New All Time Highs Reached and the Bull Market Rolls On

May 4, 2019 In this strategy briefing… FS Insight Investment Views

The business cycle looks resilient. Stock market upside this year will Near Term Business cycle looks resilient; 2019 be driven by both an expansion in the market price/earnings (P/E) ratio View: shaping up to be like 2009 and by better than expected EPS revisions. The S&P 500 index 2019 yearend target is raised about 7%, to 3,125 from 2,925, using a 17 P/E YE Target: 3,125 (YE P/E 17x · 2020E EPS $184) ratio and 2020 EPS of $184 – Strategy – Page 3 Style: Value & Cyclical

The technology sector’s secular leadership trend remains unbroken. Some cyclical sectors, such as the S&P financials and industrials are 25 Focus AAPL, GOOG, FB, AMGN, BKNG, DIS, becoming more interesting for investors. Though those two sectors Stock MO, PM, QCOM, TSLA, XLNX, ABBV, have been in relative performance downtrends since early 2018, they ideas: AMZN, BBY, DOV, EMR, GILD, GRMN, are very near to reversing those downtrends – Technical – Page 8 ITW, JNJ, LMT, MSFT, ROP, V, XOM

Tension between the Republicans and Democrats in Congress is Additions: AMZN, BBY, DOV, GRMN, ITW, MSFT, growing. This does not bode well for any bipartisan agreement at a V time when big decisions need to be made. Nasty headlines could ensue – Policy – Page 10 Deletions: AMP, CSCO, LOW, ROK, BWA, INTC, MMM

The Wall Street Debrief

New All Time Highs Reached And the Bull Market Rolls On

Brand new all-time stock index records; a hugely boisterous initial public offering for a company that offers fake meat; the famously tech-phobic Warren Buffet invests in Amazon (AMZN), and an FOMC meeting where nothing happened were all rolled up into a couple of days of trading action.

And, oh by the way, the U.S. economy looks pretty good right about now. So last week pretty much had it all. And it ended on a up note after a couple tough trading sessions Vito J. Racanelli Wednesday and Thursday. Senior Editor & Marketing Intelligence Analyst Formerly a Senior Writer at Barron's, Everyone likes new records and both the Standard & Poor’s 500 index and the Nasdaq where he covered stocks, bonds, and financial markets obliged, setting new highs last week, though the S&P finished Friday a whisker away from another high. Still, I see that and strong momentum—more on this below—as a @WSintelligencer pretty good sign that the bull lives and lives well. I don’t like that the Dow Jones Industrial Average has yet to confirm with its own record new high. But the DJIA is an arithmetic index of only 30 names—albeit highly important ones—and I’m thinking that it too will hit a new record later this year. Problems with Boeing (BA) and 3M (MMM) restrained the over 100-year old index.

For those keeping score, the S&P 500 index finished at 2945.64, up slightly on the week and set a new record closing high of 2945.83 Tuesday. After a terrible fourth quarter, the market has gotten off to one of its best starts in many years, up 17.5% year to date.

A lot of folks think that the Fed is driving this. Specifically, that its “patience” in not raising rates is artificially boosting returns. I’ll concede that lower rates for longer hasn’t hurt at all. I tend to think that the greater part of the market has been heartened by strong economic data. Remember, not long ago, investors were worried about a global slowdown. The U.S. at least is proving that false.

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The economic numbers in the U.S. are good, strong even. The GDP in the first quarter rose a better than expected 3.2%, despite a partial government shutdown during part of it. Inflation remains in the sweet spot of being not hot enough to rile the Federal Reserve into raising rates and not low enough to create fears of a recession. For now, it’s irrelevant that the Fed seems not to be able to come to a conclusion on whether this low inflation—now around for years—is a sustainable change or merely a blip.

The good economic news rolled on Friday. The April jobs report came in ahead of expectations, with nonfarm payrolls increasing a seasonally-adjusted 263,000, the Labor Department reported. The unemployment rate ticked down to 3.6% last month. Yes, 3.6%. I don’t remember a number that low and I’ve been around a long time.

