Developed Countries
Beverage industry profit results have shown the negative impact of the previously strong U.S. dollar, causing some profit-taking in related shares. Nevertheless, underlying earnings fundamentals remain sound, and the currency should soon cease to be a drag. As a non-durable goods industry enjoying comparatively short sales cycles, beverages should be among the first beneficiaries of the recent depreciation in the U.S. dollar, particularly again against emerging market currencies. The chart shows that U.S. consumer goods exports have already rebounded strongly. That is corroborated by healthy shipment growth (top panel), and resurgent pricing power. These trends are consistent with decent top-line performance, which should translate into higher profits, given that labor and other input cost inflation is in decline (bottom panel). We reiterate our high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: - S5SOFTD, KO, PEP, MNST, DPS, CCE.
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.
Saudi oil policy, like its defense policy, will be more aggressive and less predictable, following Deputy Crown Prince Mohammed bin Salman's apparent nullification of a production "freeze" deal at Doha.
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.
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.
The United States and China continue to see relations worsen, particularly over China's activities in the South China Sea. But that is not the only reason geopolitical risk is migrating from the Middle East into Asia Pacific - a trend that investors cannot afford to ignore.
BCA's Energy Equity Strategy, our newest sector-specific service, recently published a report arguing for a rebalancing of global oil markets in the second half of this year, and modestly higher oil prices, a view which was not predicated on an OPEC production freeze. Instead, rebalancing should be driven by larger-than-expected production declines. Low prices are doing their job. Plunging cash flows and the resulting massive increase in capital constraints have strangled exploration budgets, particularly in U.S. shale formations. BCA's forecasts signal that consumption will outpace production significantly by yearend. Consequently, the heavily bombed out S&P energy exploration & production (E&P) index could surprise on the strong side as the year progresses, as relative E&P performance is highly correlated with oil prices, irrespective of the trend in production. In other words, even if production growth is contracting, as long as the latter leads to higher commodity prices, then share prices can outperform. Importantly, producers are enjoying the benefits of technology advancement in drilling techniques, which are driving down production costs. Massive overcapacity in the services industry means that producers will continue to dictate pricing terms. Consequently, we upgraded the S&P E&P index to overweight in yesterday's Weekly Report, which brings our overall energy sector weighting up to neutral, locking in a 14% profit from our underweight call.
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.