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There was enough bad news last week to depress even a Pollyanna, let alone most investors, and unnerve any stock market, too, it seems to me. And yet US equities managed to recover from late in the week blues to finish around highs for the week. The market’s resiliency continues to impress me. The Standard & Poor’s 500 index rose about1.3% to finish around 3271. The benchmark rose over 5% in July, its best performance since April. The week was marked by ups and downs, as investors worked through the FOMC meeting and winced at the US 2Q GDP number: -33%. I’ll get to why I think the market rose despite the poor backdrop, but here’s what likely restrained the market. The number of cases in the US and the spread of the coronavirus (COVID-19) still seems dangerously high, even if, as my colleague Tom Lee points out beginning page 3, we appear to be approaching an inflection point on this. Then there was the worst quarterly US gross domestic product result ever seen, including the Great Depression. That’s right. Ever. And second quarter earnings—outside the big tech companies, like the FAANG stocks, are not doing to well. Yet both the GDP number and the EPS reporting fell within parameters that the market was generally expecting. In fact, the GDP number, bad as it was, was better than the expected -35%! And then President Donald Trump—whose grandiose tweets have been fewer and fewer in number since COVID-19 hit—returned to his old habit of shooting first and asking questions later. The President suggested in a tweet that the November elections be delayed for the first time. Now anyone who has taken a US civics class knows that won’t happen, but still folks find it unnerving. And the new stimulus that investors are expecting from Washington seems to be struggling to be passed into law, with much of the aid having run out July 31. Nevertheless, our Washington strategist, Tom Block, expects a bill to be passed and signed in August. For more on this see page 10. On balance I think sentiment remains bad—and that’s good for bull markets. Earlier this week, I tweeted (@WSIntelligencer) some interesting data from Bespoke Investment Group, which showed the last regularly weekly survey of American Association of Individual Investors at a high number of individual investor bears relative to bulls, untypical in rising markets. In fact, the current 23-week AAII bearish streak is much less frequent and associated with high forward returns. The second quarter earnings reporting season is in full swing and, even though I believe investors are doing their best to ignore them and do expect poor numbers, the figures have been mixed. Big consumer companies like conglomerate 3M (MMM) and McDonald’s (MCD) fell on weak earnings reports. Tech on the other hand, such as Apple (AAPL), Facebook (FB) and Amazon. com (AMZN), posted better than expected numbers, and their stocks rose. On the subject of tech, I’ll note additionally that there was the spectacle of Congressional hearings—a circus that’s always fascinating in the way of a train wreck—with the CEOs of Amazon, Apple, Facebook and Google. They faced frankly hostile criticism about their business practices during a House antitrust hearing. One of the reasons investors could be feeling down is that, on the surface, the coronavirus spread doesn’t seem to be easing. The Wall Street Journal reported that new coronavirus cases in the U.S. climbed back above 70,000, as daily reported deaths rose to their highest level in more than a month Thursday, according to data compiled by Johns Hopkins University. The U.S. death toll from the coronavirus pandemic passed 150,000. For the record, the Commerce Department said U.S. gross domestic product fell at a seasonally and inflation adjusted 32.9% annual rate in the second quarter, or a 9.5% drop compared with the prior quarter. The figures were the steepest declines in more than 70 years of record-keeping. Meanwhile, the Labor Department said workers applying for initial unemployment benefits rose for the second straight week—by 12,000 to 1.43 million in the week ended July 25—after nearly four months of decreases following a late-March peak. The number of people receiving unemployment benefits increased by 867,000 to 17 million in the week ended July 18, ending a downward trend that started in mid-May. All this and FOMC meeting, too, in which nothing new was said. For more on this, see page 11. One bit of good news came out way back on Monday: durable goods jumped by 7.3% in June from a month earlier, the second consecutive monthly gain. Economists expected a 5.4% rise. The VIX (or so-called Fear Index) bounced around with the market last week, but finished below 25, down from 26 last Friday. A falling VIX indicates investors are making fewer bets that the market will fall. Questions? Contact Vito J. Racanelli at vito. racanelli@fundstrat. com or 212 293 7137. Or go to

