Developed Countries
Earlier this month we made a full shift from underweight to overweight in the S&P cable & satellite index, a sub-component of the broader media sector, in response to receding risk that cord cutting and skinnier cable packages would threaten profits. Given that the outlook for the heavyweight S&P movies & entertainment index has improved, it no longer pays to be underweight. This group has underperformed the broad market since early January, savaged by uncertainty about the outlook for key cable networks, particularly ESPN. However, if our cable read is accurate, then material and widespread deterioration in the value of high-quality specialty channels and networks is unlikely. In fact, one of the drivers of higher media spending has been recreational outlays. That improvement may reflect a delayed response to the windfall from lower fuel bills (second panel). Importantly, attendance at theme parks, movie theaters and other attractions has been sufficiently strong to generate increased ticket prices (third panel). That will buffer any advertising slippage from TV to digital. At the same time, wage inflation is non-existent. Against this backdrop, there is less risk of sustained profit margin pressure in the movies & entertainment index. Underperformance has returned valuations to an attractive level, with the relative forward P/E well below the broad market and not far above the Great Recession low (bottom panel). This warrants a lift in our underweight stance. Bottom Line: Lift the S&P movies & entertainment index to neutral, and take the S&P media group off the high-conviction underweight list. For additional details please see yesterday's Weekly publication. The ticker symbols for the stocks in this index are: BLBG: S5MOVI - DIS, TWX, FOXA, VIAB, FOX.
We turned more cautious on banks in January, but in hindsight, could have become outright bearish. Banks are headed for a triple whammy of profit trouble. Loan growth is set to cool, the credit cycle has shifted from tailwind to headwind and the yield curve continues to flatten. Moreover, following several years of downsizing, banks are no longer shedding labor. In fact, banks are adding staff, according to BLS data (middle panel). The timing of hiring is questionable, given that our measure of productivity growth, bank loans/bank employment, is now decelerating (bottom panel). That will undermine profitability, particularly against a backdrop of net interest margin compression. Expectations in the swap curve are for an ongoing yield curve flattening (top panel). It will be very difficult for long-term Treasury yields to rise sustainably as long as other global government bond yields are melting, because the divergence will cause outsized U.S. dollar appreciation which transmits deflationary pressure into the U.S. The implication is ongoing net interest margin compression. Bottom Line: Downgrade the S&P banks index to underweight. This also moves our overall financials exposure to below benchmark. For additional details please see yesterday's Weekly publication. The ticker symbols for the stocks in this index are: BLBG: S5BANK - BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION.
Like the economy, banks show no major imbalances. But the "glide path" for credit is slower than in previous cycles.
Sell the bounce in banks, which face a triple whammy of earnings threats. This will reduce our financials sector allocation to underweight, making room for last week's energy upgrade.
Last month, we highlighted that the S&P consumer finance index had far undershot bullish readings from our macro indicators, reflecting company specific issues. As the latter fade into the rearview mirror, relative performance should reengage with its upbeat outlook. For instance, the tighter U.S. labor market is pushing up wage & salary growth, supporting robust gains in revolving consumer credit (second panel). Rising income growth also suggests credit quality is unlikely to become a profit drag, paving the way for a re-rating in historically attractive relative valuations. That contrasts with the corporate sector, which is struggling with highly-indebted balance sheets and faltering profit growth (our Corporate Health Monitor is shown advanced, bottom panel). It is no wonder that personal loans are outpacing C&I credit growth (third panel) This backdrop is bullish for consumer finance stocks relative to the market, and relative to the S&P bank index. We reiterate our overweight S&P consumer finance index recommendation as well as our recently established pair trade vs. banks. The ticker symbols for the stocks in this index are: BLBG: S5CFINX - AXP, COF, SYF, DFS, NAVI.
The dollar countertrend move has more downside, but beyond the next few months, the dollar remains in a cyclical bull market. Improvements in global growth, even if temporary, are likely to lift non-U.S. rates more than U.S. ones. The euro will benefit from that move as investors still have deep negative feelings toward EUR/USD, exactly as economic momentum has moved in favor of Europe. The SEK should outperform.
The reflation trade will continue for a few more months on Chinese fiscal/monetary stimulus and a more dovish Fed. Despite a slightly better-than-expected start to the earnings season, Q1 S&P 500 profits are set to fall for a fourth consecutive yoy decline. Ex-energy, things aren't so bleak. Domestically-focused companies will experience flat earnings and modestly-positive revenue growth in Q1. Although margins have almost certainly peaked, their decline will be drawn-out. Remain overweight Europe/Japan/China versus the S&P 500 (currency-hedged).
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.