Sectors

While the financial sector relief bounce is likely to peter out as the Fed threatens to tighten monetary conditions during a profit recession, the more defensive REIT sub-component should continue to outperform. REITs are still not overvalued, despite the relentless decline in yields on competing assets. While Fed rate hikes could be construed as an impediment if they lift the cost of capital, REITs have not typically run into trouble until policy has tightened by enough to cause a trifecta of headwinds: a cresting in commercial real estate prices, a peak in occupancy rates and by extension, a downturn in the CPI for rental inflation. Once these factors turn bearish, upward pressure on cap rates materializes. None of these concerns currently exist. Keep in mind that with QE and NIRP, there is still a massive search for yield in global financial markets. Roughly $9T of global bonds trade at a negative yield, a massive increase from only two years ago, which should sustain the secular advance in REITs. Moreover, REITs are slated to become a new GICS1 sector on August 31, a new classification that has the potential to augment investor interest. Adding it up, the security, safety and yield appeal of REITs should remain intact regardless of the Fed's near-term zigs and zags, unlike the overall financials sector. Stay overweight and see yesterday's Weekly Report for more details. REITs Remain In A Structural Bull Market REITs Remain In A Structural Bull Market

The Turkish central bank has almost exhausted its foreign exchange reserve. It has been printing money to keep interest rates lower, and sustain the credit boom in the economy. Such policies are unsustainable and the currency will plunge anew. Currency depreciation will push up market-based interest rates. Stay short/underweight Turkish risk assets. A new trade: Short 2-year local currency government bonds.

Investors have embraced renewed Fed hawkishness as a vote of economic confidence and confirmation of analysts' rosy earnings forecasts, but the bounce in financials looks unsustainable, outside of REITs. Hang on to gold shares.

Consumer goods stocks enjoyed a spirited run at the end of 2015 and into 2016, but have largely consolidated that outperformance this year. However, the S&P packaged food (PF) index has bucked the trend, recently setting a new all-time relative performance high. Despite our preference for defensive groups, we are surprised by the resilience of the PF industry, and wary of its sustainability. To be sure, a surge in net earnings revisions suggests that analysts were behind the curve. However, positive profit revisions are not necessarily a sign of operating vitality, as they appear to be entirely driven by cost reductions rather than top-line strength: packaged food sales growth is contracting. PF ROE has deteriorated on the back of revenue contraction, diverging negatively from the relative valuation expansion. Typically, a sustained multiple increase can only occur within the context of a rising ROE, given the latter's direct impact on profit growth. Relative valuations may reflect an M&A premium rather than superior operating performance. Both the value and volume of deals accelerated aggressively in 2015. But 2016 has seen a sharp drop in the value of announced deals, warning that valuations may get squeezed unless growth prospects improve. We are underweight this group. The ticker symbols for the stocks in this index are: BLBG: S5PACK - MDLZ, KHC, GIS, CAG, TSN, K, MJN, SJM, HSY, MKC, CPB, HRL.VAR. bca.uses_in_2016_05_27_001_c1 bca.uses_in_2016_05_27_001_c1

The housing market remains a bright spot within the U.S. economy, which is not yet fully reflected in relative share performance. For instance, the NAHB survey has massively outperformed the ISM composite, signaling that relative profit conditions are more favorable for housing (top panel). The latest data showed that new home sales have surged, and that homes purchased but not yet under construction are at their highest level since 2007. Importantly, while banks are tightening standards on C&I loans, they remain willing to make mortgage loans, and consumers are increasingly willing to take on residential-related debt. This is bullish from a cyclical perspective, particularly since housing starts and household formation have considerable room to run before hitting a saturation point. Stay overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOME - DHI, LEN, PHM. Homebuilders Catch Fire Homebuilders Catch Fire

The latest conclusions from the sector-based (right) way to pick stock markets. Plus some important conclusions for credit markets.

Our upgrade of the S&P electrical components & equipment (ECE) index to overweight earlier this year was based on both market and industry factors. The group had undershot on technical, valuation and sentiment basis. Moreover, it was being unfairly lumped in with more resource-dependent industrial sector groups, particularly given that the index is comprised of large, diversified manufacturing businesses with exposure to a variety of end markets. However, market extremes have been unwound and headwinds to a fundamental earnings recovery have surfaced. Shipment contraction is rife, and unlikely to improve given that new orders have tumbled. Factories are likely to become underutilized. Utilization rates had stayed remarkably high during the overall economic downturn, owing to capacity shrinkage. This resilience is at risk now that leading revenue indicators are sinking. Productivity growth has dipped, and has more downside risk, given that wage inflation is outpacing deflationary pricing power growth. Adding it up, the power to sustain the advance in ECE stocks is diminishing, and we recommend moving to the sidelines. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5ELCO - EMR, ETN, ROK, AME, AYI. bca.uses_in_2016_05_25_003_c1 bca.uses_in_2016_05_25_003_c1

The S&P industrials sector has led the deep cyclical sector recovery this year, validating our upgrade to neutral to protect against a countertrend move spurred by U.S. dollar softness. However, the industrial sector share price ratio is now near the top end of a 15-year range, suggesting major resistance. An exhaustive examination of our Indicators highlights that this year's rally has been based on portfolio repositioning and reversion from oversold conditions rather than expectations of a sustainable earnings recovery. Valuations have gone from cheap to neutral, implying that further gains require earnings outperformance. The objective message from our industrials Cyclical Macro Indicator is that relative forward earnings estimates will continue to fall. The underlying bearish force is top-line malaise. Hopes for an industrial sector revival appear to be misplaced. Once credit conditions tighten and banks become less willing to extend C&I loans, the ISM manufacturing index generally weakens. Core durable goods orders are already contracting, despite the boom in auto production over the past few years. Importantly, the corporate sector is not in a position to ramp up investment, as highlighted in last Monday's Weekly Report. That is particularly true of resource companies, where the most intense leverage pressures reside. Consequently, it is premature to bet on an industrial profit recovery and we recommend returning to an underweight stance. Please see yesterday's Weekly Report for more details. bca.uses_in_2016_05_25_001_c1 bca.uses_in_2016_05_25_001_c1

Risks to global growth remain to the downside. Selling pressure in cyclical markets and assets will escalate. EM currencies will make new lows versus the U.S. dollar, the euro and yen. Take profits on our long JPY/short KRW and long JPY/short SGD trades. Short KRW versus an equal-weighted basket of the U.S. dollar, yen and euro. Continue underweighting Peruvian equities.

Chinese housing construction does not look excessive relative to the size of its rapidly growing urban population. On average, China's new urban construction has been about 500 units per 1000 new urban citizens in the past 10 years, roughly comparable to other countries, and is much smaller than Korea and Japan during the prime stage of their urbanization process.