Equities

Special Report

Commercial real estate and REITs have benefited greatly from accommodative monetary policy. Though they are approaching a peak, our analysis shows that they remain in a "goldilocks" scenario and still offer plenty of upside.

The lack of inflation makes a Fed rate hike before December unlikely. In the interim, the continued flow of liquidity could sustain the high-risk rally.

Special Report

The populist backlash, if left unchecked, could spiral out of control, leading to severe losses for investors. Concerns about lax financial regulation, rising inequality, unfettered globalization, and fiscal austerity are understandable. Addressing these grievances will hurt corporate profits short-term, but could lead to a more resilient economy longer-term. Investors should position for modestly higher inflation and steepening yield curves. Near-term, equities are technically overbought, but will benefit from the shift to more stimulative fiscal and monetary policies.

Special Report

Brazilian risk assets have rallied on the back of investor optimism about the impeachment of President Dilma Rousseff. But the political games have just begun. With all politicians looking to the October municipal elections and 2018 general elections, the Michel Temer administration is unlikely to impose fiscal and structural reforms. Debt dynamics are set to worsen, and we continue to short Brazilian equities.

The global search for yield, not an improvement in EM fundamentals, has been driving the EM rally. EM/China growth conditions have stabilized but not recovered. Barring a full-fledged cyclical profit upsurge in EM EPS, EM stocks are not cheap at all. EM/China final demand for commodities will disappoint and will likely produce a major reversal in EM risk assets.

Health care equipment stocks are overbought relative to the broad market, and a corrective pullback is inevitable. We had been concerned that the latest leg up might represent the final outperformance phase for this group, given rising wage inflation and a cooling in revenue growth indicators, but our conviction in the longevity of the cyclical bull market has been reinforced. Medical equipment demand is accelerating on a number of fronts. Domestic uptake is being driven by a rising number of procedures, as evidenced by double-digit strength in consumer spending at hospitals. That is a sustainable trend given rising income growth and broader health insurance coverage. Medical equipment exports have also reaccelerated. That is notable because it has occurred within the context of a flat, rather than weak, U.S. dollar. The implication is that demand from abroad is also on the upswing, as confirmed by the surge in the German IFO survey of medical equipment orders. As a result, backlogs should continue to build, ensuring that output growth stays on a solid footing. We recommend staying overweight. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, SYK, BDX, BSX, BAX, ISRG, EW, STJ, ZBH, BCR, VAR.

The small vs. large cap ratio peaked in 2014 and should have experienced a tumultuous corrective phase, given that the bulk of the major equity indexes such as the Value Line and Wilshire indexes endured bear markets, driven by tightening financial conditions, credit concerns, a global manufacturing recession and commodity price crunch. However, the corrective phase has been more lateral than down and our concerns about outsized profit margin compression have now come to pass: small cap margins have been crushed, especially relative to large caps. But this gap should close. The NFIB survey of the small business sector shows that labor compensation plans have rolled over. In addition, the NFIB reported price changes index has troughed. At the same time, the overall employment cost index, a good proxy for large cap wage expenses, is accelerating. The upshot is that small cap margins should soon stabilize, while large cap margins continue to get squeezed. Small caps are now slightly cheaper than large caps, according to our gauge, and a move back to a premium is probably if the profit margin gap closes on the back of renewed strength in the U.S. dollar. Bottom Line: shift to a small cap preference and please see yesterday's Weekly Report for more details.

Shift to a small vs. large cap bias as a stealth way to play the overall equity market overshoot. The oversold bounce in banks is not worth chasing, and buy dips in medical equipment stocks.

Drug retail relative valuations have divorced from bullish indicators of top and bottom-line performance. Retail sales momentum continues to accelerate. The ongoing hospital hiring frenzy is indicative of rising procedures, and provides a good indication for future prescription drug demand, and thus pharmacy retail sales. Importantly, drug retailers are gaining market share from hypermarkets (third panel), underscoring that they will receive a disproportionate share of rising store traffic. From a contrarian perspective, there appears to be little buy in to a positive sales view, given that analysts have pared back relative sales growth expectations (fourth panel). Meanwhile, investors have attached a massive risk premium to the group (bottom panel). There is room for both profit and multiple expansion, and we reiterate a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5DRUG - CVS, WBA.

The S&P retail drug store index has been undermined by concerns about the opaque pricing structure of its pharmacy benefits management arms, which has pushed relative valuations to extremely attractive levels. While it is difficult to forecast whether any major concessions will be made to appease health insurers, this focus is masking an increasingly upbeat picture for the rest of the core business. Consumers are allocating a record share of their spending to pharmacy-related items, continuing a trend in place for more than two decades. It is rare for relative performance to deviate from relative spending trends for long, as the latter provides a clear indication of the industry's ability to deliver better-than-market profitability. Importantly, drug retailers have retrenched in recent years, paving the way for solid same-store sales growth. Shorter-term performance indicators are even more upbeat, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5DRUG - CVS, WBA.