The market is showing a lot of muscle on right now and I doubt that going against it will pay off. Indeed, sentiment wise Jason Goepfert, of SentimentTrader, says that when the S&P 500 index is above its 10-day moving average for at least 21 days and the relative strength index (RSI) is at least 55, the market is up a median 2.7% two months later and is positive 80% of the time. Twelve months later it is up a median 12.6% and is positive 78% of the time.

Some interesting year-to-date statistics from Bespoke Investment Group say that the stocks performing best this year are those which in 2018 had the lowest P/E, the lowest dividend yield, and the worst performances.

The IPO of Beyond Meat brought home the bacon and got a warm reception. No, check that, hyperbolic was more like it. The company, which makes plant-based alternatives to meat and dairy products, had its stock priced by underwriters at $25 but it immediately jumped sharply higher. It closed Friday at $66.79 per share. Do you think somebody might be mad at the underwriters?

My absolute speculative guess is that a ton of retail buying was involved. Frankly, that’s a little disconcerting, particularly if we are going to see similar jumps in the lineup of unicorn IPOs about to hit the market later.

By the way, we are still waiting for a final trade deal between the U.S. and China. I think it will happen.

What about the first quarter, you might ask? In general, the quarterly earnings season is shaping up to be much better than expected. That too is just as much a support to stocks as is the Fed, probably more.

Quote of the Week: “Overall the economy continues on a healthy path, and the committee believes that the current stance of policy is appropriate,” Federal Reserve Chairman Jerome Powell said after officials ended their two-day policy-setting meeting. For now, “we don’t see a strong case for moving [rates] in either direction.”

Questions? Contact Vito J. Racanelli at [email protected] or 212 293 7137. Or go to www.fsinsight.com.

Vito Racanelli, Sr. Editor & Marketing Intelligence Analyst

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The View from Thomas Lee (Equity Strategy)

Raising Year End S&P 500 Index Target to 3125 from 2925

Last week, I noted that the earnings growth slowdown of the first half of 2019 was likely transitory and priced in by markets. A natural outgrowth is that the business cycle looks resilient to me. Hence, I raised my Standard & Poor’s 500 index yearend target by about 7% to 3,125 from 2,925. The Street’s consensus target of about 2950 will prove to be too low.

I believe upside this year will be driven by both an expansion in the market Thomas J. Lee, CFA price/earnings (P/E) ratio and by EPS revisions. Given investment grade bond yields Co-Founder & Head of Research Previously Chief Equity Strategist at stand around 3.7%, or a P/E ratio of 27 times, then an equity P/E target of 17, up from J.P. Morgan from 2007 to 2014, top 16 previously, is achievable and appropriate. Applying that to my EPS, now up $1 to ranked by Institutional Investor every year since 1998. $184—on the heels of solid first quarter results so far—the yearend target rises to 3,125.

@Fundstrat There’s still a lot of skepticism out there—which is a good contrarian sign—and 3125 might feel like a stretch to some investors given the “earnings recession.” However, from a two-year rolling perspective, this is modest. For example, the two-year rolling return of the S&P 500 index is 16%, or 8% annualized if 3100 is reached. This compares to an annual median return of nearly 15% over the past half century. At 2,800, the S&P 500 return would be 4.7%, which is seen only during recessions.

As I’ve noted before, there’s a lot of dry powder that could drive markets. The JPMorgan prime brokerage data shows that American hedge funds are still net short. They are still unbelievers.

Overall, I see risks diminishing in the second half of 2019, as the geopolitical tensions that plagued markets in 2018 fade. While there are risks of new headlines and problems, of course, the second half looks to become one of improving visibility. (See table below)

Remember, macro factors still account for an estimated 70% of overall market returns and hence, these are likely to play a role in market dynamics in the latter part of the year.

The roughly 18% rise year to date is more than a dead cat bounce on December’s severe (20%) weakness. The new all-time highs set last week point to the start of a new bull

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market. The sector performance this year similarly argues this isn’t a late cycle rally, also a point I’ve been making for a while. The top performing sectors year to date are essentially cyclical groups. I see industrials, technology and financials leading the charge.

