Sectors

It is dangerous to equate recent equity strength with economic vitality, as history shows that liquidity-fueled equity advances favor non-cyclicals over deep cyclicals. Take profits in gold, buy rails and sell industrial machinery.

The S&P restaurants index continues to deflate in relative performance terms and downside risks remain intact. The top panel of the chart shows that the Restaurant Performance Index (RPI, courtesy of the National Restaurant Association) has taken a turn for the worse. Historically, momentum in the RPI has been an excellent leading indicator of relative share prices. The RPI is picking up the downtrend in top-line performance, as measured by restaurant retail sales. The latter warn that relative forward earnings momentum is headed lower. To make matters worse, slow traffic is limiting pricing power gains, which are lagging badly behind a soaring wage bill (fourth panel). Bottom Line: While we have recently boosted the S&P consumer discretionary index to overweight, stick with a below benchmark allocation in the S&P restaurants sub-index. The ticker symbols for the stocks in this index are: BLBG: S5REST - MCD, SBUX, YUM, CMG, DRI. Restaurants: Closed For Business Restaurants: Closed For Business

A collection of 10 important charts to monitor closely through the summer months.

Chinese banks have been writing off impaired loans, and the pace has quickened sharply in recent years. This has been largely ignored by investors. Under a rather extreme scenario, Chinese commercial banks' NPL ratio could reach 14%, which could lead to a 30% hit to banks' net equity base. Chinese banks H shares have already priced in this scenario.

With the broad market breaking out to new highs courtesy of flush liquidity conditions and rising risk appetite, the momentum-driven biotech group stands an excellent change of reclaiming previous relative performance highs. We upgraded the S&P biotech index to overweight a month ago because value had been fully restored and underlying fundamentals remained solid. For instance, demand-driven pharmaceutical pricing power gains remain intact, which is driving productivity improvement. Increased profit potential should attract renewed capital inflows and translate into higher share prices, especially now that the supply of biotech stocks is ebbing fast: biotech IPOs have cratered. Importantly, drug industry M&A activity remains robust, suggesting that the S&P biotech index has the potential for a re-rating. We reiterate our recent upgrade to overweight. The ticker symbols for the stocks in this index are: BLBG: S5BIOT- AMGN, GILD, ABBV, CELG, BIIB, REGN, ALXN, VRTX. Biotech Is Coming Back Biotech Is Coming Back

In order to make room for this week's upgrade of the consumer discretionary sector, we have downgraded the utilities sector to neutral after a strong run. Overweight positions in this sector were predicated largely on external forces rather than sector-specific factors, largely that the overwhelmingly deflationary global backdrop would turbo-charge the search for yield, culminating in a re-rating in equity fixed income proxies such as utilities. Worries about a slide into recession have ebbed, because domestic consumer spending has stayed resilient, job growth has bounced back after a difficult few months, and the U.S. manufacturing sector is showing signs of life. Even the global economic surprise index has climbed into positive territory, driven mostly by an uptick in the U.S. Consequently, utility stocks may have difficulty generating additional outperformance, especially within the context of the broad market overshoot. We recommended taking profits of 17% and trimming to neutral in Monday's Weekly Report. BLBG: S5UTIL. bca.uses_in_2016_07_27_001_c1 bca.uses_in_2016_07_27_001_c1

In recent months we have outlined and acted on the bull case for media by upgrading both the S&P cable & satellite and S&P movies & entertainment indexes. This week we added another sub-component to the overweight column. The S&P advertising index has an opportunity to positively surprise in the coming quarters. Expectations are subdued, as measured by both long-term and cyclical relative forward earnings growth estimates, as well as elevated short interest (third panel). On this front, accelerating outlays on media services are a positive omen for marketing budgets, as well as advertising stocks, particularly if consumers begin to loosen their purse strings. Already, advertisers have enjoyed solid revenue growth, in contrast with the contraction in overall S&P 500 sales. As a result, ad rates have gone up, as proxied by the producer price indexes for radio, broadcasting and network TV (second panel). A demand-driven increase in pricing power should be viewed as sustainable, and has higher odds of translating into premium share price valuations given the positive impact on industry productivity (bottom panel). True, the leveling off in auto sales is a risk given the industry’s massive marketing budget, but there are offsets, including the boom in electronics spending, which has positive implications for content demand and potential digital media spending. Netting it out, the reward/risk tradeoff is favorable for an upshift to overweight. The ticker symbols for the stocks in this index are: BLBG: S5COND - OMC and IPG. bca.uses_in_2016_07_26_002_c1 bca.uses_in_2016_07_26_002_c1

In order to harvest a tactical continuation of the high-risk, momentum-driven broad market advance, we have made a few tweaks to our portfolio, while maintaining a core non-cyclical emphasis given that the global growth outlook remains sketchy. This week, we added the cyclical interest rate-sensitive consumer discretionary sector to the fold after recently upgrading the S&P home improvement retail index back to overweight. Relative performance has dropped to a four year low, once heavyweight Amazon is excluded, but a recovery window has opened if the Fed stays lax while wage growth continues to firm and the U.S dollar regains strength. The consumer is the strongest engine in the U.S. economy, and is benefiting from lower oil prices and plunging mortgage rates. Our Consumer Drag Indicator (CDI), comprising mortgage rates and gasoline prices, has climbed significantly, heralding ongoing consumption resilience. Importantly, the CDI has a good track record in leading relative performance (second panel). Money growth is sending a similar message, particularly given a healthy clip in consumer lending growth (top panel). After deleveraging for several years, financial obligations are not onerous, even if interest rates rise modestly. Any upgrade in consumer confidence as a consequence of income growth could unleash pent up dry powder for consumption. As a result, we recommend buying into relative performance weakness and upgrading to overweight, including a boost to the advertising group, please see the next Insight. BLBG: S5COND. Upgrade The Consumer Discretionary Sector Upgrade The Consumer Discretionary Sector

The major banks are more willing to lend to the consumer and less willing to lend to the corporate sector.

Expectations of a prolonged period of abundant liquidity and rising confidence that recession is not imminent have created the conditions for a potential blow-off phase. This week we are fine-tuning our portfolio for peak performance.