Sectors

Industrial machinery stocks have surged as if China is headed back to double-digit GDP growth and the U.S. dollar is going to reverse all of its recent year's gains. That combined scenario would produce a rebound in sales growth, and allow investors to bet on increased operating leverage. But that is wildly optimistic, especially given that the sales outlook remains murky. Our global machinery new order proxy is contracting. Global machinery exports have also gone ex-growth. Importantly, leading indicators of new orders are bearish. For instance, BCA's Global CapEx Indicator is heralding a contraction in developed country capital formation. That does not bode well for global output growth, and by extension, machinery consumption. Coal and other commodities also provide a good read for future industrial machinery demand. Clearly, coal is warning that machinery new orders will stay punk. Whiffs of reflation in China have supported other commodity prices, but it is premature to extrapolate this liquidity-driven bounce into a demand-driven upturn. Loan demand is still anemic, and machinery stocks have front run any improvement in China's cyclical outlook (bottom panel). Use the rally in the SP& industrial machinery index to downshift to an underweight position.The ticker symbols for the stocks in this index are: BLBG: S5INDM - ITW, SWK, IR, PH, PNR, DOV, SNA, XYL, FLS. bca.uses_in_2016_05_25_002_c1 bca.uses_in_2016_05_25_002_c1  

Fed hawkishness reinforces the need for an imminent profit recovery to justify current valuations. Our Indicators do not signal such an outcome. Stay defensive, and return to an underweight stance in the industrials sector.

Our recent upgrade of the S&P hypermarkets index was predicated on the view that expectations had become so depressed that upside profit margin and sales surprises were increasingly likely. Walmart's positive earnings results suggest that this thesis is starting to play out. There is tentative evidence that the industry's investments in store improvements and marketing are paying off. Hypermarket sales are rising in absolute terms, and are finally gaining ground on overall retail sales. This trend should be sustained, as lower income consumers are feeling much more confident than higher income consumers as wage inflation improves (second panel). In fact, hypermarkets could enjoy an influx of new customers given that the rising personal savings rate implies that more affluent consumers may soon 'trade down' when shopping in order to preserve capital. At the same time, costs are under control, as measured by the deflation in imported consumer goods prices and ongoing deflationary pressures from major producing countries. This is a recipe for continued upside profit surprises and we reiterate our overweight stance. The ticker symbols for the stocks in this index are: BLBG: S5HYPC - WMT, COST. bca.uses_in_2016_05_20_001_c1 bca.uses_in_2016_05_20_001_c1

Australia's equities and currency are driven largely by industrial commodities prices, Canada's by the oil price. Given our more positive view on oil, we prefer Canadian assets, though both markets face risk from stretched property prices and household debt.

China has fallen into the same "fiscal trap" that ensnarled Japan in the 1990s. Unprofitable investment projects undertaken by SOEs are a necessary evil. The underlying problem is not overinvestment, but an economy that is demand-deprived. Meanwhile, structural factors will ensure that savings remain high. Any efforts by the authorities to curb credit growth will result in a sharp economic downturn. China will continue to generate excess capacity and export deflation to the rest of the world, which is good for bonds. We recommend going long Chinese banks, the most hated equity sector.

The previous Insight showed that the financial sector remained on its heels as a consequence of ongoing global deflationary backlash. This backdrop is particularly difficult for asset managers & custody banks (AMCB). This index is a high beta play on economic and financial market confidence. When the latter is high, M&A activity, share buybacks and other sources of industry fee income tend to accelerate. The opposite is also true. At the moment, global economic confidence is sinking, as measured by our composite sentiment gauge (top panel) and the stock-to-bond ratio (bottom panel), and is likely to erode further as economic disappointment mounts (third panel). Meanwhile, M&A activity is on the wane as capital availability has become more restrictive (second panel). These forces warn that AMCB profitability is likely to underwhelm. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5AMGT- BLK, BK, STT, TROW, AMP, NTRS, BEN, IVZ, AMG, LM. Asset Managers And Custody Banks: Sell Strength Asset Managers And Custody Banks: Sell Strength

The S&P financials sector continues to battle deflationary forces. While inflation expectations are off their low courtesy of this year's dip in the U.S. dollar, they remain well below 2014 levels when the U.S. dollar began to surge (top panel). The negative profit backlash from global deflation continues to reverberate across the business sector, and has undermined corporate balance sheets to the extent that banks are much less willing to extend C&I loans, their main source of asset growth (second panel). These trends are also sustaining downward pressure on the long end of the Treasury curve, causing a relentless yield curve narrowing. With the Fed still eager to lift interest rates, despite evidence of growth slippage, the odds of a policy mistake are creeping higher. Against this backdrop, financial sector profits are likely to lose additional steam, raising the odds of a breakdown in relative performance to new lows. Stay underweight. The ticker symbols for the stocks in this index are: BLBG: S5FINL. Financials Are Not Out Of The Woods Financials Are Not Out Of The Woods

We focus on 3 stress-points in the economy and markets which segue to several high conviction investment recommendations.

The previous Insight showed that rails are working hard to reduce cost structures. However, rail profits are still tightly linked with overall freight trends. The decline in total railcar shipment growth warns that rail earnings estimates will continue to lag those of the broad market. The two major freight categories are struggling. Coal shipments have plunged, with no imminent relief in sight, as utilities, the primary coal purchasers, are suffering from a contracting electricity production. Meanwhile, intermodal shipments, the largest freight category, have slipped into negative territory. Sagging port traffic, soggy retail sales and high inventory-to-sales ratios suggest that demand for consumer goods will remain lackluster. As a result, deflation is likely to prevail a while longer and we continue to recommend only a market neutral weight, despite the appearance of good value. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_002_c1 bca.uses_in_2016_05_18_002_c1

The relief rally in rail stocks has stalled at key resistance levels, but good value and extreme cost cutting efforts make it tempting to buy into any short-term weakness. Would that be a sound strategy? Top-line growth is lagging far below the rate of overall GDP growth, which is a bearish sign. However, rails have aggressively slashed costs, as both employment and capital spending have plunged. Moreover, the decline in railcar order backlogs suggests that new cars are coming on line. Rail operators lease the bulk of their cars, and tight supply in recent years boosted lease rates. As new cars hit the network, then lease rates should ease. These factors warn against extrapolating bearishness, but are they enough to bolster rail profits? Please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5RAIL - UNP, NSC, CSX, KSU. bca.uses_in_2016_05_18_001_c1 bca.uses_in_2016_05_18_001_c1