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Click HERE to access the FSInsight COVID-19 Daily Chartbook. We are shifting to a 4-day a week publication schedule: MondayTuesdayWednesdaySKIP THURSDAYFriday STRATEGY: Rates > ISM for Epicenter trade.  Institutional investors buying Growth stocks disguised as EpicenterCase trends in COVID-19 might be stabilizing, versus the rising trend seen since mid-MarchDaily US COVID-19 case trends might be stabilizing as shown on this chart below.  This is one of our key charts and measures daily cases vs 7D ago.  And as shown, this figure had been rising since mid-March but now seems to be stabilizing.  And even trending down:- cases were rising recently, not entirely clear why, but maybe combo of vaccine boldness and Spring Break- MI cases have somewhat flattened out at 5,000 per day.  But this is virtually the same as FL and NY- MI is a lot smaller than either state, so MI is an outlier to an extent   Source: Fundstrat and state health departments    ... CA reopening on June 15th argues the entire USA will be fully re-opened by June 15thIn another sign yet that US is making progress against COVID-19, CA Gov Gavin Newsome today announced that the state could fully re-open on June 15th.  The mask mandate would still be in place, and an opening is subject to two criteria:- sufficient vaccine supply for all CA adults (on track)- hospitalization rates remain stable and low (not clear)CA has been among the most restrictive of states.  And if they are pursuing a re-opening, one could argue that the entire US is likely fully re-opened by June 15th. Source: investors suggest since economic momentum peaking, time to rotate back into GrowthToday a few clients forwarded this story to us, published by Bloomberg's Lu Wang.  This affirms what we have seen from our discussions with our institutional clients in both zooms and emails and phone calls (yes, we still do phone calls).  In general, there has been a general reluctance by hedge funds and institutional investors to buy Epicenter stocks aka Cyclicals.- BofA data shows cyclical exposure (of its clients) is lowest in decades- Morgan Stanley shows their clients are pulling back on Cyclical exposure in 2021The BofA exposure data, as the chart below shows, is really quite striking. /news/articles/2021-04-06/hedge-funds-see-something-in-the-reflation-trade-they-don-t-like? sref=NVS0rEaEPart of this stems from the growing consensus view that economic momentum is peaking.  The GDP growth rate print will peak in the next quarter or two, and as a consequence, many investors believe this peak in the data will signal a peak in Epicenter stocks relative to Growth. To use economic momentum as the sole signal, we think this is a somewhat overly simplified view of the drivers of Epicenter stocks.  But as the chart below shows, there is an approximate relationship between ISM and Epicenter vs Growth:- As PMIs rise, Epicenter stocks tend to outperform (see below)- But the relationship has weakened considerably over the last 20 years (gap widening) Source: Bloomberg and FundstratRe-opening economy plus infrastructure program creates supportive environment for cyclical stocks... There are multiple factors at play, beyond just economic momentum, and let me list a few reasons why a peak in economic momentum is not necessarily a peak in Epicenter stocks:- US economy just emerging from a Depression and seems early to call it mid-cycle- Epicenter companies have undergone dramatic cost cutting, hence, we believe there will be a substantial operating leverage story in the coming 24 months- Meaning EPS beats coming = re-rate higher EPS + higher P/E- US could pass a massive infrastructure program (Tom Block sees a 75% chance by Fall)- US infrastructure spending has lagged for nearly 15 years, hence, substantial justificationOn this latter point, look at this data from Morgan Stanley which shows a near $1.25T gap in real government spending.  Thus, this essentially provides a greater argument for a massive stimulus program. Source:  important, interest rates seem to be more important to Epicenter vs Growth, moreso than PMIs... Arguably, the more important macro driver for Epicenter stocks (vs Growth) is the trend in interest rates.  This reflects both the positive impact of higher rates (on Epicenter topline, balance sheet heavy tailwind too) and negative effects (discount rate for Growth stocks).  