Consumer Discretionary

Two Portfolio Changes And A Stop Buy Order Two Portfolio Changes And A Stop Buy Order Today we close two high-conviction trades and place a stop buy order for the June 2021 expiry VIX futures as a hedge to the remaining positions. Homebuilders have proven to be more resilient than we expected, especially given the selloff in the bond market. Clearly the US consumer is not concerned about a rebound in rates, at least not yet. Moreover, the looming fiscal stimulus will only facilitate more excesses, even in the residential housing market, as a fresh wave of liquidity will likely more than offset the tightening in monetary conditions. Thus, we have lost confidence in our high-conviction underweight stance in this niche consumer discretionary group and are taking a loss of 11% since inception. The S&P consumer staples sector was a natural high-conviction underweight given our end-2021 4,000 SPX target that we arrived at on the November 9 Special Report. Now that the market is within spitting distance of our target, the risk reward is no longer as favorable as it used to be for this defensive sector. Thus, we are closing this high-conviction trade today for a gain of 8% since inception. Finally, we successfully capitalized on our long VIX futures hedge to the tune of 19% recently, but given that volatility is settling down, it pays to institute a stop buy order for the June 2021 expiry VIX futures near the 25 mark. Bottom Line: Close the S&P consumer staples and the S&P homebuilding high-conviction underweights for 8% and -11% returns, respectively since the December 7 inception; and place a stop buy order for the June 2021 VIX futures at the 25 level.

Dear client, Next week instead of our regular Strategy Report we will be sending you a Special Report from BCA’s Equity Analyzer service on Inflation and Factor investing penned by my colleague Lucas Laskey, Senior Quantitative Analyst. Finally, on February 22 we will be hosting our quarterly webcast one at 10am EST for North American and EMEA clients and one at 8pm EST for Asia Pacific, Australian and New Zealand clients “From Alpha To Omega With Anastasios”. Mathieu Savary, who heads our Daily Insights service, will be our special guest in the morning webcast. On March 1 we will resume our regular publication schedule. Kind Regards, Anastasios Highlights Portfolio Strategy China’s engineered economic deceleration, the knee jerk US dollar bounce along with signs of soft US capital expenditures entice us to protect our deep cyclicals versus defensives portfolio gains and institute a 2.5% rolling stop to this share price ratio. Rising relative capital outlays, firming software pricing power and an M&A frenzy more than offset the negative relative profit signal from our models that sell side analysts already anticipate. Continue to overweight the S&P software index.  Recent Changes Last Tuesday we closed out our VIX futures hedge for a gain of 19% since the December 7, 2020 inception. Last Wednesday we re-initiated our long “Back-To-Work”/short “COVID-19 Winners” pair trade. Feature Equity volatility settled down last week following a ferocious ten-day SPX oscillation that sent the VIX soaring to roughly 38 near the peak at the end of January, courtesy of the GME/Wallstreetbets (WSB) saga before collapsing back down near 21 last week. Chart 1 shows that this was likely an equity-only event: both risk off currencies – the yen and the franc – actually fell versus the USD, junk bond spreads barely budged and the vol curve violently inverted, a move that more often than not signals that complacency has morphed into panic. Importantly, when the Fed embarks on active QE the SPX drawdown maxes out at 10% based on empirical evidence, including the recent September/October 10% drawdown. Using the ES futures low hit two Sundays ago, the S&P 500 experienced a 5.3% peak-to-trough pullback well within the range of previous Fed active QE iterations. As a reminder, the 2010 and 2011, 17% and 20% respective drawdowns took root after the Fed had concluded QE1 and QE2 operations. The implication is that for a more significant drawdown to materialize, likely the Fed has to end the current QE operation and reinject some volatility in the bond markets (bottom panel, Chart 1).  Isolating the true signal from all this noise, convinced us to book handsome gains to the tune of 19% in our VIX June futures hedge (conservatively assuming that no leverage was used), reinitiate the long “Back-To-Work”/short “COVID-19 Winners” pair trade and put the small cap size bias on our upgrade watch list. As volatility has slowly died down, investors can start to refocus on profit fundamentals. Similar to the steep fall in EPS that the SPX 35% drawdown predicted in March of 2020, in recent research we showed that were we to hold the SPX at current levels, its 12-month rate-of-change would surpass the 61% mark next month and forecast that profit growth would rise by a similar amount. Indeed, sell side analysts’ bottom up earnings estimates corroborate this analysis as quarterly EPS will peter out roughly at a 48% year-over-year (YOY) growth rate next quarter and vault to all-time highs in quarterly level terms in Q3 following a three-year hiatus (Chart 2). Chart 1Equity-only Event Equity-only Event Equity-only Event Chart 2Joined At The Hip Joined At The Hip Joined At The Hip Importantly, the tech sector no longer commands an earnings weight similar to its market cap weight likely because it’s run ahead of itself and also because the rest of the sectors are playing catch up this year as the US economy is slated to reopen on the back of the herculean inoculation efforts (profit weight and mkt cap weight columns, Table 1). Table 1Sector EPS And Market Cap Weights Re-grossing? Re-grossing? This is most evident on the sector contribution to this year's SPX earnings growth. Historically, the tech sector commanded the lion’s share of profit explanation for the SPX, but not in 2021. In fact, the S&P IT sector is ranked 4th in terms of contribution to overall SPX profits, behind industrials, financials and consumer discretionary (Chart 3).   Delving deeper into 12-month forward earnings growth figures is instructive. Table 2 shows our universe of coverage ranked first by GICS1 sector growth rates and then re-ranked per sub-group. As an aside the energy sector’s EPS is slated to contract in calendar 2020 and thus any YOY growth rate figures are rendered useless for the broad sector and the energy sub-industries. Chart 3Sector Contribution To 2021 SPX EPS Growth Re-grossing? Re-grossing? Table 2Identifying S&P 500 Sector EPS Growth Leaders And Laggards Re-grossing? Re-grossing? Our portfolio positioning is well aligned with the sector ranking of EPS growth for the coming year. Put differently, given the havoc that COVID-19 wreaked to the US industrial and service bases it is normal that deep cyclical sectors along with financials and the decimated services-heavy parts of the consumer discretionary sector to occupy the top ranks. In contrast, defensives sectors that were largely COVID-19 beneficiaries (especially health care and consumer staples) are near the bottom of the pit. The sole misalignment is the bombed out real estate sector that we remain overweight (Table 2). Netting it all out, our sense is that the market has successfully navigated a tumultuous two-week period and we reiterate our long-held sanguine 9-12 month cyclical view on the prospects of the S&P 500. This week, we update a defensive tech sub-group and put a tight stop in the cyclicals/defensives portfolio bent in order to protect profits. Risks To The Cyclicals Over Defensives Portfolio Bent Last December we highlighted that China’s four year cycle will peter out in the back half of 2021 and could cause some equity market consternation, with stocks likely sniffing out any trouble likely by the end of Q1/2021. It appears that investors have been sleeping at the wheel and largely distracted by the GME/WSB saga. Not only did they neglect the robust SPX profit season, but they also ignored that something is amiss in China as we first showed last week (please refer to Chart 12 here). Importantly, what worries us most is the transition from China being the primary locomotive of global growth to the US taking the reins in coming quarters. Clearly such a handoff is tumultuous, especially given the recent added risk of a reflex rebound in the greenback that we first warned about on January 12 when we set the cyclicals/defensives ratio on downgrade alert. Subsequently, we upgraded the S&P utilities sector to neutral locking in gains of 15% for the portfolio, and today we decide to institute a 2.5% rolling stop in the cyclicals/defensives portfolio bent, in order to participate on further upside but also protect 16% gains for the portfolio since the July 27, 2020 inception in case of a market relapse. Practically, when the rolling stop gets triggered we will move the cyclicals/defensives bent down to neutral via executing the downgrade alert we have in the S&P materials sector. In more detail, China’s slamming on the brakes is the key risk to cyclicals/defensives. Not only are the Chinese authorities trying to engineer a slowdown with the recent reverse repo operations, but also BCA’s China Monetary Indicator, the selloff in the Chinese sovereign bond market and the cresting in the PBOC’s balance sheet are all corroborating the economic deceleration signal (Chart 4). Chinese total social financing has peaked, the 6-month credit impulse is plunging, and the nosedive in Goldman Sachs’ Chinese current activity indicator (CAI) are all firing warning shots that the economy is slated to slowdown (Chart 5).  