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Tom Lee's Equity Strategy

Tom Lee's Equity Strategy

I would like to start this note by offering my thoughts and prayers to all those impacted by the current severe weather. Overall, trends in the US regarding COVID-19 are positive particularly regarding daily cases which are down 33,466 from a week ago. However, with the vast interruptions in testing due to weather there might be some under-reporting occurring. Another complication is that it seems about 7% of total US cases are new variants. Given that some are more virulent and contagious, and that vaccines are less effective against the variants, it is a possibility that this could reverse positive progress on cases. Right now though, one of the most encouraging signs we’ve seen for a while just occurred. As Nate Silver pointed out, the daily positivity rate in the US has been below 5% for two consecutive days. Source: COVID-19 Tracking Project and Fundstrat This is a big deal because it has not occurred since mid-October. If the trend continues, we could get below the 5% level before very long, which we view as a significant level. The lower positivity rate is likely not caused by temporary interruptions in testing. As we pointed out on Tuesday, it is also possible the drop in testing is accompanied by a drop in the R0 as social interaction is diminished by road closures and other issues caused by the severe weather. So, it’s difficult to say what the net effect of this winter weather will be with regards to the path of the virus. Progress also continues on vaccinations. The comments from Treasury Secretary Yellen on supporting the Biden admin’s stimulus and the moving of focus to the likely passage of the newest round of COVID-19 relief are also things that make us believe markets are still poised to shift to ‘risk-on’ despite this week’s action. What seemed like a very volatile week masked a very positive undercurrent in our estimation, cyclically sensitive stocks that should perform well in re-opening performed well and had a good week despite what happened at the index level. The drag caused by tech and health care were enough to drag the index down; however, the performance of these ‘Epicenter’ sectors in comparison to the rest of the market is decidedly positive in our estimation. Markets rise on a wall of worry and they fall down a slope of hope as the saying goes. I have found that generally when the ‘top callers’ start calling ‘tops’ that it is a contrarian positive. Furthermore, despite the choppy market action this week at the index-level some interesting ‘risk-on’ undercurrents were going on if you look down to the GICS-1 sector level. Source: Tireless Ken, Bloomberg Since it appears that cyclicals are being bought and the VIX has been behaving reasonably we would assert that while certain sectors appear to be overstretched the wider market-rally will likely remain intact. Commodities are strong, economic data is strong and as our team will discuss below, we think ‘taper tantrum’ fears, at least in the short-term are overdone. Mr. Powell will likely reassure markets next week as he’s gotten quite accustomed to doing. In other words, what we might be seeing is the top being in for growth in the short-term rather than for the entire index. The fundamentals are still in place for a robust economic re-opening. The behavior of the VIX this week despite the turmoil is supportive of this thesis; that markets took a pause this week that won’t significantly interrupt their upward trend. It was sending mixed signals, but we are of the opinion that this week was a counter-trend test of the 24 level. Last week, the VIX fell below 20 for the first time since COVID-19 roiled markets. Stocks were very choppy and it surged toward 24 before settling around 22. You could look at this in two ways; either it hit resistance at 24 and will move back below 20 or the VIX is in a channel making ‘higher highs and higher lows.’ We think that the VIX is in a counter-trend and will resume its downward move. The outperformance of ‘Epicenter’ sectors and the relatively tame behavior of the VIX given the serious selling this week suggests that the broader rally is likely still intact. Bottom Line: We think bullish fundamentals are still in place and that you should be shifting exposure to ‘Epicenter’ names. Be sure to check out our recently revised ‘Epicenter Trifecta’ stock list. Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

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Bear Arrives; Markets Want to See U.S COVID-19 Case Peak