The chart below is the past 18 months:- as the US 10Y has risen (red line)- notice the near perfect tracking of Epicenter vs Nasdaq 100? Yes, interest rates matter. Source: Bloomberg and Fundstrat Even zooming out for the past 20 years, one can see this relationship has held pretty strongly.  In other words, rates matter more than ISM for the relative performance. Source: Bloomberg and Fundstrat $SPHB $QQQNaturally, this raises the question about whether interest rates will rise into year-end or fall into year-end.  I simply don't know.  To me, interest rates are highly unpredictable, just as unpredictable as equity markets. But if I had to look at the factors influencing rates:- US economic outlook strengthening = bias higher rates- US deficit spending rising = bias higher rates- inflationary pressures are likely higher vs lower = higher rates- global growth is improving = bias higher ratesEXTRA CREDIT: Demographics could also argue for higher interest ratesSo, in summary, there seems to be factors pushing towards higher rates.  If interest rates are set to move higher, this is a tailwind for Epicenter stocks.... Demographics might argue for higher ratesTake a look at the growth rate of Americans age 30-50, or prime age, and notice how it has varied over time.  - since 2016, this figure has actually turned positive and similar to the upturn 1972 onwards- notice how US interest rates moved up sharply following this? Multiple factors support this relationship, but simply, prime age adults are prime concerns and simultaneously prime workforce (highest skills), so this has a reflationary impact on the economy.  Thus, a rise in this cohort is reflationary and thus interest rates rise.- If this is true, the upturn in this cohort through 2030 argues for a structural rise in rates In fact, even the upturn in prime age Americans also argues for CPI or inflation to rise.  Since 1935, there seems to be a casual relationship between this growth of the cohort and CPI.- and if true in today's context, inflation should be rising over the next decade STRATEGY: Institutional investors buying Growth stocks disguised as EpicenterAs much as the Bloomberg article resonates with us (institutions avoiding Epicenter), we wrote yesterday how it seems like institutions are actually starting to nibble at Epicenter stocks.  - within the Epicenter sectors, about 1/4 of the stocks are also in the Russell 1000 Growth Index- in other words, about $922 billion of the $3.2T of pure Epicenter is Russell 1000 Growth ... Growth disguised as Epicenter outperforming since 3/24/2021The price performance of this Growth disguised as Epicenter has been particularly strong since 3/24/2021.  Take a look below:- Epicenter rose 20% 12/31 to 3/24 and Growth fell- Growth disguised as Epicenter outperformed Growth- Since 3/24/2021, Epicenter is up another 4.5%, similar to Growth- Growth disguised as Epicenter is up nearly 11% in that timeframeOne way to interpret this.  Growth investors are edging into Epicenter, by buying the Growth components of those indices.   ...12 Growth stocks disguised as EpicenterBelow are 12 stocks which are illustrative of the Growth stocks disguised as Epicenter and are also part of the S&P 500 High Beta ETF, which we have used as a proxy for the Epicenter trade.  Of the 12 names, half Cyclical Technology stocks (semis and semicap equipment). But notice that names like Wynn and even a REIT ($SPG) and insurance company ($LNC).  But you get the picture. Source: Fundstrat, Bloomberg $AMAT, $ENPH, $EXPE, $KLAC, $LNC, $LRCX, $MCHP, $PAYC, $SPG, $SYY, $TDG, $WYNN ADDENDUM: We are attaching the stock lists for our 3 portfolios:We get several requests to give the updated list for our stock portfolios.  We are including the links here: - Granny Shots  -->       core stocks, based on 6 thematic/tactical portfolios- Trifecta epicenter  --> based on the convergence of Quant (tireless Ken), Rauscher (Global strategy), Technicals- Violence in USA --> companies that are involved in some aspect of home or personal security. We are not recommending these stocks, but rather, bringing these stocks to your attention. Granny Shots:Full stock list here --> Click hereTickers: AAPL, CSCO, INTC, MXIM, NVDA, EBAY, KLAC, GRMN, GOOG, MNST, MSFT, AMZN, QCOM, TSLA, PYPL, AXP, BF/B, PM, XLNX, TGT, PG, XOM, VLO, GL, RF, ATVI, BBY, GE, AMAT, LRCX, MU, HPQ Trifecta Epicenter (*):Full stock list here --> Click hereTickers: