Developed Countries

With the broad market struggling to find a floor in the midst of a disappointing earnings season, it still pays to play defense. This week's ISM releases reinforce that a defensive over cyclical portfolio bias is still warranted. The bottom panel of the chart shows the relative employment outlook for ISM manufacturing versus ISM services, with the pendulum swinging in favor of services industries. This relative employment ratio heralds more pain for cyclical vs. defensive equities, as most defensive sectors are services-oriented while deep cyclicals are manufacturing-intensive. Meanwhile, the bond market continues to flag elevated financial stress. Cyclical junk bond yields have been shooting higher, especially compared with defensive junk yields, reflecting relative deteriorating balance sheets. The implication is that relative share prices have more room to fall (top panel). Bottom Line: we continue to recommend a defensive versus deep cyclical portfolio tilt.

Oil markets will continue to be buffeted by Russian overtures to OPEC suggesting a desire to orchestrate a production cut-back, while uncertainty over the Fed's next move keeps markets on edge.

An improvement in the euro area credit impulse is encouraging, but we explain why it is not enough to sustainably boost risk-assets.

Energy service stocks are so oversold and cheaply valued that contrarians are chomping at the bit to establish long positions. Is it time? In previous research, we have cited a number of common elements at bear market troughs: a cresting in total OECD oil inventories; a peak in global crude oil production; and a rising global oil rig count. These conditions do not yet exist, and OPEC seems unlikely to turn off the taps, lest cede market share that they have worked so hard to protect. However, the downturn in U.S. oil production may be providing a preview of what to expect in the rest of the world, particularly as credit and equity market stress robs producers of the access to capital needed to fund drilling programs. There is still a large amount of drilling slack to mop up before pricing power will improve, but the scope of bear market suggests share prices will turn well in advance of any fundamental improvement. We upgraded to neutral last October, and continue to look for an attractive point to shift to overweight. The ticker symbols for the stocks in this index are: BHI, CAM, DO, ESV, FTI, HAL, HP, NOV, SLB, RIG.

A recent article in Barron's painted a bright picture for bank stocks, but we have a more cautious view. While value is attractive, the earnings picture has darkened. The narrowing yield curve and budding downturn in credit quality will put pressure on credit creation to drive profitability. However, we are skeptical that loan growth will improve much. The latest Fed Senior Loan Officer survey showed that banks continue to tighten standards on both C&I and commercial real estate loans. While they remain willing to make consumer and mortgage loans, demand for a number of these categories is drying up. Against a backdrop of increased credit stress and rising corporate bank bond spreads, loan loss reserves are likely to accelerate, warning that low valuations are likely to persist. We recommend only a market neutral weighting. The ticker symbols for the stocks in this index are: BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION.

Rising demand for U.S. dollars in EM and further yen depreciation, if it transpires, assures global exchange rate volatility will rise. Rising currency volatility, especially in the RMB, will push the global risk premium higher, weighing on global share prices. In Turkey, a wage-inflation spiral is unfolding and the central bank is behind the curve; the currency will plummet further.

Maintain an above-benchmark portfolio duration since, favoring markets with the highest real yields that stand out in a world where 65% of Developed Market government bonds trade with a negative yield.

It is highly unusual for equities to enter a bear market without the economy going into recession. Since we see the risk of recession as low, we recommend a neutral allocation between bonds and equities.

Spread product performance has been foreshadowing changes in market rate hike expectations since early last year, and the recent bout of weakness means it is probably time for the Fed to temper its hawkishness.

The current profit backdrop for the machinery industry is grim, but the relative price ratio has already made a large downward adjustment and short interest is sky high. Importantly, machinery companies are finally addressing the need to reinvigorate productivity as an offset to the competitive drag from a strong exchange rate. Importantly, history underscores the likelihood of at least a temporary hiatus in the bear market. Going back to the 1950s, we have identified five durable machinery relative performance bear markets. On average, they lasted 42 months and recorded 44% in declines from peak to trough. In comparison, the current downturn has been underway since 2011, with the price ratio shedding 36%. Interestingly, a cycle-on-cycle analysis shows that machinery stocks have troughed prior to any turnaround in either the ISM index or the U.S. leading economic indicator. Instead, the group appears to have taken its cue from U.S. dollar weakness and a rally in commodity prices, both of which herald better times ahead for primary machinery end markets. Consequently, continued economic deterioration may not translate into additional relative underperformance. We upgraded to neutral in yesterday's Weekly Report, protecting a profit of 19%. The ticker symbols for the stocks in this index are: CAT, ITW, DE, PCAR, CMI, SWK, IR, PH, SNA, DOV, PNR, XYL, FLS.