Tech Stocks Hit a Speed Bump; Better Entry Points in Q3 Seen

Tech Technology stocks hit another speed bump this past Thursday following the reversal day that developed on July 13th. That’s two technical shots across the bow to pay attention to, folks. The S&P 500 index Technology sector ETF (XLK) has broken below its 15- and 20-day moving averages for the first time since bottoming in March as did leaders such as AAPL and KLAC. The steady uptrend from the March lows is showing evidence of changing and investors should be pay close attention to the technical reactions in the market in the coming weeks. If you remember, last week my note contrasted well advanced growth stocks with lagging value and cyclical stocks. Technology pullbacks testing support So now what? In the very short-term, many of these leading technology stocks are already bouncing up from trading support near their respective rising 50-day moving averages. This raises the question of whether the correction is over or whether there is more downside risk. I recommend stepping back from the short-term, daily charts to review the intermediate-term backdrop through weekly charts. I find the weekly charts important for a multi-quarter perspective. The three technical points I view to be important are: First, the Nasdaq’s price and relative performance uptrends remain intact. That may seem like an obvious point, but it is an important reminder that pullbacks should be viewed as corrections in an ongoing longer-term uptrend. It’s premature to conclude the bull market in technology stocks is ending. Nevertheless, weekly momentum indicators, tracking 1-2 quarter shifts, are overbought and beginning to turn down as the Nasdaq has rallies to the upper end of 10-year trend channel. This data suggests a pause or pullback is likely to develop into the early Fall. (See chart below.) A choppy August and September would not be surprising but don’t lose sight of the bullish longer-term cycle. Pausing at resistance within a longer term bull market Bottom Line: After a 60%+ rebound, I’m expecting growth stocks to trade in a broad trading range through August into September that would ideally see the Nasdaq catch up with its rising 200-day moving average in the fall roughly near 9700. Overall a 10-15% correction from the highs or 5-10% from current levels would not be surprising and would set the stage for better entry points on many leading growth stocks later in Q3. Figure: Weekly Sector ReviewSource: FS Insight, FactSet Figure: Best and worst performance sectors over past 3 months

S&P 500 Mega-Caps Not in a ‘Bubble’; Big EPS = Big Mkt Cap

It was a rough week with S&P 500 down 0.3% and with the carnage in the mega-caps. There’s a growing chorus the S&P 500 is significantly distorted by the outsized market cap of the Big 5 tech names (AAPL, MSFT, AMZN, FB, GOOG), now a 22% weight in the index. I don’t see the bubble. The top 5 are 18% of earnings and >80% of 2020 EPS growth. So, that 22% market cap share does not seem so out of line with their nearly 20% net income share. After all, aren’t these franchise companies? (More below.) It looks like this is the week that saw US case surge finally plateau (and hopefully turn into a decline this weekend). And the White House is now endorsing mask use. Thus, we see the economy risks diminishing. And as I have noted in the past, as the national disease panic fades, local behavior recovers. This is why I am not too shocked at seeing economic data stall in the past week. Virus spread reaccelerated in early June and the media and skeptics and policymakers have been quite alarmed — appropriately. But this dampened economic momentum. If cases are peaking, economic momentum will resume. Our policy strategist, Tom Block, expects a stimulus package passed and signed by early August. The set up for stocks, in our view, is attractive right now, with the disease plateauing (again), economic momentum should recover; fiscal stimulus coming; sentiment still negative (see San Diego CFA survey below); and $5 trillion cash on sidelines. Yet many are ringing the bell (top of market). STRATEGY: Not a “bubble.” As a Salmon Bros. wireless analyst in 1999, I had a ringside seat at the dot-com bubble implosion. There’s not enough space here to describe the mania prevalent then. Effectively, the dot-com stocks that soared had no profits nor expectations of such. Had they been profitable, nobody would have called it a bubble. Equity prices rose faster (straight up) than earnings (straight down). There was a growing and visible disconnect between asset prices and EPS. Fast forward to 2020. Over the past few weeks, there has been a growing chorus of investors saying this equity market is ultra-concentrated, mirroring 1999, and that the S&P 500 market is “unhealthy” because the top 5 stocks are too big. Yet, the market cap of the top 5 in the S&P 500 (AAPL, MSFT, AMZN, FB, GOOGL), 22%, generally corresponds with their EPS share, 18%. Also, one can argue these top 5 have