Sectors
The excitement surrounding steel stocks earlier this year on the back of the liquidity-driven bounce in commodity prices, whiffs of stabilization in Chinese economic growth and new steel import duties is diminishing. We used the rally to reduce positions back to underweight several months ago, as valuations overshot on the back of short covering. We remain concerned that relative performance downside risks have not abated after failing at a key trend line. New orders for steel products continue to contract, signaling that underlying steel commodity prices are at risk of sinking anew. Importantly, new vehicle sales have leveled off, and total construction spending growth has downshifted to almost nil. The implication is that steel demand is likely to stay sluggish in the coming quarters. To make matters worse, China appears likely to ramp up export activity, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S15STEL-NUE, STLD, RS, X, WOR, ATI, CMC, CRS, AKS, HAYN, SXC, TMST, ZEUS.
Mental Accounting Bias creates an irrational attraction to yield, while The Halo Effect incentivizes companies to generate yield. Neither phenomenon is sustainable. We identify three sectors to avoid, and two to own.
The budding recovery in the S&P biotech index is likely to gather steam. Big pharma is desperate to replenish its drug pipeline, putting biotech equities back into play following a drawn out de-rating phase. This phenomenon is not limited to U.S. pharmaceutical companies, as European and Japanese firms are also racing to scoop up promising biotech assets. As a result, deal premia for coveted U.S. biotech companies have skyrocketed, hitting all-time highs (middle panel). Both the relative forward P/E and P/E/G ratios are sufficiently depressed to expect a wholesale re-rating as a low cost of capital and receptive markets embolden pharmaceutical companies to buy future growth (third panel). Bottom Line: We reiterate our recent boost to an overweight stance in the S&P biotech index. The ticker symbols for the stocks in this index are: BLBG: S5BIOTX - VRTX, CELG, GILD, AMGN, REGN, BIIB, ALXN, ABBV, BXLT.
REITs have been climbing a wall of worry in recent years, as the group has had to overcome chronic concerns about potential supply growth and low cap rates. To be sure, the group typically experiences a boom/bust cycle. However, outside multifamily dwellings, REIT supply growth has been subdued globally: our proxy for global construction growth has been remarkably subdued since the Great Recession. Low cap rates have been an issue for years, but the proliferation of negative interest rates around the world and persistently high economic uncertainty argues against expecting a sudden reversal. Instead, low interest rates are spurring strong commercial real estate demand (bottom panel), which has propelled commercial property prices to new highs. In the absence of a sudden and unanticipated surge in overall inflation, the forces that have supported the REIT bull market should remain intact. Stay overweight and please see yesterday's Special Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5REITS-SPG, AMT, PSA, CCI, PLD, HCN, EQIX, VTR, AVB, EQR, WY, BXP, HCP, VNO, O, GGP, DLR, ESS, HST, KIM, SLG, FRT, MAC, EXR, VDR, IRM, AIV.
Commercial real estate and REITs have benefited greatly from accommodative monetary policy. Though they are approaching a peak, our analysis shows that they remain in a "goldilocks" scenario and still offer plenty of upside.
The populist backlash, if left unchecked, could spiral out of control, leading to severe losses for investors. Concerns about lax financial regulation, rising inequality, unfettered globalization, and fiscal austerity are understandable. Addressing these grievances will hurt corporate profits short-term, but could lead to a more resilient economy longer-term. Investors should position for modestly higher inflation and steepening yield curves. Near-term, equities are technically overbought, but will benefit from the shift to more stimulative fiscal and monetary policies.
Health care equipment stocks are overbought relative to the broad market, and a corrective pullback is inevitable. We had been concerned that the latest leg up might represent the final outperformance phase for this group, given rising wage inflation and a cooling in revenue growth indicators, but our conviction in the longevity of the cyclical bull market has been reinforced. Medical equipment demand is accelerating on a number of fronts. Domestic uptake is being driven by a rising number of procedures, as evidenced by double-digit strength in consumer spending at hospitals. That is a sustainable trend given rising income growth and broader health insurance coverage. Medical equipment exports have also reaccelerated. That is notable because it has occurred within the context of a flat, rather than weak, U.S. dollar. The implication is that demand from abroad is also on the upswing, as confirmed by the surge in the German IFO survey of medical equipment orders. As a result, backlogs should continue to build, ensuring that output growth stays on a solid footing. We recommend staying overweight. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, SYK, BDX, BSX, BAX, ISRG, EW, STJ, ZBH, BCR, VAR.
Shift to a small vs. large cap bias as a stealth way to play the overall equity market overshoot. The oversold bounce in banks is not worth chasing, and buy dips in medical equipment stocks.
Drug retail relative valuations have divorced from bullish indicators of top and bottom-line performance. Retail sales momentum continues to accelerate. The ongoing hospital hiring frenzy is indicative of rising procedures, and provides a good indication for future prescription drug demand, and thus pharmacy retail sales. Importantly, drug retailers are gaining market share from hypermarkets (third panel), underscoring that they will receive a disproportionate share of rising store traffic. From a contrarian perspective, there appears to be little buy in to a positive sales view, given that analysts have pared back relative sales growth expectations (fourth panel). Meanwhile, investors have attached a massive risk premium to the group (bottom panel). There is room for both profit and multiple expansion, and we reiterate a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5DRUG - CVS, WBA.
The S&P retail drug store index has been undermined by concerns about the opaque pricing structure of its pharmacy benefits management arms, which has pushed relative valuations to extremely attractive levels. While it is difficult to forecast whether any major concessions will be made to appease health insurers, this focus is masking an increasingly upbeat picture for the rest of the core business. Consumers are allocating a record share of their spending to pharmacy-related items, continuing a trend in place for more than two decades. It is rare for relative performance to deviate from relative spending trends for long, as the latter provides a clear indication of the industry's ability to deliver better-than-market profitability. Importantly, drug retailers have retrenched in recent years, paving the way for solid same-store sales growth. Shorter-term performance indicators are even more upbeat, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5DRUG - CVS, WBA.