Technology

At current levels, Treasury yields are consistent with our assessment of fair value. Further, the Fed's Labor Market Conditions Index does not suggest an imminent recession. Expect payrolls to stabilize above levels consistent with further progress on wage growth and inflation, allowing the Fed to hike rates later this year.

The S&P technology sector has been drifting lower in relative performance terms, which is notable given that the broad market has made a charge toward the top end of its trading range. The lack of leadership from this traditionally high beta sector reflects ongoing deterioration in earnings drivers. The San Francisco Fed's Tech Pulse Index, a coincident indicator of tech sector activity including employment, output and shipments, has rolled over after a multiyear expansion. Additional downside is probable, given that tech new orders have slipped into the contraction zone on the back of the nascent retrenchment in corporate sector capital spending and relentless contraction in emerging market exports (bottom panel). Technical conditions are warning that the downturn in relative performance is the start of a sustained bear market. Our Technical Indicator has declined into the sell zone after diverging negatively from the share price ratio. Breadth is thin, as far less than half of the sub-industry groups are trading above their 40-week moving average, in relative terms, and/or with a positive 52-week rate of change. The bottom line is that an underweight stance is the best way to protect portfolios from looming underperformance. bca.uses_in_2016_06_10_001_c1 bca.uses_in_2016_06_10_001_c1

What is liquidity? How is it created and destroyed? And when does it trigger turning-points in financial 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 tech sector is sagging on the under the weight of contracting sales growth. There is no imminent reprieve, underscoring that the cresting in overall sector margins is likely to accelerate. Consumer spending on technology products and services has climbed as a share of total outlays (second panel), but the sector is not receiving support elsewhere. Businesses are being forced to retrench. Profits are under pressure while balance sheets are increasingly debt-laden. As a result, executives are unable to pursue expansion. Companies have spent the bulk of the money raised to repurchase shares rather than to invest. Why would that improve if the gap between the return on and cost of capital continued to close, as is currently the case? Both our capital spending model and the narrowing gap between the return on and cost of capital warn that business investment on tech goods is headed south (third and fourth panels). Importantly, the financials sector, a large technology spender, is already laying out an historically high portion of its sales on capital spending. Financial sector investment is likely to be reined in now that the credit cycle has taken a turn for the worse and more money needs to be set aside for bad loans (bottom panel), which will remove another support for tech final demand. We reiterate our underweight tech sector view, please see yesterday's Weekly Report for more details. bca.uses_in_2016_05_17_002_c1 bca.uses_in_2016_05_17_002_c1

Stocks whipsawed violently last week. Volatility could intensify if recent whiffs of a domestic economic slowdown proliferate and the Fed still adopts a more hawkish tone.

The overall tech sector has been under pressure as a consequence of shoddy profits. We do not expect any imminent reprieve, particularly within the heavyweight S&P computer hardware, storage and peripherals index. This group is highly sensitive to swings in capital spending budgets. The latter are under pressure from a narrowing in the gap between the return on and cost of capital in the overall business sector. New orders for computer hardware products have dropped into the contraction zone, warning of potential shrinkage in top-line growth. To make matters worse, wage inflations has surged in recent quarters. That is a recipe for productivity disappointment. Until overall business sector profits are poised to recovery on a sustained basis, demand for hardware is likely to stay on its heels. We reiterate our underweight position. The ticker symbols for the stocks in this index are: BLBG: S5THSP - AAPL, EMC, HPE, HPQ, SNDK, WDC, NTAP, STX. bca.uses_in_2016_05_12_002_c1 bca.uses_in_2016_05_12_002_c1

Asian exports (volumes and prices) have been contracting, as global trade has hit a wall. While this broad deflationary backdrop has taken a toll on Asian DRAM prices (bottom panel), global semiconductor supply/demand imbalances best explain the industry's dwindling pricing power. Not only are global semi sales shrinking, but also BCA's global semi inventory proxy is surging. Taken together, our global semi sales-to-inventories (S/I) ratio is contracting at an accelerating pace, signaling that an inventory liquidation phase is looming. Historically, the S/I ratio has been an excellent leading indicator of semi earnings and the current message is to expect a significant drop in profits (middle panel). Bottom line: Steer clear from the broad tech sector, continue to underweight the tech hardware, storage & peripherals sub-index and we reiterate our high-conviction underweight status for the S&P semis index. The ticker symbols for the stocks in the S&P semis index are: BLBG: S5SECO - INTC, QCOM, TXN, AVGO, NVDA, ADI, SWKS, XLNX, MU, LLTC, MCHP, QRVO, FSLR. The ticker symbols for the stocks in the S&P technology hardware, storage & peripherals index are: BLBG: S5THSP - AAPL, EMC, HPE, HPQ, SNDK, WDC, STX, NTAP. bca.uses_in_2016_04_28_002_c1 bca.uses_in_2016_04_28_002_c1

In mid-April we cautioned investors not to position for a betterment in tech sector earnings despite the seemingly low sell-side analyst hurdle. A slew of tech heavyweights have come up short this earnings season both on the top and bottom line fronts. More importantly, bellwether Apple struck a cautionary note on consumer electronics end-demand, especially in China and warned that profit would underwhelm in the current quarter. This is disconcerting especially given Apple's global reach, and is signaling that the tech sector tide is likely turning following a nearly uninterrupted decade-long relative share price bull market run. The top & middle panels of the chart show that this outperformance phase is running on empty as relative profit trends have given way. Meanwhile, on the demand side the outlook remains grim. Overall tech new order growth is contracting and the message from weakening Korean and Taiwanese exports is that more pain lies ahead for tech sector profitability. Deflating Asian export prices are underscoring that semis should also be avoided (see the next Insight). bca.uses_in_2016_04_28_001_c1 bca.uses_in_2016_04_28_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.