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Our pillar core views are pro-Quality and Earnings delivery. Our 3 Major Overweights all combine positive Earnings profiles, higher Quality and lower B/S risk with a recent de-rating. And, as macro surprise peaks, we move U/W in Autos & Parts, Travel & Leisure and Basic Resources joins Oil & Gas. But it’s not ‘all about Cyclicals vs. Defensives’: like Utilities, Insurance is lower Quality and joins it as Major Underweight, and Health Care is cut to Neutral. The Quality story is there: the Earnings one isn’t.
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Macro Beta: Neutral - allocated framework weight 0%
Our Activity Surprise Indicator and PMI Diffusion Indicators pointed to strong macro momentum. But we may be nearing the best of the growth acceleration, as activity surprise has peaked. As the reflation narrative gets tested by policy delay and lack of detail, for now, we neutralise the Macro Beta pillar in our framework process.
Relative Valuation: modest positive – allocated weight 10%
High overall Equity market valuations suggest some focus within the market on relative cheapness: low valuation is a protection against event risk and market risk. We do have a positive weight of 10% on relative valuation in our process. But, for now, we believe that Quality and Earnings delivery are the key characteristics.
Forward Earnings: Positive – allocated weight 40%
We are not in a growth-rich world: we anticipate a near-term improvement in EPS growth, but 12m fwd expectations are likely to be disappointed. We allocate a 40% weight to our Earnings pillar, which checks growth with revisions and EPS Surprise. Delivery, not promises, matter if growth underwhelms and EPS uncertainty rises.
Balance Sheet Strength: modest positive – weight 10%
Low profits growth and uncertainty act to highlight balance sheet risk. But potential bankruptcy risk doesn’t guarantee disaster. Recessions are the trigger for mass corporate default, and our 6m probabilities are sub-10%. Quality and Earnings delivery provide protection. For now, we weight Balance Sheet Strength at 10%.
Quality: Positive – allocated framework weight 40%
A backdrop of macro surprise peaking, uncertain EPS growth and rising funding costs promotes persistent cash flow generation and higher debt comfort. Quality is an obvious way to protect against risk, while the relative valuation of Quality is now unstretched. Quality as a characteristic will command a premium: pillar weight 40%.
Sector recommendations: they reflect broader ASR views
Our Sector recommendations have a more Defensive tilt. This chimes with other ASR tenets: that Macro momentum is to fade; a more selective view on reflation; bond yields to rise, but modestly; and incipient credit and market risk. Change is possible, but the realpolitik is that it’s difficult to engineer and harder to deliver.
ASR Equity Strategy: Global Sector recommendations & changes
VOL: VIX/VSTOXX hits overbought levels; US Bond & FX vol oversold (P4)
FX: AUD/CAD optimism a risk; MXN/JPY breakout points to upside (P1/3)
POSITIONS: GBP net shorts historic extremes; big cut to Crude (P13/14)
Clouded VIX/VSTOXX picture; contrarian plays in AUD/CAD
Stretched Vol. Historically low levels of volatility are now evident in US bonds, FX, Gold and equities. The recent spike lower in the VSTOXX has also lifted the VIX versus VSTOXX SBI to levels that have in the past been followed by a relative reversal in VIX versus VSTOXX on over 80% of occasions in the next 30D (by an average 11%). However, things may be different this time around. A different picture emerges when the relative is based on 4th futures contracts, which suggest French Election uncertainty is built into vol futures. Charts on p4.
AUD/CAD has reached stretched optimism levels as the cross-rate challenges a key technical inflection point c.1.03. SBI levels of 95+ in the past 10Y been followed by a fall in AUD/CAD over the next 30/65-days on 70% of occasions (by average 1.1% and 2.8% respectively). This underlines the likelihood of a pull-back in AUD/CAD. This would be consistent with Australian equities coming under downward pressure versus Canadian. Especially given optimism on Australia/Canada ($) is also stretched. See p3.
Chart of the Week: MXN/JPY. In FX, there are signs of a change in trend on MXN/JPY, with the cross-rate pushing above key resistance c.5.86 and moving averages becoming more positively aligned. Sentiment and positioning is not a constraint. Next upside target is 6.4 (38% retracement of 2014-16 decline).
Economics: Watered down (animal) spirits
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