Sectors

Within the EM equity space, country effects still significantly overwhelm sector impact. In turn, the importance of country selection within advanced countries has dropped. Macro analysis is still very pertinent with respect to adding alpha when investing in EM stocks. At this moment, the macro outlook does not warrant a bullish stance on EM.

Both the demand for and availability of capital favors consumers over businesses, on the margin. The latest Fed senior loan officer survey showed that banks are tightening standards on C&I loans, the most rapidly growing component of bank assets. This reflects the broad-based deterioration in corporate sector balance sheet health. Conversely, willingness to extend consumer credit remains high. Previous deleveraging has vastly improved household balance sheets. Debt servicing payments are historically low as a share of income. Consumer spending is outpacing capital spending, which is driving a rise in personal loans relative to business credit. A narrowing yield curve has much more bearish implications for banks than it does for credit card companies, whose interest rate spreads are far less susceptible to yield curve swings. This is borne out in the tight inverse correlation between the yield curve and the share price ratio (bottom panel). Consequently, we recommend initiating a pair trade in the undervalued consumer finance/banks share price ratio. Please see yesterday's Weekly Report for more details. bca.uses_in_2016_03_22_002_c1 bca.uses_in_2016_03_22_002_c1

Consumer finance stocks have been among the worst financial sector performers in the last six months creating a negative divergence with bullish macro drivers. For instance, relative performance has far undershot the level implied by the decline in unemployment claims and the housing market (top panel). Household net worth has spiked back toward all-time highs as a share of disposable income courtesy of the recovery in financial markets and residential real estate value. Importantly, wages & salaries growth is robust, courtesy of U.S. dollar strength and the collapse in fuel prices, which should underpin consumer appetite for debt. Revolving consumer credit, a good proxy for credit card debt, has been growing at a pre-financial crisis clip since last autumn. That is a major change from the first few years after the crisis, when debt growth was extremely volatile, which created uncertainty about the sustainability of credit card company receivables growth, and capped valuations. A more stable outlook should translate into a higher multiple, all else equal. We recommend an overweight position, and a new long/short trade vs. banks, please see the next Insight. The ticker symbols for the stocks in this index are: AXP, COF, SYF, DFS, NAVI. bca.uses_in_2016_03_22_001_c1 bca.uses_in_2016_03_22_001_c1

The Fed's recent dovishness represents an acknowledgement of the feedback loop between Fed policy and financial conditions. Expect Fed hawkishness to ramp back up prior to the next rate hike, likely in June.

The Fed's recent dovishness represents an acknowledgement of the feedback loop between Fed policy and financial conditions. Expect Fed hawkishness to ramp back up prior to the next rate hike, likely in June.

A dovish Fed bought the bounce a bit more time, but there is little incentive to add portfolio risk. Buy consumer finance, especially vs. banks, and expect communications equipment outperformance.

Similar to the euro area, Japanese consumer discretionary stocks have a long runway ahead. Japan is the latest country to join the NIRP club following the late-January BOJ surprise move to charge deposit-taking institutions a negative deposit rate. While interest rate suppression has negative connotations for Japanese banks, it should spur demand for discretionary consumer outlays if it breaks the deflationary consumer mindset. The top panel of the chart shows that relative share prices are inversely correlated with interest rates and the current message is to expect a rebound in Japanese consumer discretionary relative performance. Japan's NIRP should also lure banks to focus on loan volumes. Loosening bank credit standards typically boost discretionary spending. Importantly, a wide gap has opened between loan growth and relative share prices, which will likely narrow via a catch up phase in the latter. Meanwhile the Japanese labor market is tight, but this is neither reflected in relative consumer discretionary share prices, nor in relative valuations (third & fourth panels). Bottom Line: Overweight Japanese consumer discretionary stocks. For additional information on global consumer discretionary stocks please read the Global Alpha Sector Strategy report titled "In the Eye Of The Hurricane" at gss.bcaresearch.com. (Part III) The Global Consumer Discretionary Juggernaut Is Over (Part III) The Global Consumer Discretionary Juggernaut Is Over

Unlike in the U.S., current opportunities in consumer discretionary stocks lie in Europe and Japan. NIRP in the euro area will likely prove a powerful tonic for local consumers, and discretionary spending (top panel). The ECB is aggressively easing monetary conditions and is injecting unprecedented liquidity into the banking sector which should entice bankers to extend credit instead of hoard cash, on the margin. In fact, the ECB is squarely targeting banks to grow their lending books and provide breathing room to the economy, especially in the credit-starved periphery. Following the double-dip recession, euro area credit growth is slated to reaccelerate, as the ECB's fresh TLTROs and QE should open the lending spigots (second panel). On the labor front, while euro area unemployment is still running at double digit rates, excess slack is diminishing. The implication is that pent up consumer demand is only now being unleashed in the euro area, which should boost relative share prices (third panel). None of this encouraging consumer discretionary demand backdrop is reflected in ultra-cheap valuations, given that euro area consumer discretionary stocks are trading at a 25% EV/EBITDA discount to the global consumer discretionary index. Bottom line: Overweight euro area consumer discretionary stocks in a global portfolio (see the next Insight). (Part II) The Global Consumer Discretionary Juggernaut Is Over (Part II) The Global Consumer Discretionary Juggernaut Is Over

The outlook for the S&P consumer discretionary sector is bearish. The time to buy this early cyclical sector is when the Fed is embarking on an easing cycle, in a bid to improve the labor market conditions and restart the credit cycle. The opposite is now true, full employment has already been reached, and the Fed is poised to continue lifting interest rates this year. Historically, interest rates have been inversely correlated with relative performance and the current message is to avoid the U.S. consumer discretionary sector (top panel). Credit is a powerful fuel for consumer discretionary stocks. On this front, the recent continued tightening in U.S. lending standards is worrisome, especially given waning loan demand, according to the latest Fed's senior loan officer survey. The broad-based deterioration implies that tighter credit will persist, to the detriment of loan growth (second panel). Finally, relative consumer discretionary valuations in the U.S. are expensive. The bottom panel of the chart shows that the U.S. is trading at a 6% EV/EBTIDA premium to the global consumer discretionary sector. Bottom Line: A below benchmark allocation is warranted for the U.S. consumer discretionary sector, but opportunities exist outside the U.S., please see the next Insight. bca.uses_in_2016_03_17_001_c1 bca.uses_in_2016_03_17_001_c1

We recently boosted weightings in the S&P electrical equipment & components index, and the latest data reinforce this view. Final demand has stayed more resilient than other manufacturing and resource-intensive industries, as reflected in both new order and capital investment trends (second panel). Despite this top-line resilience, electrical equipment manufacturers have been among the most aggressive in protecting profit margins through cost cutting and capacity reduction. That is evident in rising utilization rates, a remarkable feat given that the manufacturing sector is flirting with recession, and improving productivity growth. The implication is that health returns on equity should persist, heralding a re-rating in very depressed relative earnings growth expectations, and valuations. The ticker symbols for the stocks in this index are: AME, ETN, EMR, ROK. Chart bca.uses_in_2016_03_16_002_c1 bca.uses_in_2016_03_16_002_c1