I asked for a sanity check last week since the S&P 500 index was selling at a 16 P/E and Treasuries at over a 100 P/E but the response was simple panic. Indeed, in the frenzied and sharply downward trading last week in reaction to the spread of coronavirus, or COVID-19, it seems the market sees the cure as worse than the disease. That is, it appears increasingly possible that the volatile lurching in financial markets could drive the US economy into a recession, a self-fulfilling prophecy. The market has digested a lot of negative news in the past week, leaving little room for a sanity check. Several companies drew down credit facilities, like Boeing (BA), Wynn Resorts (WYNN); the World Health Organization declared COVID-19 a pandemic; President Trump’s initiatives fell short of expectations. Tom Hanks and his wife Rita revealed they tested positive for COVID-19 and major league sports have suspended their play. So the disruption is becoming tangible in the US. and “price discovery” remains non-existent in equities. By that, I mean the market is so uncertain that stock prices are moving in unison on one or two simple macro factors, with high correlations to each other, instead of on their own corporate merits. Source: FS Insight, Bloomberg Markets have become deeply pessimistic because the “cure” for the pandemic seems worse than the disease. Social distancing, limiting movement, managing intercity and international movements look to be disruptive. Already, industries linked to travel and entertainment, among others, are suffering. The financial markets volatility is worsening an already weak liquidity environment. Italy has now taken drastic measures to curtail movement. What remains unknown is the ultimate path and level of spread in the US, which has a case count ~1,300 and growing. The paths seen by Iran and even Europe are very similar but Italy seems to be accelerating at a pace that makes this the worst case scenario. This is the reason many investors say the US is two weeks behind Italy. Despite the panic, rationality is required, and the best way to compare COVID-19 spread between countries, in my view, is to look at cases per 1 million population. Among the fastest spreads have been Italy, Iran and South Korea which saw 85-152 cases per 1 million within two weeks after passing the US milestone (1.4 cases, or 100 times increase in two weeks). This particular measure implies the U.S. could see 50,000 cases by the end of March. (See chart above.) However, this is only one potential path and if cases peak towards the end of the month (Italy seems the exception), this should result in a turning point for the equity markets. This was the case with China, Hong Kong, South Korea and even Japan, so that’s the “bright side” of an adverse case. I will also point out that the countries with the highest number of cases have the lowest level of toilet hygiene (measured as “percent of people washing hands after using toilet, as China and South Korea are among the worst). Perhaps this could be differentiating national experiences. The U.S. is in the middle on this metric. Source: FS Insight, Bloomberg Currently, the US has about 1.5 cases per 1 million pop, about the same as Canada. Both nations have reported their first case 40 days ago. This is curious, as it suggests both countries are tracking similarly in terms of disease outbreak. Yet, the US is only testing 5 people per 1 million Pops vs Canada at 222. In a sense, while we expect the cases in US to grow sharply in coming weeks (and no doubt there are many undiagnosed cases), perhaps the path does not have to follow Italy or Iran. The market bottom in the Asia equity markets (vs MSCI) all coincided with the peak in Corona COVID reported cases. (See chart above.) This is why the Street is so fixated on the “case count” in the US and Europe. In the meantime, stocks remain relentless oversold by many metrics. Some 75% of cumulative 10-day volume is down, an event that has happened only four times since 1990. Just 1.6% of industries are up month over month, something not seen since December 24, 2018 and before that, January 21, 2016. Those times turned out to both be good times to be long. Finally, another positive development last week was the yield curve fixed itself and is no longer “inverted” from 1 month forward. What could go wrong? COVID-19 could indeed morph into a more dangerous disease, changing the risk profile and the required response of markets. The good news is China’s cases seem to have peaked and are falling. Moreover, US policy makers and central bankers are ready to take necessary action. BOTTOM LINE: Price discovery remains non-existent as investors view fundamentals as uncertain. In our view, the panic by US households and markets, while disruptive, is likely to limit the spread of COVID-19. Case peak remains key bogey for markets at the moment. Figure: Comparative matrix of risk/reward drivers in 2020Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019 Source: FS Insight, Bloomberg

Markets Seem Poised For ‘Risk-On’ as Data Improves

As we finish the second week in February, the developments in COVID-19 have been largely positive. Notably, yesterday the White House signed the purchase agreement to secure an additional 200 million doses of COVID-19, bringing the total to 600 million by July (enough for 200 million Americans). 1.5 million vaccines were given this week vs. 1.2 million last week. There has been nearly a 20% drop in the positivity rate compared to seven days ago. Yet there seems to be a persistently negative public perception compared to many of these positive developments. We have been monitoring organic case trends which have been very positive, despite the surge in more virulent mutations. Even in the nations where these strains originated, cases seem to be significantly collapsing. So, we are definitely experiencing a sustained organic trend in the right direction. At this rate, we could very well see less than 50,000 new cases a day by the end of February and half that by the middle of March. We’ve now seen 31 consecutive days of case decline. Many of you have been familiar with the work of IHME, which we have regularly highlighted as one of our favorite sources of data and forecasts on the path of COVID-19. Unfortunately, due to new variants and a forecasted decline in mask compliance, the organization is forecasting a 4th wave in March and April. Hopefully, this does not occur but this is incorporated into our base case. It stands to reason, if vaccination progress continues at the pace that it is, that markets may react less adversely to this potential uptick than past ones. This is since valuations are mostly comprised of future earnings that by the day have less and less chance of being affected by COVID-19 for wide stretches of the future. Of course, the virus is exceedingly mysterious, and we do not take the risks of the new strains lightly. Our close monitoring of the vaccine technologies encourages us that existing platforms will be able to respond quickly, as Dr. Fauci has also indicated. So, for now despite risks we acknowledge we think it’s highly likely that stocks are now primed for a more ‘risk-on’ speed. There are signs all around the economy pointing to a coming boom fueled by pent-up demand and post-pandemic celebration. As we noted last week, the extraordinary hedge-fund de-grossing that occurred along with the positive fundamentals we’ve been discussing led us to change our base-case which predicted a Q1/Q2 mid-bull market correction of 10%. We have seen volatility continue to collapse this week, despite very choppy action and 3/5 down-days. This is another positive divergence that we wanted to highlight that we think indicates markets are getting ready to rally. The VIX sank to its’ recent low Friday despite the churn in equity markets. This suggest to us that fear is receding from the market. As our clients are aware, we have been carefully watching the VIX and we view a decisive move below 20 as significant for two reasons. Firstly, a fall below 2020 takes the ‘Fear Index’ to pre-COVID-19 levels which would be a welcome ‘risk-on’ development. The second reason we know this to be significant is because systematic and quantitative equity strategies that drive the majority of institutional capital often allow increased leverage into the market as volatility drops below this key level. Well, on Friday the VIX collapsed nearly 6% and settled right above 20 but broke down to an intra-day low of 19.96. We see this as confirming our base case that volatility will collapse in 2021 and the stocks that provide the best risk/reward are the Epicenter stocks. Accordingly, with our change in base case we reiterate that we believe ‘Epicenter’ stocks will lead the indexes to significant new highs. Be sure to check out updated Epicenter Trifecta Stock list. This further constructive action in the VIX makes us think markets will shift to ‘risk-on’ sentiment next week. We want you to consider some of the main macro events on the timeline in 2021. COVID-19 receding, Global GDP acceleration, prodigious fiscal relief, dovish Fed, greater interest in stocks, baby boomers shifting allocations from bonds to stocks, and interest rate increases should all result in equity risk premia collapsing (P/E rising). Wait, P/E’s going up when interest rates rise? It may seem counterintuitive but check out this analysis we did against different rate environments, inflation environments and Fed leadership. If the US 10Y is below 5% and rates are rising P/E will rise. Bottom Line: Our Base Case is no longer predicting a Q1/Q2 correction. Healthcare data and economic fundamentals are pointing to a strong recovery. Epicenter will have high EPS. Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Less Stretched Markets Can Focus on Positive Fundamentals