Chart 4Everywhere… Everywhere… Everywhere… Chart 5…One Looks… …One Looks… …One Looks… Already both the Chinese manufacturing and services PMIs have hooked down with the manufacturing new orders-to-inventories (NOI) in free fall and export orders in outright contraction. Tack on the reversal in the Citi economic surprise index (ESI) for China and the outlook dims further for US cyclicals/defensives (Chart 6). No wonder Chinese demand for loans has turned the corner, infrastructure spending has topped out and railway freight volumes have ticked down as a direct response to the tightening in Chinese monetary conditions (Chart 7). Chart 6…China… …China… …China… Chart 7…Is Slowing… …Is Slowing… …Is Slowing… Chinese imports flirting with the zero line best capture all this softening in Chinese data and also warns that the US cyclicals/defensives ratio is nearing a zenith (Chart 8). Beyond the dual risk of a counter trend rally in the USD and China’s undeniable deceleration, returning to US shores reveals another source of potential trouble for cyclicals/defensives. Chart 8…Down …Down …Down The US Citi ESI has come back down to earth, and the ISM manufacturing PMI cooled off last month with the NOI ratio flashing red (Chart 9). Importantly, Goldman Sachs’ US CAI is sinking like a stone corroborating that, at the margin, US economic data is softening (Chart 10). Moreover, US capex is in the doldrums courtesy of the collapse in EPS last year that dealt a blow to CEO confidence. Worrisomely, the rollover in the latest capex intentions from regional Fed surveys along with the downbeat NFIB survey’s capital outlays in 6-months component underscore that CEOs remain reluctant to invest (Chart 9). Chart 9Even US Trouble… Even US Trouble… Even US Trouble… Finally, relative valuations have surged to all-time highs leaving no cushion in case of a mishap, while relative technicals are in extreme overbought territory near a level that has marked the commencement of prior relative share price drawdowns (Chart 11). Chart 10…Is Brewing …Is Brewing …Is Brewing Netting it all out, China’s engineered economic deceleration, the knee jerk US dollar bounce along with signs of soft US capital expenditures entice us to protect our deep cyclicals versus defensives portfolio gains and institute a 2.5% rolling stop to this share price ratio. Bottom Line: Prepare to move the cyclicals/defensives portfolio bent back down to neutral from currently overweight. Today we recommend investors establish a 2.5% rolling stop to the cyclicals/defensives relative share price ratio as a risk management tool in order to protect profits. Chart 11Overstretched And Pricey Overstretched And Pricey Overstretched And Pricey Software On The Ascend While we remain on the sidelines with regard to the broad S&P technology sector we continue to recommend a barbell portfolio approach preferring defensive software and services stocks to aggressive hardware and equipment equities. In that light, we reiterate our overweight stance in the key S&P software sub-industry that still commands the highest market cap weight in the tech sector just shy of 33%. While overall capex is sluggish as we highlighted above, software capital outlays have recovered smartly and according to national accounts are growing at a 10%/annum pace. Stock market-reported capex confirms that software capital expenditures are on an absolute tear and remain a key pillar of our secular preference for this defensive tech group (Chart 12). On the sales front, COVID-19 accelerated the push to the cloud and 2020 has been a bumper year for industry sales. True there is an element of stealing revenues from the future, but as long-time readers of our publication know we do not believe that SaaS is a fad and the adoption of cloud services remains in the early innings. Impressively, while relative forward top line growth expectations have rolled over, the attempt of the software price deflator to exit deflation suggests that software stocks will easily surpass this lowered revenue bar in coming quarters (Chart 13). Chart 12Primary Capex Beneficiary Primary Capex Beneficiary Primary Capex Beneficiary Amidst the IPO frenzy that has captured investors’ imagination especially given the spectacular increases in both SNOW and PLTR (neither of which is in the SPX yet), software M&A fever remains as high as ever. This constant reduction of software stock supply, coupled with the insatiable appetite of software executives to aggressively retire equity, signals that software equity prices will remain well bid (Chart 14). Chart 13Software Tries To Exit Deflation Software Tries To Exit Deflation Software Tries To Exit Deflation Chart 14Positive Share Price Dynamics Positive Share Price Dynamics Positive Share Price Dynamics Nevertheless, our relative EPS growth models are waving a yellow flag. The SPX is slated to grow profits north of 25% this year, but according to our profit models software will only manage to grow in the single digits, thus trailing the broad market by a wide margin. Encouragingly, this grim relative profit growth backdrop is already reflected in depressed sell side analysts’ forecasts (Chart 15). Finally, while relative valuations are still lofty they recently have corrected back to one standard deviation above the historical mean. Similarly, relative technicals have worked off overbought conditions and have settled down near the recent historical average (Chart 16). Chart 15Risks… Risks… Risks… In sum, rising relative capital outlays, firming software pricing power and an M&A frenzy more than offset the negative relative profit signal from our models that sell side analysts already anticipate. Bottom Line: Continue to overweight the S&P software index. The ticker symbols for the stocks in this index are: BLBG: S5SOFT – MSFT, ADBE, CRM, ORCL, INTU, NOW, ADSK, ANSS, SNPS, CDNS, FTNT, PAYC, CTXS, NLOK, TYL. Chart 16…To Monitor …To Monitor …To Monitor   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Overdose? Overdose? Size And Style Views January 12, 2021  Stay neutral small over large caps July 27, 2020 Overweight cyclicals over defensives (2.5% rolling stop) June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, ABNB, V). January 22, 2018 Favor value over growth

In last week’s US Sector Insight we showed how TSLA’s inclusion in the S&P 500 pushed consumer discretionary 5-year forward EPS growth into the stratosphere. We then dove deeper into this GICS1 sectors in this Monday’s Strategy Report and downgraded the S&P automobiles & components index to underweight. On the profit front, a wide gap has opened between relative share prices and relative forward EPS, which suggests that high-flying auto stocks will soon stop defying gravity (Chart 1). At the same time, technicals are also waving a red flag: the S&P autos & components relative annualized 13-week rate of change clocked in at over 250%/annum, steeply diverging from relative net EPS revisions (Chart 2). Chart 1Shy Away From Cult Stocks Shy Away From Cult Stocks Shy Away From Cult Stocks Chart 2Shy Away From Cult Stocks Shy Away From Cult Stocks Shy Away From Cult Stocks   Given that auto manufacturing is a cutthroat business with razor thin margins and that other Japanese, German and Chinese BEV manufacturers are entering the scene (for example VW Group outsold TSLA last year by a factor of over 3-to-1 in Norway, which is the most advanced BEV market), we doubt that prices will sustain their divergence from profits for much longer. Bottom Line: We trimmed the S&P automobiles & components index to underweight. The ticker symbols for the stocks in this index are: BLBG: S5AUCO – TSLA, GM, F, APTV, BWA.

