Developed Countries

Equities are celebrating domestic economic disappointment rather than re-pricing the risk of ongoing profit struggles. This reinforces that liquidity and share price momentum are still the dominant market forces.

Wedged between an improving labor market but icy global conditions, the Fed may be on the verge of conducting a policy mistake. This would be dollar and yen bullish. Commodity and EM currencies should bear the brunt of any pain. The pound's upside is limited, but so is the downside. NZD should soon buckle. Draghi did nothing, yet the euro rebounded little.

While a September rate increase is still possible, the recent batch of disappointing U.S. economic data, combined with lackluster inflation readings and election uncertainty, suggest that a December hike is much more probable. Similar to last year, risk assets are likely to react negatively to the prospect of further monetary tightening. Stay tactically short global equities and position for a stronger dollar.

S&P communications equipment greenshoots are turning into full blossom, signaling additional share price outperformance ahead. The latest Federal Reserve industrial production (IP) release highlighted that telecom equipment factories are revving their engines, in contrast with muted overall output growth. Historically, industry IP growth has been closely correlated with shipments-to-inventories momentum and the current message is positive (second panel). Output is booming relative to capacity, inventories are lean and telecom equipment imports are subdued, which is supportive of pricing power. All of this is boosting our industry productivity proxy (third panel). The upshot is that S&P communications equipment profits will outperform the S&P 500, serving as a catalyst for a relative valuation re-rating phase (bottom panel). Bottom line: While we are underweight the broad tech sector, we are reiterating our early-August high-conviction overweight stance in the S&P communications sub-group. The ticker symbols for the stocks in this index are: BLBG: S5COMM - CSCO, MSI, HRS, JNPR, FFIV.

A common perception is that the euro has been a failure for Italy. We challenge this perception and explain why it is so important for investors, whether it is wrong or right.

The latest FDIC Quarterly Banking Profile showed that bank earnings' improvement remains lackluster. What caught our attention from the release was the persistent widening in the C&I non-current loan rate, coupled with rising C&I charge-offs. C&I loans now comprise the largest category of bank credit and the recent credit quality deterioration is unnerving, despite the low starting point (C&I non-current rate shown inverted, top panel). There are high odds that the credit cycle has turned for the worse given deteriorating corporate balance sheets. Moreover, the latest reading from the labor market conditions index - the Fed's preferred labor market indicator - is signaling that total non-performing loans will soon hook back up (middle panel). This message is also corroborated by the quickly flattening yield curve, which has historically been an excellent leading indicator of the credit cycle (yield curve shown inverted, third panel). Bottom line: Shy away from the banking sector. The ticker symbols for the stocks in this index are: BLBG: S5BANKX-JPM, WFC, BAC, C, USB, PNC, BBT, STI, MTB, FITB, KEY, CFG, CMA, HBAN, ZION, RF, PBCT.

While we recently boosted the broad consumer discretionary index to overweight, we continue to avoid the auto components sub-group. Relative earnings prospects remain poor. The second panel of the chart shows that relative profitability is on the cusp of a melt-down, according to the relative shipments-to-inventory (S/I) ratio. The decline in the S/I reflects both an unwanted inventory build and decline in shipments. Overproduction will ensure that pricing power stays in deflationary territory (third panel). It would take an upsurge in vehicle demand to reverse these trends, but that is unlikely given tightening auto credit on the back of concerns about auto loan quality and a saturation in vehicle sales (bottom panel). Consequently, auto-related corporate profitability will remain under pressure. Bottom line: Stick with a below benchmark weighting in the S&P auto components index. The ticker symbols for the stocks in this index are: BLBG: S5AUTC - JCI, DLPH, BWA, GT.

The S&P air freight & logistics index has been in a long relative performance funk, during which time valuations have been squeezed down to very attractive levels at a time when fundamentals should begin to improve. Business sales are rising relative to inventory. The top panel shows that when inventories are falling relative to GDP, it provides a tailwind to relative performance. Tight inventories intensify the need for rapid delivery services to ensure optimal supply chain management. When inventories are plentiful, there is less need for high-priced, just-in-time, air freight services. Thus, the rundown in inventories is a positive sign for future revenue growth. Even emerging markets are likely to contribute. Asian manufacturing inventories are being depleted, heralding an improvement in Asian air freight growth. Nevertheless, it is important to keep expectations in check, because deleveraging, protectionist/anti-globalization sentiment and low productivity growth globally will cap global trade growth potential. Still, burgeoning online retail sales growth is a boon for package delivery. While some large retailers may take delivery in-house, spillover onto traditional carriers is inevitable. The latest surge in online sales bodes well for an end to industry deflation. We upgraded this group to overweight, please see yesterday's Special Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5AIRFX - UPS, FDX, CHRW, EXPD.

In a Special Report published yesterday, we showed that the transport relative performance bear market and valuation squeeze had already matched what has typically occurred during a recession. Consequently, any stabilization in underlying drivers of global trade could produce a positive share price outcome. Evidence supports the view that the long slump in world export growth is ending. Export volume growth in many emerging countries has climbed back into positive territory. These regions have been the epicenter of global goods production. Global export price deflation has eased, suggesting that some sort of new equilibrium has been established. Importantly, an inventory restocking phase could provide a fillip to overall export growth. Inventories have been rundown in the U.S. and other developed countries, while inventory-to-sales ratios in a number of developing countries have also rolled over. Inventory cycles are fleeting, and investment decisions should key off of overall final demand, but at current valuations, even small amounts of good news could lift the sector. Against a backdrop of productivity and profit margin resilience, the likelihood of a playable advance in the transport sector has increased, particularly in the S&P air freight index. The ticker symbols for the stocks in this index are: BLBG: S5TRAN - UNP, UPS, FDX, DAL, NSC, CSX, LUV, AAL, UAL, KSU, CHRW, EXPD, ALK, JBHT, R.

With recent comments strongly hinting that the Fed is on track for a rate hike in December, the dy-namics of the Fed Policy Loop make spread product appear extremely vulnerable.