AN, GM, F, GRMN, LEG, TPX, TOL, NWL, MAT, PII, RL, MGM, HLT, MAR, NCLH, RCL, WH, TNL, SIX, DRI, SBUX, FL, GPS, KSS, LB, VFC, FITB, WTFC, ASB, BOH, FHN, FNB, PB, PBCT, RF, STL, TFC, WBS, PNFP, PACW, SBNY, NYCB, MTG, EVR, GS, IBKR, VIRT, BK, STT, SYF, BHF, AGCO, OC, ACM, WAB, EMR, GNRC, NVT, CSL, GE, IEX, PNR, CFX, DOV, MIDD, SNA, XYL, FLS, EAF, TTC, ITT, ALK, DAL, JBLU, LUV, MIC, KEX, UNP, JBHT, R, UBER, UHAL, LSTR, MAN, XOM, HP, BKR, HAL, NOV, SLB, COP, EOG, FANG, HES, MRO, MUR, PXD, XEC, HFC, MPC, PSX, LYB, EXP, MLM, CF, MOS, ESI, NEU, NUE, RS, SON, IP, BXP, HIW, UDR, KIM, NNN, WRI, VNO, JBGS, RYNViolence in USA:Full stock list here --> Click here POINT 1: Daily COVID-19 cases 55,870, -2,243 vs 7D ago..._____________________________Current Trends -- COVID-19 cases: - Daily cases    55,870 vs 58,113 7D ago, down -2,243- 7D positivity rate   4.7% vs 4.9% 7D ago- Hospitalized patients   38,814  up +5.2% vs 7D ago- Daily deaths    608,  down -36% vs 7D ago_____________________________- The latest COVID-19 daily cases came in at 55,870, down -2,243 vs 7D ago.  - 7D delta in daily cases turned negative again. Unlike last Friday and Sunday, today's negative 7D delta is not likely a result of data distortion. However, it is also too early to conclude the decline in daily cases resumes.- The overall case trends remain stable. As the 7D average line (blue dash line in the 7D delta chart below) shows, the daily confirmed case figures have been stalled in the past three weeks.- At this stage of pandemic, vaccinations might matter more than daily case trends. As long as vaccinations work, eventually the rollout of the vaccines will lead to a decline in the pervasiveness of the COVID pandemic. Source: Fundstrat and state health departments7D delta in daily cases has been flat-lined over the past 3 weeks...7D delta in daily cases turned negative again. Unlike last Friday and Sunday, today's negative 7D delta is not likely a result of data distortion. However, it is also too early to conclude the decline in daily cases resumes. The overall case trends remain stable. As the 7D average line (blue dash line) shows, the daily confirmed case figures have been stalled in the past three weeks.   Source: Fundstrat and state health departments    US hospitalization still rolling over ... and even US deaths seem to be rolling over... Below we show the aggregate patients who are currently hospitalized due to COVID. It has fallen significantly from the wave 3 peak. Source: Fundstrat and state health departments Source: Fundstrat and state health departments Source: Fundstrat and state health departments  Source: Fundstrat and state health departmentsPOINT 2: VACCINE: 45 states near ~60% infected + vaccinated..._____________________________Current Trends -- Vaccinations: Vaccinations ramping steadily- avg 3.0 million this past week vs 2.8 million last week- overall, 18.9% fully vaccinated, 32.4% 1-dose+ received_____________________________Vaccination frontier update --> 45 states now near or above 60% combined penetration (vaccines + infections)Below we sorted the states by the combined penetration (vaccinations + infections).  As we commented in the past, the key figure is the combined value >60%, which is presumably near herd immunity.  That is, the combined value of infections + vaccinations as % population > 60%.- Currently, 45 states (see below) are basically all at this level- SD, ND and RI are now above or near 90% combined penetration (vaccines + infections)- So slowly, the US is getting to that threshold of presumable herd immunity Source: CDC and FundstratCollectively, these 45 states represent about 94.1% of the US population.  As the chart below highlights, the US is seeing steady forward progress and this figure continues to rise steadily. Source: CDC and FundstratThere were a total of 1,396,975 doses administered on Monday, down 21% from 7D ago. However, the pace is steadily rising, as evidenced by the 7D moving average (see blue line). Source: CDC and Fundstrat ~73.2% of the US has seen 1-dose penetration >30%... To better illustrate the actual footprint of the US vaccination effort, we have a time series showing the percent of the US with at least 15%/20%/25% of its residents fully vaccinated, displayed as the orange line on the chart. Currently, almost all US states have seen 15% of their residents fully vaccinated.   However, when looking at the percentage of the US with at least 20% of its residents fully vaccinated, this figure is 27.6%. And only New Mexico and South Dakota have seen 25% of its residents fully vaccinated - 0.9% of US population.- While almost all US states have seen vaccine penetration >25%, 73.2% of them have seen 1 dose penetration >30% and only 16.5% of them have seen 1 dose penetration > 35%.