a glut of distillate inventories and boosting overall fuel supplies. Overall refined product consumption is barely growing, underscoring that inventories will continue to build. Weakening overall demand for finished oil product is also evident in the plunge in railcar shipments, which heralds a potentially painful decline in relative stock performance (top panel). Part of the plunge in rail shipments of oil reflects reduced shale oil production, which will boost refiner input costs via higher crude oil prices. Keep in mind that refining margins are already under cyclical stress, because of the tight spread between Brent and WTI crude oil prices (third panel). Our refiner earnings model, based on refining margins and utilization rates, is plunging. Consequently, the odds of a sustained profit squeeze are high. We reiterate our high conviction underweight. The ticker symbols for the stocks in this index are: BLBG: S5OILR - PSX, VLO, MPC, TSO.
One refrain from market bulls is that sentiment is too bearish, which is contrarily positive. Indeed, our own Composite Sentiment Gauge is still decisively in a bearish zone. However, action trumps rhetoric. Investors are responding to polls bearishly, but do not appear to be positioned that way. True bearishness elicits a rush for the equity exits, which prompts position deleveraging, a valuation squeeze, a dramatic increase in cash levels and a premium on portfolio protection, as measured by the VIX and SKEW indexes. Yet valuations are probing historic highs, as measured by the median industry group price/sales ratio (bottom panel). Investors are not nervously hedging long positions, as evidenced by historically depressed readings in the VIX and SKEW indexes. Meanwhile, margin debt remains near record levels, both in absolute terms and compared with market cap and/or GDP (fourth panel). Moreover, investor cash holdings are historically low, the opposite of a bearish signal. The broad market lows in 2000 and 2009 were marked by unanimity among these indicators, namely bombed out sentiment and speculation readings, extreme anxiety about a potential crash, cheap valuations, low margin debt, high cash levels and a high degree of global economic pessimism. At the moment, none of these indicators is confirming that investors are positioned defensively. Consequently, we are reluctant to champion a bullish equity outlook on the basis that pessimism reigns. We expect our outsized exposure to non-cyclical sectors to continue generating alpha.
Bearish sentiment is a red herring, as most other measures of investor positioning point to a strong undercurrent of bullishness. That is contrarily worrying.
The equity bear case is obvious. Prices are approaching overhead resistance and face fundamental headwinds.
This week <i>Global Alpha Sector Strategy</i> in conjunction with <i>Emerging Markets Strategy</i> is sending out a <i>Special Report</i> on EM deep cyclical sectors, discussing debt and cash flow dynamics, identifying how far advanced the capital expenditure down cycle is, and determining if recent EM deep cyclical strength should be bought or faded.
An Insight yesterday showed that the overall technology sector was likely to record its worst quarterly earnings performance in four years. The highest beta components of the sector are most at risk. For instance, the semiconductor industry is losing its main source of support, namely an M&A premium. Last year's mini-M&A frenzy is petering out, which will put the onus on profits to support relative performance. However, global chip sales continue to deteriorate, and leading indicators such as Chinese electronics imports and Emerging Market currencies continue to warn of tepid chip demand. With chip producer inventories still growing at a historically rapid clip, there will be downward pressure on average chip selling prices. TSMC's profit warning earlier this week likely provides a good read for the overall industry, and we reiterate our high-conviction underweight rating. The ticker symbols for the stocks in this index are: BLBG: S5SECO - INTC, QCOM, TXN, AVGO, NVDA, ADI, SWKS, XLNX, MU, LLTC, MCHP, QRVO, FSLR.
A stronger yen is hampering efforts to revive the Japanese economy and the BoJ's failed NIRP experiment leaves open the option of direct currency intervention. Probability is also high that the April 2017 sales tax hike will be postponed, perhaps indefinitely. A major stimulus package, "helicopter drops" of money, and a 4% inflation target may be the only way to permanently overcome deflation. Near-term, further yen strength is likely, but the long-term path is down.
The S&P technology sector is forecast to deliver its worst quarterly earnings performance since 2012/2013, when the sector suffered a relative performance steep correction (top panel). That period was marked by a downturn in capital spending momentum, and a contraction in technology new orders-to-inventories. A similar backdrop is currently unfolding. BCA's Capital Spending Model has moved sharply lower, heralding share price underperformance. In addition, demand for tech goods remains anemic, as proxied by tech new orders and exports (second panel). That represents a headwind to future production growth, and by extension, productivity. The implication is that tech sector deflationary conditions are likely to remain intense, and it is too soon to position for better technology earnings. We remain underweight the overall tech sector.
One of our highest-conviction investment ideas for the next few years.