Developed Countries

Special Report

Australia's equities and currency are driven largely by industrial commodities prices, Canada's by the oil price. Given our more positive view on oil, we prefer Canadian assets, though both markets face risk from stretched property prices and household debt.

China has fallen into the same "fiscal trap" that ensnarled Japan in the 1990s. Unprofitable investment projects undertaken by SOEs are a necessary evil. The underlying problem is not overinvestment, but an economy that is demand-deprived. Meanwhile, structural factors will ensure that savings remain high. Any efforts by the authorities to curb credit growth will result in a sharp economic downturn. China will continue to generate excess capacity and export deflation to the rest of the world, which is good for bonds. We recommend going long Chinese banks, the most hated equity sector.

Gold will remain well bid over the short term. The surge in demand that pushed prices up by 20% ytd (Chart of the Week) will continue to dominate supply growth.

The previous Insight showed that the financial sector remained on its heels as a consequence of ongoing global deflationary backlash. This backdrop is particularly difficult for asset managers & custody banks (AMCB). This index is a high beta play on economic and financial market confidence. When the latter is high, M&A activity, share buybacks and other sources of industry fee income tend to accelerate. The opposite is also true. At the moment, global economic confidence is sinking, as measured by our composite sentiment gauge (top panel) and the stock-to-bond ratio (bottom panel), and is likely to erode further as economic disappointment mounts (third panel). Meanwhile, M&A activity is on the wane as capital availability has become more restrictive (second panel). These forces warn that AMCB profitability is likely to underwhelm. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5AMGT- BLK, BK, STT, TROW, AMP, NTRS, BEN, IVZ, AMG, LM.

The S&P financials sector continues to battle deflationary forces. While inflation expectations are off their low courtesy of this year's dip in the U.S. dollar, they remain well below 2014 levels when the U.S. dollar began to surge (top panel). The negative profit backlash from global deflation continues to reverberate across the business sector, and has undermined corporate balance sheets to the extent that banks are much less willing to extend C&I loans, their main source of asset growth (second panel). These trends are also sustaining downward pressure on the long end of the Treasury curve, causing a relentless yield curve narrowing. With the Fed still eager to lift interest rates, despite evidence of growth slippage, the odds of a policy mistake are creeping higher. Against this backdrop, financial sector profits are likely to lose additional steam, raising the odds of a breakdown in relative performance to new lows. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5FINL.

We focus on 3 stress-points in the economy and markets which segue to several high conviction investment recommendations.

The previous Insight showed that rails are working hard to reduce cost structures. However, rail profits are still tightly linked with overall freight trends. The decline in total railcar shipment growth warns that rail earnings estimates will continue to lag those of the broad market. The two major freight categories are struggling. Coal shipments have plunged, with no imminent relief in sight, as utilities, the primary coal purchasers, are suffering from a contracting electricity production. Meanwhile, intermodal shipments, the largest freight category, have slipped into negative territory. Sagging port traffic, soggy retail sales and high inventory-to-sales ratios suggest that demand for consumer goods will remain lackluster. As a result, deflation is likely to prevail a while longer and we continue to recommend only a market neutral weight, despite the appearance of good value. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU.

The relief rally in rail stocks has stalled at key resistance levels, but good value and extreme cost cutting efforts make it tempting to buy into any short-term weakness. Would that be a sound strategy? Top-line growth is lagging far below the rate of overall GDP growth, which is a bearish sign. However, rails have aggressively slashed costs, as both employment and capital spending have plunged. Moreover, the decline in railcar order backlogs suggests that new cars are coming on line. Rail operators lease the bulk of their cars, and tight supply in recent years boosted lease rates. As new cars hit the network, then lease rates should ease. These factors warn against extrapolating bearishness, but are they enough to bolster rail profits? Please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU.

Within an overweight allocation to Euro Area corporates versus U.S. corporates, favor single-B rated Euro Area High-Yield and Euro Area Investment Grade sectors that offer higher duration-adjusted spreads.

Stronger GDP growth will permit the Fed to hike rates once more before year-end, no earlier than September. However, the feedback loop between the Fed and financial conditions will prevent a second rate hike this year.