Telecommunication Services

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.

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.

Late last year we highlighted that the S&P telecom services sector had the potential to be a sleeper pick for 2016, and we put it on our high-conviction list. While this sector has jumped sharply out of the gate, the move has not made a dent in the severe undervaluation created by years of underperformance (third panel). While the sector faces many challenges to grow revenue, its focus on profit margins should be sufficient to create value. Chronic competitive pressures have eased a notch following consolidation efforts, enough to drive meaningful pricing power gains. That is supporting growth in average revenue per user (ARPU), opening the door to improved profit margins. These positive internal dynamics alone provide sufficient reason to stay bullish, but tack on global growth concerns and sinking bond yields, and the incentive to funnel capital into this non-cyclical sector rises another notch. We reiterate our high-conviction overweight. bca.uses_in_2016_01_28_002_c1 bca.uses_in_2016_01_28_002_c1