Consumer Discretionary

Underweight When we downgraded the S&P hotels, resorts and cruise lines index to underweight last year, it was because the index's outperformance to that date had been due to the cruise line component companies (second panel) and we believed a mean reversion in profits was in the offing. Margins had been steadily climbing (third panel), a result of rising occupancy rates (a number which cannot rise ad infinitum) and, eventually, a capacity growth cycle would have to begin anew with all the associated negative margin implications. Margins have, in fact, tightened considerably, but not for the reasons we had expected. Rather, fuel prices have been soaring and, given that these can represent 30-40% of total operating expenses, have been significantly cutting into profitability. Carnival Corp., with an off-cycle year-end, has given us a preview on at least the first two months of the year and the outlook is grim; unit profits dropped by nearly 90% year-on-year in Q1. Meanwhile, in the hotel component of the index, cutthroat competition is continuing to drive pricing power deflation and the industry is trying to compensate with huge capacity additions (bottom panel); this should eventually show up in earnings and take some of the exuberance out of thus far resilient hotel stock prices (second panel). Overall, we reiterate our underweight recommendation. The ticker symbols for the stocks in this index are: BLBG: S5HOTL - MAR, CCL, RCL, HLT, WYN, NCLH. Fuel Costs Are Taking The Fun Out Of Cruises Fuel Costs Are Taking The Fun Out Of Cruises

Highlights Key Portfolio Highlights Our portfolio positioning remains firmly behind cyclicals over defensives, driven principally by our key 2018 investment themes: synchronized global capex growth (Chart 1A) and higher interest rates on the back of a pickup in inflation (Chart 1B). The positioning has been lifted by synchronized global growth and a soft U.S. dollar (Chart 1C), while the key risk to our portfolio of a hard landing in China looks to be mitigated (Chart 1D). A return of volatility, spurred on by Fed tightening (Chart 1E), caused an SPX pullback in February, and while the market pushed through that rough patch, it has since been replaced with fears of a trade war, exacerbated by musical chairs in the Trump administration (Chart 1F). Our buy-the-dip strategy remains appropriate on a cyclical time horizon (Chart 1G), given a dearth of evidence of a recession in the next year. SPX forward EPS estimates still show near-20% increases this calendar year (corroborated by our EPS growth model, Chart 1H) which should underpin outsized equity returns in the absence of a major valuation rerating. Still, the return of volatility warrants a review of our macro, valuation and technical indicators. The best combination in our review is S&P financials (Overweight) with an elevated and accelerating cyclical macro indicator (CMI), fed by both of our key capex growth and rising interest rate themes, combined with a modest undervaluation. The worst combination is S&P telecom services (Underweight, high-conviction), whose CMI recently touched a 30-year low as sector deflation hit acute levels. Valuations make the sector look cheap, but every indication is that telecoms are a value trap. Chart 1AGlobal Trade Is Rising... Global Trade Is Rising... Global Trade Is Rising... Chart 1B...But So Too Is Inflation ...But So Too Is Inflation ...But So Too Is Inflation Chart 1CA Weaker Dollar Is A Boon To Growth A Weaker Dollar Is A Boon To Growth A Weaker Dollar Is A Boon To Growth Chart 1DSoft Landing In China Seems Likely Soft Landing In China Seems Likely Soft Landing In China Seems Likely Chart 1EThe Return Of Vol May Spoil The Party... The Return Of Vol May Spoil The Party... The Return Of Vol May Spoil The Party... Chart 1F...And Policy Uncertainty Doesnt Help ...And Policy Uncertainty Doesnt Help ...And Policy Uncertainty Doesnt Help Chart 1GBuy The Dip Has Worked Out Nicely Buy The Dip Has Worked Out Nicely Buy The Dip Has Worked Out Nicely Chart 1HHeed The Message From A Booming EPS Model Heed The Message From A Booming EPS Model Heed The Message From A Booming EPS Model Feature S&P Financials (Overweight) Our financials cyclical macro indicator (CMI, Chart 2) has climbed to new cyclical highs with significant upward momentum, driven by broad improvement in virtually all of its underlying components. More than any other variable, rising yields and the accompanying higher price of credit are a boon to financials. Higher interest rates is one of BCA's key themes for 2018 and an ongoing selloff in the