New cases have now been falling for 24 consecutive days. What this means is that we could be below 50,000 new daily cases by Valentine's Day. Hospitalizations are also down as are daily deaths. Even in South Africa, where a feared variant originated, cases are collapsing significantly despite the presence of B.1.351. These items should serve as a sanity check that markets can now begin to focus on re-opening. The United States is also seeing greater penetration of vaccinations. Now 42% of the United States has vaccinated more than 10% of residents. We believe a key turning point will be 100% of the US reaching at least 30% vaccination rates. The market rout last week that was most notably experienced by Long/Short Hedge Funds has led to an evolution of our thinking on the near-term path of markets. Given that downward price pressure, and the largest corrections, are driven by the overextension of capital, particularly institutional capital, we think there is a high possibility that the scope and scale of the position squaring and ‘blood-letting’ that occurred last week was great enough to make the occurrance10% correction that we and the consensus were predicting highly unlikely. Thus, our base-case has changed. One of the primary drivers of our evolving thinking is that the S&P 500 Volatility Index experienced its most rapid 3 day drop in its’ entire history. Yup. One of the things we typically monitor when we are trying to identify good entry points and changes in market direction is when the VIX is inverted, or in backwardation. The normal relationship between volatility in time is usually pretty straightforward; the more time there is, the more things can go wrong. However, when the stock market is experiencing significant levels of stress, fear, and uncertainty the VIX literally implied the opposite that there is more volatility in the short-term than over time. We use the 4M-1M VIX futures contracts to act as a proxy for VIX inversion. We suspect that the high-intensity market route that occurred actually saved us from the correction we were predicting and now markets can focus on positive fundamentals. We have been focusing on the cyclical economic recovery that the data says is coming. For example, the steepening yield curves (30Y-10Y and 10Y-2Y) have been signaling increasing expectations for a robust economic recovery. In addition to this, we are predicting a major corporate profits recovery from the Epicenter Stocks. Our base case has been altered. We think the prior leadership resumes. Be sure to check out our Trifecta Epicenter stock list to see which names we think will benefit from the drop in volatility. Every single time this cadre of stocks margins have dropped to similar levels to where they are now they have rapidly and significantly recovered. We think other longer-term distortions in the VIX, like the fact it was in backwardation for most of last year, also support our thesis that to play the reflationary and cyclically expansive forces we are detecting in the economy, you want to be OW Epicenter aka. Value/Cyclicals. As you can see what is suggested by the purely historical data is that a massive corporate recovery is underway. Take a look at the EBIT margin chart. The dark blue line is Epicenter EBIT margins (industrials, Discretionary, Materials, Energy, and Financials). The 2020 collapse clearly mirrors the Global Financial Crisis, in fact they have nearly bottomed at the same level. There are multiple reasons to think that the 2021 profit recovery should be even stronger. Thus we think EPS beats as one of the primary reasons to be overweight Epicenter stocks. Be sure to check out the list. Bottom Line: Our Base Case is no longer predicting a Q1/Q2 correction. Healthcare data and economic fundamentals are pointing to a strong recovery. Epicenter will have high EPS. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Virus Still Receding, Millennial Investors’ Rising Influence

