Developed Countries

Renewed strength in the U.S. equity market sponsored by another round of global monetary easing has revived the debate about whether it is finally time to transition out of our alpha-generating defensive portfolio strategy. A number of strategists and media outlets have championed the view that yield proxies and non-cyclical sectors are expensive, and no longer offer an attractive reward/risk trade-off, particularly within the context of the recent easing in credit spreads, commodity price relief and the dip in the U.S. dollar. However, it is crucial to distinguish between absolute and relative measures when analyzing valuations. In absolute terms, nearly every sector and group is expensive, given that the broad market is trading at historically rich multiples. Our metrics do not support the notion that defensive sector outperformance has overly skewed relative valuations. Defensive sector strength has been almost entirely earnings driven (top panel), as measured by the steady upward march in relative forward earnings estimates. Our relative valuation gauge for defensives is barely above neutral despite multiyear outperformance. At the same time, cyclical sectors have experienced a steady decline in relative forward profit estimates, which has kept our valuation gauge close to neutral when the energy sector is excluded. The implication is that forecasting a cyclical sector comeback based on a valuation basis could lead investors down the wrong path. Instead, the lack of a major valuation anomaly means that relative performance should continue to be dictated by relative profit trends, please see the next Insight.

Special Report

Renewed strength in the U.S. equity market sponsored by another round of global monetary easing has revived the debate about whether it is finally time to transition out of our <i>alpha</i>-generating defensive portfolio strategy. This <i>Special Report</i> examines the critical factors shaping this investment decision.

Special Report

In this <i>Special Report</i>, we present a detailed discussion on the outlook for Australian credit markets. Our conclusion is that investors should begin increasing exposure to Australian spread product.

The inflation outlook priced into the market is overly bearish, and TIPS breakevens will move higher as the drag on inflation from food and energy prices dissipates.

Bank Credit Analyst

The old cyclical market axiom that "nothing cures low prices like low prices" has never held
truer than in today's oil market.

The rally in risk assets could persist. Dollar and oil moves are not yet exhausted. But valuations and poor earnings quality warrant a cautious approach.

For the month of March, the model outperformed both global and U.S. equities in U.S. dollar terms. For April, the model has further pared back its equity risk exposure, shifting the allocation into cash. While Europe remains the largest equity overweight, there was a modest recalibration to defensive markets such as the U.S. and Switzerland. The allocation to EM was also nudged up a bit, on momentum and valuation grounds. In the fixed-income space, the model is sticking with U.S., Italian and Spanish paper.

Special Report

There is little evidence suggesting that declining productivity growth in recent years has resulted from measurement error. Businesses have plucked many of the low-hanging fruits made possible by the IT revolution, while cyclical factors stemming from the Great Recession have also weighed on productivity. Low productivity growth tends to be deflationary in the short run, but inflationary longer-term. For now, this is good news for bonds, but is likely to become bad news by decade-end.

The British pound may be prone to further weakness in the coming months as the odds of a Brexit rise.

The S&P pharmaceutical index has checked back relative to the broad market, reflecting the powerful short covering and relief rally in higher beta sectors in recent weeks. While this trend may persist in the very near run, we expect relative performance to follow relative forward earnings growth. On this front, conditions are bullish. In absolute terms, pharmaceutical companies are enjoying a productivity revival, as a demand-driven surge in pricing power is underway. That stands in marked contrast with the rest of the corporate sector, which is battling deflation, as evidenced by the relentless decline in bond yields (shown inverted, top panel). The chart shows that when firms are cutting selling prices, pharmaceutical profits outperform, as is currently the case. Moreover, drug companies continue to use excess capital in a shareholder-friendly manner, as shares outstanding continue to sink. The bottom line is that pharmaceutical earnings are on track for further outperformance, which should pull up the share price ratio. Stay overweight. The ticker symbols for the stocks in this index are: AGN, BMY, LLY, ENDP, JNJ, MNK, MRK, MYL, PRGO, PFE, ZTS.