higher revenue and EPS growth, with considerably more dominant market positions, which warrants a smaller equity risk premia (higher PE). Thus, one can see the valuation is not necessarily distorted. Moreover, their position is about in line with stock markets in the rest of the world. For example, and the high market cap share of the top 1% largest companies in an index should be disproportionately high. Take a look at the S&P 500 compared to 5 major global stock indices. (See nearby chart.) Earnings share = market cap share for the rest of the world, just like the US. That said, please note, as I’ve pointed out for months, that 2021 EPS growth is primarily driven by Epicenter stocks = OW Epicenter…. I’m not saying that secular growth/FANG/bond proxies are going to continue to outperform. Look at EPS growth contributors in 2021, based on consensus forecasts. (See nearby chart.) The epicenter, Industrials, Discretionary, Financials and Energy, will account for 62% of EPS growth, but they are only 26% of market cap today. And going back to our prior observation, if the virus is weakening (our view), we want to OW cyclically sensitive. This is a lot of potential market cap rotation from 72% of the market to 28%. POINT #1: More and more likely US cases “peaking” — 4 days cases flat week over week. Total USA cases came in at 70,593 Thursday, which is flat with the case figures a week ago and this is looking more and more likely that USA cases have plateaued. The case figures for Friday (7/24) will be the decider as that is 7 days past the all-time high of 76,737 seen on 7/17. POINT #2: Cases have almost certainly peaked in FL, AZ and TX. Waiting for CA. (F-CAT). The trends in F-CAT, about half US cases, are quite positive as well. It has been 7 days since the record 40,278 reported. More importantly, F-CAT cases have been down vs 7 days ago in each of the last 3 days. So if F-CAT has peaked, along with NY tristate, and some other large states, then about 60% of the US is past wave 1. POINT #3: In a presentation I gave to the San Diego CFA Society Thursday, I asked 5 questions and the interesting results follow, along with my annotations. First, CFA members are bearish/neutral, with only 44% seeing >10% upside in stocks, and 59% think growth outperforms over next 12 months. That’s not a surprise, but it shows how consensus this view is. Second, 50% say the most important market driver is the disease vs 47% saying the Fed. But if 47% see a vaccine in next 12 months, how could they be bearish? Everybody loves growth at 59% and 22% love defensives. Only 22% like Cyclicals. If a cure is discovered, I think this ratio flips 180 degrees. And the plurality sees a cure/vaccine in 12 months. So, there is inherent optimism on a healthcare solution. Again, I think if this happens, sentiment flips big time = stocks go up. Lastly, I asked about willingness to get on a plane. Here 41% of those surveyed will not get on a plane until there is a vaccine. You can see personal preference is governing market positioning. Again, upside. Because if we see a cure = flip in sentiment. Essentially, this is one more survey that highlights how cautious investors are. Interestingly, the disease is seen as more important than the Fed. I suspect if we see a decisive breakdown in cases, this would certainly support sentiment turning bullish. Figure: Comparative matrix of risk/reward drivers in 2020Per FS Insight Figure: FS Insight Portfolio Strategy Summary – Relative to S&P 50** Performance is calculated since strategy introduction, 1/10/2019 Source: FS Insight, FactSet* Portfolio strategy introduced in December ’19 rebalance, replacing 2019 portfolio recommendation – “FANG in odd years”

If EPS Rises to Pre-Covid-19 Level, XLNX Could See Old Highs

– XLNX stock recovery from March lagging tech and cyclical stocks; we think unjustified – Huawei, slowing 5G rollout fear has dented sentiment; in our Granny Shots portfolio – As sales approach pre-COVID-19 levels, stock could rise to old high, up to 40% rise Xilinx (XLNX), which designs and develops programmable chips, has seen its share price rise about 50% to around $103 in the recent rally from the March lows, as the market broadly discounts a lessening of the COVID-19 spread, and a reopening of global economies.  Source: FSInsight. com, Bloomberg XLNX is basically one of two big players (the other being Intel’s (INTC) Altera unit) in the field of integrated circuits (ICs) in the form of programmable logic devices (PLDs), including programmable System on Chips (SoCs), and other devices. They have end markets ranging from aerospace/defense to communications/data centers to automotive and testing. It’s complicated stuff, requiring a lot of R&D. It’s is a competitive environment, but XLNX is recognized as a leader, having invented field programmable gate arrays (FPGA), ICs designed to be configured by a customer after manufacturing. A standard application specific chip (ASIC), which is cheaper than FPGAs, cannot be programmed. The latter are typically more expensive but also flexible, so a user can change the hardware circuit as needed. Investors unfamiliar with XLNX might find this interesting: while many other high-quality tech—and even cyclical—companies have surpassed their old highs in this rebound since March, XLNX has not.  