Our 2019 thesis has been that “2009 is the best analog for 2019,” as the combination of, among other factors, credit dislocation in 2018 (caused by Fed policy error) and December’s waterfall panic decline in stocks (last seen in March 2009) set the stage for a powerful rally, once incoming data could prove the resilience of the business cycle.

Indeed, this has been the case.

Cyclical stocks and sectors will likely be the drivers of gains into YE19 given more synchronized central bank interest rate policy moves, a flattening USD, and a likely upturn in purchasing manager indexes (PMI). So far, 2019 has been led by technology, discretionary and industrials, the top 3 with gains of about 28%, 22% and 22%, respectively.

With USD and PMIs trends reversing this year compared to 2018, when USD soared and PMIs tanked, this should drive further outperformance of cyclicals.

What could go wrong? Investor confidence remains fragile and, while we believe investors are getting “reluctantly” pulled into this rally, there remains significant headline and political risks. That said, we see 2009 as the template for 2019, which means a lot of bad news was baked into December’s panic.

Bottom line: Investors will ultimately see 2019 as start of a “new bull market” given the breadth of market declines seen in 2018. And like 2009, cyclicals led the recovery. Below are some attractive stocks within the 3 sectors we see leading through YE2019, technology, industrials and financials.

The tickers are LMT, RTN, CAT, CMI, ROK, CSCO, ADP, KLAC, QCOM, MSFT, BLK, NTRS, COF, PRU and PNC.

Thomas Lee, Co-Founder & Head of Research

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Figure: Comparative matrix of risk/reward drivers in 2019 Per Fundstrat

Figure: Fundstrat Portfolio Strategy Summary - Relative to S&P 500 ** Performance is calculated since strategy introduction, 1/10/2019

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FS Fed Watch

FOMC to Investors: Rates Are Steady as She Goes

Last week’s Federal Open Market Committee meeting concluded with no change in the Federal funds rate, as the market expected. It remains at 2.25%-2.50%. The Fed’s

“patient” attitude was reconfirmed.

What investors liked was that Fed Chairman Jerome Powell, speaking after the meeting, suggested that recent weak inflation could be transitory and didn’t necessarily mean broader economic weakness. @federalreserve

However, what investors—and probably President Donald Trump, too—didn’t like was that Powell dashed hopes the Fed might be preparing to lower interest rates later this year. (See quote of the week above.)

Still, as I have noted in past notes, the CME’s fed futures market has been a pretty good predictor of where rates are doing, even better than the Fed itself. Right now, the market sees a rate cut as early as January 2020. It must be added, however, that even the futures market is backing off the idea of a rate cut this year, after some strong economic data recent, such as 3.2% first quarter growth and an unemployment rate of 3.6%.

While the Fed’s monetary policy remains on hold for now, let’s see what happens later in the year if annual inflation continues to stay weaker than expected.

Separately, the Wall Street Journal reported that Fed officials said their 2% inflation target is symmetric, meaning they expect inflation will drift mildly above and below it at different times. They seek to keep inflation at that level because they see it as consistent with a healthy economy.

Upcoming: 6/18-19 - FOMC meeting.

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Focus Insight Stock List

Below we’ve highlighted the FocuS stocks that we recommend across at least two of our investment strategies for 2019.

