Developed Countries

Gold and gold stocks have bounced nicely in recent weeks. But from a multiyear perspective, both remain extremely depressed (top panel). While gold has had several false starts in recent years, a number of factors suggest that the latest rally will have durability. Gold raises in stature as policymakers lose efficacy. That is certainly the case now, as incremental QE has done little to foster a return to above-trend growth and a growing number of countries have resorted to negative deposit rates to reinvigorate anemic economic activity. Real interest rates, the opportunity cost of holding gold, which is a zero-yielding asset, are low and falling around the world and may need to fall further to reverse the decline in economic confidence. Importantly, gold has begun to rise in a number of currencies, suggesting that it is no longer just a play on a lower U.S. dollar. From a tactical perspective, sentiment toward the yellow metal is still pessimistic, despite the jump in gold prices in recent weeks. That is a contrary positive. As a result, we recommend an overweight position in gold equities, both as portfolio protection and also as a long-term hedge on monetary policy exhaustion. While the S&P 1500 gold index has only two stocks, the Global Gold Miners ETF (GDX) provides a liquid and diversified proxy for gold equities, which we will use to track gold stock performance. Please see yesterday's Weekly Report for more details.

In yesterday's Weekly Report, we outlined our top ten reasons to underweight the technology sector, an out of consensus call based on the sector's resilience during the past few months' of broad market turmoil. At the root of our concern is that tech sector productivity growth is eroding at the same time that previously bulletproof balance sheets are slowly deteriorating. Declining sector productivity can be remedied through increased capital spending, but the chart shows that tech has underinvested as a share of sales for the better part of a decade. While the latter is slowly creeping higher, it will take time before it feeds into increased efficiency and faster earnings growth. Worse, our overall capital spending model is sinking steadily (bottom panel). In particular, the financial and public sectors have traditionally been large technology spenders. Despite ultra-low borrowing costs, government spending is still politically constrained and thus on a tight leash. Meanwhile, the financial sector has already ramped up its capital spending significantly (middle panel), without a corresponding positive impact on new order growth, signaling that weakness from other end markets has been a large drag. If the financial sector pulls in its horns as overall credit quality sours, it will remove a support for tech capital spending. We are bearish on relative performance prospects, and recommend underweight positions. Please refer to yesterday's report for more details.

We still recommend a cautious stance on portfolio risk, for both credit and duration exposure, given that monetary policy expectations priced into Developed Market yield curves are already extremely dovish.

As confidence in the sustainability of corporate sector profitability declines, the multiple accorded to equities should recede. Ten reasons to stay underweight the tech sector. Initiate an overweight position in gold shares.

The relief rally is not over, and could benefit from commodity and currency market movements. Oil prices likely are banging out a bottom. In general, however, a healthy dose of caution is warranted. Our bias is to sell into, rather than chase, rallies in risk assets.

Over the coming two weeks, the G3 central banks will be holding key policy meetings that could prove instrumental in setting major FX trends for the next several months. What can currency traders expect?

Near-term, global yields will remain depressed, but the structural forces suppressing yields should abate and even reverse in the long-run. Slower potential GDP growth - and lower commodity prices - will eventually shift from tailwind to headwind for bonds. Stepped-up efforts to increase inflation will boost long-term nominal yields; populist politics and calls to curb income inequality will amplify this trend. Long-term investors should stay neutral global bonds for now, but prepare to shift to a structural underweight beyond this decade.

A stunning 9.9 million-barrel build in U.S. oil inventories this week failed to arrest the upward climb in prices.

While we are neutral the broad industrials sector (please see yesterday's Insight) and sub-surface exposure should remain selective, we continue to recommend an above benchmark weighting in the BCA defense index. Following years of global government austerity, rising global fiscal thrust should boost demand for defense capital goods. Tack on a rise in geopolitical risk in a number of volatile regions in the world, and the outlook for defense spending significantly brightens. In more detail, China/Japan nervousness (with Australia recently joining the chorus of rising defense spending in the pacific) and escalating middle east/Russia tensions are a harbinger of rising defense spending budgets globally. The prime beneficiaries of this cyclical turn in demand are U.S. defense manufacturers/contractors. Already, U.S. defense new orders are surging, signaling that relative performance momentum has more upside (middle panel). Importantly, the U.S. defense capital goods shipments-to-inventories ratio is also expanding at a healthy clip (bottom panel). The implication is that busy defense factory activity should underpin revenue and profit growth. Bottom Line: Stay overweight the BCA defense index. The ticker symbols for the stocks in this index are: LMT, GD, RTN, NOC, LLL.