Corporate Profits
A dovish Fed bought the bounce a bit more time, but there is little incentive to add portfolio risk. Buy consumer finance, especially vs. banks, and expect communications equipment outperformance.
While the FOMC was more dovish than expected, rising inflation may cause the Fed to escalate hawkish rhetoric. The bounce in oil should help high-beta stocks. Underweight U.S. equities versus Europe, Japan and H-shares. We estimate U.S. equities will deliver returns of 4%, ann. over the next 10 years, <i>vis-à-vis</i> 9% for the euro area and Japan, and 14% for H-shares. Central banks have more options to combat any possible debt-deflation spiral in Europe/Japan/China than is often recognized.
If the EM rally is sustained, the Fed will once again become resolute in its commitment to hiking interest rates. This in turn will spur another relapse in EM risk assets. Chinese policymakers are attempting to juggle contradictory objectives without a clear and realistic plan of action to resolve existing problems.
Confirming indicators still do not validate the oversold rally. Fade the materials sector bounce, by selling steel down to underweight.
Are the arguments for overweighting European equities still valid? If so, overweighting relative to what?
The recent rebound is not a harbinger of a prolonged recovery in risk assets. The many potential negatives will keep volatility high and trigger further occasional selloffs.
Credit growth acceleration in China is a bearish development in the long run. Potential non-performing loans at Chinese banks could wipe out 40-55% of their equity capital. "Muddling through" for China, from its own internal standpoint, is possible. However, Chinese stocks and China-related equities worldwide will remain in a bear market. From the perspective of the rest of the world, China is now in recession.
Lean against rally attempts until leading profit indicators improve. The conditions for a tradable oilfield services rebound remain elusive. Capital markets may bounce, but we would sell on strength.
There is no sign that the Chinese economy has suddenly lost momentum. The credit and monetary cycle appears to be picking up. Meanwhile, our bottom-up analysis shows no evidence of a rapid buildup in leverage in China's corporate sector, as commonly perceived.