Obeying The Stop: Close The Intra-Real Estate Pair Trade Obeying The Stop: Close The Intra-Real Estate Pair Trade In the January 19th Special Report we instituted a long S&P REITs / short S&P homebuilders pair trade with a 10% stop loss. Yesterday, our stop was triggered and we are obeying it and closing this pair trade. Among other reasons, one of the macro drivers that compelled us to put this pair trade on was the 10-year US Treasury yield: historically the correlation between the relative share price ratio and interest rates would snap positive especially following a recession. Hence, a pullback in yields was also a key risk we highlighted for this pair trade. The 10-year US Treasury yield peaked near 1.19% and has continued to correct breaking below 1.04%, which at the margin boosts the allure of homebuilding stocks and consequently put our pair trade offside. While the original reasoning for putting this pair trade on remains intact, we refrain from fighting the trend and opt to move to the sidelines for the time being. We will be on the lookout for a better-timed entry point in the near future. Bottom Line: Obey the trailing stop and close the long S&P REITs / short S&P homebuilders pair trade for a loss of 10%.  

Highlights Portfolio Strategy Speculative fervor dominates trading in the S&P auto & components group, but soaring long-term profit projections, lofty valuations, overbought technicals, and a looming German/Japanese/Chinese BEV competitive attack on TSLA’s BEV home turf, all but guarantee some cooling off in the recent exuberance in this GICS2 industry group, and compel us to downgrade exposure to underweight. This move also pushes the S&P consumer discretionary sector to a below benchmark allocation, today. A firming operating backdrop, a stealthy turn in select macro data, extreme sell-side pessimism, bombed out technicals and compelling valuations all signal that it no longer pays to be bearish the S&P utilities sector. Upgrade to neutral.  Recent Changes Downgrade the S&P automobiles & components index to underweight, today. This move also pushes the S&P consumer discretionary sector to a below benchmark allocation, today. Upgrade the S&P utilities sector to neutral today, locking in gains of 14.8% since inception. Last Wednesday our rolling stop on the long “Back To Work”/short “COVID-19 Winners” pair trade got triggered and we booked gains of 21.5% since the September 8 inception. Table 1 Overdose? Overdose? Feature The SPX cheered Joe Biden’s inauguration and vaulted to fresh all-time highs last week. It is now at spitting distance from our 4,000 target, a mere 3.8% higher. While loose fiscal and easy monetary policies have staying power and will remain largely intact in 2021, their efficacy is dwindling. Crudely put, it would take additional extra-ordinary larger amounts of stimuli to move the needle, as all the good news and then some, is already reflected in fully valued stocks. Financial conditions are the easiest on record, as we highlighted recently, and investor complacency reigns supreme given the 0.34 print in the equity put/call ratio (Chart 1). Chart 1Complacency Reigns Complacency Reigns Complacency Reigns In the near-term, something’s got to give. Importantly, a rising number of indicators we track are flashing red. Not only is there a plethora of anecdotes that the newly minted stock traders using Robinhood are chasing story stocks armed with freshly-written stimulus checks, but margin debt is also exploding (Chart 2). Granted, the latter is a coincident indicator, nevertheless the stampede into stocks via tapping margin accounts is near previous cyclical zeniths: the annualized 13-week rate of change of margin debt uptake surpassed 100%/annum, a move last seen in 2007/2008 and 1999/2000 (Chart 2). Correcting margin debt for GDP and total stock market capitalization for the size of the US economy (Buffett Indicator) is revealing. Both measures are at an extreme using data going back to the 1970s, making the equity market susceptible to disappointment (Chart 3). Buyer exhaustion will come sooner rather than later, and such a dearth of buyers will cause at least an air pocket in stocks. Chart 2Maxed Out On Debt? Maxed Out On Debt? Maxed Out On Debt? Chart 3Off The Charts Off The Charts Off The Charts Moreover, there is an element of pre-GFC-type excesses, but now investors are speculating with equities instead of housing. Back then, NINJA loans, ARM loans and subprime loans in general were sustaining the house of cards as long as the price of the underlying asset kept on rising. As soon as prices crested and moved sideways to lower, debt deflation hit real estate speculators hard, especially ones that owned multiple homes. Currently, anecdotes of homeowners speculating on the stock market via Mortgage Equity Withdrawals (Greenspan-Kennedy MEW)1 are also mushrooming. In other words, many retail investors are tapping into their home equity and money saved from ultra-cheap re-financings and redeploying it into stocks. As of Q3/2020 MEW is running at the highest level since the GFC at $300bn or roughly 2% of disposable income; keep in mind that the latter has also gotten a COVID-19 fiscal boost to the order of $1.2tn, which makes the galloping MEW even more remarkable (Chart 4). Chart 4Even MEW Is Spiking Even MEW Is Spiking Even MEW Is Spiking While MEW is nowhere near its 2007/2008 peak, surely some of it is leaking into equities, beyond PCE, further fueling the recent stock market exuberance. Another indicator that has sprang to life of late is our Equity Capitulation Index. Back in March we used this indicator from a contrary perspective when we recommended investors go long equities on a cyclical basis (reason #16 to start buying equities). Subsequently we have remained cyclically exposed, but we cannot neglect the negative signal this indicator is now emitting: it has clawed back all the losses since March and is now at a level that has marked previous near-term tops, and at an eerily similar level as during the 2010 SPX peak (second panel, Chart 5). Further on the sentiment front, bulls are abundant, but bears have gone extinct: according to Investors Intelligence the bull/bear ratio is closing in on 4, an historically elevated ratio (Chart 6). Chart 5Contrary Alert: Bears Capitulated? Contrary Alert: Bears Capitulated? Contrary Alert: Bears Capitulated? Chart 6Extreme Sentiment Reading Extreme Sentiment Reading Extreme Sentiment Reading Netting it all out, speculative fervor has taken over the equity markets and at least a healthy near-term breather is warranted in order to consolidate recent impressive gains. We remain cautious on the short-term prospects of the broad equity market and continue to recommend investors go long a $390/$410 call spread on the SPY exchange traded fund financed by a short $340 put on the SPY for either March or June option expiries. This week, we downgrade a consumer goods index to underweight that is at the epicenter of the recent equity market bubble talk. This change also pushes the S&P consumer discretionary index to a below benchmark allocation. Further, we trigger our upgrade alert on a niche defensive sector monetizing sizable gains for the portfolio. Downgrade Autos & Components To Underweight We recommend investors shy away from the S&P automobiles & components GICS2 industry group, and today we downgrade it to an underweight stance. Before analyzing this group that has an 80%+ weight in TSLA in more detail, a couple of bubble-related observations are in order. The top panel of Chart 7 shows the google trends search term ‘stock market bubble’ as a time series, and it has hit all-time highs since the 2004 start in this data search query. Importantly, linking this to the SPX is instructive. Every time these search results pick up steam, so does S&P 500 momentum until it cracks. Assuming a sideways move from here onward on the S&P until the spring, it will boost year-over-year momentum to a peak over the 50%/annum mark (bottom panel, Chart 7). Using weekly data, the SPX has only managed such a feat three other times since WWlI, in 1983, in 1998 