For example, both Apple (AAPL) and Microsoft (MSFT) have made new highs and even truck equipment and parts maker Paccar (PCCR) has, too. Not XLNX, whose all-time high was $142 back in April, 2019. What gives? There are a few issues investors are grappling with (more on this below) but there are also reasons to be cheerful about the stock. As the COVID-19 outbreak continues to ease and economies around the world ramp up, I think XLNX’s results will return to pre-Covid levels faster than Wall Street analysts are expecting. That could lead to the shares approaching the old high in a year or two, a possible 40% rise. There is a pathway with high probability of returning to peak earnings but the stock has only reflected the broad market’s recovery, says a bullish Paul Latta, principal and portfolio manager at Cedar River Capital, which owns XLNX shares for clients. While not all XLNX end markets are “bulletproof,” other companies with worse outlooks have stocks that have recovered back to highs, he notes. Additionally, XLNX is in our very own Granny Shots portfolio, which has beaten the market by over 3,490 basis points since inception on January 10, 2019. (See nearby table.)  The San Jose, CA-based tech company is expected to benefit from improving purchase-manager index trends; from growing use of artificial intelligence; and from our expectation of higher inflation in the long term. For more on Granny Shots, click here. The issues: as with most companies, COVID-19 has dented sentiment, though the company has said the coronavirus hasn’t generally disrupted its business. Nevertheless, car sales were already softening (in China, in particular) pre-COVID-19,  so that end market has suffered. Source: FSInsight. com, Bloomberg Second, the ongoing US-China trade war, with reference to Huawei, has hurt sales. Huawei, reportedly 6%-8% of total XLNX revenue, was placed on the US restricted “entities list” in May, 2019. The UK recently did the same. Last year, XLNX removed Huawei from its forecasts but it is still getting some sales and recently restrictions were eased a bit. Latta points out that XLNX quarterly EPS has dropped to a run rate of 65-70 cents lately from about 95 cents in 2018-2019 before COVID-19 and the ruckus with Huawei began in May of 2019. Yet, the good news, he adds, is that Nokia (NOK) and Ericcson (ERIXF) are stepping into the breach. Secondly, their products use higher XLNX content than Huawei, which is attempting to source supply in China.  Clearly XLNX will benefit eventually from the continuing rollout of 5G as well as AI, he says. In the year ended March 28, 2020, XLNX sales rose 3% to $3.2 billion from 2019, when revenues rose 24%. What XLNX terms its advanced products rose 15% in 2020 but core products fell 17%. Europe and Japan were weak, while North America and Asia Pacific grew nicely. Gross margins were 66.9% vs 68.9% EPS $3.11 vs $3.47, respectively. XLNX expects for the first fiscal quarter ended June 29, to be reported July 30, sales of $720 million to $734 million, up from previous guidance of $660 million to $720 million with gross margins of 67%-68%. The company said it is seeing stronger than expected revenues in its Wired and Wireless Group and Data Center Group, more than offsetting weaker than expected revenues in consumer-oriented end markets, including automotive, broadcast, and consumer. Robert Sluymer, our head of technical analysis, notes that XLNX crossed above its declining 200-dma in June, and has continued to trend higher above its rising 50-day moving average.  Unlike other peer firms at or near new highs, XLNX appears to be in the early stages of a new bull cycle. He recommends accumulating.  According to Brian Rauscher, our head of global portfolio analysis, XLNX is screening favorably in his single stock ERM model as his proprietary analyst sentiment measure (ASM) for the stock has bottomed and is now rising, which is historically a bullish sign. XLNX isn’t standing still either. It has said it intends to continue to displace ASICs and traditional PLDs in next generation electronic systems. Latta believes that in the future, programmable chips will likely take share from ASIC. The company has a strong balance sheet with a cash position net of long-term debt of near $1 billion. Analysts’ consensus is near $4 in EPS in fiscal 2023, which suggests they believe it can get back to peak revenues eventually. If it does, Latta thinks the stock could re-approach its all-time high of $140 in early 2019, when Wall Street last thought $4 EPS was within reach, before COVID-19 and the Huawei issues arose. Where I could be wrong: The US-China trade war could worsen. XLNX gets most of its chip supply from Taiwan Semiconductor (TSMC). Bottom Line:  XLNX stock is at a level where the market is not expecting recovery of its end markets. If that happens, as we believe, the stock should rise. Prior “Signals”     DateTopicSubject / TickerThe Signal7/15/20StockMarket ConcentrationNarrow Mkt Rally Fuels Worry; We Expect Cyclicals To Join7/8/20StockSEC FilingsOther Voices: Why Reading 10K Filings Is Crucial; Part 17/1/20StockSimply Good Foods (SMPL)Post-COVID-19, Simply Good Foods Stock Looks Appetizing6/24/20StockLam Research, Applied MaterialsLam Research, Applied Materials Set to Reap IoT Harvest6/17/20StockNordic Semiconductor (Nod. 