Figure: Focus Insight Stock List As of 05/03/19

YTD perf DQM Mkt Cap (relative to P/E Ticker Company Rank ($M) S&P 500) ('19E) Value /Seasonality GrowthFANG Tilt Millennialsin odd AIyears / AutomationInflationQuTe Strategy Count 1 AAPL Apple Inc 220 $971,104 16.4% 18.4x • • • • • • 6 2 GOOG Alphabet Inc 101 821,897 (3.3%) 25.4x • • • • • 5 3 FB Facebook Inc 78 556,615 31.3% 26.6x • • • • 4 4 AMGN Amgen Inc 97 107,925 (26.5%) 12.6x • • • 3 5 BKNG Booking Holdings Inc 5 80,086 (11.5%) 18.2x • • • 3 6 DIS Walt Disney Co/The 23 241,385 5.0% 20.2x • • • 3 7 MO Altria Group Inc 347 100,263 (8.9%) 12.8x • • • 3 8 PM Philip Morris International In 202 132,803 10.4% 16.4x • • • 3 9 QCOM Qualcomm Inc 471 107,991 38.7% 22.5x • • • 3 10 TSLA Tesla Inc 2080 44,742 (41.4%) N/A • • • 3 11 XLNX Xilinx Inc 38 30,033 21.9% 30.8x • • • 3 12 ABBV Abbvie Inc 122 116,167 (32.2%) 9.0x • • 2 13 AMZN Amazon.Com Inc 106 965,044 13.1% 71.6x • • 2 14 BBY Best Buy Co Inc 479 20,128 24.5% 13.3x • • 2 15 DOV Dover Corp 147 14,401 22.2% 17.1x • • 2 16 EMR Emerson Electric Co 189 43,647 1.4% 19.2x • • 2 17 GILD Gilead Sciences Inc 304 85,609 (10.1%) 9.8x • • 2 18 GRMN Garmin Ltd 430 15,087 8.1% 21.3x • • 2 19 ITW Illinois Tool Works Inc 307 51,183 6.6% 19.8x • • 2 20 JNJ Johnson & Johnson 269 376,938 (7.4%) 16.5x • • 2 21 LMT Philip Morris International 40 94,244 10.0% 16.3x • • 2 22 MSFT Microsoft Corp 27 986,281 9.3% 28.1x • • 2 23 ROP Roper Technologies Inc 199 37,259 17.2% 27.9x • • 2 24 V Visa Inc 230 323,602 5.5% 30.2x • • 2 25 XOM Exxon Mobil Corp 217 330,533 (2.9%) 18.4x • • 2

Average (relative to S&P 500) 269 $266,199 3.9% 21.8x Median (relative to S&P 500) 199 $107,925 6.6% 18.8x

Additions: AMZN, BBY, DOV, GRMN, ITW, MSFT, V Deletions: AMP, CSCO, LOW, ROK, BWA, INTC, MMM

Focus Portfolio Performance (Since Introduction on 1/10/19, Relative to S&P 500)

The Focus Portfolio outperformed the S&P 500 by 390 bps since its inception.

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Technicals: Robert Sluymer

Technology Still Rules but Watch Financials, Industrials

The technology sector’s secular leadership trend remains unbroken (see top panel of the charts below), but that don’t ignore the potential elsewhere. As Tom Lee has noted this week, more cyclical sectors, such as the S&P financials and industrials (see the center and bottom panels) are becoming more interesting for investors. It will pay to watch them. Here’s why: Though those two sectors have been in relative performance downtrends since early 2018, they are very near to reversing those downtrends. Robert Sluymer, CFA Moreover, given my bullish technical outlook for equities overall through 2019, I expect Head of Technical Analysis Strategy Former Managing Director leading to see performance improve across more and more cyclical sectors, such as financials RBC’s U.S. Technical Research team with over 26 years of expertise in and industrials. Keep an eye on the following: a move above the downtrends indicated investment research and technical by the blue arrows on the charts below would be one technical development to signal analysis. an improvement in these cyclical sectors. Since technology is already up a lot, the @rsluymer financials and industrials could prove rewarding too. Stay tuned.

Secular and cyclical growth sectors compared

Leader: As noted above, technology’s relative performance uptrend is intact. However, short-term trading indicators remain overbought, suggesting a temporary performance pause developing. Similar to technology, the relative performance of consumer discretionary remains steady with a short-term pause developing.

Laggard: Healthcare’s relative performance weakness persists, but as I mentioned here in the past two weeks, the sector looks oversold short-term. A rebound is developing, but it is unlikely the beginning of longer-term performance trend reversal. Keep the underweight.

