Technology

Despite our reservations about the broad tech sector, which has bounced under the leadership of only a handful of stocks, we are encouraged by the outlook for the communications equipment sub-component. This extremely undervalued group is enjoying a broad-based technical breakout, based on fundamental improvements. Our industry relative advance/decline line has touched new highs at the same time that the share price ratio has broken decisively above its multiyear downward sloping trend-line on an upsurge in momentum. That alone is indicative of a major trend change, a view that is driven by positive macro forces, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5COMM - CSCO, MSI, HRS, JNPR, FFIV.

A two-speed economy requires selective portfolio construction, favoring consumer-oriented and mainly non-cyclical industries. Put communications equipment on the high-conviction overweight list, and stay clear of refiners.

In successful investment analysis "less is more, and usually much more effective."

The breakout in the S&P 500 could boost flows to EM, and momentum could overwhelm fundamentals for several weeks. Nevertheless, U.S. interest rate expectations will rise and it, along with weak EM profits, will cap upside in EM risk assets. Take profits on our short EM stocks/long 30-year U.S. Treasurys position. Reduce short exposure to EM currencies by closing the currency trades where the long side is partially against the yen.

Our <i>Cyclical Indicator Update</i> reveals that a defensive portfolio strategy remains the best bet to navigate the crosscurrents of stagnant profit/economic growth yet abundant global liquidity.

Housing activity should accelerate in the back half of the year given the drop in Treasury yields. Buy home improvement retailers and add to long homebuilding positions.

At current levels, Treasury yields are consistent with our assessment of fair value. Further, the Fed's Labor Market Conditions Index does not suggest an imminent recession. Expect payrolls to stabilize above levels consistent with further progress on wage growth and inflation, allowing the Fed to hike rates later this year.

The S&P technology sector has been drifting lower in relative performance terms, which is notable given that the broad market has made a charge toward the top end of its trading range. The lack of leadership from this traditionally high beta sector reflects ongoing deterioration in earnings drivers. The San Francisco Fed's Tech Pulse Index, a coincident indicator of tech sector activity including employment, output and shipments, has rolled over after a multiyear expansion. Additional downside is probable, given that tech new orders have slipped into the contraction zone on the back of the nascent retrenchment in corporate sector capital spending and relentless contraction in emerging market exports (bottom panel). Technical conditions are warning that the downturn in relative performance is the start of a sustained bear market. Our Technical Indicator has declined into the sell zone after diverging negatively from the share price ratio. Breadth is thin, as far less than half of the sub-industry groups are trading above their 40-week moving average, in relative terms, and/or with a positive 52-week rate of change. The bottom line is that an underweight stance is the best way to protect portfolios from looming underperformance.

What is liquidity? How is it created and destroyed? And when does it trigger turning-points in financial markets?

Our upgrade of the S&P electrical components & equipment (ECE) index to overweight earlier this year was based on both market and industry factors. The group had undershot on technical, valuation and sentiment basis. Moreover, it was being unfairly lumped in with more resource-dependent industrial sector groups, particularly given that the index is comprised of large, diversified manufacturing businesses with exposure to a variety of end markets. However, market extremes have been unwound and headwinds to a fundamental earnings recovery have surfaced. Shipment contraction is rife, and unlikely to improve given that new orders have tumbled. Factories are likely to become underutilized. Utilization rates had stayed remarkably high during the overall economic downturn, owing to capacity shrinkage. This resilience is at risk now that leading revenue indicators are sinking. Productivity growth has dipped, and has more downside risk, given that wage inflation is outpacing deflationary pricing power growth. Adding it up, the power to sustain the advance in ECE stocks is diminishing, and we recommend moving to the sidelines. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5ELCO - EMR, ETN, ROK, AME, AYI.