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Market rises 1.3%; Tech Slips but Value, Cyclicals Rebound

Even as market seems to go from the pillar of rising coronavirus (COVID-19) infections in the US to the post of a potential vaccine, each with differing impact on the economy, equities continue to rise. As I and my colleagues have noted, the market is a discounting machine and right now it appears to be looking to a 2021 that could be better for humans and markets. Clearly, the talk of a vaccine from Moderna (MRNA) raised expectations and stock prices, on the one hand, but the heavy rise in U.S. COVID-19 cases—but not hospitalizations or deaths, see Tom Lee’s piece below—turned investors cold and sank prices. So there were many cross currents in a week that saw the Standard & Poor’s 500 index rise 1.3% to 3225. That’s about where it was when it hit a post-Covid19 panic high June 8, 3232.39, so stocks effectively have been marking time. For the year of 2020, the market’s total return eased into positive territory, up 1%. It was a week of reversals. Monday in particular was an unusual day, which saw the market jump out to a big rise, then only to fall after California rolled back its reopening plans, putting a damper on the economic recovery. Much is being made of the NASDAQ’s move up 2% that day to a new high and a 2% lower close, the only other time that happened was in March of 2000. A sample size of two doesn’t really do it for me in terms of scariness. As noted, stocks were pushed up on talk of a Moderna COVID-19 vaccine progressing through trials, but pushed down by the increasing number of coronavirus cases in the U.S. Again, as Tom Lee points out beginning page 3, serious hospitalizations and deaths are generally going in the opposite direction as cases, which is a good sign. Among sectors, cyclicals and value stocks are rebounding, something that colleague Rob Sluymer has been writing about. See page 7. Last week, value and cyclical stocks like financials, industrials and materials were among the leading sectors, up about 2%,6%, and 5%, respectively, while the info tech sector had a rare down week, off over 1%. And all that leaves out the beginning of the second quarter earnings reporting season. We’ve been saying that investors will look through what is sure to be a poor profits quarter. And there are more crosscurrents to parse. U.S. jobless claims showed 1.3 million filed for unemployment in the week ended July 11, not much changed. Yet U.S. retail sales for June rose 7.5%, more than economists expected. Industrial production—a measure of output at factories, mines and utilities—rose a seasonally adjusted 5.4% in June from May, the Fed said, higher than the 4% rise anticipated by economists. For 2Q20 as a whole, the index fell at an annual rate of 42.6%, the largest quarterly decrease since World War II. Despite some good data, there is worry about a double dip recession given some of the reversals in state re-openings. For example, job openings in July are down from last month across the U.S., and Google searches for “file for unemployment” are creeping up. Meanwhile, the major U.S. banks’, JPMorgan Chase (JPM) and Citigroup’s (C)—though beating analysts’ 2Q estimates—also reported setting aside reserves of billions of dollars as loan loss provisions. That’s rarely a good sign. Overall, investors are expecting corporate earnings among companies in the S&P 500 to have fallen 45% in the second quarter from the year-earlier period, according to FactSet. Financial companies within the S&P 500 are expected to take an even bigger hit—a roughly 57% drop. Chinese stocks had a tough week, down nearly 7%, on rising coronavirus infections and worries about the global economy. Data on China’s retail sector showed it is recovering more slowly than expected, with sales falling 1.8% in June from a year earlier. Economists had projected 0.3% growth. Still, the stock market remains resilient, despite the numerous negatives, supported by a basic expectation of an eventual recovery and stimulus from the Federal Reserve and the Federal government. As the market rose, the VIX (or so-called Fear Index) fell to 26 from about 32 one week ago. Quote of the Week: The Wall Street Journal: “The markets are looking out six months from now, and saying that things will be a whole lot better by then,” said Randy Frederick, vice president of trading and derivatives at Charles Schwab. He cautioned that uncertainty about the pandemic or the upcoming U.S. election could still sour the market’s rally in the coming months. Questions? Contact Vito J. Racanelli at vito. racanelli@fundstrat. com or 212 293 7137. Or go to

