Developed Countries

Our sense is that the current reflation trade will extend into the summer, sending stock and commodity prices higher and the U.S. dollar down. Global government bond yields should rise during this phase. Beyond the near term, we expect these reflation trades to go into reverse. Stay defensive.

Special Report

Monetary policy at systematically important central banks will determine the winners and losers in global ag export markets going forward. The evolution of fundamentals - supply, demand, and inventories - will remain essential drivers. Mother Nature is the wild card.

Asian exports (volumes and prices) have been contracting, as global trade has hit a wall. While this broad deflationary backdrop has taken a toll on Asian DRAM prices (bottom panel), global semiconductor supply/demand imbalances best explain the industry's dwindling pricing power. Not only are global semi sales shrinking, but also BCA's global semi inventory proxy is surging. Taken together, our global semi sales-to-inventories (S/I) ratio is contracting at an accelerating pace, signaling that an inventory liquidation phase is looming. Historically, the S/I ratio has been an excellent leading indicator of semi earnings and the current message is to expect a significant drop in profits (middle panel). Bottom line: Steer clear from the broad tech sector, continue to underweight the tech hardware, storage & peripherals sub-index and we reiterate our high-conviction underweight status for the S&P semis index. The ticker symbols for the stocks in the S&P semis index are: BLBG: S5SECO - INTC, QCOM, TXN, AVGO, NVDA, ADI, SWKS, XLNX, MU, LLTC, MCHP, QRVO, FSLR. The ticker symbols for the stocks in the S&P technology hardware, storage & peripherals index are: BLBG: S5THSP - AAPL, EMC, HPE, HPQ, SNDK, WDC, STX, NTAP.

In mid-April we cautioned investors not to position for a betterment in tech sector earnings despite the seemingly low sell-side analyst hurdle. A slew of tech heavyweights have come up short this earnings season both on the top and bottom line fronts. More importantly, bellwether Apple struck a cautionary note on consumer electronics end-demand, especially in China and warned that profit would underwhelm in the current quarter. This is disconcerting especially given Apple's global reach, and is signaling that the tech sector tide is likely turning following a nearly uninterrupted decade-long relative share price bull market run. The top & middle panels of the chart show that this outperformance phase is running on empty as relative profit trends have given way. Meanwhile, on the demand side the outlook remains grim. Overall tech new order growth is contracting and the message from weakening Korean and Taiwanese exports is that more pain lies ahead for tech sector profitability. Deflating Asian export prices are underscoring that semis should also be avoided (see the next Insight).

How big a problem are the non-performing loans in Italy and Greece? And what is the solution?

Cyclical sectors are manufacturing-dependent, whereas defensive sectors are services-oriented, highlighting that cyclicals are more levered to the inventory cycle's ebbs and flows. The latest durable goods report made for grim reading. Both the new orders-to-inventories and shipments-to-inventories (S/I) ratios remain tepid. This corroborates the reading from the S/I ratios in the wholesale, retail & manufacturing sectors, where all are steadily sinking, underscoring that forecasting a rise in manufacturing output on the basis of an inventory cycle is overly optimistic. The implication is that additional pain looms for the cyclicals/defensives relative performance (middle panel). Moreover, diverging debt dynamics are weighing on the cyclicals/defensives ratio. Relative interest coverage and net debt-to-EBITDA are sending a distress signal (not shown). Tack on a narrowing in relative profit margins (bottom panel) and the continuing deterioration in relative top-line growth which according to our sales models has more staying power (please see chart 7 from the March 29 Special Report), and the ingredients are in place for a resumption in the downtrend in the relative share price ratio. Relative profit trends will drive the next phase in the cyclicals/defensives ratio and defensives retain the upper hand (top panel). Bottom Line: Continue to favor defensives over deep cyclicals.

The near-term (next month or two) market dynamics in EM risk assets remain a coin toss. Beyond that the outlook for EM risk assets remains downbeat. EM financial markets are complacent and there are many potential negative EM/China developments that could derail the current EM rally. A new trade: go long the KOSPI / short EM overall equity index.

Most financial assets are trading within the confines of the feedback loop between markets and Fed policy. Investors should avoid expensive assets such as spread product, and hold positions with attractive long-term value such as U.S. TIPS over nominal Treasuries and U.S. Treasuries over German bunds.

Most financial assets are trading within the confines of the feedback loop between markets and Fed policy. Investors should avoid expensive assets such as spread product, and hold positions with attractive long-term value such as U.S. TIPS over nominal Treasuries and U.S. Treasuries over German bunds.