- Almost all of the US has at least 15% of its residents fully vaccinated, However, only 27.6% of US has fully vaccinated >20%- This is still a small figure (15%/20% of residents fully vaccinated) but this figure is rising sharply now. This figure could rise even more rapidly after the JNJ's 1-dose vaccines roll out. Source: CDC and Fundstrat This is the state by state data below, showing information for states with one dose and for those with two doses. Source: CDC and Fundstrat The ratio of vaccinations/ daily confirmed cases is generally trending higher (red line is 7D moving avg) and this is the most encouraging statistic. - the 7D moving average is about ~50 for the past few days- this means 50 vaccines dosed for every 1 confirmed caseThis figure is rising nicely and likely surges in the coming weeks Source: CD and FundstratIn total, about 107 million Americans have received at least 1 dose of a vaccine.  This is a good pace and as we noted previously, implies 50% of the population by May.   Source: CDC and Fundstrat POINT 3:Tracking un-restricted and restriction-lifted states We are changing Point #3 to focus primarily on tracking the lifting of restrictions, as states begin to ease various mandates.  Keep in mind, easing/lifting restrictions can take multiple forms:- easing indoor capacity- opening theaters, gyms, salons, saloons- eliminating capacity restrictions- eliminating mask mandatesSo there is a spectrum of approaches.  Our team is listing 3 tiers of states and these are shown below.  - states that eased in 2020: AK, OK, MO, FL, TN- states that eased start 2021 to now: SD, ND, NB, ID, MT, IA, NC, MS, SC, AZ, TX, MD- states that announced future easing dates: GA, NY, WI, AR, CA, AL, CTGROUP 1:  States that eased restrictions in 2020... The daily case trends in these states is impressive and it is difficult to say that lifting restrictions has actually caused a new wave of cases.  Rather, the case trends in these states look like other states. GROUP 2: States that eased restrictions in 2021 to now... Similar to the list of states above, the daily case trends in these states are impressive and it is difficult to say that lifting restrictions has actually caused a new wave of cases.  - we have previously written about how ND and SD, in particular, have seen an utter obliteration of COVID-19 cases in those states- that seems to be a function of vaccine penetration + infection penetration, leading to something akin to herd immunity GROUP 3: States that announced plans ease restrictions in 2021... These states have upcoming dates to ease restrictions.  The dates are indicated on each chart.  The cases trends in these states have been mostly positive, with perhaps the exception of NY state:- NY state case levels seem awfully stubborn at these high levels- weather is improving in NY area, so if weather has any effect on virus transmission, it should slow cases

COVID-19 UPDATE: CA set to re-open by June 15th, suggesting entire USA will be open by then. Rates > ISM for Epicenter trade.  Institutions might be buying these 12 Growth stocks disguised as Epicenter
  • Alpha City
May 31, 2020

Not Time To Exit Growth; How To Fund Financials Exposure

With negative headlines continuing to hit the tape, the U.S. equity continues to climb the wall of worry as the bears get louder and louder, voicing both their displeasure and amazement. Our work continues to be medium term constructive and still supports a barbell approach towards secular growth/FAANG and Values/Cyclicals. Given the riots across the country and rising US-China tensions, the bears are vocal that the current move is unjustified and will end painfully at any minute. However, based on our work, we do not support this negative outlook and have been advising investors to keep their eyes on the bigger picture —the economy is beginning to heal and there is massive monetary/fiscal stimulus to fuel equity prices on a 6-12 month view. We reiterate our main conclusions since 3/20, when our key indicators flashed buy signals for the S&P 500. Our key conclusions are as follows. ➢ Despite the possibility of tactical consolidation/pullback, we are constructive on US equities for 6-12months and are viewing tactical weakness as a buying opportunity. ➢ Our work indicates that (1) the low for the S&P 500 index (SPX) is in and there is a chance the benchmark index could make new HIGHS before the year is over, and (2) the market is NOT extremely overvalued as some are fearing. Instead, our research suggests an SPX target