Japan

China has fallen into the same "fiscal trap" that ensnarled Japan in the 1990s. Unprofitable investment projects undertaken by SOEs are a necessary evil. The underlying problem is not overinvestment, but an economy that is demand-deprived. Meanwhile, structural factors will ensure that savings remain high. Any efforts by the authorities to curb credit growth will result in a sharp economic downturn. China will continue to generate excess capacity and export deflation to the rest of the world, which is good for bonds. We recommend going long Chinese banks, the most hated equity sector.

Helicopter money is coming, and once deployed, will prove to be much more successful than most people imagine. Stay long Japanese and German inflation swaps. USD/JPY and EUR/USD are ultimately likely to reach 140 and 0.9, respectively, over the next two years. The U.S. economy will remain resilient enough to make helicopter money unnecessary but a strengthening dollar will greatly curtail the ability of the Fed to raise rates. Investors should overweight Treasurys relative to bunds and JGBs. Helicopter money will benefit gold as well as the beleaguered European and Japanese stock markets.

The Fed is accentuating bearish dynamics for the dollar over the next three to six months. The upcoming National Congress of the Communist Party of China provides Chinese authorities with an incentive to ramp up stimulus this year. The new Treasury semi-annual report pre-empts meaningful direct interventions to soften the yen. More than just Brexit risk is weighing on the pound.

The end of the Debt Supercycle will be a key theme influencing economic and financial trends for many years to come. Its hallmark will remain the inability of central banks to engineer a new credit cycle, despite extremely low interest rates. China is one of the few remaining countries where the Debt Supercycle has yet to end, and history suggests the catalyst for a turning point will be a financial crisis.

The trading action of gold is currently sending a bearish message on the dollar as the price of the precious metal has broken above critical resistance. Though the causation between the dollar and gold usually runs from the former to the latter, gold also has a tendency to sniff out broad-based moves in the greenback. We remain broadly short USD in our portfolio.

The factors that drove the recent rally - Fed dovishness, China reflation, and a pickup in economic data - are largely over. 

Corporate earnings rarely shrink outside of economic contractions, so investors can be forgiven for worrying that we are on the brink of a global recession. Earnings-per-share (EPS) for the MSCI all-country world index are estimated to have fallen by 7% in the year to March, the fourth quarter in a row of annual decline (top panel). This is by far the worst performance since the Great Recession. EPS growth in both the U.S. and the U.K. (local currency) is deep in negative territory. Profit growth is still positive, albeit decelerating, in the Eurozone and Japan in local currencies (bottom panel). How much more downside is there? When will EPS bottom and how strong will the recovery be? These are obviously key questions for the appropriate equity weighting within balanced portfolios, especially given that stocks are not cheap, downside global growth risks abound and the FOMC is biased to lift rates. It is difficult to justify being overweight equities without seeing some profit relief on the horizon. In yesterday's Special Report, we took a top-down approach to projecting EPS for the global index, the U.S., the Eurozone and Japan. The rebound in oil prices and some positive economic signs out of China have raised hopes that the profit recession is close to the end. Indeed, the good news is that world EPS annual growth should bottom in the third quarter. However, the bad news is that the climb back into positive growth territory will take time. Barring very strong (and unrealistic) growth assumptions for the rest of 2016, investors should not expect positive year-on-year global EPS growth until early in 2017. Bottom-up earnings estimates currently are too optimistic. On a regional basis, U.S. earnings growth will likely trail both Japan and the Eurozone over the next two years, although much depends on currency movements (see the next Insight). (Part I) Global Earnings Recession: How Deep? How Long? (Part I) Global Earnings Recession: How Deep? How Long?

This week <i>U.S. Equity Strategy</i> is sending you the latest <i>BCA Special Report</i>, where Mark McClellan and Anastasios Avgeriou tackle the questions of "Global Earnings Recession: How Deep? How Long?"

Reflation continues to dictate short-term market moves. Behind this sugar-high, the global economic backdrop remains poor. Commodity currencies can rally for a few more weeks, but once markets refocus on Chinese and EM core weaknesses, commodity currencies will make new lows. Within the complex, favor the NOK and the CAD over the AUD and the NZD. Our portfolio remains positioned for additional yen strength.

For the month of April, the model's performance was in line with the S&P 500, but lagged global equities. For May, the model is aggressively paring back its equity risk exposure. Both Europe and Emerging Markets were downgraded, but still possess the lion's share of the equity allocation, while defensive markets such as the U.S. and Switzerland received a boost. In the fixed-income space, U.S., Italian and Spanish paper were the model's favorites.