BCA, Independent Investment Research Since 1949

Outlook For EM Equities

The underperformance of EM equities has lasted for six years and is likely to persist for a while longer.

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The previous cycle of EM underperformance suggests we could have a drawn-out bottoming process rather than a quick rebound. Emerging equities look like decent value on the simple basis of relative price-earnings ratios (PER), but the comparison continues to be flattered by the valuations of just two sectors – materials and financials. Valuations are less compelling if you look at relative PERs on the basis of equally-weighted sectors.

More importantly, the cyclical and structural issues undermining EM equities have yet to be resolved. The deleveraging cycle is still at an early stage, the return on equity remains extremely low, and earnings revisions are still negative. The failure of the past year’s rebound in non-oil commodity prices to be matched by strong gains in EM equities highlights the drag from more fundamental forces.

Bottom Line: We expect EM equities to underperform developed markets.

U.S. Banks: Higher Rates Vs Weaker Loan Growth

Bank stocks have experienced a sentiment-driven surge since the U.S. election, supported by expectations for higher interest rates. Lost in the exuberance has been a marked deceleration in credit creation.

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Total bank loan growth has dropped to nil over the last three months, led by the previously booming C&I category. That is a sign that while businesses are expecting an economic improvement, they are not yet positioning for one via increasing working capital requirements. Coupled with increased bank staffing levels, the growth in bank loans-to-employment, a decent productivity proxy, has also dropped to zero. Importantly, the yield curve steepening trend has taken a breather, which may be a catalyst for some profit-taking.

Bottom Line: Our U.S. equity strategists are underweight banks.

BCA Research’s Oil Recommendations Up 95% in 2016

BCA Research’s Commodity & Energy Strategy reported returns on its oil recommendations were up 95% last year, during one of the most difficult trading markets in memory. CES is run by Bob Ryan, SVP and Chief Commodity Strategist. The service early on expected global oil supply and demand would rebalance on the back of fierce supply destruction, and the Saudi-Russia detente, which was apparent as early as January 2016. BCA’s CES started looking for ways to get long back in January 2016, and its recommendations paid off handsomely. CES recommended an energy overweight to oil Feb. 4, 2016, and remains bullish as the supply cuts negotiated by Saudi Arabia and Russia take hold.

Our results are not a P&L — we don’t run trading books. We report simple percent returns on recommendations we make following our assessment of the market. Our analysis is driven by fundamentals – supply, demand, inventories and monetary policy – and by our assessment of the geopolitical landscape, which is the product of Mr. Ryan’s 30-plus years of experience in the commodity trading markets, and access to BCA’s world-leading Geopolitical Strategy service run by Marko Papic. Where the returns are positive, we’ve correctly judged where the market was going; where they’re negative, it tells us we are missing something and need to reassess.

For a complimentary recap of 2016 results, and our view of the important issues affecting commodity markets this year, please contact us here.

BCA Commodity Recommendations in 2016
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Global Equities To Trend Higher

Although a short-term correction is likely, the current reflationary window should provide a tailwind for global equities in 2017.

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We expect global equities to be higher in 12 months than they are today. However, the risks for stocks are tilted to the downside over both a shorter term horizon of less than two months and a longer-term horizon exceeding two years.

The near-term outlook is complicated by the fact that global equities are overbought, and hence vulnerable to a selloff. Our bullish sentiment indicator is stretched to the upside. Expectations of long-term U.S. earnings growth have also jumped to over 12%, something that strikes us as rather fanciful. Renewed rumblings in China could also spook the markets for a while.

We expect global equities to correct 5-10% from current levels, setting the stage for a more durable recovery. Once that recovery begins, higher-beta developed markets such as Japan and Europe should outperform the U.S.

Outlook For Euro Area Growth

The European economy grew at an above-trend pace in 2016 and should do the same in 2017.

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Euro area growth should remain reasonably strong in 2017, as telegraphed by a number of leading economic indicators. Fiscal austerity has been shelved in favor of modest stimulus. The European Commission is now even advising member countries to loosen fiscal policy more than they themselves are targeting.

Ongoing efforts to strengthen the euro area’s banking system will also help. As banking stresses recede, the gap in economic performance between northern and southern Europe should narrow. The overall stance of monetary policy will facilitate this trend. If the ECB keeps interest rates near zero for the foreseeable future, as it almost certainly will, Germany’s economy will overheat. Higher wage inflation in Germany will give a competitive advantage to Club Med producers seeking to sell their goods in the euro area’s biggest economy and will help erode Germany’s current account surplus.

Bottom Line: Stronger euro area growth rests on the assumption that Germany accepts an overheated economy. This will clash with Germany’s historical antipathy towards inflation, meaning that political risk could escalate over the coming years.