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. FSINSIGHT | www.fsinsight.com 5/4/2019 | Page 1 . 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 FSINSIGHT | www.fsinsight.com 5/4/2019 | Page 2 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 FSINSIGHT | www.fsinsight.com 5/4/2019 | Page 3 market.