range of 3600-4400. ➢ We are still recommending a barbell approach that includes a mix of FAANG/secular growth stocks and cyclicals/value equities as Overweights and defense and cash as Underweights. ➢ There have been clear signs of healing as shown by our proprietary earnings revisions work, which completely supports the ongoing rally. GROWTH/TECH CONCLUSIONS From a tactical perspective, some of our preferred multi-factor models have rolled over for Tech, as an overall proxy for Secular Growth/FAANG. That said, the entirety our indicators suggest that the relative performance pause/pullback will likely be short-lived and small magnitude. From a strategic view, Tech’s key earnings revision metrics are quite supportive. Thus, we are NOT suggesting that any investors abandon Secular Growth/FAANG/Tech. FINANCIALS CONCLUSIONS From a tactical perspective, our preferred indicator is showing signs of positively inflecting versus the overall market, which has historically been a bullish occurrence. When digging deeper, the sector looks particularly attractive on this basis versus Energy, Materials, Staples, Health Care, Utilities, and Real Estate. From a strategic view, key earnings revision metrics for Financials suggest the biggest theme is things are less bad. Our readings back solid relative performance gains going forward. Hence, we reiterate our “above benchmark” view for the sector.

  • Signal from Noise
Apr 15, 2020

First Republic Stock Looks Cheap in Post COVID-19 World

– Bank stocks hit hard by COVID-19 pandemic on economic shutdown fears – FRC is a fast-growing midcap bank with niche focus on wealthy and urban areas – Its stock off over 20% but 20%+ potential recovery possible after shutdown ends Bank stocks have been the bleeding edge of the coronavirus-related bear market of the past eight weeks.  The financial sector is off big and banks, in particular, are down, too.  The financial sector has fallen 27% as of Monday from the market’s Feb. 19 high; the major banks -34 %, and the regionals minus 37%.  Not a pretty picture. Yet that should be no surprise to an experienced investor, given their preeminently important position in the American industrial eco-structure, and their critical role in the smooth functioning of the economy. In almost every bear market, if there is fear about the economy, then banks and their stocks take the hit.  Business drops, lending dries up, real estate markets freeze. In this bear, with the ongoing dislocations caused by the virus-related economic shutdown of the U.S., they been among the biggest focal points or whipping boys for investors.  Consequently, I believe banks, in general, are mispriced, and there is a significant amount of potential dislocation in the financial system. None of this should be ignored, but it is also true that because U.S. banks are so important that they’ve been heavily regulated to help them survive. The great majority should thrive again. Moreover, as the Federal Reserve’s annual stress tests have shown, the banks are in much better shape than they were in the previous bear market of 2008-09. That’s key. For an investor interested in the financial sector, it’s paramount to find a high-quality bank that will come out of this crisis with its profitability and business outlook intact for the long term. I believe that the dislocation of fear in the financial system is probably exaggerated. Unless you think the COVID-19 is a problem that will never be solved—and I don’t—then banks could be a good place to prospect for stocks, particularly for a relatively faster recovery. This could be especially relevant since the governmental authorities have come running with buckets of cash to ease liquidity issues, something that didn’t happen quickly enough in 2008-09, arguably a much worse bear—so far.  As a result, it took longer than for the banking sector to recover, but it did. Banks will be reporting first-quarter results in the next few weeks, so there will be updates on this. This time around, I believe the group will recover faster. One high-quality bank to look at is First Republic Bank (FRC), a midcap. What investors should find interesting about it is its strong culture, niche markets, and history of being well-run, thanks to a strong founder. Yesterday, FRC posted first-quarter results that were entirely keeping with its past trend of mid-teens percentage loan growth and earnings growth in the low teens percentage. The bank reported, among other things, that revenue rose 13.5% to $916 million; net interest income was $752 million, up over 11%, and net income of $219 million and $1.20 in EPS, down 4%-5%. Tangible book rose 12%.  