Equities

The S&P media sector has been in a consolidation phase for over two years, in relative performance terms. That is consistent with cash flow trends, which flat-lined alongside a slump in sales growth and rising costs. However, we expect both relative performance and cash flow to turn higher. Sales growth has hooked back, because the industry has been able to introduce new services and raise selling prices by enough to drive up consumers' share of spending on media services (second panel). Pricing power has surged in both the cable and entertainment industry. If cash flow grows again, as we expect, then an increasing scarcity of media shares outstanding should ultimately act as an upward force on share prices as investors boost allocations to the space. We reiterate our recent moves to overweight in both the S&P cable & satellite and S&P movies & entertainment sub-components. The ticker symbols for the stocks in this index are: BLBG: S5MEDA - DIS, CMCSA, TWX, FOXA, CBS, OMC, VIAB, IPG, SNI, DISCA, NWSA, TGNA, DISCK, FOX, NWS.

Rising policy uncertainty is negative for global equity multiples.

If the damage of the Brexit is contained in the U.K., the direct economic impact on China should be marginal. China's relatively closed financial system makes it less exposed to global shocks than most other countries. It is too soon to expect a policy response from the Chinese authorities just yet, but Brexit has pushed China's "balancing act" needle further toward stimulus.

The combination of biotech stabilization and a health care facilities plateau argues for profit taking in our long/short trade between the two groups. We had exploited the valuation mismatch because hospital profit prospects were far superior to those of the biotech group, especially within the context of a soaring U.S. dollar. Now that the primary upward thrust in the currency has played out, the revenue playing field will shift to a more neutral setting, on the margin. Indeed, while hospital spending is still growing much faster than pharmaceutical exports, a proxy for relative top-line trends, pricing power has not followed suit. Against a backdrop of soaring hospital wage bills, especially relative to pharmaceutical wages, we are closing this pair trade for a profit of 10%. The ticker symbols for the stocks in both indexes are: BLBG: S15HCFA - HCA, UHS, WOOF, AMSG, LPNT, THC, CYH, SCAI, SEM, KND, ENSG, USPH, QHC and BLBG: S5BIOT - AMGN, GILD, ABBV, CELG, BIIB, REGN, ALXN, VRTX.

Health care facilities equities may become the odd man out in the overall health care sector bull market. While we are not concerned that hospitals will see a drop off in activity levels, slowing revenue growth may constrain incremental valuation expansion. Hospital procedures are labor-intensive, underscoring that business models are not scalable. Hospitals have hired at the most aggressive pace in the entire history of the BLS data. Other costs are also inflating. Hospitals are one of the largest buying groups for pharmaceuticals, and the relentless advance in drug prices is profit margin sapping. The producer price indexes for physician services and medical equipment, while still low in absolute terms, are beginning to accelerate. These forces will limit earnings growth potential, especially given that they appear to have been strong enough to offset the benefit from falling bad debt expenses and low capital spending. If operating margins and ROE cannot expand in the current environment, both are unlikely to improve much if overall employment growth continues to cool, as we expect, causing a second derivative slowdown in bad debt recoveries and surgical procedures. Downshift to neutral. The ticker symbols for the stocks in this index are: BLBG: S15HCFA - HCA, UHS, WOOF, AMSG, LPNT, THC, CYH, SCAI, SEM, KND, ENSG, USPH, QHC.

A gap has opened between the Nasdaq and S&P biotech indices, suggesting broad-based selling has reached a stage where discrimination is occurring. The former is infused with concept stage companies with no revenue or earnings, while the latter comprises more mature, pharmaceutical-type firms. We are becoming more favorable toward the S&P biotech index. Using the tech bubble as a guide, on a relative price/sales basis, the S&P biotech group has deviated from fair value by more than the tech sector did after the turn of the century. With value fully restored and robust pharmaceutical industry fundamentals, buying interest should ensue. At least one potential threat to pricing power has been deferred, as the U.S. governments' drug pricing control measures have reportedly been delayed. Consequently, the risk premium associated with doubts about pricing power sustainability should lift. We recommended shifting from underweight to overweight in yesterday's Weekly. Please refer to that report for more details. The ticker symbols for the stocks in this index are: BLBG: S5BIOT - AMGN, GILD, ABBV, CELG, BIIB, REGN, ALXN, VRTX.

The health care sector is poised to resume its bull market, but the character of the rally will change. Sell hospitals and buy biotech.

The U.K. vote is a major blow to the cause of European integration. Fears that "others are next" are likely to put upward pressure on peripheral European bond yields, potentially setting the stage for a self-fulfilling debt crisis. Risk assets are likely to recover some of today's losses over the coming trading days, but the risk to equity prices is now to the downside. Investors should assume a more cautious stance.

Special Report

If the U.K. ultimately exits the EU, it will be a major break in the 70 years of European integration. Multipolarity will be reinforced, increasing global geopolitical risk. We expect global risk assets to start taking cues from Europe, not the Fed and China. However, risks of N-Exit - that other EU member states follow suit - may be overstated.

Equity and Treasury market positioning support the notion of a bounce in risk assets, possibly egged on by dollar weakness.