* We maintain our neutral stance on equities and stick to our year-end targets of 2,150 for the S&P 500 and 3,350 for the Euro Stoxx 50.
* What has improved, but is unlikely to improve further? (1) China: housing (prices rising in 65 out of 70 cities) and infrastructure (state/SoE investment up 23% Y/Y, a five-year high) but economic lead indicators look like they are rolling over, our policy indicators show tightening and there has been no rebalancing. (2) Oil: almost all risk trades have been correlated to oil. We believe if oil moves above $50pb, Saudi Arabia does not meet its apparent economic/political objectives, including preventing the US becoming selfsufficient in energy. Moreover, speculative positions are at all-time highs. (3) The Fed became more dovish as the market rallied, but this is now reversing (our economists expect two rate hikes this year; the market expects one). (4) Bond yields have never decoupled to this extent from ISM new orders, cyclicals or commodities. (5) Credit: in Europe there has been a c.50% retracement in HY spreads from their trough in Summer 2014. Spreads now look fair value. (6) US earnings revisions have turned positive for the first time since June 2014, but much of this is down to the dollar and commodities and hence this normally very positive signal could be misleading. (7) US lead indicators are now unusually ambiguous, and if anything, trending weaker
* What has not improved: (1) Global PMI or global nominal GDP growth (which is the weakest it has been outside of 2008/9). (2) US labour is getting some modest pricing power (which is bad for profit margins) and hence the gap between nominal GDP and wage growth has fallen to its lowest in this cycle. (3) There is significantly above-average political risk (relating to immigration, the Italian referendum, the US presidential election).
* The other worries for equities: (1) Both our fair value models are close to fair value (US ERP is 5.7% against a warranted of 5.6%). (2) We have never seen so much disruption to business models from new technology, regulation, and China in an environment where governments are helping labour relative to capital (via taxation and minimum-wage legislation). (3) We marginally raise our 2016 US EPS growth forecast to 1% from zero. The problems for corporates are: i) labour is getting pricing power, ii) operating earnings appear abnormally overstated compared to reported, and iii) one-off factors, which accounted for c.60% of margin improvement, are diminished. (4) Buybacks as a style is underperforming. (5) Seasonals are unsupportive: since 1988, May to September has seen flat markets. (6) A fall in the 50-week MA below the 100- week MA sees down markets 56% of the time over the next six months
* We remain benchmark of equities: (1) 'Fair value' for equities could be considered reasonable when bonds/real estate appear so expensive. The cost of equity in the US is 9.1%, still in its normal range (though at the lower end). (2) Risk appetite is pricing in an ISM below 50. (3) Excess liquidity is extremely high, and retail, institutional and prime positioning is also supportive. (4) Market breadth has improved.
* The critical issues to watch are Chinese lead indicators, US wage growth and US lead indicators.