Equities

The Fed delivered a "hawkish hold." Remain tactically short U.S. equities and position for a stronger dollar. Meanwhile, the Bank of Japan laid out a radical overhaul: The new framework is consistent with price-level targeting and debt monetization. Long-term investors should position for a weaker yen and higher Japanese equity prices. Also, stay structurally underweight Japanese bonds: Zero is a resting point, rather than a final destination, for 10-year JGB yields.

In a Special Report published on September 6, we made the case that the transportation sector was already discounting a deep recession, and that only a stabilization rather than acceleration in economic prospects was required to realize good value. As part of that report, we upgraded the S&P air freight & logistics group to overweight. Global revenue ton miles have returned to positive growth, which should ultimately restore pricing power. The sustainability of the increase in air traffic is decent, given that inventories in the key manufacturing regions of the world are contracting, which is a positive sign for future activity levels. On the domestic front, non-store retail sales are handily surpassing overall retail sales at the fastest clip since the tech bubble burst, and are signaling that a relative valuation re-rating phase is looming (bottom panel). Meanwhile, the air freight group has a low earnings hurdle to surpass, as evidenced by relative forward earnings growth estimates, and confirmed by upbeat results from FedEx earlier this week. Bottom Line: We reiterate our recent shift to overweight. The ticker symbols for the stocks in this index are: BLBG: S5AIRFX - UPS, FDX, CHRW, EXPD.

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.

Special Report

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.

Special Report

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.