COVID-19 Progress has been mostly positive. Novavax and Johnson & Johnson both made progress on vaccines. AstraZeneca-Oxford’s vaccine was also approved by a European regulator. US daily cases are in a downward trajectory and may fall below 100,000 new cases a day in the next ten days. The ratio of vaccines to new cases is at 9x and could exceed 10x as early as next week. We are happy to report that COVID-19 cases have now been falling for 17 consecutive days. We are now definitely seeing the strongest retreat in cases since Wave 2. Despite this positive news, we are still seeing some ‘growing pains’ in the US vaccination process. Moderna and Pfizer’s vaccines are the only ones approved for EUA in the US. Right now, this is contributing to supply-constraints. The Biden administration recently announced that weekly deliveries should reach 10 million doses, higher than the current level of around 8 million. Until more vaccines are approved in the United States, delivered vaccines can be considered a ‘ceiling’ and until that number grows the number of doses is essentially constrained. On Thursday, nearly one and a half million Americans received a dose. STRATEGY: 2021 is already proving to be as challenging as 2020… Millennials are structurally changing markets.. 2021 is proving to be as challenging as 2020, and the tumultuous trading in heavily shorted stocks is the current “mass extinction” event. In our many zooms with institutional investor clients (so many zooms this week), the obvious question is whether the surge in retail trading is a structural change, or merely transitory. The latter camp believes that the surge is a result of stimulus checks and stay-at-home orders and is a temporary phenomenon. The structural camp thinks that Millennials’ generational preferences will forever and significantly change markets; like their preference to direct their own funds instead of giving them to money managers. While this is not a ‘this or that’ answer, I believe the rise of retail investors is structural and led by Millennials. Please see my blast from earlier today where I highlighted the e-mail I received from a well-informed source on the issue. In essence, this individual believes the Reddit WSB/Robinhood trading style stems from the Millennial cohort. This is the best educated generation in history, they are thoughtful and cost-conscious, and they have very different habits than their predecessors that have already disrupted other major industries; Airbnb, Uber, Electric Vehicles…. Perhaps now it is the turn of financial markets? We repeatedly have pointed out that Millennials are set to inherit $68T over the next twenty years, or about 70% of the approximately $100T controlled by US households. Boomers have dominated markets for the last 20 years and naturally, Millennials will dominate the next 20. We’d like to reiterate our thoughts on this change. We think the overall impact of this generational shift will be a substantial inflow of at least $6T of investor inflows into equities in the next decade. Of this, $3T is investors taking 10% of capital allocated to bonds over into stock and the other $3T is investors’ savings flow. Remember 94% of inflows went to bonds over equities since 2008. Given that over the past decade total equity inflows were only a mere fraction of what we are predicting at only $180 billion, we are predicting a significant collapse in equity risk premia. We think this process could result in the P/E multiple for the entire S&P 500 rising to a neighborhood of 30x. These projected inflows are so large that they likely cause “all boats to rise.” In our January 26th note we noted the similarities between bonds in 2011 and equities in early-2021. Bond valuations in 2011 were at ‘all-time’ lows when looking at historical data. Thus, many investors who thought bond valuations were historically stretched got an unpleasant lesson. Bond shorts got demolished because the market was re-rating bonds; 7.5% was the yield for IG bonds for years and now this is what CCC junk grade is yielding. If stocks are in a similar situation to bonds in 2011, which we think they are, then the P/E ratio of the S&P 500 will likely go far higher than consensus expects. Investors who ‘insanely’ poured their money into bonds trading near ‘all time’ lows were handsomely rewarded. We think those calling valuations ‘extended’ or in bubble-territory are as wrong as people that were bearish on bonds in 2011. Central banks are dovish. We think generational factors and increased savings will result in equity inflows over the next ten years many factors higher than in the past. Bottom Line: We think stocks have positive risk/reward in the near term. Our base case remains seeing the S&P 500 reach 3,900-4,000 sometime between Feb and April. We still think this will represent a local top before a large correction ensues. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

COVID-19 In Retreat and Multiple ‘Risk-On’ Signals

Dr. Anthony Fauci gave his first President of the Biden administration. He preliminarily confirmed what tireless Ken’s data has been showing; that the virus appears to be ‘plateauing ‘ in the United States. This confirms what tireless Ken’s data has been showing. We have also had a significant period of consecutive declines in daily cases. Unfortunately, the new mutations that have been identified in South Africa and Brazil appear to reduce the effectiveness of monoclonal antibodies, which therefore reduce the effectiveness of current vaccines. It is yet unclear if the effectiveness of the vaccines is reduced enough to render them ineffective against the strains. On the bright-side, Fauci mentioned that the new vaccine platforms can be easily adjusted to target new strains. This press conference was cautiously optimistic. Even in the face of these mutations, the US strategy of rolling out vaccines and mitigation still makes sense. And with the executive orders by the White House, among them, expediting production and supply of COVID-19 materials plus mask mandates in Federal buildings, the focus remains on mitigation in addition to vaccination. The mutations make the vaccination program all-the-more urgent as the less the virus is reproducing, the less it can mutate further. COVID-19 cases are decisively turning lower in the United States as a whole. We’re not sure what’s exactly causing this. Vaccinations could be working in tandem with lockdowns but one discrepancy we find in the data highlights the ongoing mysteriousness of this perplexing virus. Strangely, states with ‘zero lockdowns’ saw COVID-19 peak in November and December. Yet, CA, which had a strict mask mandate and among the most restrictive lockdown measures, saw cases surge through November and December and even now the cases their have not receded as quickly as the ‘zero lockdown’ states of North Dakota, South Dakota and Florida. STRATEGY: Rally in HY + Fall in VIX + COVID-19 retreat= Market More Risk-On Than Consensus The gains in equity market in the past week were led by Technology, while Energy, which had been leading, declined sharply. Quite a number of our client s mentioned the relatively attractive risk/reward of Technology given the recent underperformance as well as the strong 4Q2020 results reported by some of these companies like Netflix and Intel. Their outperformance was an understandable catalyst for relative performance. However, we do not think the market is becoming ‘defensive’ as leadership by Tech can sometimes indicate. HY Credit is rallying, the VIX is falling, COVID is moving in the right direction and it looks as if vaccinations are picking up. HY bonds generally marches higher basically every day, including Thursday when the VIX simultaneously fell. So, even though Thursday may have seemed like a weak day on its face since cyclicals got pounded and small-caps sold off the ‘leading indicators’ in the adjacent markets of credit and derivatives suggested strength. This leads us to believe that the recovery in technology is healthy and justified. Despite the adverse market action on Thursday the forward-looking indicators are suggesting that the market will soon shift to a more ‘risk-on’ sentiment that should reward investors who are OW small-caps and epicenter stocks. We are currently seeing the strongest string of declines (7D delta) that was not seen since Wave 2 ended over the Summer. This is undoubtedly a big downturn which lends itself to the natural question of whether this is a sustained downturn that will lead us to a robust recovery, or will the mutant strains reverse progress significantly? We have long talked about how lags in the data can occur in an adverse way, like when there is a ‘catch-up period’ after holidays. It is also possible that the ‘real trend’ in COVID-19 cases could be more positive than what we are observing. If this is the case this would be very supportive for epicenter stocks. Based on the vaccine data we are seeing, it looks as though significant progress is being made. The efforts of the new administration certainly seem on their face as if they will continue the progress already made. Bottom Line: We are seeing some of the strongest evidence since the virus began that it is in full-blown retreat. The HY debt markets and VIX also lead us to believe that the market could be setting up for a significantly more ‘risk-on’ sentiment than general consensus perceives. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Factors in Place For “Tesla like” Rally in Energy