Perhaps the biggest negative was that credit losses and unfunded loan commitments rose to $62.4 million from $14 million, but given the times, that doesn’t seem so bad. Nonperforming assets were just 10 basis points of total assets. Total deposits increased to $93.7 billion, up 14.8% compared to a year ago. One fan of FRC, with a market cap of $16 billion, is Jason Benowitz, a senior portfolio manager at Roosevelt Investment Group, which owns shares of FRC for clients.  The FRC first quarter would have been a good one even without the pandemic, he argues. The bank’s results looked typical for it and management didn’t change guidance for 2020, a good sign, I think. Benowitz points to a number of enduring FRC traits that make it look appealing at the current stock price of around $95, which is up from $70 but down from $122. If you look at its results, it has been a strong and steady grower, particularly for a bank, with annual rises in the past five years in every major metric from interest income to EPS to dividends. It’s a strong picture and the shares have outperformed the group. Benowitz attributes this to a concentrated focus in (1) a wealthy clientele, who have at least $1 million in investable assets, and (2) U.S. urban areas.  They cater to the wealthy, a class that’s grown sharply in the 11-year bull market. It’s a major bank in San Francisco, for example, with 10% share of deposits and it’s taking that playbook to New York and Boston, says Benowitz. The jumbo mortgage is a core product and then that leads to additional products, like lending to the clients’ businesses or nonprofit organization and wealth management. Its underwriting is conservative, with about 80% of loans collateralized by real estate and a low average total loan to value of 55%. Source: FSInsight, Bloomberg Previous to the drop, the bank’s shares traded over the past five years at an average of 2.2 times book value. With book value now about $54 per share, that suggests the stock could get back to about $115, up over 20%.  And while net interest margin is under some pressure, as it is at all banks thanks to low-interest rates, Benowitz says that seems to be priced into the stock. In the first quarter, it was 2.74%, up from 2.73% in the year ago period. FRC has no loans to the oil and gas, airline and casino industries and just 2.5% of the loan book to hotel and retail. Nor does it buy back its own common stock. James H. Herbert, II is the founder and chairman and he has instituted a strong customer-centric culture at the bank. Where I could be wrong:  The pandemic goes on beyond 2020 and the economy continues to be shut down. Bottom Line:  FRC is a well-run and steadily growing bank, with a relatively cheap valuation.  If the world doesn’t end and the economy gets back on its feet later this year, FRC should be among the beneficiaries. Prior “Signals” Date Topic Subject / Ticker The Signal 4/8/20 Stock Galapagos (GLPG) If Galapagos Arthritis Drug Is Approved, Stock Looks Cheap 4/1/20 Stock DaVita (DVA) In Uncertain Markets, DaVita’s Stable Rev/EPS Look Attractive 3/25/20 Q&A InsiderInsights In Roiled Market, Insider Activity Could Offer Directional Clues 3/18/20 Market US Stock Market Market Discounts Recession; GDP, EPS Growth Worries Mount 3/11/20 Market COVID-19 COVID-19 Worry Overblown; Market Discounts Recession 3/4/20 Stock iHeartMedia (IHRT) iHeartMedia Stock Could Rise on Cost Cuts, Digital Revenue 2/26/20 Market South Korean Stock Market When Virus Fears Ease, Hard Hit Korean Stocks Look Cheap 2/19/20 Q&A Atlantic Investment Management Atlantic’s Concentrated Approach Yields Strong Returns 2/12/20 Stock Casper Sleep (CSPR) Casper Stock Might Not Let You Get a Whole Lot of Sleep 2/5/20 Stock Arch Coal (ARCH) After Sentiment Plunge, Arch Coal Stock Looks Inexpensive 1/29/20 Sector Healthcare Healthcare Looks Inexpensive; Some Healthy ETFs to Play 1/22/20 Stock Spirit Airlines (SAVE) Why Spirit Airlines Shares Could Take Off in 2020 1/15/20 Market 4Q19 EPS Season Market to Focus on SPX EPS Growth after 4Q19 EPS Season 1/8/20 Stock Alibaba (BABA),Tencent (700 HK) Alibaba, Tencent Look Attractive on Strong Growth Potential 1/2/20 Stock 2019 Report Card Signal From Noise 2019 Picks: 74% Win Rate, Beat SPX 12/26/19 Market Stock Market 2020 2020 Could Be the Year “Animal Spirits” Return to Equities

Don't Fight the Fed: Go for Growth and Cyclical Sectors