bond market bodes well for profits in the heavyweight banks sub-index and should deliver the next up leg in bank stocks performance (top panel, Chart 3). Another of BCA's key themes for 2018 is a global capex upcycle; higher demand for capital goods should drive outsized capital formation in the year to come. Our U.S. commercial banks loans and leases model echoes this positive outlook, pointing to the best loan growth of the past 30 years (middle panel, Chart 3). Lastly, a low unemployment rate drives both expanding consumer credit and much better credit quality. At present, the unemployment rate is testing all-time lows, sending an unambiguously positive message for financials profitability (bottom panel, Chart 3). Despite the much-improved cyclical outlook and a revival of overall animal spirits, our valuation indicator (VI) suggests that financials are modestly undervalued. At this point in the cycle, we would expect a modest overvaluation; the implication is that financials should be a core portfolio overweight. Our technical indicator (TI) has approached overbought levels several times over the course of this bull market, though history suggests it can stay at elevated levels for a considerable time. Chart 2S&P Financials (Overweight) S&P Financials (Overweight) S&P Financials (Overweight) Chart 3RS1 Rising Yields Are A Boon To Financials Earnings RS1 Rising Yields Are A Boon To Financials Earnings RS1 Rising Yields Are A Boon To Financials Earnings S&P Industrials (Overweight) Our industrials CMI (Chart 4) has gone vertical and is very near its all-time high. A combination of a supportive currency, a recovery in commodity prices and synchronized global growth are responsible for the rise. A falling U.S. dollar and capital goods producers' top line growth acceleration have historically moved hand-in-hand as this group is one of the most international of the S&P 500. The trade-weighted U.S. dollar has fallen by more than 10% from its most recent peak at the end of 2016 which suggests U.S. industrials should have a leg up in sales for the year to come (top panel, Chart 5). The slide in the U.S. dollar is coming at an opportune time; global growth is remarkably synchronized (and remains a key BCA theme for 2018) and has proven an excellent harbinger of industrials margins (bottom panel, Chart 5). Overall, an expanding top line and widening margins imply solid relative EPS gains. Our valuation gauge is near the neutral zone, where it has been for much of the past 3 years as the market has failed to capture the sector's outlook strength. Our TI echoes the neutral message, having unwound a significant overbought position at the beginning of last year. Chart 4S&P Industrials (Overweight) S&P Industrials (Overweight) S&P Industrials (Overweight) Chart 5Global Euphoria Should Lift Industrials Global Euphoria Should Lift Industrials Global Euphoria Should Lift Industrials S&P Energy (Overweight) Our energy CMI (Chart 6) has maintained its upward trajectory after bouncing off all-time lows last year. Importantly, the relative share performance does not yet reflect the drastically improved cyclical conditions, underpinning our overweight recommendation. Falling oil inventories and rising prices (top and second panel, Chart 7) combined with solid gains in domestic production underlie the CMI recovery. Our key themes for 2018 of a global capex expansion and synchronized global growth should be the most important drivers for energy stocks this year. With respect to the former, the capex intentions from the Dallas Fed survey hit their highest level in a decade, which usually presages domestic oil patch expansion and energy stock outperformance (third panel, Chart 7) With respect to global growth, emerging markets/Chinese demand is the swing determinant of overall oil demand, and non-OECD demand has been moving higher for most of the past year (bottom panel, Chart 7). Our VI has retreated far into undervalued territory, a result of the aforementioned failure of stocks to react to the enticing macro outlook. The TI too is in deeply oversold levels, suggesting that an oversold bounce could soon occur at a time when valuations are so appealing. Chart 6S&P Energy (Overweight) S&P Energy (Overweight) S&P Energy (Overweight) Chart 7Energy Share Prices Have Trailed Oils Recovery Energy Share Prices Have Trailed Oil's Recovery Energy Share Prices Have Trailed Oils Recovery Energy Share Prices Have Trailed Oil's Recovery Energy Share Prices Have Trailed Oils Recovery S&P Consumer Staples (Overweight) Our consumer staples CMI (Chart 8) has turned up recently, following