Vaccination efforts have begun to improve and there are some glimmers of light in healthcare data. We also are seeing evidence in alternative economic data that the economic recovery will be stronger than forecast. So, even as the US is in the midst of winter, it seems like COVID-19 case trends have improved considerably. But the holiday distortions could still be in effect (making 7D delta look better than it actually is). However, net hospitalizations turned negative for the first time since September. This is a very good sign. Strategy: FOMO Scenario: Energy in 2021 somewhat akin to Tesla in early 2020 So far, 2020 has marked the start of the rotation out of FANG into Energy and Financials. These two sectors are up 18% and 7%, respectively to start the year. FANG and Comm. Services are down about 5% and 4%, respectively. Wow. As I wrote in my 2021 Outlook, the re-alignment of supply/demand outlook for Energy is the most dramatic of any sector. The new White House is likely to limit future supply growth. Capital availability is limited as private equity unlikely to bail out the sector like they did in 2016. And demand will certainly also recover as the global economic recovery accelerates. And at 2.5% weight, Energy is now the smallest sector in the S&P 500. The troubles with this sector are well-known but Energy’s weighting is still tiny: GOOG, AAPL, AMZN, FB and other stocks individually have a weighting greater than Energy. And many institutions likely have a zero weighting. Early in 2020, our clients might recall we wrote about how TSLA was likely to cause Russell 1000 Growth manager’s Fear of Missing Out (FOMO). At that time, we noted that many Russell 1000 Growth managers had a zero weighting in TSLA and their performance was accordingly suffering underperformance as the stock surged parabolically. We told our subscribers that when Russel 1000 managers went to a benchmark weighting of 0% to 0.7% that it would cause the stock to rise quickly. We believe a similar set-up is ripening for the Energy sector. Here is how this could develop: (i) Energy stocks could surge around 20% which would drive fund manager underperformance, (ii) Energy fundamentals could improve in 2021, reversing 4 years of misery, and (iii) Valuations could improve (in case you were not aware, Energy stocks trade below replacement cost= P/B is about 1.0x which is similar to financials). And looking at commodity data, energy has a lot of catching up to do. Thus, we see a catch-up trade coming and Energy remains one of our top 3 sectors for 2021 (others are Industrials and Discretionary). Just take a look at the chart nearby. Copper is up about 27% since the start of 2020. Oil is down about 5%. Energy is down 38% and Oil Services are down 39%. Noticed the gap? We also know that Energy companies have slashed costs to achieve higher operating leverage. This is why, despite all the aforementioned bullish harbingers, we think that energy is poised to significantly outperform historical estimates based on a cost-structure that has been significantly improved as a result of the necessary ‘do-or-die’ cuts. Additionally, our analysis of bull markets in the energy sector would suggest we are in the very early stages of one and that there is a lot of upside left in this sector for 2021. However, as we warned, Energy has the least consensus and is the riskiest of these sectors. Taking a step back to the greater macro picture, evidence from alternative economic data sources point to the conclusion that any pullback in Q1 would be a hiatus before pent-up demand leads to what I would consider a booming economic recovery. Even as COVID-19 spreads rapidly around the world, the global economy is staging an impressive recovery. The contemporaneous data shows this recent PMIs are surprising to the upside and many forward-looking indicators are improving. In fact, the steepening of yield curve (30 year less 10Y )is one of the strongest signals for continued strength. Our clients will recall that we have shown that since 1987 the 30Y less 10Y curve has led the ISM by 17 months. Historical data therefore suggests that there will be robust growth in 2021. Bottom Line: We see any pullbacks that could occur through the first half of this year as pauses that will refresh in a longer-run bull market cycle that pushed equity markets higher into year end. Energy is well positioned to benefit from several structural factors that could support a “Tesla-like” reaction over the coming weeks and months. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Epicenter Off to Strong Start; Signs of Economic Recovery

