Sectors

Risks to global growth remain to the downside. Selling pressure in cyclical markets and assets will escalate. EM currencies will make new lows versus the U.S. dollar, the euro and yen. Take profits on our long JPY/short KRW and long JPY/short SGD trades. Short KRW versus an equal-weighted basket of the U.S. dollar, yen and euro. Continue underweighting Peruvian equities.

Chinese housing construction does not look excessive relative to the size of its rapidly growing urban population. On average, China's new urban construction has been about 500 units per 1000 new urban citizens in the past 10 years, roughly comparable to other countries, and is much smaller than Korea and Japan during the prime stage of their urbanization process.

Industrial machinery stocks have surged as if China is headed back to double-digit GDP growth and the U.S. dollar is going to reverse all of its recent year's gains. That combined scenario would produce a rebound in sales growth, and allow investors to bet on increased operating leverage. But that is wildly optimistic, especially given that the sales outlook remains murky. Our global machinery new order proxy is contracting. Global machinery exports have also gone ex-growth. Importantly, leading indicators of new orders are bearish. For instance, BCA's Global CapEx Indicator is heralding a contraction in developed country capital formation. That does not bode well for global output growth, and by extension, machinery consumption. Coal and other commodities also provide a good read for future industrial machinery demand. Clearly, coal is warning that machinery new orders will stay punk. Whiffs of reflation in China have supported other commodity prices, but it is premature to extrapolate this liquidity-driven bounce into a demand-driven upturn. Loan demand is still anemic, and machinery stocks have front run any improvement in China's cyclical outlook (bottom panel). Use the rally in the SP& industrial machinery index to downshift to an underweight position.The ticker symbols for the stocks in this index are: BLBG: S5INDM - ITW, SWK, IR, PH, PNR, DOV, SNA, XYL, FLS. 

Fed hawkishness reinforces the need for an imminent profit recovery to justify current valuations. Our Indicators do not signal such an outcome. Stay defensive, and return to an underweight stance in the industrials sector.

Our recent upgrade of the S&P hypermarkets index was predicated on the view that expectations had become so depressed that upside profit margin and sales surprises were increasingly likely. Walmart's positive earnings results suggest that this thesis is starting to play out. There is tentative evidence that the industry's investments in store improvements and marketing are paying off. Hypermarket sales are rising in absolute terms, and are finally gaining ground on overall retail sales. This trend should be sustained, as lower income consumers are feeling much more confident than higher income consumers as wage inflation improves (second panel). In fact, hypermarkets could enjoy an influx of new customers given that the rising personal savings rate implies that more affluent consumers may soon 'trade down' when shopping in order to preserve capital. At the same time, costs are under control, as measured by the deflation in imported consumer goods prices and ongoing deflationary pressures from major producing countries. This is a recipe for continued upside profit surprises and we reiterate our overweight stance. The ticker symbols for the stocks in this index are: BLBG: S5HYPC - WMT, COST.

Special Report

Australia's equities and currency are driven largely by industrial commodities prices, Canada's by the oil price. Given our more positive view on oil, we prefer Canadian assets, though both markets face risk from stretched property prices and household debt.

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.

The previous Insight showed that the financial sector remained on its heels as a consequence of ongoing global deflationary backlash. This backdrop is particularly difficult for asset managers & custody banks (AMCB). This index is a high beta play on economic and financial market confidence. When the latter is high, M&A activity, share buybacks and other sources of industry fee income tend to accelerate. The opposite is also true. At the moment, global economic confidence is sinking, as measured by our composite sentiment gauge (top panel) and the stock-to-bond ratio (bottom panel), and is likely to erode further as economic disappointment mounts (third panel). Meanwhile, M&A activity is on the wane as capital availability has become more restrictive (second panel). These forces warn that AMCB profitability is likely to underwhelm. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5AMGT- BLK, BK, STT, TROW, AMP, NTRS, BEN, IVZ, AMG, LM.

The S&P financials sector continues to battle deflationary forces. While inflation expectations are off their low courtesy of this year's dip in the U.S. dollar, they remain well below 2014 levels when the U.S. dollar began to surge (top panel). The negative profit backlash from global deflation continues to reverberate across the business sector, and has undermined corporate balance sheets to the extent that banks are much less willing to extend C&I loans, their main source of asset growth (second panel). These trends are also sustaining downward pressure on the long end of the Treasury curve, causing a relentless yield curve narrowing. With the Fed still eager to lift interest rates, despite evidence of growth slippage, the odds of a policy mistake are creeping higher. Against this backdrop, financial sector profits are likely to lose additional steam, raising the odds of a breakdown in relative performance to new lows. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5FINL.

We focus on 3 stress-points in the economy and markets which segue to several high conviction investment recommendations.