Sectors

One refrain from market bulls is that sentiment is too bearish, which is contrarily positive. Indeed, our own Composite Sentiment Gauge is still decisively in a bearish zone. However, action trumps rhetoric. Investors are responding to polls bearishly, but do not appear to be positioned that way. True bearishness elicits a rush for the equity exits, which prompts position deleveraging, a valuation squeeze, a dramatic increase in cash levels and a premium on portfolio protection, as measured by the VIX and SKEW indexes. Yet valuations are probing historic highs, as measured by the median industry group price/sales ratio (bottom panel). Investors are not nervously hedging long positions, as evidenced by historically depressed readings in the VIX and SKEW indexes. Meanwhile, margin debt remains near record levels, both in absolute terms and compared with market cap and/or GDP (fourth panel). Moreover, investor cash holdings are historically low, the opposite of a bearish signal. The broad market lows in 2000 and 2009 were marked by unanimity among these indicators, namely bombed out sentiment and speculation readings, extreme anxiety about a potential crash, cheap valuations, low margin debt, high cash levels and a high degree of global economic pessimism. At the moment, none of these indicators is confirming that investors are positioned defensively. Consequently, we are reluctant to champion a bullish equity outlook on the basis that pessimism reigns. We expect our outsized exposure to non-cyclical sectors to continue generating alpha. bca.uses_in_2016_04_19_001_c1 bca.uses_in_2016_04_19_001_c1

Bearish sentiment is a red herring, as most other measures of investor positioning point to a strong undercurrent of bullishness. That is contrarily worrying.

This week <i>Global Alpha Sector Strategy</i> in conjunction with <i>Emerging Markets Strategy</i> is sending out a <i>Special Report</i> on EM deep cyclical sectors, discussing debt and cash flow dynamics, identifying how far advanced the capital expenditure down cycle is, and determining if recent EM deep cyclical strength should be bought or faded.

An Insight yesterday showed that the overall technology sector was likely to record its worst quarterly earnings performance in four years. The highest beta components of the sector are most at risk. For instance, the semiconductor industry is losing its main source of support, namely an M&A premium. Last year's mini-M&A frenzy is petering out, which will put the onus on profits to support relative performance. However, global chip sales continue to deteriorate, and leading indicators such as Chinese electronics imports and Emerging Market currencies continue to warn of tepid chip demand. With chip producer inventories still growing at a historically rapid clip, there will be downward pressure on average chip selling prices. TSMC's profit warning earlier this week likely provides a good read for the overall industry, and we reiterate our high-conviction underweight rating. The ticker symbols for the stocks in this index are: BLBG: S5SECO - INTC, QCOM, TXN, AVGO, NVDA, ADI, SWKS, XLNX, MU, LLTC, MCHP, QRVO, FSLR. bca.uses_in_2016_04_15_001_c1 bca.uses_in_2016_04_15_001_c1

Overall consumer spending growth has been sub-par, as the windfall from lower energy prices has translated largely into a high personal savings rate rather than increased consumption growth. As a result, performance among retailing stocks has become highly fragmented, as marked divergences in spending among specific retailing industries are developing. Investing alongside top-line trends tends to pay off. The latest retail sales report showed the industries such as hypermarkets and retail drug stores are experiencing accelerating top-line momentum (top and second panels), consistent with a more discerning consumer. That bodes well for related-industry profit outperformance and valuation expansion. Conversely, restaurant sales are slipping, similar to the cautious message from the National Association of Restaurants. We are overweight retail drug stores and hypermarkets, but underweight restaurants. bca.uses_in_2016_04_14_002_c1 bca.uses_in_2016_04_14_002_c1

The S&P technology sector is forecast to deliver its worst quarterly earnings performance since 2012/2013, when the sector suffered a relative performance steep correction (top panel). That period was marked by a downturn in capital spending momentum, and a contraction in technology new orders-to-inventories. A similar backdrop is currently unfolding. BCA's Capital Spending Model has moved sharply lower, heralding share price underperformance. In addition, demand for tech goods remains anemic, as proxied by tech new orders and exports (second panel). That represents a headwind to future production growth, and by extension, productivity. The implication is that tech sector deflationary conditions are likely to remain intense, and it is too soon to position for better technology earnings. We remain underweight the overall tech sector. bca.uses_in_2016_04_14_001_c1 bca.uses_in_2016_04_14_001_c1

One of our highest-conviction investment ideas for the next few years.

Chinese PPI deflation will likely continue to ease going forward. There are non-trivial odds that the PPI deflation may turn positive. Our models predict a sharp upturn in China's profit cycle. Meanwhile, Anti-corruption investigation cases have dropped substantially since the beginning of the year, a sign that the Communist Party may be reorienting priorities to boost economic growth.

Treasuries appear overbought in the near-term, especially given evidence of a rebound in global manufacturing, but we would need to see evidence of a sustained re-synchronization of global growth before advocating a shift to below benchmark duration on a 6-12 month horizon.

We do not expect Russia and OPEC members to reach a production-limiting agreement at the April 17 meeting in Doha, but that does not diminish our bullish expectations for a rebalancing of oil markets in H2 2016.