Markets wrapped up their first full week of 2021 and after a sloppy stumble on Monday, the S&P 500 managed to recover and close up 1.2% for the week. There has already been a substantial bifurcation of sector performance. Energy is up 9.3% YTD. And of the Epicenter sectors, five out of five are up on a YTD basis. Equities seem to be telling us to expect a pretty vigorous economic recovery in coming months. And we can see this possibility, given the continued ramp in vaccinations and along with better seasonal weather (starting March), COVID-19 cases could turn down sharply. Nevertheless, COVID-19 is unpredictable and the renewed post-holiday surge in cases reminds us that the virus remains prevalent. Daily cases came in at 261,571 on Thursday, a new all-time high and up +41,113 vs one week ago. Keep in mind that the holiday effect is going to cause distortions for several weeks. Over Thanksgiving, it was not until a full two weeks later that underlying trends were visible. This will be the case with current data, meaning mid-Jan is when we can start to get a better handle on trends. On the vaccine front, the developments this week were clear: vaccinations are ramping up. Yesterday about 580,000 doses were administered in the US. This is an impressive daily rise of 31% and inches the US closer to achieving one million per day, at which point about 30% of citizens would be vaccinated by early April. The vaccines have proven effective in trials, but the real world test is whether infections slow after a region has vaccinated >30% or more of its residents.  The nation to watch is Israel.  As data below nearby shows, the % of citizens vaccinated is 17% (up from 6% a week ago) and is on course to hit 30% within 2 weeks. So, this is the real test. Cases in Israel should begin to slow dramatically in coming weeks. And if they do, we see a roadmap for the end of the pandemic. If cases do not slow, this is worrisome and could be an indication that the vaccine does not work. STRATEGY: Epicenter off to strong start to kick off the year There have been some gains posted by Energy stocks YTD, and the sector is the best performing so far, up ~9.3% YTD (short year so far). But take a look at the 10-year price history of Energy vs S&P 500 nearby. The surge in Energy stocks YTD is a mere blip. Even getting to parity with the start of 2020 levels means a +70% more in Energy stocks. And look at the decline over the past decade. Needless to say, if Energy proves to be a leader in 2021, this is just the beginning. Here are the nine stocks that we consider the Energy trifecta that are rated Overweight by each of the three macro teams: HP, NOV, SLB, EOG, PXD, HFC, MPC, PSX, XEC. But the story does not end at Energy. Five out of five Epicenter stock sectors are in the green on a YTD basis and I continue to view this as a favorable place to deploy capital. That is not to mention that the current economic data has been robust and supportive of the rally in epicenter stocks. Both December ISMs (manufacturing and services) posted very solid beats for the month and are up versus November. In fact, I’d consider these levels to be arguably boomy. Source: FSInsight, Bloomberg Furthermore, investor sentiment remains cautious. The latest AAII Bulls less Bears survey, which is a reliable way to measure retail investor sentiment for older Americans, came in at 12.5 which is a middle of the road reading, and not really indicative of ebullience. And more importantly, expectations for future volatility, as measured by the VIX futures market remain stubbornly high over the next 9 months. As we wrote in our 2021 outlook, periods of high volatility tend to be followed by a collapse in volatility which is supportive for equity markets and suggests a rise in institutional investment. Bottom Line: Investors are not as bullish you may think. Equities seem to be telling us to expect a pretty vigorous economic recovery in coming months and I continue to favor Epicenter stocks. Figure: Way forward ➜ What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Santa Claus Here: SPX Up 1% Despite COVID Relief Bill Impasse

