Quality is another attribute to take advantage of while markets remain range-bound and volatile.  This carries on from our other recommendation of pursuing an active and contrarian approach to stock picking.  We believe markets will remain range-bound and volatile while lead indicators are rolling over.  Looking at equities during lead-indicator rollovers, we conclude that equity indigestion can last for 3-12 months, so this could play out for another 1-2 quarters. 

We remain cautious but look for reasons to become more constructive.  There is a growing dichotomy between risk measures, which have stabilized, and equity markets, which remain weak.  This suggests that investor concerns have migrated more completely away from risk appetite towards economic momentum.  This transition rests on market fundamentals.  Spreads on some sovereigns remain elevated, but (for now) stress in funding markets seems to be past its zenith. 

Relative revisions momentum as a sector rotation tool - looking for turning points.  We studied changes in the spread between the earnings revisions ratio for a sector or industry and that of the market.  On this basis, commodity sectors, especially energy, look attractive assuming no global double-dip.  For financials, macro sentiment may matter more than earnings momentum.  But we see negatives for the consumer discretionary group.   

We continue to believe credit markets will compress, leaving lower-quality credit to outperform higher-quality, and keeping intact our BB over BBB theme for high-grade-mandated investors.  However, that trade does not come for free.  And should equity volatility rise over the next several months, the valuation argument for credit just looking to volatility will face stiffer headwinds than we currently assume based only on the macro challenges we see today.  

Many factors that undermined the euro so far in 2010 are likely to weigh on it again in 2H10.  Indeed, if there are growing risks that US growth disappoints, then the same is likely for the euro-zone, especially as fiscal policy is being tightened in Europe.  Tighter fiscal and monetary policy, along with a stronger currency over the past month, are likely to hinder the growth outlook.  In our FX portfolio, we have increased the euro/US dollar short position to 20% from 10%. 

Western economies seem to be drifting towards a Japan-like backdrop of low growth, low yields, scaled-back equity returns, and big but surprisingly sustainable budget deficits.  If the drift continues, it will end in a deflation scare.  No one is more scared of deflation than today's cohort of central bankers.  The end-game, over the horizon for now, may be an inflationary print-fest.  To over-simplify, we seem to have moved into a world where too many people want to save. 

Global telco valuations are low relative to history, and they deserve to be, in our view.  Low valuation multiples do not mean telcos are cheap but rather reflect a continued muted growth outlook.  We believe the sector is performing as a simple yield play.  At best, we think the sector offers relative re-rating potential if equities go through another correction period.  In absolute terms, we see limited scope for broad sector multiple expansion. 

Double-dip fears and stress tests have heightened investor anxiety; we remain sanguine.  Our tactically constructive view is built on three pillars: 1) no double-dip recession; 2) greater confidence than most in the efficacy of European bank stress tests; and 3) a more positive view on China, where the renminbi de-peg is an important step toward our "Goldilocks" soft-landing scenario.  With the S&P 500 up 5% in early July, we believe the market is catching up to our view. 

Mexico's central bank is unlikely to cut interest rates, despite the country's recent low inflation readings and mounting fears about the US economy.  Not only has the downturn in inflation been caused in great part by a series of temporary factors, but expectations have remained stubbornly high.  Given that the Mexican economy is still showing good momentum, the growing ranks of Mexico watchers looking for imminent interest rate cuts are likely to be disappointed.  

Double dips are rare in Japan, but ‘mini-dips' in the course of expansions are not.  While indicators suggest such a mini-dip, seasonal adjustments may be distorting the data.  Also, the recent drop of JGB yields is not a bubble, in our view.  There are good macro and regulatory reasons for JGBs to be strong.  Uncertainty on monetary and fiscal policy will likely continue at least until the party president election in the ruling Democratic Party, now expected on September 5.

Soft landing under way.  In light of the moderation in growth and receding inflationary pressures, we believe China's policy cycle has troughed and will likely turn growth-supportive by the fourth quarter.  The pattern of sequential growth momentum suggests that a soft landing is well under way.  We have revised our GDP growth forecasts to 10% (from 11% previously) for 2010 and 9.5% (from 9.0% previously) for 2011.    

Despite its shortcomings, we think that inflation targeting (IT) is here to stay.  The financial crisis resulted in a wholesale re-examination of how monetary policy is conducted.  The most important issue is whether, and how, monetary policy should respond to asset price developments.  Policymakers seem poised to employ a ‘macroprudential rule' that will link asset price developments with capital and liquidity requirements for financial intermediaries. 

Business credit demands pace slow revival.  The ebbing of the credit crunch has promoted a moderate economic recovery.  But contrary to our expectations four months ago, the record-setting bust in private credit demands appears to be far from over.  Still, there are straws in the wind that credit demands are beginning to perk up.  Businesses are pacing this stealthy, slow revival, reflecting a shift from inventory liquidation to accumulation and accelerating capital spending.

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