Corporate Profits

Clients should forgive us for being too gloomy at the start of the year -- it is difficult to be optimistic in the dead of a Montreal winter. However, with springtime comes the reflation trade, born on the wings of massive Chinese fiscal and credit expansion. In this report, we discuss how long (not very) the trade can go (and how to play it). Our In Focus feature returns to pessimism, with a discussion of why the Anglo-Saxon laissez-faire economic model may be in for a big pendulum swing.

Chinese PPI deflation will likely continue to ease going forward. There are non-trivial odds that the PPI deflation may turn positive. Our models predict a sharp upturn in China's profit cycle. Meanwhile, Anti-corruption investigation cases have dropped substantially since the beginning of the year, a sign that the Communist Party may be reorienting priorities to boost economic growth.

A lack of confirming growth indicators puts the equity advance at risk. Lift hypermarkets to overweight, stick with homebuilders and fade any small and/or mid cap relative strength.

Chinese GDP growth may have picked up slightly in the first quarter, and growth numbers will likely continue to exceed expectations in the coming months. The market is overly bearish on China's earnings outlook, and may be on the verge of reassessment. Stay positive on H shares.

We are sending you the Q2 <i>Global Investment Strategy Outlook</i>, which discusses the ten predictions we expect to drive global financial markets throughout the rest of the year.

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.

The RMB has moderated considerably since mid-last year, which should lead to improved capacity utilization and easing PPI deflation. There is a strengthening case for an upswing in China's profit cycle, driven by falling interest rates and a weaker RMB, while investors are ill-prepared for any positive earnings surprises.

The rally in risk assets could persist. Dollar and oil moves are not yet exhausted. But valuations and poor earnings quality warrant a cautious approach.

A dovish Fed bought the bounce a bit more time, but there is little incentive to add portfolio risk. Buy consumer finance, especially vs. banks, and expect communications equipment outperformance.

While the FOMC was more dovish than expected, rising inflation may cause the Fed to escalate hawkish rhetoric. The bounce in oil should help high-beta stocks. Underweight U.S. equities versus Europe, Japan and H-shares. We estimate U.S. equities will deliver returns of 4%, ann. over the next 10 years, <i>vis-à-vis</i>  9% for the euro area and Japan, and 14% for H-shares. Central banks have more options to combat any possible debt-deflation spiral in Europe/Japan/China than is often recognized.