and in 2010 (as a reminder we drew SPX parallels to 1998 and 2010 earlier this month). True, this does not prove that the SPX is in a bubble per se, however it does highlight that it is overstretched and at risk of a snapback. While everyone was preoccupied with the effect TSLA’s SPX inclusion would have on the index’s 12-month forward P/E, the real change crept up in the long-term EPS growth expectations. This story stock caused the S&P 500’s five-year profit growth expectation to skyrocket from 12% to 21% overnight (top panel, Chart 8) and pushed down the S&P 500 forward P/E/G ratio to near par (not shown). Chart 7Bubble Talk Mushrooming Bubble Talk Mushrooming Bubble Talk Mushrooming Chart 8"It's too good for true, honey, it's too good for true" (Adventures of Huckleberry Finn, 1884), Mark Twain. "It's too good for true, honey, it's too good for true" (Adventures of Huckleberry Finn, 1884), Mark Twain. "It's too good for true, honey, it's too good for true" (Adventures of Huckleberry Finn, 1884), Mark Twain. Back in late-1999, YHOO’s SPX inclusion also caused a bump in this metric, but it paled in comparison to TSLA’s current dominance. In other words, nine percentage points of growth are attributed to a single stock or 43% of the SPX EPS growth is tied to the fortunes of TSLA. We highly doubt this will occur as analysts have been upgrading profit estimates and price targets for TSLA hand over fist over the past few months, with some using DCFs out to 2040 in order to back up their forecasts. Drilling deeper beneath the surface into the consumer discretionary sector is revealing. TSLA’s inclusion pushed the sector’s 5-year forward profit growth estimates to 83% (bottom panel, Chart 8). To put this in perspective it translates into consumer discretionary profits increasing 20 fold in the next 5 years; no, this is not a typo. Assuming that stock prices follow profits as it typically transpires, then prices will have to rise by a similar amount. Again, our sense is that this is highly unlikely. In comparison, AMZN’s graduation to the SPX in late-2005 barely budged this profit growth metric for the GICS1 sector as tech stocks were still licking their wounds from the dotcom bubble burst. One level lower into GICS2 territory and circling back to S&P auto & components, data series go fully parabolic, to a degree not seen even during the dotcom bubble era. The same aforementioned long-term growth rate zooms to over 300% for the S&P automobiles & components index compared with the broad market (Chart 9). Turning over to relative revenue expectations for the coming 12 months that data point surges close to 15% (middle panel, Chart 9). With regard to valuations, relative forward P/E, relative P/S and P/B are all in the stratosphere, warning that there is no valuation cushion to fall back on in case of an earnings mishap (Chart 10). Chart 9Dizzying… Dizzying… Dizzying… Chart 10...Heights ...Heights ...Heights Importantly, on the profit front, a wide gap has opened between relative share prices and relative forward EPS, which suggests that high-flying auto stocks will soon stop defying gravity (Chart 11). Technicals are also waving a red flag: the S&P autos & components relative annualized 13-week rate of change clocked in at over 250%/annum, steeply diverging from relative net EPS revisions (Chart 12). Chart 11Stocks Should Follow Profits Stocks Should Follow Profits Stocks Should Follow Profits Chart 12Cult Stock… Cult Stock… Cult Stock… Using the datastream index equivalent to the S&P automobiles & components (this data provider had included TSLA prior to the S&P’s inclusion in the S&P 500) reveals that this relative share price ratio is on a tear and warns investors that the S&P automobiles & components index is not as depressed as it first appears to the naked eye (Chart 13). Chart 13...Effect ...Effect ...Effect Looking at the single stock level, TSLA exemplifies the mania of the 2020s (bottom panel, Chart 14). This story stock has been moving in lockstep with M1 money supply. Such a breakneck pace of appreciation is clearly unsustainable (Chart 15). Chart 14TSLA Is A Mania TSLA Is A Mania TSLA Is A Mania Chart 15Spurious? Doubt It Spurious? Doubt It Spurious? Doubt It Finally, comparing TSLA to its global peers is also mind boggling. TSLA is worth a couple hundred billion US dollars more than all of the other global auto stocks put together (top panel, Chart 14)! Auto manufacturing is a cutthroat business with razor thin margins. Thus, we doubt that the German and Japanese (and lately even Chinese BEV makers) auto makers are not going to make inroads into TSLA’s BEV home turf. In Norway, the most advanced BEV market in the world, VW Group outsold TSLA last year by a factor of over 3-to-1. In sum, speculative fervor dominates trading in the S&P auto & components group, but soaring long-term profit projections, lofty valuations, overbought technicals, and a looming German/Japanese/Chinese BEV competitive attack on TSLA’s BEV home turf all but guarantee some cooling off in the recent exuberance in this GICS2 industry group. Bottom Line: Trim the S&P automobiles & components index to underweight today. This move also pushes the S&P consumer discretionary sector to a below benchmark allocation. The ticker symbols for the stocks in this index are: BLBG: S5AUCO – TSLA, GM, F, APTV, BWA. Act On The Utilities Upgrade Alert, Lock In Gains And Lift Exposure To Neutral We have been on the right side of the underweight utilities position for the better part of the past two years, but now that the easy money has been made we are compelled to book handsome gains of 14.8% for the portfolio since inception and move to the sidelines. The bearish story is well known on utilities and avoiding them is now a consensus trade. Chart 16 shows that when the economy is in expansion mode, it pays to minimize utilities exposure. The pendulum always swings the opposite direction and when the cycle matures, investors seek the safe haven stable cash flow status of this niche defensive sector. Extreme euphoria has taken over in the overall equity space and while the vaccine rollout news is a big positive, we doubt the ISM manufacturing survey reading can rise significantly from the current historically stretched level (ISM survey shown inverted, top panel, Chart 16). Similarly, junk yields are at all-time lows confirming that investor complacency is sky-high, and the USD very oversold with positioning stretched to the short dollars side. Any hiccups would cause all three of these macro indicators to reverse course abruptly, which would boost relative utilities share prices (Chart 16). Already, the CITI economic surprise index is sinking like a stone, equity market vol refuses to fall below 20, and the gap between the 10-year US Treasury (UST) yield and relative share prices remains historically wide, leaving ample room for utilities to catch up to the year-over-year drubbing in yields (yields shown inverted, top panel, Chart 17). In fact, were the broad equity market to correct as we expect in the near-term, there are high odds that the 10-year UST yield would fall, further boosting the allure of high yielding utilities. Chart 16Bearish Story Is Well Known Bearish Story Is Well Known Bearish Story Is Well Known Chart 17It No Longer Pays To Avoid Utilities It No Longer Pays To Avoid Utilities It No Longer Pays To Avoid Utilities On the operating front, nat gas prices have stopped hemorrhaging and as this least dirty fossil fuel gains broader investor acceptance in the new EV/ESG and responsible investing world, there is scope for utilities to reassert some of their lost pricing power. As a reminder, natural gas prices are the marginal price setter for utilities and the recent jump in momentum in the former is encouraging for utilities selling prices (second panel, Chart 18). Chart 18Positive Operating… Positive Operating… Positive Operating… Chart 19...Backdrop ...Backdrop ...Backdrop Moreover, industry inventories are whittled down and utilities construction has been receding, throughout last year (inventories shown inverted, top panel, Chart 19). In