Equities
The sharp spike in HIBOR will be short lived. The RMB "carry trade" has been largely unwound. The RMB will not experience the intense selling as seen in the past year. H shares are still trading at substantial discounts to A shares, which will inevitably continue to draw domestic investors. Strategically, H shares remain a better bet than their domestic counterparts.
A playable pair trade opportunity has emerged on the back of shifting capital spending patterns: long communications equipment/short machinery.
We put the odds of an oil-production freeze agreement between OPEC and Russian officials next week in Algiers at slightly better than a coin toss.
Following a temporary reprieve, banks are about to run into a brick wall. The latest Bank For International Settlements (BIS) Quarterly Review[1] made for grim reading on the global loan growth front: the global credit impulse continues to nosedive reflecting capital constraints and deleveraging. Weak demand for and limited availability of credit is a serious constraint to banking sector profitability. The bottom panel of the chart shows that the BIS global credit impulse indicator has been an excellent leading indicator of relative bank profitability, and the current message is bearish. Higher interest rates are unlikely to solve this problem, as appears to be the hope based on the short-term positive correlation between interest rates and bank stock relative performance. Bottom Line: Every bank rally has proved self-limiting year-to-date and at least a retest of the July relative performance lows is looming. Stay underweight the S&P banks index. 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. [1] http://www.bis.org/publ/qtrpdf/r_qt1609.htm
An attractive cyclical pair trade opportunity is developing between the S&P telecom services and S&P financial sectors. Both are depressed from an historical standpoint, but will perform differently in the face of relentless global deflationary pressures. To a large extent, the fortunes of this position will depend on whether the global economy can finally break out of its see-saw pattern of low amplitude mini-cycles, all within the context of secular stagnation and a scarcity of final demand growth. When deflation is the dominant global force, corporate credit quality comes under pressure. Overall ratings migration is deteriorating, underscoring that non-performing loans will weigh on the financial sector's earnings. Notwithstanding the recent blip up in global yields from exceptionally low post-Brexit depths, the undercurrent of chronic excess global capacity and deleveraging will keep long-term yields under downward pressure, to the detriment of financials sector net interest margins. While both sectors are largely domestically-focused, telecom services should have the upper hand given the non-cyclical nature of their revenue stream. If the U.S. continues to import profit strains through U.S. dollar strength, the financials sector will be harder hit. We recommend using the recent pullback to initiate a long telecom services/short financials pair trade. Please see yesterday's Weekly for more details.
History shows that premium valuations for high quality stocks are sustainable when overall final demand is sub-par. Using consumer products as a guide, when real GDP is low and/or volatile, relative P/E multiples tend to reside at the top end of their range. That makes intuitive sense, because low potential GDP growth and the persistent threat of deflation in an economy operating close to stall speed are consistent with a low neutral real interest rate. The latter is a more powerful boost to long duration non-cyclical sectors than it is for short-cycle, economically-sensitive cyclical sectors. This phenomenon can be seen globally. For instance, in Japan, defensive sectors crushed their cyclical counterparts during the deflationary 1990s. Importantly, the share price ratio has been steadily making new highs for the past few years, and is well above the peak reached at the depths of the Great Recession even as the BOJ grew its balance sheet aggressively over that period. Not surprisingly, countertrend moves in favor of Japanese cyclicals required a period of accelerating global economic growth, as measured by our global leading economic indicator (shown inverted). The lesson from Japan is that when liquidity, not economic growth, drives equity markets, long duration sectors can overshoot by a wide margin.
Consumer products stocks are likely to move to an even larger valuation premium before the cyclical outperformance phase ends.
The secular bond bull market is over. Safety is in a bubble. The shift from monetary to fiscal easing is the most likely candidate to prick the bubble in safety.
In this piece we revise our yield portfolio to increase its resilience to interest rate shocks.
The previous Insight showed that top-line growth for medical equipment companies was accelerating. It is notable that manufacturers' inventories of medical supplies are contracting at their steepest rate since 2009, which bodes well for factory utilization and pricing power. Moreover, medical equipment wage inflation has turned sharply lower. Higher sales, rising backlogs and a lack of cost inflation imply that there is scope for profit margin expansion. The latter is not factored into valuations, nor earnings growth expectations. Stay overweight. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, DHR, BDX, SYK, BSX, ISRG, BAX, ZBH, EW, STJ, BCR, HOLX, VAR.
Health care equipment stocks are pulling back, but this is a correction from overbought levels rather than a trend change. Profit margin prospects remain upbeat. The surge in consumer spending at hospitals has encouraged an expansionist mindset, as highlighted by the surge in health care facility construction activity. The latter is highly correlated with medical equipment new orders, as a larger footprint will add to the volume of procedures performed over and above the increase from faster health care spending. Importantly, revenue gains also reflect global factors. U.S. medical equipment exports are set to return to a growth track, based on the upbeat message from the German IFO survey of medical equipment demand. Wage inflation is also in retreat, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, DHR, BDX, SYK, BSX, ISRG, BAX, ZBH, EW, STJ, BCR, HOLX, VAR.