U.S. Equities: Is Sentiment Truly Bearish?

While not an exact science, a number of metrics suggest that investors are far more bullish than sentiment readings imply.

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True bearishness elicits a rush for the equity exits, which prompts position deleveraging, a valuation squeeze, a dramatic increase in cash levels and a premium on portfolio protection, as measured by the VIX and SKEW indexes.

None of these conditions exists yet. Valuations are probing historic highs, as measured by the median industry group price/sales ratio. This metric is more reliable than any forward earnings measure, as the collapse in commodity-related profits can artificially inflate P/E ratios. Ergo, thin equity risk premiums are not consistent with doubts about earnings prospects. Also, investors are not nervously hedging long positions, as evidenced by historically depressed readings in the VIX and SKEW indexes.

Meanwhile, margin debt remains near record levels, both in absolute terms and compared with market cap and/or GDP. This is worrisome because it implies a paltry overall cash flow cushion to cover margin calls in the event of a decline in collateral values, i.e. share prices.

Moreover, investor cash holdings are historically low, the opposite of a bearish signal. Other indicators also suggest a lack of fear among investors. Please see the next Insight, (Part II) U.S. Equities: Is Sentiment Truly Bearish?

Brazil: Beyond The Impeachment Process

Our Emerging Markets Strategy service argues that investors should avoid the temptation to buy Brazilian assets.

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Brazilian assets surged in the run-up to this past Sunday’s vote in the lower house of congress to impeach President Dilma Rousseff. Yet now that the impeachment proceedings against the president have been set into motion – next stop is a hearing in the Senate – investors need to take a step back to look at the bigger picture.

Regardless which party is in charge and who is the president, the fragmentation in Brazil’s congress, which has 27 parties spread out along all ideological lines, is a structural constraint to governance. This is especially true when it comes to adopting painful fiscal reforms, amid a shrinking economy, to prevent a fiscal/public debt crisis.

Barring significant fiscal tightening starting this year, Brazil is headed for a fiscal/public debt crisis in the coming years. Fiscal accounts have deteriorated dramatically in recent years. The overall budget deficit has widened to a whopping 10.5% of GDP and the primary deficit has slipped to 2% of GDP. Moreover, the interest rate on government borrowing is roughly 13% while nominal GDP growth was a mere 3.8% in 2015. Given that the gross government debt-to-GDP ratio stands at 73%, Brazil’s current debt dynamics are unsustainable. A full out debt crisis is in the cards unless the primary deficit is brought back into surplus, or borrowing costs drop precipitously and growth booms. Please see the next Insight, (Part II) Brazil: Beyond The Impeachment Process.