Overweight Value, Cyclicals; Favor Tech, Energy, Industrials

In my previous missives about 2020, I outlined our market view from 30,000 feet, so to speak, that our base case outlook is U.S. stocks rise 10% plus—to about 3450 on the Standard & Poor’s 500 index. This is predicated on index earnings growth of about the same amount or better this year. Let’s dive deeper now and see what styles, sectors and stocks I believe might work in this new year. My basic longer term-premise is that investors should overweight value and cyclical stocks, for reasons I’ll enumerate below. In particular, I favor technology, industrials, energy and basic materials sectors. In general, my themes for 2020 include the following: Overweight American stocks, as the U.S. decouples from the rest of the world Overweight technology, as technology/industrial companies will supply “nonhuman” labor and increase productivity Overweight asset heavy companies, as coming reflation will hurt those “subscription” asset light models and boost asset heavy models. Overweight companies exposed to the Millennial generation, as this bulging demographic cohort will be the primary driver of credit expansion in the future. And, in general, overweight value stocks versus growth, because we expect that as economic growth improves it will become a rising rate world, and history suggests that value beats growth in that environment. The base case for our “EPS is key” outlook is a recovery in 2020 EPS growth towards double-digits, as I noted in last week’s piece. The deep cyclical sectors are driving this recovery, led by technology, industrials, energy and basic materials. Collectively, these sectors are forecast to be more than 45% of the SPX’s EPS gains in 2020, so it’s pretty crucial to the thesis. Let’s look at history. Since 1949, whenever Purchasing Manager Indexes recover to above 50 level, as we expect, cyclical and value stocks have done well. More interesting, in the last 25 years, 3 groups consistently outperform in that scenario: technology, energy, among sectors, and value, in style. Why does value tend to outperform when the PMIs recovers above 50? The composition of the Russell 1000 Value Index, for example, could explain this. The “deep cyclical” sectors that are most sensitive to change in economic condition – the aforementioned industrials, materials and energy—represent some 21% of that Value index. Additionally, technology (including communication services) and financials represent more than one third of the Value index. They are the best performing sectors when PMIs rise above 50. The U.S. manufacturing sector contracted in December, thanks mainly to trade tensions. The Institute for Supply Management said on Friday its manufacturing index fell to 47.2 in December from 48.1 in November. The PMI is still in the process of bottoming and, as I’ve noted in the past, the UST 10-year-30-year bond spread suggests PMIs will recover later this year. On the other hand, the S&P 500 index has a higher mix of ‘high margin” or “high value” sectors such as technology and healthcare and has the lowest share of “deep cyclicals” like industrials, energy and basic materials. As a sidelight, I’d add that the inventory cycle is adding a little “oomph” to the PMI recovery. A factor supporting the bottoming of the industrial cycle (and hence, upside to 2020 growth) is this potential reversal of the previous inventory destocking. Another positive supporting stronger EPS growth in 2020 is that financial conditions continue to ease and markets stand at the best financial conditions since March 2018. The Goldman Sachs Financial Conditions index shows that financial conditions have eased in the past few weeks. (See chart below.) One thing not generally considered by investors is the turnover inside the S&P 500 index and what it means. Newly added companies will drive 23% of gains in S&P 500. Notably, my confidence in the future gains in the S&P 500 is driven by the realization that new companies will produce a meaningful share of gains. More than 23% of the return of the S&P 500 within any 10-year period is derived from companies added within the prior 10-year period. For example, in the last decade this has included new profits from Google (GOOGL), Facebook (FB), and Twitter (TWTR). Bottom line: Given that, my forecast is for the SPX to reach about 3,450 (from about 3235 currently) in our base case, or a bit less than 18 times price/earnings ratio on that $178 EPS. My best case scenario is for $184 EPS, to which we apply an 18 multiple for a level of nearly 3600 on the SPX.

