Sectors

Although the Fed is on track to hike rates in December, the credit cycle is far more advanced than the monetary tightening cycle. Position for a December rate hike by being short duration and in curve flatteners. Weakening corporate balance sheet fundamentals mean the long-term trend is for corporate spreads to widen.

Stocks are flirting with new highs, courtesy of a gradualist Fed and the reduced threat
of incremental near-term U.S. dollar strength.

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. bca.uses_in_2016_09_23_001_c1 bca.uses_in_2016_09_23_001_c1

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.

Are negative yields on $10 trillion of global bonds a sure sign of a bubble? The answer is no... and yes.

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. Banks: Follow The Global Credit Impulse Banks: Follow The Global Credit Impulse [1] http://www.bis.org/publ/qtrpdf/r_qt1609.htm

The fiscal spending impulse in China is still positive but receding. The nation's productivity and potential GDP growth are bound to decline due to a rising role of government in capital and resource allocation. Hence, cyclical stabilization could well be overwhelmed by a structural slowdown. Another bubble is forming in China, this time in the corporate bond market. The amelioration in Korean and Taiwanese exports is due to the technology sector/semiconductors, and does not reflect broad-based improvement in global trade.

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. bca.uses_in_2016_09_20_002_c1 bca.uses_in_2016_09_20_002_c1

Consumer products stocks are likely to move to an even larger valuation premium before the cyclical outperformance phase ends.