Developed Countries

The current profit backdrop for the machinery industry is grim, but the relative price ratio has already made a large downward adjustment and short interest is sky high. Importantly, machinery companies are finally addressing the need to reinvigorate productivity as an offset to the competitive drag from a strong exchange rate. Importantly, history underscores the likelihood of at least a temporary hiatus in the bear market. Going back to the 1950s, we have identified five durable machinery relative performance bear markets. On average, they lasted 42 months and recorded 44% in declines from peak to trough. In comparison, the current downturn has been underway since 2011, with the price ratio shedding 36%. Interestingly, a cycle-on-cycle analysis shows that machinery stocks have troughed prior to any turnaround in either the ISM index or the U.S. leading economic indicator. Instead, the group appears to have taken its cue from U.S. dollar weakness and a rally in commodity prices, both of which herald better times ahead for primary machinery end markets. Consequently, continued economic deterioration may not translate into additional relative underperformance. We upgraded to neutral in yesterday's Weekly Report, protecting a profit of 19%. The ticker symbols for the stocks in this index are: CAT, ITW, DE, PCAR, CMI, SWK, IR, PH, SNA, DOV, PNR, XYL, FLS.

Equities are attempting to find support. This year's savage downward adjustment has created short-term oversold conditions and pushed sentiment gauges to depressed levels. These circumstances can often presage violent countertrend rallies. Sentiment can be a reliable contrary indicator, but is often misleading as a standalone. BCA's Composite Sentiment Index is depressed within the context of the past few years, but it is not yet at the extremes seen at previous bear market lows and/or during recessions. Moreover, sentiment can stay low when selling begets selling as corporate profits shrink. On this front, current leading indicators are signaling ongoing vulnerability: Global trade is in recession, deflation still haunts the corporate sector courtesy of the strong U.S. dollar and the latest durable goods report was very weak. Consequently, the recent equity bounce should be treated with caution and as a cash-raising opportunity.

The oversold bounce is not supported by policy or profits, and should be treated as countertrend. Lift machinery to neutral and differentiate between pharmaceuticals and the unwinding of the biotech mania.

Any recovery in risk assets and selloff in safe havens is unlikely to extend into the cyclical horizon.

Last month, the model outperformed both global and U.S. equities in local-currency and U.S.-dollar terms. For February, the model is aggressively increasing its risk exposure and has included a bet on commodities for the first time since 2012. For equities, the largest overweight remains Europe, but EM and Canada enjoyed significant upgrades. For bonds, the model favors the European periphery.

The previous Insight showed that the overall industrials sector was in recession territory, based on the message from sinking capital goods orders. At a minimum, that argues for a highly selective investment approach. For instance, in December, we separated our coverage of the S&P aerospace & defense index into its two distinct components, underweight the former and overweighting the latter. We showed that a divergence between these two groups is typical during recessions. The latest data bear out this view. Aerospace new orders are very soft, arguing the commercial aerospace cycle is on the downswing. In turn, that implies lower plane deliveries and future profit margin pressure, as evidenced by Boeings' earnings miss. Conversely, defense orders are moving higher, which is supportive of ongoing earnings growth. We reiterate our overweight view of defense stocks, and underweight stance on aerospace names.

The industrials sector stands out as having operating margins well above its historic average, along with an elevated price/sales ratio, as shown in Table 1 from this week's report. The ISM manufacturing index heralds a reversion to the mean in profit margins (bottom panel). The latest durable goods report confirmed this bearish message: core durable goods orders were very weak, which is consistent with negative relative forward earnings momentum. The Philadelphia Fed Survey of corporate capital spending intentions is sinking steadily, warning that durable goods orders are likely to stay weak. The implication is that profits remain at risk of disappointing. It is too soon to lift underweight positions, and sub-surface exposure should stay selective, please see the next Insight.

Informe especial

We are introducing a quantitative equity country allocation for the MSCI World universe. Currently the model recommends overweight U.S. and eurozone while underweight Japan, U.K., Canada and Australia, broadly in line with our judgement except that we are more bullish on Japan than the model.

The setback in global financial markets has not been enough to persuade the FOMC to alter its stance. Although the Fed is signaling that the tightening cycle has further to run, the U.S. dollar is showing signs of fraying at the edges.

The Fed will upset the rebalancing of oil markets if it misreads the current sell-off as weakness in oil demand.