When is good news bad news? Or vice versa? We highlight some interesting examples:

 US bonds have rallied despite very strong growth and inflation data as well as huge fiscal stimulus. The TIPS yield is almost back to November levels, but the explanation in our view is not policy (as the 2-year note yield is little changed). If it were ECB bond buying causing a Euro/Treasury switch, then ECB bond buying would be up more and the dollar would be stronger. We think the 10-year bond yield will end up rising again, given further rising inflation expectations, the Fed buying only a third of issuance and our view that US GDP growth will come in closer to 8% this year. Critically, we think the TIPS yield will not rise. A rise in inflation expectations without a rise in the TIPS yield is typically an ideal combination for equities until inflation gets to 3%. Such an environment is particularly positive for financials (European banks look c30% cheap on our models). 

Strong economic data and rising inflation expectations, but non-financial cyclicals in aggregate are not outperforming. Since 1 March, we have seen much stronger data and very strong earnings, but non-financial cyclicals have performed only in line with the market. We think this is because non-financial cyclicals are already very expensive, pricing PMIs in the low 70s while US ISM has peaked (Eurozone should peak in Q3). This is why we have been reducing non-financial cyclicals and adding to ‘cyclical’ defensives (alcoholic beverages, CPI-linked utilities and telecoms), e.g. National Grid, Diageo, BT and Vodafone. US growth is being revised up strongly, but the dollar has not strengthened by much. The recovery in US consumption has caused the current account position to be a near-record 6.5pp of GDP worse than Europe’s. Structurally, net foreign debt is 66% of GDP, the dollar is expensive on all PPP measures and 60% of FX reserves are in the dollar. This is positive for domestic Europe (banks, budget airlines, utilities), GEM and US international earners (eBay, Alphabet, Citigroup). China defaults have risen, but credit spreads have fallen. 

China is able to control its debt market given its significant net foreign assets and basic balance of payments surplus. We don’t expect the credit bubble in China to unwind until real estate prices fall sharply (yet to happen), and property developer performance implies they will remain resilient. This indicates investors can still be structurally exposed to China once its recent round of tightening has finished (we are benchmark China, having reduced in mid-February). China TSF and PMIs slow, but iron ore and copper prices rise. Normally, mining is a China play (if TSF and PMIs slow, mining underperforms c80% of the time), and we halved our mining overweight in mid-March. But this time around, commodities have been driven by the recovery in non-China (pushing global IP to 10% by Q3), the rise in inflation expectations (commodities are an inflation hedge), and very strong green-related demand. This shows the strength of the structural story in mining. We are only a small overweight of mining and note the sector should benefit once China’s tightening is complete. New US sanctions, but Russian bonds and the ruble rally. We think this is because Russian fundamentals on our scorecard are similar to South Korea’s, but its credit spreads are similar to Indonesia’s. We are overweight non-commodity Russia as the negatives appear largely priced in.