Developed Countries

U.S. dollar softness has failed to lift equities of late, a tentative warning that correlations are changing as the U.S. economy cools.

While we recently downgraded financials and banks to underweight, this bearish view does not extend to each of the sector's components. REITs are a positive exception. The group is still not overvalued, despite the relentless decline in yields on competing assets. This may reflect an undercurrent of skepticism regarding the sustainability of cash flow growth and low cap rates. However, both appear sustainable. The CPI for homeowner's equivalent rent, a proxy for REIT pricing power that has a good correlation with relative performance, is still accelerating even though it is already well above the overall rate of inflation. Moreover, commercial property price inflation continues to climb. While Fed rate hikes could be construed as an impediment if they lift the cost of capital, REITs have not typically run into trouble until policy has tightened by enough to cause a cresting in commercial real estate prices, a peak in occupancy rates and by extension, a downturn in the CPI for rental inflation. None of these concerns currently exist. Consequently, we recommend maintaining an overweight position. BLBG: S5REITS

The trading action of gold is currently sending a bearish message on the dollar as the price of the precious metal has broken above critical resistance. Though the causation between the dollar and gold usually runs from the former to the latter, gold also has a tendency to sniff out broad-based moves in the greenback. We remain broadly short USD in our portfolio.

Utilities appear to have successfully consolidated this year's sharp relative performance run up, as the share price ratio is firming anew after holding at its 40-week moving average. The incentive to maintain an overweight exposure to this fixed income proxy is heavily influenced by whether global deflationary forces have finally ebbed. While the U.S. dollar has softened in recent months, it has not caused an upsurge in inflation expectations nor has failed to cause a sell-off in Treasurys. U.S. yields are being pinned down by persistently low global bond yields, which reflect chronic deflationary pressures. As long as the total return of bonds is beating equities, then utilities relative performance momentum should stay positive (third panel). Without any valuation barriers to further outperformance, we continue to recommend an above-benchmark weighting. BLBG: S5UTIL.

Following up from yesterday's S&P banks update, as banks go so do financials, given that they comprise the highest weight in the sector. Worrisomely, financials relative EPS momentum has more downside. Using the latest Fed Senior Loan Officer survey data, we constructed a C&I loan supply/demand indicator (middle panel). The news is grim for financial sector profits. C&I loan volumes are decelerating and banks are tightening lending standards. C&I now represents the highest lending category exposure on bank balance sheets, warning of a magnified negative impact on profitability. As long as deflationary forces prevail, as proxied by persistent weakness in our global leading economic indicator (GLEI), then credit quality will continue to erode: it is no wonder that financials relative performance and the GLEI are highly correlated. Bottom Line: We reiterate our recent downgrade to underweight. BLBG: S5FINL.

We discuss the technical and political problems with helicopter money, plus the near-term outlook for the euro area economy and markets.

At this stage of the business cycle, the bull case for banks rests on the ability of accelerating loan growth to offset the beginnings of deteriorating credit quality. However, the latest Fed Senior Bank Loan Officer Survey has poured cold water on such an outcome. Banks are tightening lending standards on their main source of asset growth, namely C&I and commercial real estate loans. These are the main sources of excess leverage. Consequently, it is logical for banks to become more discerning when doling out related credit when credit quality is eroding (bottom panel). While mortgage and consumer lending demand remains decent, it is unlikely to be sufficient to offset higher charge-offs and a slowdown in business-linked loan creation. We reiterate our recent downgrade to underweight. The ticker symbols for the stocks in this index are: BLBG: S5BANKX - WFC, JPM, BAC, C, USB, PNC, BBT, STI, MTB, FITB, CFG, RF, KEY, HBAN, CMA, ZION, PBCT.

A spate of mergers in the medical equipment space has helped propel relative performance to new cyclical highs. In our latest update, we noted our expectation for another upleg, but some niggling concerns about the future revenue outlook caused us to put the group on downgrade alert. However, recent data are supportive of a continuation of the uptrend. The medical equipment shipments-to-inventory ratio is trending steadily higher. Importantly, investment in medical equipment has reaccelerated, as has new health care facility construction. That bodes well for future equipment demand, and should keep factories operating at optimal rates. Consequently, we recommend maintaining overweight positions for a while longer, especially since value is not problematic. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, SYK, BDX, BSX, BAX, ISRG, EW, STJ, ZBH, BCR, HOLX, VAR.

The powerful short covering bounce in the S&P steel index is starting to fizzle. The latest upleg had been driven by a surge in Chinese domestic steel prices. That, combined with news that the country plans to reduce steel capacity in the coming three to five years, was enough to send shorts scrambling for cover. However, it will take time for the global steel market to rebalance. In the short run, the jump in Chinese steel prices has already encouraged domestic producers to re-ramp steel production (second panel). Persistent sluggishness in indicators of China's domestic consumption mean that steel inventories are likely to build as production picks up anew, which will put upward pressure on exports to the rest of the world. Fading construction growth and tightening lending standards in many developed countries suggest that increased steel supply from China will have a negative impact on steel prices. We reiterate our recent downgrade back to underweight. The ticker symbols for the stocks in this index are: BLBG: S15STEL - NUE, STLD, RS, X, CMC, ATI, WOR, CRS, AKS, TMST, HAYN, SXC, ZEUS.

The factors that drove the recent rally - Fed dovishness, China reflation, and a pickup in economic data - are largely over.