Equities
Our <i>Cyclical Indicator Update</i> reveals that a defensive portfolio strategy remains the best bet to navigate the crosscurrents of stagnant profit/economic growth yet abundant global liquidity.
The blowout June nonfarm payrolls report reflects a tightening labor market, consistent with stronger ISM manufacturing and non-manufacturing readings. This will take time to impact Fed policy.
Please see attached our <i>Third Quarter Strategy Outlook<i/> which discusses the major investment themes and views we see playing out for the rest of the year.
Consumer staples stocks have been on a tear recently, climbing to all-time highs. While valuations are in overshoot territory, the conditions to sustain this overshoot exist. A flurry of intra-sector M&A activity, anemic global growth and the plunge in global bond yields all argue for a premium valuation in long duration sectors. In fact, the rising stock-to-bond ratio (top panel) coupled with the firming dollar (second panel) and resurgent volatility across asset classes (bottom panel) are a boon for non-cyclical consumer equity relative performance. Earnings expectations are not demanding, particularly relative to the overall corporate sector, underscoring that defensive staples stocks are not only well insulated from overall market turbulence, but also well positioned to thrive in a deflationary/disinflationary global backdrop. Bottom Line: Stick with a defensive portfolio tilt and continue to overweight the S&P consumer staples sector.
Smart beta strategies can be useful in both strategic and tactical asset allocation. Combining different smart beta strategies can smooth out the cyclicality of individual strategy and provide a better return/risk profile.
Airlines have been punished lately, trailing not only the S&P 500, but also their industrials peers. News that Delta would not meet already weak passenger yield expectations underscores that analysts still remain overly optimistic. Airlines have expanded capacity too aggressively while fuel prices were low, and are now being hit with pricing pressure as travel budgets are pruned. A simple airline margin proxy juxtaposing airline selling prices with fuel prices, signals that the industry's margin expansion will turn into a much steeper correction than analysts anticipate (bottom panel). As a result, profits are slated to underwhelm. Bottom Line: We are reiterating our high-conviction underweight stance in the S&P airlines index. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK.
A renewed flare-up in euro area banking sector stress will have ramifications for U.S. bank stocks, despite little direct geographic exposure. The chart shows that risk premiums for U.S bank stocks have been tightly correlated with those of the euro area during previous stress episodes, as this represents a deflationary shock that suppresses the global interest rate structure and undermines global economic activity. Our Global Sector Strategy service has been recommending underweight exposure to euro area banks since mid-March in global equity portfolios. Worrisomely, things are about to get worse before any improvement materializes. The Brexit referendum result has served as a catalyst to expose euro area banks as the weak global financials links. Both absolute and relative performance are probing all-time lows (top panel), dropping even below the depths of the Great Recession. Eurozone banks are plagued by compressing net interest margins, courtesy of NIRP and QE, and still elevated non-performing loans (second panel). This is a lethal combination for bank profits as loan growth is failing to provide an offset. What is missing in the Eurozone is a true bank recapitalization, as happened in the U.S. in late-2008 via TARP. On that front, we are eagerly awaiting the EBA/ECB stress test results slated for July 29 for an update on the health of the euro area's banking sector. Beyond any recapitalization efforts, an opening of the fiscal taps would also serve as a potential positive catalyst to help revive moribund loan demand. Until then, global bond yields will likely dive deeper into negative territory, anchoring bank ROE (third panel). Bottom Line: Resist any temptation to bottom fish in euro area, or U.S., banks. For additional details please visit http://gss.bcaresearch.com/
We test three channels of contagion from the Brexit shock: political, banking system, and economic.
There is a strong incentive for homeowners to invest in their own homes, as existing home prices have eclipsed pre-crisis peaks. Mortgage credit is also readily available and growing again after a multiyear contraction, which will aid in the resale process. There is significant scope for mortgage credit to grow, which implies a long sales runway for home improvement retailers. The latter had battened down the hatches following the housing crisis, closing stores and curtailing investment. Low construction spending is supportive of near-term same-store sales performance, and also implies that the industry can shift back into expansion mode at some point. If so, then historically appealing relative valuation levels have room to expand. We recommend moving back to an overweight stance in this group. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW.
The decline in global bond yields and negative interest rates outside the U.S. represent a windfall for U.S. housing, to the extent that U.S. mortgage rates are pushed below levels warranted on U.S. fundamentals alone. With a fully functioning banking system, and a willingness to extend mortgage credit, the housing sector should accelerate in the second half of the year. By extension, the S&P home improvement retailing index is poised for liftoff. The group has corrected laterally in recent months, ignoring the bullish signal from the plunge in Treasury yields (shown inverted, top panel). There is already evidence that lower mortgage rates are stoking housing demand: mortgage purchase applications are gaining traction after a long slumber, and refinancing activity is perking up. Mortgage rates have declined sufficiently to make refinancing a viable option for many homeowners. As housing-related financing becomes more readily accessible, the means and incentive to undertake renovation projects should accelerate. The NAHB remodeling survey has been grinding lower, but a reversal is likely given rising mortgage demand and a high level of pending home sales, a catalyst for home improvement projects. Importantly, there is a long runway for growth ahead, please the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW.