Valuations

This month's <i>Special Report</i> reviews the literature on equity market timing, and identifies the key indicators that historically have had the best track record. We then aggregate the indicators into an overall scorecard that should prove to be valuable for investors in these volatile times.

Fed hawkishness reinforces the need for an imminent profit recovery to justify current valuations. Our Indicators do not signal such an outcome. Stay defensive, and return to an underweight stance in the industrials sector.

A June rate hike is a real possibility, but the Fed still needs evidence that growth is rebounding toward 2% in order to follow through. Whether the next rate hike occurs in June or later this year, a persistent hawkish shift from the Fed will send Treasury yields higher during the next few months.

This week, we present five of the more interesting yield curve trades in the Developed Markets for the latter half of 2016.

Tougher Fed talk warns that the Goldilocks combination of higher stock and bond prices in place since February is not sustainable.

As the sole shock absorber left in the global economy, FX markets will grow more volatile. The currency market's reaction to the recent Fed minutes exemplifies this phenomenon. Despite its sores and blisters, the U.S. economy wins the global beauty contest. Caught between those forces, the USD will continue to weaken over the next quarter or two before resuming its broader bull market.

Australia's equities and currency are driven largely by industrial commodities prices, Canada's by the oil price. Given our more positive view on oil, we prefer Canadian assets, though both markets face risk from stretched property prices and household debt.

Gold will remain well bid over the short term. The surge in demand that pushed prices up by 20% ytd (Chart of the Week) will continue to dominate supply growth.

There is a considerable dichotomy between the EM equity universe and EM corporate credit markets. EM credit markets remain mispriced. EM currencies are at risk of renewed depreciation. This will push sovereign and corporate spreads, as well as high-yielding domestic bond yields, higher. Continue underweighting Indonesian stocks, sovereign credit and domestic bonds within their respective benchmarks.

Stronger GDP growth will permit the Fed to hike rates once more before year-end, no earlier than September. However, the feedback loop between the Fed and financial conditions will prevent a second rate hike this year.