(COVID-19 remains a global crisis and we realize that many people need to keep up with COVID-19 developments, particularly since we are moving into the more critical stage (restart economy), so feel free to share our commentary to anyone who has interest.) It was a relatively quiet final 2020 week of pre-New Year’s Eve holiday trading, but the Standard & Poor’s 500 index still managed about a 1 % rise to about 3738. Still, all investor eyes are on Washington, D.C. where the Senate is holding up another round of $2,000 coronavirus relief checks. It’s unclear when this will be resolved. (For more, see page 11.) The House had passed, by unanimous consent, this larger payment, but the Senate Majority Leader Mitch McConnell wants to take up three issues simultaneously: (i) stimulus checks, (ii) election fraud and (iii) section 230 protecting tech companies from liability. Congress is running against the clock as the year ends and a recess approaches. Trends in COVID-19 are still largely improving with the hotspots remaining along the coastlines and the Northeast (winter). Positivity rates are holding flat, but the true trend case numbers remain hard to discern given holiday closures. In fact, Texas reported a +10,000 increase in cases (see Point #2), but this is due to many counties reporting 3-4 days case backlog on Tuesday. Additionally, the UK COVID-19 variant showed up for the first time in the US. The patient has no known travel history, so it seems to be a case of community transmission. There are now 17 nations reporting cases of this UK variant. This bears watching to see if the attack rate or the rate of transmission of this variant is meaningfully higher. If yes, it raises the importance of the pace of vaccinations. Small caps have been hard hit in the past few days. The Russell 2000 has underperformed the S&P 500 by ~500 basis points, a sizable drop. I think this is mostly profit-taking because the conditions for a small-cap rally are intact: Stimulus checks = economic positive; COVID-19 rolling = risk-on; Santa Claus rally = risk-on; and – VIX index is falling = risk-on. I see small caps beginning to rally fairly soon. STRATEGY: 67 stocks in the 'Top 3' sectors. Our data science team, led by tireless Ken, has put together the trifecta list of stocks, coming from what we view as the 'top 3 sectors: Consumer Discretionary, Industrials and Energy. These are stocks on which there is consensus among myself, Brian Rauscher, head of global portfolio strategy and Rob Sluymer, our head of technical strategy. Consumer Discretionary (30 stocks): AN, GM, F, HOG, GRMN, LEG, TPX, PHM, TOL, NWL, HAS, MAT, PII, MGM, HLT, MAR, NCLH, RCL, WH, WYND, SIX, DRI, SBUX, FL, GPS, LB, CRI, VFC, GPC, BBY Industrials (28 stocks): AGCO, OC, ACM, WAB, EMR, GNRC, NVT, CSL, GE, MMM, IEX, PNR, CFX, DOV, MIDD, SNA, XYL, FLS, DAL, JBLU, LUV, MIC, KEX, UNP, JBHT, R, UBER, UHAL Energy (9 stocks): HP, NOV, SLB, EOG, PXD, HFC, MPC, PSX, XEC POINT 1: As of Tuesday, the COVID-19 daily cases came in at 185,549, up +3,887 vs 7D days ago. Texas had a massive backlog and saw daily cases jump to 26,990 from 16,607 stemming from multiple counties backlog. (See Point 2.) So cases are still rolling over, but the holiday effect is going to cause distortions for several weeks. The 7-day delta turned positive, but ex-Texas, it would have been down ~7,000. CA remains the state with the highest daily count in cases. POINT 2: We are starting to see backlog caused jumps in cases. As the Texas Health Dept. noted, this is due to a substantial backlog of cases being reported Dec. 29. Of course, Texas is not the only state experiencing this. This is the reason we can expect the holiday reporting to cause some distortions, or rather, contain distortions. As I have noted, multiple counties did not report case data for the Christmas holiday weekend last Friday through Sunday. Those three days were reported Dec. 29 and this is the reason for the surge. POINT 3: The New York Times published an article suggesting a surprising number of COVID-19 patients subsequently develop severe psychotic symptoms. The severity of these symptoms is what alarmed me. Moreover, there appear to be dark voices suggesting these recovered patients murder or harm others. In some ways, this could be another reason why Violence in 2021 could become more pertinent. /2020/12/28/health/covid-psychosis-mental. html However, the article does not address whether this is not similarly found from those receiving vaccinations. A British study (same article) found that among 153 patients, 10, or ~8% had new-onset psychosis. This is a shockingly high statistic. One of the patients described having voices tell her to murder her children. I am really astonished and alarmed by these reports. The obvious question is why this is happening. And while there is no clear explanation, scientists think this is possibly from neurotoxins being released as a result of the immune reaction. Bottom Line: Have a safe and wonderful New Year! I pray that 2021 is a year where the world can heal and that each of you have a blessed holiday. Figure: Way forward  What changes after COVID-19Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

Stocks up 1.3% on Week; Seasonal Surge Underway

The positive seasonal trends for December are underway. Despite a shaky start to the week on Monday with the market opening higher and finishing lower, the S&P 500 rallied hard on Tuesday (12/15) right in typical seasonal fashion and posted a strong close on Friday - finishing up 1.3%. on the week. And given headlines from Washington around the fiscal relief package and government shut down, I’d consider this a win. On the COVID-19 front, the virus is retreating in (in large numbers) everywhere except the United States. And when the US finally reaches its apex on Wave 3, we should see COVID-19 globally rolling over. Looking at daily cases per 1mm residents, the US ranks #9 in the World. But it is the highest of major nations. For context, Lithuania and Croatia are top of the list with 1,129 and 966 cases per 1mm which is roughly in line with the massive spread we saw in North Dakota and South Dakota. And if there is one State holding the US back from rolling over it is California. The Golden State reported upwards of 50,000 cases in a single day this week. At current levels, this accounts for about 25% of all daily cases in the US. California only represents about 12% of the population. And looking at daily cases per one million, California’s are approaching 1,000 which is nearly double what New York State saw at its peak. Wow. So, clearly something is going very bad there. Cases are rising in the face of very strict lockdowns. Excluding California, COVID-19 is rolling over in the other 49 states.  Well to be more precise, it is also rising in some other states, but none are seeing an outbreak of this size and scale. And as we are still in the holiday season, the threat of a renewed spread remains high. Strategy: 2021 Year Ahead --> Pause that refreshes leads to ~25% rally It is natural instinct to think a 'boom' in 2021 is too optimistic. One can point to healthy levels of spending already. Or one can cite the destruction of the US economy. But overall, I think there are several reasons that 2021 should resemble the performance we have seen in the second half of 2020. But I don’t think it will be a straight ride up. History says stocks are likely to correct in February -April 2021 with a 10% dip to 3,500. The 1982 and 2009 bull markets provide useful context. Both saw prodigious stock gains in the first 12 months. And then a deep pullback. If we mirror the 1982 analog, the correction starts in February 2021. If we mirror the 2009 analog, the correction starts in February 2021. In other words, there is going to be a period of major market turmoil. Be ready for this. And using our analogs, history says stocks are likely to correct in February – April 2021 with a 10% dip to S&P 500 3,500. So, I’d recommend accumulating some dry powder in January 2021 to capitalize on that sell-off and allocating to 'epicenter' stocks. But overall, I expect 2021 should be more of the same as 2H2020 and see a strong stock market, the economy surging, an easy Fed, and cash coming off sidelines. That is not to mention: (i) COVID-19 is waning and there have been positive developments on the vaccine front, (ii) there will be a massive unleashing of pent-up demand (consumer + capex), and (iii) a falling VIX that is likely to average below 20 through 2021 and 2023. Once through this period of market turmoil, I see the combination of these factors pushing the market up 25% in the second half of the year to S&P 500 4,300. So, where to put that dry powder to work in January? I like Consumer Discretionary, Energy, and Industrials. And yes, you heard that correctly, Energy. And no, I am not saying that I think oil is going to become more and more popular. But I do see strong demand recovery on the horizon, and context is important. Valuations are far from being stretched: Compared to the other GICS 1 sectors, Energy is at the bottom from a 2021E Price to Book (P/B) perspective and at rock bottom Price to Sales Ratio (P/S). And oh yeah, the price charts from the Energy sector have not been this bad since roughly the Moby Dick era so it certainly a non-consensus strategy. Bottom Line: The December seasonal surge is underway. Looking forward to 2021, history says stocks are likely to correct in February -April. Overall, I expect 2021 should be similar to 2H2020 and see the most opportunity within Consumer Discretionary, Energy and Industrials. Figure Comparative matrix of risk/reward drivers in 2020Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