fact, it is contracting at roughly a 10%/annum pace (construction shown inverted, bottom panel, Chart 19). Taken together, it no longer pays to be overly bearish this niche defensive sector. Unsurprisingly, sell-side analysts have thrown in the towel and relative 12-month profit forecasts have plummeted, probing all-time lows near the negative 20% mark (third panel, Chart 18). Analyst pessimism is even more pronounced on the five-year outlook, with relative profit growth collapsing again near the negative 17% mark (bottom panel, Chart 18)! Granted this is a single stock’s effect as we showed in the previous section, with late-December TSLA inclusion to the index pushing the SPX long-term profit growth estimate to nearly 21%. We would lean against such pessimism. Finally, relative technicals and valuations also warn against staying negative on the prospects of the S&P utilities sector (Chart 20). Importantly, our Technical Indicator has fallen to one standard deviation below the historical mean, a level that has marked six countertrend up-moves in the past 25 years (bottom panel, Chart 20). Adding it all up, a firming operating backdrop, a stealthy turn in select macro data, extreme sell-side pessimism, bombed out technicals and compelling valuations all signal that it no longer pays to be bearish the S&P utilities sector. Bottom Line: Execute the upgrade alert and augment the S&P utilities sector to neutral today locking in gains of 14.8% since inception. The ticker symbols for the stocks in this index are: BLBG: S5UTIL – NEE, D, DUK, SO, AEP, EXC, XEL, ES, SRE, WEC, AWK, PEG, ED, DTE, AEE, EIX, ETR, PPL, CMS, FE, AES, LNT, ATO, EVRG, CNP, NI, NRG, PNW. Chart 20Unloved And Undervalued Unloved And Undervalued Unloved And Undervalued   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com     Footnotes 1     https://www.federalreserve.gov/pubs/feds/2007/200720/200720pap.pdf Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Overdose? Overdose? Size And Style Views January 12, 2021  Stay neutral small over large caps October 26, 2020 Favor small over large caps July 27, 2020 Overweight cyclicals over defensives (Downgrade Alert) June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth

Melt Up Arithmetic Melt Up Arithmetic While everyone was preoccupied with the effect TSLA’s SPX inclusion would have on the index’s 12-month forward P/E, the real change crept up in the long-term EPS growth expectations. This story stock caused the S&P 500’s five-year profit growth expectation to skyrocket from 12% to 21% overnight (top panel) and push down the S&P 500 forward P/E/G to near par (not shown). Back in late-1999, YHOO’s SPX inclusion also caused a bump in this metric, but it paled in comparison to TSLA’s current dominance. In other words, nine percentage points of growth are attributed to a single stock or 43% of the SPX EPS growth is tied to the fortunes of TSLA. We highly doubt this will occur as analysts have been upgrading profit estimates and price targets for TSLA hand over fist, with some using DCFs out to 2040 in order to back up their forecasts. Drilling deeper beneath the surface into the consumer discretionary sector is revealing. TSLA’s inclusion pushed the sector’s 5-year forward profit growth estimates to 83% (bottom panel). To put this in perspective it translates into consumer discretionary profits increasing 20 fold in the next 5 years; no, this is not a typo. Assuming that stock prices follow profits as it typically transpires, then prices will have to rise by a similar amount. Again, our sense is that this is highly unlikely. In comparison, AMZN’s graduation to the SPX in late-2005 barely budged this profit growth metric for the GICS1 sector as tech stocks were still licking their wounds from the dotcom bubble burst. Bottom Line: Frothiness is prevalent in certain parts of the equity market and some near-term caution is warranted. We reiterate our recent recommendation that investors deploy fresh capital via going long the $390/$410 SPY call spread and financing it via a $340 put either for March or June expiries. For additional analysis please look forward to this coming Monday’s Strategy Report.

2021 High-Conviction Underweight Calls: S&P Homebuilders 2021 High-Conviction Underweight Calls: S&P Homebuilders Underweight We deem that most, if not all, of the good news (low mortgage rates, low inventories, high demand, work-from-home reality, all-time highs on the overall NAHB housing sentiment survey) is already priced in galloping homebuilders stock prices and exuberant expectations. If our economic reopening thesis proves accurate next year, then the COVID-19 winners – homebuilders included – will take the back seat. Historically, interest rates and relative share prices have been inversely correlated and a steep selloff in the bond market is bad news for homebuilding stocks (top panel). On the operating housing front, some cracks are forming. New home sales, while brisk in absolute terms, are losing out to existing housing sales and homebuilders have resorted to price concessions in order to drive volumes (second & third panels). Profit margins are at the highest level since the subprime crisis and are vulnerable to a squeeze courtesy of rising input costs. Framing lumber comprises roughly 15% of a new home’s commodity related costs and lumber prices have been expanding all year long (bottom panel). Bottom Line: Put the S&P homebuilding index to the high-conviction underweight call list. The ticker symbols for the stocks in this index are: BLBG: S5HOME – LEN, PHM, DHI, NVR. ​​​​​​​

Dear client, Next Monday December 14, 2020 we will be hosting our last webcasts for the year “From Alpha To Omega With Anastasios”, one at 10am EST for our US, European and Middle Eastern clients and one at 8pm EST for our Asia Pacific, Australia and New Zealand clients; our final weekly publication for 2020 will be on Monday December 21, 2020 where we will highlight our top charts of the past year. Kind Regards, Anastasios Highlights Portfolio Strategy Our high-conviction overweight calls comprise four “Back-To Work” beneficiaries, and a hedge. In marked contrast, all of our high-conviction underweights are focused on “COVID-19 Winners” that should lose some of their luster next year. Recent Changes Upgrade the S&P real estate sector to overweight, today. Feature Favorable Macro Backdrop Easy monetary and loose fiscal policies will remain intact and sustain flush liquidity conditions next year. As a result, the global economy will continue to gain traction. Importantly, early-August marked a critical economic inflection point. Gold prices peaked and 10-year real and nominal yields troughed (yields shown inverted, top & middle panels, Chart 1). The bullion and bond markets corroborated the economic recovery that equities and the ISM manufacturing surveys sniffed out in late-spring. This is important for cementing the bull market in equities which is predicated on a durable economic recovery. In other words, the rise in real yields serves as a green light for further stock gains as it signals that the economy is on the recovery path. The bottom panel of Chart 1 also highlights that non-US equity markets started sporting accelerating profit growth expectations in August. Eurozone and other ex-US bourses zoomed past the US EPS growth trajectory as the latter reached a plateau. Chart 1Inflection Point Inflection Point Inflection Point This gives us confidence that 2021 will be a bumper year for SPX profits and help carry the market higher near our 4,000 target. As a reminder, on November 9 in a Special Report, we lifted our EPS estimate to $168 for calendar 2021 and introduced an end-2021 SPX target of 4,000 (Chart 2). Chart 2Earnings Will Do The Heavy Lifting In 2021 Earnings Will Do The Heavy Lifting In 2021 Earnings Will Do The Heavy Lifting In 2021 Two Risks To Monitor Nevertheless, the bond market represents a risk to our sanguine equity market view. Simply put, if the 10-year US Treasury yield stalls, then it will also stop the rotation trade in its tracks. The budding improvement in the Chinese and EM economic cycles will