• Global equities remain in a consolidation mode, but with significant regional divergences.
Year-to-date, European equities are outperforming, now up 8-10% off the lows, in contrast to the EM which
are at the lows and the US which is only 2% off the lows. A lot of the recent EM underperformance has
been accompanied by a sharp correction in EM currencies. At a sector level, Cyclicals outperformed
Defensives, with US Cyclicals making fresh new highs relative to Defensives and European Cyclicals
regaining most of the recent losses. • In the US, the earnings season has thus far acted as a
catalyst to flush out some market dislocations. More so, rapid deleveraging in a poor market
liquidity/depth environment is making some of the blue chip defensive names behave more like high beta
stocks. For stocks that are effectively priced for perfection even small adjustment in guidance has
resulted in disproportionate underperformance (e.g. KHC, PM, and PG are down -29%, -24% and -22% YTD
respectively). Besides traditional low volatility sectors, stocks from non-traditional bond-proxy
sectors, with strong momentum and compressed volatility, have faced similar risk (e.g. Capital Goods).
While downside risk for this space should be more limited going forward, given the significant shift in
their realized volatility profile, some further rotation from low volatility stocks to high volatility
(e.g. value) stocks could be driven by Quant rebalancing early in May. The team is also reiterating its
Energy OW and sees that sector as having the best risk/reward on the back of improving fundamentals, poor
investor sentiment, and attractive valuation. • Our Global Equity strategists are constructive on
stocks and reiterate the key regional trades for this year: 1) Eurozone to keep bottoming out vs the US
as the main drivers behind the US outperformance over Eurozone are fading – i.e. earnings, Tech and the
FX. The worst of the currency headwind happened in Q1, and they believe that in the 2nd half positive
sales surprises will shift from the US to Eurozone. Within Eurozone, Italy remains their top pick, but
they see DAX as getting increasingly more attractive as well, especially if Euro continues to trade
lower. 2) They were OW EM vs DM in 2016 and in 2017, but do not expect EM to outperform this year. FX,
Fed, flows, Tech, trade, China dataflow and unwind of QE hurting inflows are some of the reasons behind
their more cautious stance on EM, in relative terms.
We remain positive on equities based on two strong fundamental drivers: record-setting US corporate
earnings, and robust and synchronized global economic growth, expected to rebound in 2Q from the 1Q
temporary downshift. Meanwhile, key risks we highlighted in recent months appear to have eased:
positioning is meaningfully lower, previously elevated valuations are now below historical averages, and
central banks’ policies are likely to remain on balance accommodative. Although politics and trade war
concerns are still a significant overhang, the worst of uncertainty and political risks might be behind
Currently, about 80% of US states have an unemployment rate below the NAIRU (which is 4.5%), and that is
normally when the Fed funds rate peaks. We continue to see the Fed funds rate moving higher but something
is different this time around, and our biggest fear is that we will get a non-linear burst in wage and
price inflation once the economy runs out of people willing or able to work.
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