Developed Countries

Special Report

A combination of physical rebalancing in the oil markets and geopolitical risk have pushed oil prices above $50/bbl. We therefore close our recommendation - made jointly with BCA's Commodity & Energy Strategy team - to long a December 2016 WTI $50/$55 call spread for a 106.3% gain.

The latest conclusions from the sector-based (right) way to pick stock markets. Plus some important conclusions for credit markets.

Bank Credit Analyst

This month's <i>Special Report</i> reviews the literature on equity market timing, and identifies the key indicators that historically have had the best track record. We then aggregate the indicators into an overall scorecard that should prove to be valuable for investors in these volatile times.

Bank Credit Analyst

This month's <i>Special Report</i> reviews the literature on equity market timing, and identifies the key indicators that historically have had the best track record. We then aggregate the indicators into an overall scorecard that should prove to be valuable for investors in these volatile times.

Our upgrade of the S&P electrical components & equipment (ECE) index to overweight earlier this year was based on both market and industry factors. The group had undershot on technical, valuation and sentiment basis. Moreover, it was being unfairly lumped in with more resource-dependent industrial sector groups, particularly given that the index is comprised of large, diversified manufacturing businesses with exposure to a variety of end markets. However, market extremes have been unwound and headwinds to a fundamental earnings recovery have surfaced. Shipment contraction is rife, and unlikely to improve given that new orders have tumbled. Factories are likely to become underutilized. Utilization rates had stayed remarkably high during the overall economic downturn, owing to capacity shrinkage. This resilience is at risk now that leading revenue indicators are sinking. Productivity growth has dipped, and has more downside risk, given that wage inflation is outpacing deflationary pricing power growth. Adding it up, the power to sustain the advance in ECE stocks is diminishing, and we recommend moving to the sidelines. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5ELCO - EMR, ETN, ROK, AME, AYI.

The S&P industrials sector has led the deep cyclical sector recovery this year, validating our upgrade to neutral to protect against a countertrend move spurred by U.S. dollar softness. However, the industrial sector share price ratio is now near the top end of a 15-year range, suggesting major resistance. An exhaustive examination of our Indicators highlights that this year's rally has been based on portfolio repositioning and reversion from oversold conditions rather than expectations of a sustainable earnings recovery. Valuations have gone from cheap to neutral, implying that further gains require earnings outperformance. The objective message from our industrials Cyclical Macro Indicator is that relative forward earnings estimates will continue to fall. The underlying bearish force is top-line malaise. Hopes for an industrial sector revival appear to be misplaced. Once credit conditions tighten and banks become less willing to extend C&I loans, the ISM manufacturing index generally weakens. Core durable goods orders are already contracting, despite the boom in auto production over the past few years. Importantly, the corporate sector is not in a position to ramp up investment, as highlighted in last Monday's Weekly Report. That is particularly true of resource companies, where the most intense leverage pressures reside. Consequently, it is premature to bet on an industrial profit recovery and we recommend returning to an underweight stance. Please see yesterday's Weekly Report for more details.

Industrial machinery stocks have surged as if China is headed back to double-digit GDP growth and the U.S. dollar is going to reverse all of its recent year's gains. That combined scenario would produce a rebound in sales growth, and allow investors to bet on increased operating leverage. But that is wildly optimistic, especially given that the sales outlook remains murky. Our global machinery new order proxy is contracting. Global machinery exports have also gone ex-growth. Importantly, leading indicators of new orders are bearish. For instance, BCA's Global CapEx Indicator is heralding a contraction in developed country capital formation. That does not bode well for global output growth, and by extension, machinery consumption. Coal and other commodities also provide a good read for future industrial machinery demand. Clearly, coal is warning that machinery new orders will stay punk. Whiffs of reflation in China have supported other commodity prices, but it is premature to extrapolate this liquidity-driven bounce into a demand-driven upturn. Loan demand is still anemic, and machinery stocks have front run any improvement in China's cyclical outlook (bottom panel). Use the rally in the SP& industrial machinery index to downshift to an underweight position.The ticker symbols for the stocks in this index are: BLBG: S5INDM - ITW, SWK, IR, PH, PNR, DOV, SNA, XYL, FLS. 

Fed hawkishness reinforces the need for an imminent profit recovery to justify current valuations. Our Indicators do not signal such an outcome. Stay defensive, and return to an underweight stance in the industrials sector.

A June rate hike is a real possibility, but the Fed still needs evidence that growth is rebounding toward 2% in order to follow through. Whether the next rate hike occurs in June or later this year, a persistent hawkish shift from the Fed will send Treasury yields higher during the next few months.

This week, we present five of the more interesting yield curve trades in the Developed Markets for the latter half of 2016.