Weak Global Vital Signs

According to our U.S. equity strategists, to forecast that a weaker U.S. dollar will revitalize rather than simply stabilize profits on a broad-basis, it is critical for the rest of the world to demonstrate an internal demand impulse. That would signal that other countries can cope with currency strength, otherwise U.S. dollar depreciation would simply redistribute a shrinking global profit pie back to the U.S.

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Profit redistribution may be enough to avert a serious crunch in stocks, but it is hardly fodder for a sustained breakout when P/E multiple compression is already underway.

The contraction in global exports, particularly in Asia, underscores that global final demand is still sub-par. Our global leading economic indicator, excluding the U.S., is still below the boom/bust line. The global ex-U.S. PMI has also sunk below the key expansion/contraction line. These subdued readings suggest that growth outside the U.S. is not yet on the cusp of a reacceleration.

That is consistent with the message from the bond and equity markets. Global stocks outside the U.S. are barely off their lows, suggesting that foreign profits remain weak. Treasury yields and inflation expectations remain historically low, and yield curves continue to flatten.

We remain wary of global deep cyclicals, but selling pressure in the domestic and interest rate-sensitive S&P consumer discretionary sector may have run its course, particularly if the long end of the U.S. yield curve continues to rally. Our U.S. equity strategist recommend lifting this sector to neutral from underweight.

An Update On Global Growth

According to our EM strategists, there is not much evidence to argue that global growth is improving:

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  • Global trade volumes are contracting and EM share prices – advanced by six months – indicate that the pace of global trade volume contraction will escalate.
  • EM import volumes are contracting, and U.S. import volume growth is heading to zero.

Indicators shown in the next Insight also point towards downbeat growth conditions.

When To Favor U.S. Cyclical Equities?

Our U.S. equity strategists are monitoring a number of key signposts that would help signal when the tide would turn sustainably in favor of cyclical sectors:

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  • Broad-based and sustained U.S. dollar weakness, particularly against a basket of EM currencies in countries with large current account deficits. That would show these regions were poised to gain better access to much needed foreign capital after having regained some competitiveness. So far, these currencies have made an effort to stabilize, but not by enough to signal better economic times ahead.
  • The Chinese manufacturing GDP deflator stops deflating. While the rate of manufacturing pricing cuts has eased, the sector continues to deflate.
  • Global PMIs firm, especially in EM. Inventory liquidation is ongoing, but not fast enough to avoid piling up relative to shipments in many key manufacturing centers.

Please see the next Insight for other indicators that warrant monitoring.

A Trump Victory Would Be Bullish For The Dollar

The latest Global Investment Strategy Weekly Report entitled “A Trump Victory Would Be Bullish For The Dollar” challenges the notion that a Trump win would be bad news for the dollar. All three of Trump’s signature policy proposals – increased deficit-financed infrastructure spending, a more restrictive immigration policy, and trade protectionism – are dollar bullish. These policies could cause the U.S. economy to overheat, forcing the Fed to raise real rates more than it otherwise would. In terms of other asset classes, equities could rally in the near term following a Trump victory, but are likely to face stiff longer-term headwinds. Treasurys would still suffer modest losses, while, ironically, the one asset that could suffer the most from a Trump victory is gold.

To access the report entitled “A Trump Victory Would Be Bullish For The Dollar”, please click here.

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The ECB Is Done For Now

The ECB will remain on the sidelines for the foreseeable future as the eurozone’s economic recovery continues and inflation accelerates.

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The eurozone is experiencing moderately above-trend GDP growth and headline inflation has most likely bottomed. Our models indicate that growth will continue at about 1.75% for the remainder of the year (remember, trend growth in the euro area is barely 1%). The ECB’s updated forecasts expect this pace of GDP growth to persist for the next few years. Meanwhile, the recovery in oil prices and low base effects from last year will begin to push headline inflation higher in the second half of 2016.

Having just announced additional easing measures in March, the ECB is now in a wait-and-see mode. Corporate bond purchases will begin on June 8 and the first new TLTRO auction is scheduled for June 22. Before considering any further policy steps, the ECB will need to evaluate the economic impact of its most recent measures.

If the eurozone economy performs reasonably well and inflation keeps edging higher, then the ECB will remain on the sidelines for the foreseeable future. This means that the downside pressure on the euro stemming from the ECB’s accommodative policies has most probably abated. Therefore, EUR/USD will be more beholden to the Fed. The hawkish minutes from the April FOMC meeting knocked the euro down from its recent high near 1.15. Further euro weakness will hinge on the Fed following through with rate hikes.