Sectors

The breakout in the S&P 500 could boost flows to EM, and momentum could overwhelm fundamentals for several weeks. Nevertheless, U.S. interest rate expectations will rise and it, along with weak EM profits, will cap upside in EM risk assets. Take profits on our short EM stocks/long 30-year U.S. Treasurys position. Reduce short exposure to EM currencies by closing the currency trades where the long side is partially against the yen.

In yesterday's Cyclical Indicator Update, incorrect text was placed with the telecom services sector chart. Below is the proper analysis. The telecom CMI has made meaningful positive strides. The sector has exited deflation just as the rest of the corporate sector has been engulfed by it. Both consolidation and increased consumer and business spending have eased competitive pressures sufficiently to reduce the odds of destructive pricing strategies. As such, modest, but positive, growth in average revenue per user is a reasonable forecast. Importantly, wage inflation has rolled over, a critical step to support margins in this slow-growth sector. The sector is overbought, which suggests some tactical vulnerability, but undervaluation, low profit growth expectations, record low global bond yields and success in lifting selling prices for the first time in ages argue for holding through any near-term volatility. At the end of prolonged trends, a swing to extremely oversold or overbought conditions can often signal a major trend change has occurred. Our bias is that technical readings should not be viewed contrarily, especially within the context of the overall corporate earnings recession. Bottom Line: Stay overweight the S&P telecom services sector. The ticker symbols for the stocks in this index is: BLBG: S5TELS. bca.uses_in_2016_07_12_001_c1 bca.uses_in_2016_07_12_001_c1

Our <i>Cyclical Indicator Update</i> reveals that a defensive portfolio strategy remains the best bet to navigate the crosscurrents of stagnant profit/economic growth yet abundant global liquidity.

Consumer staples stocks have been on a tear recently, climbing to all-time highs. While valuations are in overshoot territory, the conditions to sustain this overshoot exist. A flurry of intra-sector M&A activity, anemic global growth and the plunge in global bond yields all argue for a premium valuation in long duration sectors. In fact, the rising stock-to-bond ratio (top panel) coupled with the firming dollar (second panel) and resurgent volatility across asset classes (bottom panel) are a boon for non-cyclical consumer equity relative performance. Earnings expectations are not demanding, particularly relative to the overall corporate sector, underscoring that defensive staples stocks are not only well insulated from overall market turbulence, but also well positioned to thrive in a deflationary/disinflationary global backdrop. Bottom Line: Stick with a defensive portfolio tilt and continue to overweight the S&P consumer staples sector. Consumer Non-Cyclical Stocks Are A Staple For Every Portfolio Consumer Non-Cyclical Stocks Are A Staple For Every Portfolio

Airlines have been punished lately, trailing not only the S&P 500, but also their industrials peers. News that Delta would not meet already weak passenger yield expectations underscores that analysts still remain overly optimistic. Airlines have expanded capacity too aggressively while fuel prices were low, and are now being hit with pricing pressure as travel budgets are pruned. A simple airline margin proxy juxtaposing airline selling prices with fuel prices, signals that the industry's margin expansion will turn into a much steeper correction than analysts anticipate (bottom panel). As a result, profits are slated to underwhelm. Bottom Line: We are reiterating our high-conviction underweight stance in the S&P airlines index. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. bca.uses_in_2016_07_07_002_c1 bca.uses_in_2016_07_07_002_c1

A renewed flare-up in euro area banking sector stress will have ramifications for U.S. bank stocks, despite little direct geographic exposure. The chart shows that risk premiums for U.S bank stocks have been tightly correlated with those of the euro area during previous stress episodes, as this represents a deflationary shock that suppresses the global interest rate structure and undermines global economic activity. Our Global Sector Strategy service has been recommending underweight exposure to euro area banks since mid-March in global equity portfolios. Worrisomely, things are about to get worse before any improvement materializes. The Brexit referendum result has served as a catalyst to expose euro area banks as the weak global financials links. Both absolute and relative performance are probing all-time lows (top panel), dropping even below the depths of the Great Recession. Eurozone banks are plagued by compressing net interest margins, courtesy of NIRP and QE, and still elevated non-performing loans (second panel). This is a lethal combination for bank profits as loan growth is failing to provide an offset. What is missing in the Eurozone is a true bank recapitalization, as happened in the U.S. in late-2008 via TARP. On that front, we are eagerly awaiting the EBA/ECB stress test results slated for July 29 for an update on the health of the euro area's banking sector. Beyond any recapitalization efforts, an opening of the fiscal taps would also serve as a potential positive catalyst to help revive moribund loan demand. Until then, global bond yields will likely dive deeper into negative territory, anchoring bank ROE (third panel). Bottom Line: Resist any temptation to bottom fish in euro area, or U.S., banks. For additional details please visit http://gss.bcaresearch.com/ Euro Area Banks Are Free Falling Euro Area Banks Are Free Falling

We test three channels of contagion from the Brexit shock: political, banking system, and economic.

There is a strong incentive for homeowners to invest in their own homes, as existing home prices have eclipsed pre-crisis peaks. Mortgage credit is also readily available and growing again after a multiyear contraction, which will aid in the resale process. There is significant scope for mortgage credit to grow, which implies a long sales runway for home improvement retailers. The latter had battened down the hatches following the housing crisis, closing stores and curtailing investment. Low construction spending is supportive of near-term same-store sales performance, and also implies that the industry can shift back into expansion mode at some point. If so, then historically appealing relative valuation levels have room to expand. We recommend moving back to an overweight stance in this group. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW. bca.uses_in_2016_07_06_002_c1 bca.uses_in_2016_07_06_002_c1

The decline in global bond yields and negative interest rates outside the U.S. represent a windfall for U.S. housing, to the extent that U.S. mortgage rates are pushed below levels warranted on U.S. fundamentals alone. With a fully functioning banking system, and a willingness to extend mortgage credit, the housing sector should accelerate in the second half of the year. By extension, the S&P home improvement retailing index is poised for liftoff. The group has corrected laterally in recent months, ignoring the bullish signal from the plunge in Treasury yields (shown inverted, top panel). There is already evidence that lower mortgage rates are stoking housing demand: mortgage purchase applications are gaining traction after a long slumber, and refinancing activity is perking up. Mortgage rates have declined sufficiently to make refinancing a viable option for many homeowners. As housing-related financing becomes more readily accessible, the means and incentive to undertake renovation projects should accelerate. The NAHB remodeling survey has been grinding lower, but a reversal is likely given rising mortgage demand and a high level of pending home sales, a catalyst for home improvement projects. Importantly, there is a long runway for growth ahead, please the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW. bca.uses_in_2016_07_06_001_c1 bca.uses_in_2016_07_06_001_c1

A number of divergences have emerged in global financial markets. These gaps are unsustainable. The recent improvement in Asian trade/manufacturing has been largely due to firming demand for electronics/semiconductors. Meanwhile, demand/output for industrial goods and basic materials - the areas leveraged to Chinese capital spending - remain weak. Fixed-income traders should bet on yield curve steepening in India: receive 1-year/pay 10-year swap rates.