likely be sustainable next year, consistent with the Chinese four-year cycles of the past twenty years (Chart 3). Each up-cycle has typically been driven by credit expansion and capital spending, on the back of fiscal and monetary easing. These conditions are in place once again. Chart 3Follow The Chinese Four-year Cycle Follow The Chinese Four-year Cycle Follow The Chinese Four-year Cycle We recently showed that China’s fiscal easing will likely continue to grease the wheels of global trade into mid-2021 and thus debase the greenback (Chart 4), but will likely run out of steam in the back half of next year. Thus, China’s reflation going on hiatus is another key risk we will monitor in 2021 that could serve as a growth scare catalyst and reset stocks. Chart 4Laggard Deep Cyclicals Have The Upper Hand Laggard Deep Cyclicals Have The Upper Hand Laggard Deep Cyclicals Have The Upper Hand Year In Review 2020 is a year to forget as far as the coronavirus human toll is concerned; the economic and EPS recessions, while short lived, were deep. The COVID-19-inflicted wounds, especially to services industries the world over, were deep and there will be severe scarring. Early in the year, equities felt the COVID-19 tremor and collapsed 35% from the February 19 highs, but extremely aggressive monetary and fiscal policy responses filled the void and were the dominant themes in the ensuing recovery that saw the SPX vault to all-time highs. Our portfolio was resilient and was able to absorb the COVID-19 shock as we were bulletproofing it in the back half of 2019 and early-2020 for a recession owing largely to the yield curve inversion. Importantly, we were not dogmatic and on March 16 we turned cyclically bullish. This eventually culminated into the March 23 Strategy Report where we penned 20 reasons to start buying stocks and coincided with the trough in the SPX. This cyclical shift in our view from bearish-to-bullish aided our portfolio performance as we started adding cyclical exposure and trimming defensive exposure in order to benefit from the immense monetary and fiscal policy responses. Early on, we deemed these macro forces were forceful enough to really turn things around and we remained bullish on a cyclical time horizon. All in all, our trades produced alpha to the tune of 425bps. While our pair trades were sub-par (as is custom we are closing the remaining today), our high-conviction trades and cyclical portfolio moves recorded solid gains (please see the final tally below). Ray Of Light Encouragingly, there is light at the end of the tunnel, as a number of vaccines will become available late this year and/or early in 2021. This is great news for the economy and for stocks. We have positioned the portfolio to benefit from the reopening of the economy and the vaccine will act as an accelerant as our flagship publication posited last week while documenting BCA’s upbeat Outlook for 2021. Our portfolio enjoys a cyclical-over-defensive bent, has a small cap bias and we remain committed to the “Back-To-Work” basket versus the “COVID-19 Winners” basket (Chart 5). In the short-term, equities have discounted a lot of good news, which is likely to steal from next year’s returns. However, as populations get inoculated and large parts of the global economy reopen, a virtuous cycle of increasing consumer and business confidence would boost investment and GDP and prove a boon for corporate profits. Already the rally is broadening out with the value line arithmetic and geometric indexes outshining the SPX (Chart 6). An active ETF (RVRS:US) that has a reverse weighting to US large caps is also besting the S&P 500 and signals that more gains are in store in the New Year, especially for the still beaten down deep cyclical laggards. Chart 5Stick With The Reopening Trade Stick With The Reopening Trade Stick With The Reopening Trade Chart 6Rally Is Broadening Out, And That’s Healthy Rally Is Broadening Out, And That’s Healthy Rally Is Broadening Out, And That’s Healthy More Overweights Than Underweights As is custom every year, this Strategy Report introduces our high-conviction calls for 2021. This year we have four overweights, a bonus volatility trade on the long side, three underweights, and a bonus structural trade that we add to our trades of the decade first introduced in mid-December 2019. Our overweights comprise three “Back-To-Work” beneficiaries, a great rotation trade and a hedge. All of our underweights are focused on “COVID-19 Winners” that should lose some of their luster next year. Finally, this year we take a page out of Byron Wien’s annual “10 surprises” list and offer our clients three “also rans”, which got close but ultimately failed to make our high-conviction list.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com   Overweight Hotels (Back-To-Work Theme) The recent positive vaccine news is a key reason we are warming up to this consumer discretionary sub group. While neither lodging nor cruise line vacationing will return to their previous peaks any time soon, both industries will survive and thus should no longer be priced for bankruptcy. One key industry demand determinant is confidence. Consumer sentiment has staged a W-shaped recovery. It is still flimsy, but the vaccine efficacy news should catapult confidence higher in the coming quarters. The implication is that the wide gulf between consumer confidence and relative share prices will narrow via a catch up phase in the latter (top panel, Chart 7). Moreover, the ISM non-manufacturing survey is on a sling shot recovery following the bombed out spring readings. This rebound also suggests that the path of least resistance is higher for lodging stocks (second panel, Chart 7). Our hotel demand indicator does an excellent job in encapsulating all these different forces and forecasts an enticing lodging services demand backdrop into 2021 (third panel, Chart 7). Already, consumer outlays on hotels are staging a comeback, albeit from an extremely depressed level. The upshot is that an earnings-led bounce is in the cards (fourth panel, Chart 7). Finally, washed out technicals and extremely alluring valuations provide an attractive reward/risk tradeoff at the current juncture (bottom panel, Chart 7). Bottom Line: The S&P hotels, resorts & cruise lines index is a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOTL – MAR, HLT, CCL, RCL, NCLH. Chart 7Buy Hotels Buy Hotels Buy Hotels Overweight Real Estate (Back-To-Work Theme) Boost the S&P real estate sector all the way to overweight today, in order to benefit from the looming full reopening of the economy on the back of the vaccine’s arrival. We have been bearish this niche S&P sector and delivered alpha to our portfolio both via the cyclical and high-conviction underweights this year. Nevertheless, we do not want to overstay our welcome and the time is ripe for a bullish commercial real estate (CRE) stance. The bearish story is well known, but some bullish undertones are widely neglected. The rebound in relative share prices is substantially trailing the 2009 episode, when REITs outshined the SPX by 65% one year following the March 2009 trough. Currently, on a similar SPX advance from the March 2020 lows, REITs are lagging the S&P 500 by 22% (top panel, Chart 8). As large parts of CRE have been at the epicenter of the pandemic, any return to even semi-normalcy in 2021 should see these beaten down stocks sling shot passed the SPX. When the fiscal package finally passes, it will likely serve as a fresh reflationary bridge to support the economy. The proverbial “kicking the can down the road” will thus lift some uncertainty hanging over CRE landlords receiving rents and also via banks not foreclosing distressed properties which would have further depressed CRE prices. CRE prices will likely recover in the New Year as vulture funds and opportunistic investors are already bargain hunting. Tack on the likely refinancing lifeline bankers will extend to CRE debt originators (middle & bottom panels, Chart 8) and such a backdrop will loosen the noose around distressed property landlords. Bottom Line: Boost the S&P real estate sector to an above benchmark allocation and add it to the high-conviction overweight call list.   