a two year decline. Strong employment gains and positive retail sales are the key pillars underlying the modest recovery. The euphoric consumer continues to push our consumer staples EPS model higher, now pointing to the best earnings growth of the past 5 years (middle panel, Chart 9). Overall industry exports are expanding at a healthy clip as a consequence of a softening U.S. dollar and robust European and rebounding emerging markets demand. Deflating raw food commodity prices are offsetting rising energy and labor input costs, heralding a sideways move to margins. Sell side analysts are also currently penciling in a lateral profit margin move (bottom panel, Chart 9). Investors have been vehemently avoiding staples stocks during the board market's uninterrupted run up, and have put our positioning offside. However, in the context of our cyclical over defensive portfolio bent we refrain from putting all our eggs in one basket, and prefer to keep consumer staples as our sole defensive sector overweight. Further, our VI is waving a green flag as consumer staples are now nearly two standard deviations below their 30-year mean valuation. Technical conditions too are completely washed out, signaling widespread bearishness, which is positive from a contrary perspective. Chart 8S&P Consumer Staples (Overweight) S&P Consumer Staples (Overweight) S&P Consumer Staples (Overweight) Chart 9Robust Consumer Confidence Bodes Well Robust Consumer Confidence Bodes Well Robust Consumer Confidence Bodes Well S&P Utilities (Neutral) Our utilities CMI (Chart 10) has spent the last decade in a long-term downtrend, albeit one with periodic countertrend moves. The key underlying factors are natural gas prices and relative spending on utilities, both of which have been retreating since 2008 (middle panel, Chart 11). Encouragingly, the sector's wage bill has slowed from punitively high levels, though pricing power has followed it down, implying muted margin changes (bottom panel, Chart 11). Like other defensive sectors, utilities have underperformed cyclical sectors in the last year; utilities equities trade as fixed income proxies, and a rising interest rate environment is punitive. As a result of the underperformance and relatively constant earnings, valuations have collapsed to the neutral zone. We reacted by booking solid gains and upgrading to a benchmark allocation earlier this year; synchronized global growth and higher interest rates are headwinds for this niche defensive sector and prevent us from lifting positions further. Our TI has fallen steeply over the past year and is now closing in on two standard deviations below the 30-year average. Chart 10S&P Utilities (Neutral) S&P Utilities (Neutral) S&P Utilities (Neutral) Chart 11Pricing Is Falling But Margins Look Neutral Pricing Is Falling But Margins Look Neutral Pricing Is Falling But Margins Look Neutral S&P Real Estate (Neutral) Our real estate CMI (Chart 12) has been in decline since its most recent peak at the end of 2016. This is confirmed by a darkened outlook for REITs; rents have crested while the vacancy rate found its nadir in 2016, suggesting further rent weakness on the horizon (top panel, Chart 13). Further, bankers appear less willing to extend commercial real estate credit, despite recent stability in underlying prices; declines in credit availability will directly impact REIT valuations (bottom panel, Chart 13). Our VI is consistent with BCA's Treasury bond indicator (not shown), indicating that both are at fair value. Our TI is starting to firm from extremely oversold levels, a positive indication for both 12- and 24-month relative performance. Chart 12S&P Real Estate (Neutral) S&P Real Estate (Neutral) S&P Real Estate (Neutral) Chart 13Peaking Rents and Tight Credit Are Headwinds Peaking Rents and Tight Credit Are Headwinds Peaking Rents and Tight Credit Are Headwinds S&P Materials (Neutral) Our materials CMI (Chart 14) has maintained its downward trajectory, largely due to the ongoing Fed tightening cycle. The heavyweight chemicals component of the materials index typically sees earnings (and hence stock prices) underperform as rates are moving higher (top panel, Chart 15). BCA's view remains that a sizable selloff in the bond markets is the most likely scenario in 2018, representing a substantial headwind to sector performance. Still, the news is not all negative. Exceptionally strong global demand growth has revitalized chemicals prices (bottom panel, Chart 15). Combined with the industry's relatively newfound restraint, capacity has not overextended and the resulting productivity