Sectors

Against a backdrop of defensive sector outperformance, our bearish call on the S&P managed care index has reduced odds of playing out. Our thesis was that when overall health care spending is accelerating, as is currently the case, health care services providers win out over the industries that bear the cost of these services. However, if the economy cools, as we expect, then upward cost pressure will be slow to materialize. Our managed care cost proxy, a composite of hospital, drug price and labor cost inflation, alongside several other medical expenses. Cost inflation is easing, despite the surge in prescription drug prices. If upward momentum in the latter cannot substantially raise managed care costs, then there should be little upside risk if drug inflation cools. Meanwhile, consumer spending on health insurance continues to outpace overall spending by a large margin, which is facilitating decent increases in premiums, as gauged by the employment cost index for health care insurance. The implication is that the group is more likely to move laterally than down, despite rising overall health care spending, and we are lifting our underweight position to neutral. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: UNH, AET, CI, ANTM, HUM. bca.uses_in_2016_02_09_002_c1 bca.uses_in_2016_02_09_002_c1

Our cautious outlook on corporate profits amid ongoing deflation pressures is reason enough to favor non-cyclical equity sectors. But the surprise Bank of Japan move to introduce negative deposit rates adds yet another catalyst for defensive and fixed-income proxies. On the margin, capital is likely to seek out high yielding government bond markets. The U.S. still has comparatively juicy yields compared with other developed countries. In fact, a growing swath of the euro area bond market has negative yields. In addition, the U.S. has a strong currency. That could create a self-reinforcing feedback loop, as the exchange rate will sustain imported deflationary pressures over and above the additional pressure on China and the rest of Asia if the yen weakens. When the ECB announced negative deposit rates in the spring of 2014, the U.S. dollar immediately vaulted higher and Treasury yields declined for the rest of the year (see the vertical line). At the same time, long duration sectors such as health care accelerated, while utilities and REITs caught a bid. We expect these sub-surface equity trends to repeat, and broaden, as telecom services should now fit into the mix, because unlike 2014, overall corporate profits are falling and financial conditions are much more restrictive. The implication is that a defensive portfolio structure remains appropriate. Another Wave Of Deflation Favors Long Duration Sectors Another Wave Of Deflation Favors Long Duration Sectors

Economic disappointment represents a serious obstacle for stocks. Stay with non-cyclical plays, including telecom services and health care. Upgrade the managed care group, and stay clear of banks, regardless of cheap valuations.

Stronger-than-expected profit results have propelled the S&P leisure products group higher in recent trading sessions. Despite the sharp gains that have already accrued, we continue to see meaningful upside potential. Positioning had become exceedingly bearish on this group, as measured by the surge in the short interest ratio. The latter showed it would take roughly ten days to cover these bearish bets. Meanwhile, analyst profit estimates were challenging multi decade lows, in relative terms. However, the plunge in oil prices and rising income are growth pushing up spending on leisure products, and retail sales and toy and hobby stores are booming. Consequently, the stage is set for a major re-rating in earnings expectations (second panel), which should force ongoing short covering. We reiterate our high-conviction overweight. The ticker symbols for the stocks in this index are: MAT, HAS. bca.uses_in_2016_02_05_002_c1 bca.uses_in_2016_02_05_002_c1

Deflationary pressures in the media space as a result of cord cutting and changing consumer consumption habits are undermining profit prospects. To make matters worse, the service sector is closing the gap with the weakening manufacturing sector: the latest ISM non-manufacturing survey showed a large drop, particularly in its employment component. Worrisomely, industry productivity (sales/employment) has ground to a halt, warning that relative profits will likely disappoint in the coming quarters, the opposite of what sell-side analysts are currently anticipating for the next 12-months (bottom panel). With media credit spreads steadily widening following the debt binge to retire equity, the risk premium in this sector is set to steadily widen. We reiterate our high-conviction underweight stance. The ticker symbols for the stocks in this index are: DIS, CMCSA, TWX, TWC, FOXA, CBS, OMC, VIAB, IPG, NWSA, DISCK, TGNA, CVC, SNI, DISCA, CMCSK, FOX, NWS. bca.uses_in_2016_02_05_001_c1 bca.uses_in_2016_02_05_001_c1

The S&P hotels index is breaking down. The era of cheap financing costs spurred a multiyear lodging industry construction binge, creating a backlog of new capacity likely to hit markets for some time to come. In the interim, there is evidence that slowing economic growth is starting to undermine revenue. Global revenue per room is contracting, even prior to much of a slowdown in traffic. The implication is that pricing power is being sacrificed to fill rooms. Looking ahead, leading indicators of consumer spending on lodging are pointing to a marked slowdown, consistent with our expectation that corporate sector travel budgets will also be pruned as profit margins get squeezed. We downgraded this overvalued group at the end of last year, and reiterate our underweight stance. The ticker symbols for the stocks in this index are: CCL, MAR, RCL, HOT, WYN. bca.uses_in_2016_02_04_002_c1 bca.uses_in_2016_02_04_002_c1

An improvement in the euro area credit impulse is encouraging, but we explain why it is not enough to sustainably boost risk-assets.

A recent article in Barron's painted a bright picture for bank stocks, but we have a more cautious view. While value is attractive, the earnings picture has darkened. The narrowing yield curve and budding downturn in credit quality will put pressure on credit creation to drive profitability. However, we are skeptical that loan growth will improve much. The latest Fed Senior Loan Officer survey showed that banks continue to tighten standards on both C&I and commercial real estate loans. While they remain willing to make consumer and mortgage loans, demand for a number of these categories is drying up. Against a backdrop of increased credit stress and rising corporate bank bond spreads, loan loss reserves are likely to accelerate, warning that low valuations are likely to persist. We recommend only a market neutral weighting. The ticker symbols for the stocks in this index are: BAC, BBT, C, CFG, CMA, FITB, HBAN, JPM, KEY, MTB, PBCT, PNC, RF, STI, USB, WFC, ZION. bca.uses_in_2016_02_03_001_c1 bca.uses_in_2016_02_03_001_c1

Spread product performance has been foreshadowing changes in market rate hike expectations since early last year, and the recent bout of weakness means it is probably time for the Fed to temper its hawkishness.

The current profit backdrop for the machinery industry is grim, but the relative price ratio has already made a large downward adjustment and short interest is sky high. Importantly, machinery companies are finally addressing the need to reinvigorate productivity as an offset to the competitive drag from a strong exchange rate. Importantly, history underscores the likelihood of at least a temporary hiatus in the bear market. Going back to the 1950s, we have identified five durable machinery relative performance bear markets. On average, they lasted 42 months and recorded 44% in declines from peak to trough. In comparison, the current downturn has been underway since 2011, with the price ratio shedding 36%. Interestingly, a cycle-on-cycle analysis shows that machinery stocks have troughed prior to any turnaround in either the ISM index or the U.S. leading economic indicator. Instead, the group appears to have taken its cue from U.S. dollar weakness and a rally in commodity prices, both of which herald better times ahead for primary machinery end markets. Consequently, continued economic deterioration may not translate into additional relative underperformance. We upgraded to neutral in yesterday's Weekly Report, protecting a profit of 19%. The ticker symbols for the stocks in this index are: CAT, ITW, DE, PCAR, CMI, SWK, IR, PH, SNA, DOV, PNR, XYL, FLS. bca.uses_in_2016_02_02_002_c1 bca.uses_in_2016_02_02_002_c1