Chart 8Upgrade Real Estate To Overweight Upgrade Real Estate To Overweight Upgrade Real Estate To Overweight Overweight Industrials (Back-To-Work Theme) Add the S&P industrials sector to the high-conviction overweight list. Emerging markets (EM) and China represent the key source for the sector’s buoyancy. The EM manufacturing PMI clocking in at 53.9 hit an all-time high (top panel, Chart 9). China’s PMIs are also on a similar trajectory, and the Chinese Citi economic surprise index has swung a whopping 277 points from -239 to +38 over the past nine months (second panel, Chart 9). The upshot is that US industrials stocks should outperform when China and the EM are vibrant. Peering over to the currency market, the debasing of the US dollar should also underpin industrials stocks via the export relief valve. A depreciating greenback also lifts the commodity complex and hence industrials equities that are levered to the extraction of commodities and other derivative activities (middle panel, Chart 9). Capex intentions are firming and CEO confidence is upbeat for the coming six months. The ISM manufacturing new orders-to-inventories ratio is corroborating the budding recovery in the soft data. Green shoots are also evident in hard data releases. Durable goods orders are on the verge of expanding anew (fourth panel, Chart 9). Sell-side analysts have never been more pessimistic with regard to the sector’s long-term EPS growth rate that is penciled in to trail the broad market by almost 800bps (bottom panel, Chart 9)! This bearishness is contrarily positive as a little bit of good news can go a long way. Bottom Line: The S&P industrials sector is a high-conviction overweight.  Chart 9Overweight Industrials Overweight Industrials Overweight Industrials Overweight Small Caps At The Expense Of Large Caps (Rotation Trade) Recent vaccine efficacy announcements have paved the way for a sustainable great rotation trade into small caps and out of large caps. One of the key small size bias drivers is the delta in sector composition between the small and large cap indexes. The relative gap in deep cyclicals alone is 13% as we highlighted in recent research. Relative share prices remain far apart from the budding recovery in the commodity complex including Dr. Copper’s flirtations with seven-year highs. Thus, the small caps catch up phase has a long ways to go (top & fourth panels, Chart 10). The financials sector gulf is also significant, with small caps’ exposure relative to their large cap brethren clocking in at over 700bps. Already, the yield curve is steepening and there are high odds of a selloff in the bond market as the economy continues to reopen (third panel, Chart 10). In addition, easy fiscal policy is a tonic to the small/large share price ratio. As a flood of money enters the economy with a slight lag, small caps will continue to make up ground lost during the early stages of the pandemic (fiscal balance shown inverted, second panel, Chart 10). Not only is fiscal stimulus providing a lifeline to debt-burdened small caps, but also the Fed’s opening up of the monetary spigots has pushed fixed income investors out the risk spectrum. Thus, the proverbial “kicking the can down the road” is boosting the allure of small cap stocks (junk spread shown inverted, bottom panel, Chart 10). Bottom Line: A small size bias is a high-conviction call for 2021. Chart 10Prefer Small Caps To Large Caps Prefer Small Caps To Large Caps Prefer Small Caps To Large Caps Long VIX June 2021 Expiry Futures (Hedge Trade) We want to hedge our overweight exposures with a long VIX futures position for the June 16, 2021 expiry. We are spending $25.3 to go long and are comfortable paying up for insurance when the SPX is at all-time highs and there is a risk of some growth disappointment in the next six months. Chart 11 draws a parallel with the March 2009 SPX lows and plots the VIX in 2009 and 2010. While the path of least resistance is lower for volatility, sporadic surges are typical in the year following recessions. The S&P 500 also troughed in March 2020 and if history is an accurate guide, the path to SPX 4,000 will be rocky next year. As a reminder, the S&P 500 suffered a 16% correction in May 2010 and the VIX spiked higher. Positioning remains lopsided with both VIX put/call ratios (volume and open interest) at historically high levels, underscoring investor complacency. Net speculative futures positions as a percent of open interest are also probing multi-year lows, corroborating the complacent options data. Finally, the equity volatility curve has flipped from a 10% backwardation to a steep contango in the past month with the 3rd month now trading at a 25% premium to spot VIX; such a complacent level typically warns of a looming spike in the VIX. Bottom Line: Go long the VIX June 2021 futures as a small hedge to overweight equity positions. Chart 11Go Long VIX Futures As A Hedge Go Long VIX Futures As A Hedge Go Long VIX Futures As A Hedge Underweight Homebuilders (COVID-19 Winner Theme) We deem that most, if not all, of the good news (low mortgage rates, low inventories, high demand, work-from-home reality, all-time highs on the overall NAHB housing sentiment survey) is already priced in galloping homebuilders stock prices and exuberant expectations. While being contrarian is fraught with danger, because more often than not the herd is right, there is a key macro driver that gives us confidence to be bearish homebuilders: interest rates. If our economic reopening thesis proves accurate next year, then the COVID-19 winners – homebuilders included – will take the back seat. Historically, interest rates and relative share prices have been inversely correlated and a steep selloff in the bond market is bad news for homebuilding stocks (top panel, Chart 12). On the operating housing front, some cracks are forming. New home sales, while brisk in absolute terms, are losing out to existing housing sales and homebuilders have resorted to price concessions in order to drive volumes (second & third panels, Chart 12). Profit margins are at the highest level since the subprime crisis and are vulnerable to a squeeze, not only from lower selling prices, but also from rising input costs. Framing lumber comprises roughly 15% of a new home’s commodity related costs and lumber prices have been expanding all year long (bottom panel, Chart 12). Bottom Line: Put the S&P homebuilding index to the high-conviction underweight call list. The ticker symbols for the stocks in this index are: BLBG: S5HOME – LEN, PHM, DHI, NVR. Chart 12Avoid Homebuilders Avoid Homebuilders Avoid Homebuilders Underweight Pharma (COVID-19 Winner Theme) The S&P pharmaceutical index is a high-conviction underweight for 2021. On the macro front, the Fed’s ZIRP bodes ill for defensive pharma equities. The Fed was uncharacteristically quick this recession to drop rates to the lower zero bound to reflate the economy. As a result, safe haven equities, Big Pharma included, typically trail the broad market as the economy gets out of the ER and into the recovery room (second panel, Chart 13). Importantly, relative pharmaceutical profits are highly counter cyclical: they rise at the onset of recession and collapse as the economy heals. Currently, as the world economy has transitioned to a V-shaped recovery, the reopening of the economy into the New Year will continue to knock the wind out of relative pharma profitability. Similarly, an appreciating greenback has historically been synonymous with pharma outperformance and vice versa (third panel, Chart 13). Keep in mind, Big Pharma make the lion’s share of their profits domestically, further cementing the positive correlation with the US dollar. This local profit sourcing represents one of the main reasons why politicians on both sides of the aisle are after domestic pharma profits. Pharma prices are on the cusp of contracting. Importantly, President Trump’s late-July executive order “to allow importation of certain prescription drugs from Canada” among other