Sectors
Some tentative signs of life in the global manufacturing data suggest that Treasury yields have some room to move higher in the near term.
Last week we added the overall health care sector to our high-conviction overweight list, given our confidence that defensive sectors will continue to outperform the broad market on a cyclical basis, regardless of the latter's near-term trend. As part of this move, the S&P managed care index now warrants overweight exposure. The pressure on payers of medical services relative to the providers of those services has ebbed, because overall health care outlays are no longer accelerating relative to total spending. That should open the door to another upleg in relative performance, provided costs stay under control. On this front, our medical cost proxy is still moving laterally, despite the previous increase in surgeries, procedures and sector pricing inflation. This will keep a lid on the medical loss ratio, alleviating potential downward pressure on profit margins, and by extension, relative valuations. Keep in mind that the impact of previous consolidation on cost containment has yet to be fully felt. The implication is that discount relative valuations should be exploited. Upgrade to overweight and please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5MANH - AET, ANTM, CNC, CI, HUM, UNH.
Our bearish thesis on the S&P cable & satellite index is not playing out. Instead of skinnier cable packages and cord cutting denting profitability, the industry has managed not only to sustain pricing power, but also to increase selling prices at a faster rate than overall inflation. The latest personal consumption expenditures report showed that cable outlays, in real terms, have begun to march higher again after flat-lining for two years. The cable industry has monopolistic properties, enjoying decades of rising 'real' pricing power. Now that real spending has reaccelerated, it will boost the odds that real selling prices will follow suit. One of our fears had been that slowing sales and rising subscriber churn would force cable providers to ramp up investment to retain customers. However, the largest cable distributors reportedly saw their total cable subscribers decline only 1% in the fourth quarter, similar to the loss in the third quarter, reinforcing that cord cutting is ebbing. The downtrend in capital spending-to-sales has been a major driver of the expansion in operating margins. If capital spending is not going to accelerate, then profit margins won't come under much pressure. We made a full shift to overweight in yesterday's Weekly Report. The ticker symbols for the stocks in this index are: BLBG: S5CBST - CVC, CMCSA, TWC.
The Fed is unlikely to derail the housing recovery.
In this report we detail our structurally bullish U.S. housing view and how to profit from it.
Equities are back in overshoot territory. We added the health care sector to our high-conviction overweight list, boosted managed care to overweight and put health care equipment on downgrade alert. Buy cable stocks.
Fed dovishness is weakening the U.S. dollar. As the ECB and BoJ move to the sidelines and the Fed remains reluctant to hike rates, the euro and Japanese yen should continue to recover versus the greenback.
Several tail risks appear less ominous compared to last month. Nonetheless, the earnings outlook has not improved and the FOMC will turn more hawkish ahead of the June meeting. Stay defensively positioned.
Monday's Special Report highlighted an overwhelmingly bullish macro backdrop for defensive sector relative performance. Health care is a key defensive component, but it has been hit hard in recent weeks, denting investor confidence. The main culprits behind the pullback have been the bounce in inflation expectations on the back of the dip in the U.S. dollar. The sector had rallied in lockstep with intensifying global deflationary pressures for the past few years, and it is only natural that it be used as a source of funds to lift exposure to cyclical sectors on the first whiff of financial stress relief. However, the path of least resistance for health care earnings is still up, in relative terms. Our Cyclical Macro Indicator is emitting bullish signals, supported by the resurgence in sector pricing power, particularly compared with moribund overall corporate sector selling price inflation. Importantly, valuation and technical factors also argue for a bullish reversal. Our relative valuation gauge is at an extremely undervalued level, while technical conditions are deeply oversold. These conditions are unlikely to last if relative forward earnings keep climbing, as we expect. Consequently, the reward/risk tradeoff is sufficiently upbeat to warrant adding the sector to our high-conviction overweight list.
Mixed data on housing turnover and new home prices have created some uncertainty surrounding the S&P homebuilders index over the past year, but we continue to see robust upside potential. Home prices are recovering after experiencing volatility in recent quarters, but not to the extent that affordability has been compromised. In fact, the Fed's dovish shift has helped push down long-term Treasury yields, further depressing mortgage rates and supporting housing affordability. The recent surge in lumber prices suggests that underlying construction activity is solid. Importantly, housing starts and real house prices remain well below prior cyclical peaks, underscoring that homebuilding companies should enjoy a prolonged period of decent growth. Moreover, the homeownership ratio has troughed, removing a major drag on the housing market. Any recovery in this ratio could turbo-charge housing demand. The implication is that homebuilders remain a core portfolio overweight. The ticker symbols for the stocks in this index are: DHI, LEN, PHM.
Risk assets are stuck in a range driven by the Fed feedback loop. But the current rally may continue for another quarter or two.