COVID-19 Case Rollover Tentative; Next Week’s Data = Critical

Equities faced some new headwinds this week. (i) Vaccine supply in the US is being questioned, as the White House passed on buying more Pfizer doses (but US has ordered 700 million doses), (ii) the stimulus relief package seems stuck in the Washington quagmire (iii) The Federal trade commission and multiple state attorney generals brought anti-trust charges to Facebook and (iv) there is a natural questions of whether the AirBnB and Doordash IPOs created a lot of new supply. And if these were not enough, COVID-19 cases are surging widely in the US, hospitalizations are at record levels and deaths are elevated. Nevertheless, I think there are still several reasons that stocks and epicenter stocks in particular have solid runway through year end and into next year. More on this below. The absolute number of COVID-19 cases continues to set new records. Thursday daily cases were 213,446, but the 7D delta (leading indicator) is slowing and excluding California (which has ~30,000 per day), this 7D delta is now negative. Hence, I see this as a tentative rollover, as post-Thanksgiving cases can again surge. Next week we will be clear of those post-holiday distortions so if the 7D delta remains negative, the rollover is confirmed. One of the key questions we all want to know is when will COVID-19 have diminished enough to be out of our lives. This week, we highlighted research from one fairly credible researcher, Youyang Gu. He has created a new model to look at herd immunity. We have referred to his work in the past, because he had built some big-data models that really well explained COVID-19 forecasted deaths -- in fact, more accurately than the IHME. And in summary he estimates a “return to normal” by June/July 2021. His rationale is straight forward. There are basically three moving parts to his model: (i) Herd immunity threshold exceeding 60% of US population, (ii) Population already infected (ergo, immune) exceeding 30% by June 2021, and (iii) required vaccinated population exceeding 30% by June 2021. Stay tuned for more on this. We are going to try to arrange a call with him for you in the coming weeks. Strategy: Is a recovery in 2021 Epicenter stock earnings too optimistic? Over the past few weeks, a number of our clients have wondered whether a 2021 recovery in Epicenter stock earnings is too optimistic.  Mostly, many think revenues levels will not recover to pre-COVID-19 levels in 2021, thus, for earnings to rebound, this requires a major margin recovery.  There are two reasons we think margins will recover quickly: First, in 2020, these companies massively cut costs and restructured operations, at a scale they never had to in history. The sheer collapse of the economy warranted this action. Second, in past expansion, Cyclicals, aka, Epicenter, saw pre-recession margin recovery within 12 months- hence, in 2021, we should see EBIT margins at or above pre-2019 level Take a look at the chart above.  As you can see, the baseline is that EBIT margins for epicenter stocks are at the troughs seen in 2009 during the Great Financial Crisis (GFC).  So, we have seen a complete 12-year round-trip on profit margins.  This is due to a sales collapse. And importantly, look at the massive rise in EBIT margins per the chart above in the 2002 and 2009 recoveries. This is during a time when I do not think companies were nearly as desperate.  In 2020, with a pandemic and global shutdown, these companies would have been forced to cut and rationalize expenses at a far greater rate. And if this is indeed the case, we should see an even sharper rebound in margins. Demand recovery could be fierce in 2021 and plus, post-GFC, margins recovered within 4 quarters. So, my guess is this rebound will surpass GFC -- I think that is reasonable. And to capitalize on this rebound, we have updated our Trifecta Epicenter stock list this week. These stocks were hit the hardest by the pandemic and have the greatest operating leverage to a re-opening. I encourage you to our Friday note for the full updated list. Bottom Line: I do not think that a recovery in epicenter stock earnings in 1021 is too optimistic. Companies have undertaken major cost cutting overhauls, and based on prior cycles, improving EBIT margins should be strongly supportive. Figure Comparative matrix of risk/reward drivers in 2020Per FSInsight Figure: FSInsight Portfolio Strategy Summary - Relative to S&P 500** Performance is calculated since strategy introduction, 1/10/2019

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