provisions is a direct blow to the profit prospects of Big Pharma (bottom panel, Chart 13). Bottom Line: We are cognizant that the COVID-19 vaccine will lift Big Pharma, but only temporarily, as cyclical forces will more than offset the positive vaccine news. The S&P pharmaceuticals index is a high-conviction underweight. The ticker symbols for the stocks in this index are: BLBG – S5PHARX: JNJ, PFE, MRK, LLY, BMY, ZTS, CTLT, MYL, PRGO. Chart 13Sell Pharma Sell Pharma Sell Pharma Underweight Consumer Staples (COVID-19 Winner Theme) Countercyclical consumer staples stocks served their purpose and supported our portfolio in the front half of 2020. Now that vaccines are coming, we are adding the S&P consumer staples sector to the high-conviction underweight call list. The current macro backdrop underscores that the path of least resistance is lower for relative share prices. Not only is the ISM manufacturing survey on fire, but also, consumer confidence is forming a trough (ISM manufacturing shown inverted, second panel, Chart 14). One of the factors that will drive relative earnings lower is the weaker US dollar. As a reminder, the S&P consumer staples sector derives approximately 32% of its sales from abroad, which is 10 percentage points lower than the S&P 500. As a consequence, on a relative basis, staples stocks benefit much less than the rest of the market from a falling currency (third panel, Chart 14). Our relative macro earnings model does an excellent job in encapsulating all these moving parts and paints a dark profit picture for this GICS1 sector in the New Year (fourth panel, Chart 14). Bottom Line: The S&P consumer staples sector is a high-conviction underweight.   Chart 14Underweight Consumer Staples Underweight Consumer Staples Underweight Consumer Staples Short NASDAQ 100 / Long S&P 500 (Secular 10-year Call) We first wrote about the extreme market cap concentration in January when we were cautioning investors of an SPX drawdown and drew parallels with the dotcom era. Back in late-1999/early-2000 the top 5 stocks comprised 18% of the S&P 500. In July we delved deeper and split the S&P 500 in the S&P 5 versus the S&P 495 to highlight the extraordinary narrow returns since 2015. Such extreme concentration in a handful of tech titan stocks is clearly unsustainable. The bullish case for tech is well documented and understood; the COVID-19 pandemic acted as an accelerant to the technological adoption of the new remote working realities. However, $2tn valuations (AAPL, MSFT & AMZN) make little sense to us, especially if there is little earnings follow through and most of the returns are explained by multiple expansion. In all likelihood, the easy money has been made. Going back to the early 1970s is instructive in order to put the tech juggernaut into proper perspective. Every decade or so there have been clearly defined booms and busts in US tech stocks (Chart 15). Schumpeter’s “creative destruction” forces are undoubtedly at play. What is interesting is that not only have tech stocks likely stalled near the dotcom era peak, but also they have been outperforming since the end of the GFC (i.e. roughly a decade); they are due for at least a breather. If history rhymes, we have entered a new bust cycle and the tech sector’s underperformance will play out over the coming decade. Bottom Line: We are compelled to add to our structural trades and recommend investors underweight the tech sector on a ten-year time horizon via the short QQQ / long SPY exchange traded funds which offer the most liquidity. Chart 15Short QQQ / Long SPX For The Next Decade Short QQQ / Long SPX For The Next Decade Short QQQ / Long SPX For The Next Decade Also Rans Within consumer discretionary, automobiles & auto parts & components piqued our interest from the long side. These stocks would greatly benefit from a reopening economy as a semblance of normality returns sometime next year. Nevertheless, two key factors kept us at bay. First, similar to homebuilders, this index has gone vertical since the March lows, besting the SPX by a factor of 2:1 (top panel, Chart 16). We maintain exposure via our “Back-To-Work” basket with GM, but even this auto manufacturer is up 50% since the September 8, 2020 inception. Finally, TSLA is about to enter the SPX at a stratospheric valuation that would dominate the automobile sub group. This is eerily reminiscent of YHOO’s SPX inclusion in late-1999 that led the dotcom bubble peak by four months. The parallel is making us nervous, therefore we are staying patiently on the sidelines. On the underweight side we wanted to include the niche S&P semi equipment index, but opted not to as the Bitcoin mania has really pushed these stocks to the stratosphere (middle panel, Chart 16). In addition, this chip sub-group has one of the highest export exposures in the SPX with a large slice of foreign revenue originating in China. Hence, news of a Biden presidency also served as a catalyst to propel them higher (i.e. at the margin, a less hawkish president on the Sino/American trade war). We really struggled with global gold miners (GDX:US). Our initial thinking was to downgrade them to underweight (from currently neutral), which is consistent with global growth reaccelerating and interest rates rising. However, we missed the boat when it set sail in early August (bottom panel, Chart 16). Now, the gold bearish trade is gaining momentum and has become a consensus trade as big macro investors (Tudor and Druckenmiller among others) are shifting toward Bitcoin and have been vociferous about their positioning. Thus, we preferred to remain on the sidelines with a benchmark allocation. Chart 16Three “Also Rans” Three “Also Rans” Three “Also Rans” Footnotes   Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations 2021 High-Conviction Calls 2021 High-Conviction Calls Size And Style Views October 26, 2020 Favor small over large caps July 27, 2020 Overweight cyclicals over defensives June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth  

On Shaky Grounds On Shaky Grounds Underweight Last Monday we executed our S&P homebuilders downgrade alert and reduced allocation in this consumer discretionary sub-group to below benchmark. While the media has been cheering homebuilder-related data recently, the reality is that the data has been fully priced in (top & bottom panels). We expect rates to continue climbing higher, which means that the catalyst that let homebuilders run wild in the first place will be heavily weighing on the index. In more detail, the middle panel of the chart shows that the ten-year US Treasury yield (shown inverted) has likely sealed the verdict for US homebuilders when looking at the sub-group in absolute terms, which makes relative outperformance a tall order. Bottom Line: We reiterate our recent underweight in the S&P homebuilding index; the position is already up 9% since the November 23 inception. The ticker symbols for the stocks in the index are: BLBG: S5HOME – LEN, PHM, DHI, NVR.  

Open For Business Open For Business In this Monday’s Strategy Report we upgraded the S&P hotels, resorts & cruise lines index to an above benchmark allocation in light of the improving macro backdrop. Consumer sentiment has staged a W-shaped recovery and while still flimsy, the brightening vaccine efficacy news should catapult it higher in the coming quarters. The implication is that the wide gulf between consumer confidence and relative hotels share prices will narrow via a catch-up phase in the latter (top panel). Closely linked to the budding recovery in confidence are discretionary versus non-discretionary retail sales. The latter have been correlated with the oscillations in relative share prices, and the current message is positive (bottom panel). Finally, the ISM non-manufacturing survey is on a sling shot recovery following the depths of the spring readings. This rebound also suggests that the path of least resistance is higher for lodging stocks (middle panel). Bottom Line: Upgrade the S&P hotels, resorts & cruise lines index to overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOTL – MAR, HLT, CCL, RCL, NCLH.