Figure: Rob’s Weekly Sector Review

Economically Sensitive

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Defensive

In the bullpen: Potential trend reversals

Cyclical sectors continue in intermediate-term relative performance downtrends, but they are near upside inflection points that would support overweight sector positions.

Financials: Again, a potential positive trend shift is developing. Although the relative performance downtrends remain intact there are interesting developments: 1) the sector is oversold on intermediate-term basis; 2) financials are showing early signs of reversing downtrends. To support an overweight position, a move above the declining 200-day moving average and January relative performance highs would be needed.

Industrials: Here too a possible positive trend shift is apparent. Relative performance remains in volatile trading range near the 2016 lows with potential to bottom. What would turn the technical backdrop bullish? A move above the 2018-2019 downtrend would be a bullish technical development and establishing a new higher high would confirm a new uptrend.

Materials: There’s a potential downside trend shift. The sector continues to drift range bound, and, once again, is challenging the lower end of its 2019 relative performance trading range.

Figure: Best and worst performance sectors over past 3 months

10 Information Technology, 9 5 Consumer 0 Discretionary, 4

-5

-10 Energy, -9 Health Care, -10

-15 Relative 3moPerformance Relative

Robert Sluymer, Head of Technical Analysis Strategy

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Views on Washington Policy from Tom Block

Growing Congressional Acrimony Over Mueller Report

Tension between the Republicans and Democrats in Congress is growing.

Last week, Attorney General William Barr took the flack for President Donald Trump, as he appeared to be disingenuous with Congressional Democrats over the issue as to whether or not he knew of any Mueller team disagreements with his summary of the Mueller Report. This culminated with the AG refusing to testify before the House Judiciary Committee. L. Thomas Block Washington and Policy Strategist I think this does not bode well for any bipartisan agreement at a time when big Formerly Global Head of Government Relations at J.P. Morgan for 21 years, decisions need to be made. Keep an eye on this. Nasty headlines could ensue. and previously served as Legislative Assistant and Chief of Staff in the Perhaps no action by Congress has more potential impact on capital markets than the House, and Legislative Staff Director in the Senate need to increase the debt ceiling later this year. There have been discussions of finding

@TomBlock_FS a popular bill to which the unpopular debt ceiling increase could be attached. While the debt ceiling bill may be the most difficult must-pass item needing action, Congress also has the threat of a government shutdown if no budget is approved by October 1. Possible double headline whammy there later this year.

There was a small sign of bipartisanship prior to Barr’s refusal to testify before the House when the President, House Speaker Nancy Pelosi, and Senate Democratic Leader Charles Schumer had a meeting to discuss a $2 trillion infrastructure program.

While there were smiles all around after the meeting, there is little Congressional Republican support for the proposal. With Republican concern over record deficit it is hard to envision a large infrastructure bill being approved.

L. Thomas Block, Washington and Policy Strategist

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Figure: Top Trump Tweets

Donald J. Trump The 45th President of United States of America

@realDonaldTrump

Economic Calendar

From 05/04/19 – 05/10/2019

NEXT WEEK'S MAJOR U.S. ECONOMIC REPORTS & FED SPEAKERS TIME (ET) REPORT PERIOD ACTUAL FORECAST PREVIOUS MONDAY, MAY 6

NONE SCHEDULED TUESDAY, MAY 7 10 AM JOB OPENINGS Q1 0.7% 3 PM CONSUMER CREDIT FEB. WEDNESDAY, MAY 8 ADP EMPLOYMENT APRIL 120,000 THURSDAY, MAY 9 8:30 AM WEEKLY JOBLESS CLAIMS 4/27 -- -- 8:30 AM PRODUCTIVITY Q1 1.9% 8:30 AM UNIT LABOR COSTS Q1 2.0% 10 AM FACTORY ORDERS MARCH -0.5% FRIDAY, MAY 10 8:30 AM NONFARM PAYROLLS APRIL 196,000 8:30 AM UNEMPLOYMENT RATE APRIL 3.8% 2 PM AVERAGE HOURLY EARNINGS APRIL 0.1% Source: MarketWatch

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