Yearend Plays: Tech, REITs, Com Services; Value Over Growth

With about two months of trading left in 2019, investors are in a strange position. True, calendar 2019 has been pretty good, with the Standard & Poor’s 500 Index up a robust 20%. However, stocks continue to hang just below the all-time highs, unable to burst through. Even though it’s been a good year, that’s in part due to last December’s bear market. So the bear warning cry is reduced to this: The market hasn’t really gone anywhere in 18 months. That’s true but my base case for the final weeks of this year remains a roughly 3% rally into yearend, taking the S&P 500 above the old closing high of 3026 (July 26) and to around my target of 3125. How should investors position their portfolios for the next ten weeks or so, particularly given the considerable macro uncertainty, such as the U.S.-China trade tiff, or Brexit, or the direction of rates? My view is based partly on what the market has done for the past 20 years, and on our work on certain potential economic signals. Since 1999, the best playbook for the last ten weeks of the year has been to stick with the “year-to-date winners” (top 3 sectors), which outperformed the middle five and bottom three sectors. Additionally, the final 10 weeks historically call for a switch from to value stocks from growth. ● PLAYBOOK 1: The year-to-date winners in the top 3 sectors—technology, real estate investment trusts (REITs), and communication services—should show persistence into the yearend by outperforming the market. Over the past twenty years, the outperformance of the three together is 0.4% with a win ratio of 63%. See table below. ●PLAYBOOK 2: Flip to overweighting value stocks. The difference year-todate in performance between value and growth has been a push, but into the yearend value begins to outperform by about 0.3%. Seasonality of style is surprising to me. Growth stocks tended to outperform value stocks from the start of the year to mid-October, then the market style rotated to value from then to the year end. For the final 10 weeks, value has beaten growth 63% of instances since 1999. It is a flip of the seasonals. See chart below. What could go wrong? Intuitively, this playbook only works if economic momentum picks up. For the rally to reach “escape velocity” from the market’s flat performance, then a key for this is purchasing manager indexes to be bottoming. Three factors suggest the US PMIs are bottoming: long term yield curve (discussed many times); key groups sensitive to PMIs are rallying, and ISM New Orders/Inventory looks like it bottomed. In the first place, as I have pointed out previously, the long-term yield curve is steepening. The long-term yield curve (10-month change of UST 30-yr-10-yr yield spread) signaled 16M ago a downturn in ISM PMI was coming. Since our April 2017 study, the long-term yield curve seems to be doing a pretty good job of predicting ISM. The continued weakness in 2018-19 was predicted 16 months ago and if the pattern holds, then the ISM should be bottoming now with an upturn expected as we move into year end. Second, PMI sensitive groups are rallying, such as semis (since 5/28), Germany’s DAX (8/16) and capital goods (10/21). Third, another possible clue is the collapse in the ratio of ISM new orders/inventory. Normally, a collapse in new orders is a foreboding sign, as it points to a collapse in the business cycle. However, if businesses slowed ordering due to “trade shock,” then this is what could be behind the recent plunge. Inventories take time to rebuild. Bottom Line: My conclusion is that for the final 10 weeks, investors should overweight those year-todate winners and also value stocks. Some stocks to consider: IBM, MXIM, ORVO, INTC, QCOM, PLD, CCI, SBAC, CBRE, IRM, CTL, T, VIAB, DISCK, ATVI, TPR, LEN, EXPE, KSS, PHM, LMT, CMI, ROK, CAT, EMR. Figure: Comparative matrix of risk/reward drivers in 2019Per 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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