What’s a Federal Reserve Board interest rate cut worth to the stock market? We’ll soon find out, but history suggest it’s quite valuable to investors when the Fed reduces rates during an expansionary period rather than ahead of or during a recession. As you’ll see below, such a move will boost U.S. cyclical, growth and large cap stocks, among other asset classes. As the second quarter earnings reporting season gets underway, I’ve heard a growing chorus of strategists and investors call for a pullback in equities. Such bearishness is perhaps no surprise given the S&P 500 index is already up ~20% YTD, and given an earnings recession is underway, the third one since 2009. (For more on this see page 1.) Two weeks from now, the U.S. central bank is likely to make its first interest rate cut in almost 5 years and, as I’ve pointed out previously, such a move has dramatic impacts on markets. Moreover, given the paucity of investor conviction, one could argue there is a lot of cash on the sidelines, especially considering the substantial retail outflows from equity mutual funds in 2019 YTD. Equities are likely to see a strong boost from a cut. Since 1971, when the Fed makes its first cut and Leading Economic Indicators (LEIs) are still positive (as is the case currently, hence, we are not in recession), stocks have risen 100% of the time three, six, nine and 12 months later. In other words, don’t fight the Fed. The timing is key. When the Fed cuts and the U.S. economy is in expansion, the move drives positive equity returns. 100% of the time. (See nearby table.) The median nine months gain is ~18%, hence, we expect stocks to rise strongly into YE and believe our current 3,125 target is low. Cyclicals, which are outperforming the market by 280 basis points and defensives groups by 690 bp, is a group that should be positively affected. Multiple factors are behind this but I think the rally in high-yield and easing financial conditions are supportive. Moreover, the steepening of the U.S. Treasury 30 year – 10 year yield curve spread historically is coincident with cyclical outperformance. The rate reduction is also likely to favor growth stocks over value stocks, a continuation of the dominant theme for roughly the last decade. I have written extensively on the thesis that rising interest rates favor asset intensive businesses, such as value stocks, so the cut is likely a headwind for value. Similarly, the Fed’s anticipated move will probably help boost large market capitalization stocks over small. While this may sound counterintuitive, I see large-caps benefitting. Why? This further amplifies the equity “there is no alternative” (TINA) to stocks thesis, and US TINA in particular. I believe investor equity flows will more likely accrue to the big guys over the small fry. Additionally, I am beginning to wonder if a long-term mean reversion is underway. Since 1999, small-caps massively outperformed large-caps, but in the past eight years performance has really flattened. Further back, from 1990-1999, there was massive small-cap underperformance—is this a repeat? I’ve favored U.S. equities over the rest of the world (ROW) for some time now, but I expect the likely impact of a cut is for the S&P 500 to further pull away from the ROW. I base this on three cornerstone arguments: (i) US corporates have strong franchises; (ii) supportive White House/gov’t policy and (iii) accommodative financial conditions in US. A Fed cut is icing on the cake. My assessment since the start of the year is that the U.S. continues its relentless outperformance versus ROW. (See chart below.) Source: FS Insight, Bloomberg, FactSet Finally, I think gold will gain traction as a “hedge” around negative rates, but it will likely also be good for emerging markets. Gold outperformance is supported by Fed cuts (weaker USD, more zero rate bonds). But there is a curious positive relationship between rising gold and rising EM equities. While weaker USD is the likely link, I wonder if this means EM could lift-off on a Fed cut. Bottom line: While consensus may be right on a pullback, Fed cuts matter more. We see a 2H19 rally and recommend the following stocks: The tickers are GOOG, MNST, NKE, TSLA, AAPL, AMGN, AMP, AMZN, AXP, BF/B, BKNG, CSCO, FB, GRMN, NVDA, PM, PYPL, ROK, XLNX, ADP, CLX, MA, PG, V. Figure: Comparative matrix of risk/reward drivers in 2019 Per FS insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 500 ** Performance is calculated since strategy introduction, 1/10/2019

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