Sectors

Recently, the insurance group has enjoyed yet another mini relative performance burst of strength, supported by the modest uptick in bond yields. However, we doubt that a sustainable outperformance phase can ensue. Pricing power momentum has rolled over. Total home and auto sales growth has decelerated close to nil, suggesting a slowing in new written premiums. In the meantime, insurance companies have been bizarrely aggressive in terms of hiring. Insurance headcount has vaulted higher in the last several quarters. A more onerous cost structure is not compatible with headwinds to top-line growth. As a result, we doubt that excellent value will be realized. Downgrade to neutral and please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are BLBG: S5INSU - AIG, CB, MET, MMC, PRU, TRV, AFL, AON, ALL, PGR, WLTW, HIG, PFG, L, CINF, LNC, XL, AJG, UNM, TMK, AIZ.

Data processing stocks have marked time since we took profits and downgraded to neutral in mid-February. Increasingly, this lateral move looks to be a consolidation rather than a trend change. This group fits into our consumption vs. capital spending theme, and outperforms when economic growth slippage is the dominant driver of a disinflationary macro backdrop. Data processing sales went through a rough patch, but the seeds of a recovery have been sown. Top-line performance is highly correlated with consumer sector transaction volumes. Resilient consumer confidence, a high savings rate, decent job growth, and rising incomes all imply that spending should remain an economic bright spot. The relative performance consolidation has allowed the industry to grow into premium valuations, at a time when the high margin and recurring revenue nature of the industry's operating profile stands out in a disinflationary world struggling to grow at trend, let alone above it. Please see yesterday's Weekly Report for more details on the upgrade. The ticker symbols for the stocks in this index are: BLBG: S5DPOS - V, MA, PYPL, ADP, FIS, FISV, PAYX, ADS, GPN, WU, XRX, TSS.

Although the Fed is on track to hike rates in December, the credit cycle is far more advanced than the monetary tightening cycle. Position for a December rate hike by being short duration and in curve flatteners. Weakening corporate balance sheet fundamentals mean the long-term trend is for corporate spreads to widen.

Stocks are flirting with new highs, courtesy of a gradualist Fed and the reduced threat
of incremental near-term U.S. dollar strength.

In a Special Report published on September 6, we made the case that the transportation sector was already discounting a deep recession, and that only a stabilization rather than acceleration in economic prospects was required to realize good value. As part of that report, we upgraded the S&P air freight & logistics group to overweight. Global revenue ton miles have returned to positive growth, which should ultimately restore pricing power. The sustainability of the increase in air traffic is decent, given that inventories in the key manufacturing regions of the world are contracting, which is a positive sign for future activity levels. On the domestic front, non-store retail sales are handily surpassing overall retail sales at the fastest clip since the tech bubble burst, and are signaling that a relative valuation re-rating phase is looming (bottom panel). Meanwhile, the air freight group has a low earnings hurdle to surpass, as evidenced by relative forward earnings growth estimates, and confirmed by upbeat results from FedEx earlier this week. Bottom Line: We reiterate our recent shift to overweight. The ticker symbols for the stocks in this index are: BLBG: S5AIRFX - UPS, FDX, CHRW, EXPD.

Special Report

A playable pair trade opportunity has emerged on the back of shifting capital spending patterns: long communications equipment/short machinery.

We put the odds of an oil-production freeze agreement between OPEC and Russian officials next week in Algiers at slightly better than a coin toss.

Are negative yields on $10 trillion of global bonds a sure sign of a bubble? The answer is no... and yes.

Following a temporary reprieve, banks are about to run into a brick wall. The latest Bank For International Settlements (BIS) Quarterly Review[1] made for grim reading on the global loan growth front: the global credit impulse continues to nosedive reflecting capital constraints and deleveraging. Weak demand for and limited availability of credit is a serious constraint to banking sector profitability. The bottom panel of the chart shows that the BIS global credit impulse indicator has been an excellent leading indicator of relative bank profitability, and the current message is bearish. Higher interest rates are unlikely to solve this problem, as appears to be the hope based on the short-term positive correlation between interest rates and bank stock relative performance. Bottom Line: Every bank rally has proved self-limiting year-to-date and at least a retest of the July relative performance lows is looming. Stay underweight the S&P banks index. The ticker symbols for the stocks in this index are: BLBG: S5BANKX-JPM, WFC, BAC, C, USB, PNC, BBT, STI, MTB, FITB, KEY, CFG, CMA, HBAN, ZION, RF, PBCT. [1] http://www.bis.org/publ/qtrpdf/r_qt1609.htm

The fiscal spending impulse in China is still positive but receding. The nation's productivity and potential GDP growth are bound to decline due to a rising role of government in capital and resource allocation. Hence, cyclical stabilization could well be overwhelmed by a structural slowdown. Another bubble is forming in China, this time in the corporate bond market. The amelioration in Korean and Taiwanese exports is due to the technology sector/semiconductors, and does not reflect broad-based improvement in global trade.