Global Profit Growth On The Upswing

Stronger global growth should continue to power an acceleration in corporate earnings over the remainder of the year.

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Global earnings revision ratio has turned positive for the first time in six years, implying that analysts have been behind the curve in revising up profit projections. Our profit indicators remain constructive for the U.S., Eurozone and Japan. In fact, our model suggests that U.S. EPS growth has a very good shot at matching perpetually optimistic bottom-up estimates for 2017.

Admittedly, it is disconcerting that the rally in oil prices has faltered in recent days as investors worry that increased U.S. shale production will thwart OPEC’s plans to trim bloated inventories. Without trimming stockpiles to more normal levels, storage capacity remains too close to topping out, which raises the risk of another price collapse.

A breakdown in oil prices could spark a major correction in the broader equity market. However, our commodity strategists expect the OPEC/Russia production cuts to be extended when OPEC meets on May 25. Consequently, we expect WTI and Brent to trade on either side of $60/bbl by December, and to average $55/bbl to 2020.

Bottom Line: Stronger global growth will lead to stronger corporate earnings growth and underpin global equities. Weaker oil prices pose a downside risk, which we are monitoring.

Opposing Market Signals

Global equities are near their cyclical highs, but several safe-haven assets are rallying.

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Three safe-haven assets have been undergoing a recovery since mid-December: gold, the Japanese yen and 10-year U.S. Treasuries. Gold has retraced all of its post-U.S. election decline. USD/JPY has given back about 62% of its rally following the election, while the10-year Treasury yield has retraced 50% of its advance. In relation to these trends, the equity market is the so-called “odd man out”.

BCA’s cyclical view of global risk assets remains bullish, but a variety of asset prices are indicating a subtle shift towards risk aversion. This could be due to geopolitical worries and/or a downgrading in growth expectations. Whatever the reason, a continuation of these trends could signal a broader retrenchment in global risk assets. We would view this as a long overdue technical setback from overbought levels. Any such correction would represent a buying opportunity on a 9-12 month cyclical investment horizon.

A Warning Sign For EM Equities

A relapse in industrial metals versus lumber prices is a poor omen for EM equities.

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The ratio of industrial metals to U.S. lumber prices has had a reasonably good track record in gauging relative performance of EM versus U.S. share prices. Industrial metals prices are a proxy for economic growth in China/EM, while U.S. lumber prices are indicative of America’s business cycle. Industrial metals prices (the LMEX index) have lately underperformed U.S. lumber prices, pointing to renewed EM underperformance versus the S&P 500.

Heading For A Choppier Market

Equity markets have given up some of their recent gains. Below, we highlight the critical variables to gauge whether a correction will devolve into a sustained sell-off.

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Investor confidence can be measured through margin debt. While extremely elevated, there is no concrete sign that access to funds is being undermined by the modest backup in interest rates. When the cost of borrowing becomes too onerous, it will manifest in reduced margin debt and forced selling.

M&A activity is losing momentum. A peak in merger activity typically coincides with a rising cost of capital. If corporate sector capital availability becomes a pressing issue, then M&A activity will decline further, signaling that the corporate sector is facing growth headwinds.

Economic signals are mostly positive. Durable goods orders have tentatively perked back up, reinforcing that profits and confidence have improved after a soft patch.

Temporary employment continues to rise. When temp workers shrink, it is often an early warning sign that companies are entering retrenchment mode. If temporary employment falls at the same time as share prices, that would be a red flag.

The relative performance of consumer discretionary to consumer staples can provide a read on purchasing power or the marginal propensity to spend. This share price ratio does not suggest that any consumption concerns exist. If consumer staples begin to outperform, then it would warn of a more daunting economic outlook.

In all, these indicators suggest that any pullback will be corrective rather than a trend change.