gains bode well for earnings growth. Despite the improving outlook, valuations have been retreating for much of the past year and our VI has fallen back to the neutral zone. Our TI has been hovering near the neutral line for the past year, though a recent hook downward indicates a loss of momentum and downside relative performance risks. Chart 14S&P Materials (Neutral) S&P Materials (Neutral) S&P Materials (Neutral) Chart 15Rising Rates Are Offset By Improving Demand Rising Rates Are Offset By Improving Demand Rising Rates Are Offset By Improving Demand S&P Consumer Discretionary (Underweight) Our consumer discretionary CMI (Chart 16) has fallen back after reaching highs earlier in 2017, though remains elevated relative to the long term trend. Rising interest rates (top panel, Chart 17) are more than offsetting higher home prices and real wage growth, both have which have recently stalled. This rising short-term interest rate backdrop is not conducive to owning the extremely interest rate-sensitive equities that fall into the S&P consumer discretionary index. Both the household financial obligation ratio and household debt service payments have bottomed and are actually increasing. A higher interest rate backdrop will sustain the upward pressure on both and likely weigh on consumer discretionary relative share prices (third and bottom panels, Chart 17). This underpins our recent downgrade to a below benchmark allocation. Elevated valuations support our negative thesis as our valuation indicator has been rising recently out of the neutral zone. Our TI has fully recovered from oversold levels, and is now well into overbought territory, though historically this indicator has been excessively volatile. Chart 16S&P Consumer Discretionary (Underweight) S&P Consumer Discretionary (Underweight) S&P Consumer Discretionary (Underweight) Chart 17Higher Borrowing Costs Bode Ill For Consumer Discretionary Higher Borrowing Costs Bode Ill For Consumer Discretionary Higher Borrowing Costs Bode Ill For Consumer Discretionary S&P Health Care (Underweight) Our health care CMI (Chart 18) rolled over last year and has been treading water at these lower levels, driven by weak fundamentals in the key pharmaceuticals sector. Poor pricing power, a soft spending backdrop and a depreciating U.S. dollar have been pressuring the sector and keeping a tight lid on the CMI (top and second panels, Chart 19). Other non-pharma indicators are mixed as lower healthcare consumer spending is offset by a tick up in overall pricing power. Relative valuations have fallen deep into undervalued territory and are approaching one standard deviation below the 25 year average. Our TI too has reversed course and is well into oversold territory. However, the message from our health care earnings model is that sector earnings will continue to decelerate; this environment in not conducive for a sector re-rating (bottom panel, Chart 19). Chart 18S&P Health Care (Underweight) S&P Health Care (Underweight) S&P Health Care (Underweight) Chart 19Pharma Pricing Power Continues To Collapse Pharma Pricing Power Continues To Collapse Pharma Pricing Power Continues To Collapse S&P Telecommunication Services (Underweight) Our telecom services CMI (Chart 20), after moving sideways for much of the past decade, has recently fallen to a new 30-year low. Extreme deflation continues to reign in the beleaguered sector as relative consumer outlays on telecom services have nosedived (top panel, Chart 21) which is broadly matched by melting selling prices (middle panel, Chart 21) as demand contracts. This is reflected in our S&P telecom services revenue growth model, which remains deep in contractionary territory (bottom panel, Chart 21). The sector remains chronically cheap, exacerbated by the recent sell-off, and is currently as cheap as it has ever been. Still, given the brutal operating environment, we think such valuations have created a value trap. Our Technical Indicator has sunk but, like the VI, cycles deep in the sell zone have not proven reliable indicators that a relative bounce is in the offing. We recently downgraded the sector to underweight and added it to our high-conviction underweight list based on the factors noted above.1 Chart 20S&P Telecommunication Services (Underweight) S&P Telecommunication Services (Underweight) S&P Telecommunication Services (Underweight) Chart 21Telecom Services Remain A Value Trap Telecom Services Remain A Value Trap Telecom Services Remain A Value Trap S&P Technology (Underweight, Upgrade Alert) The technology CMI (Chart 22) has been falling for the past three years, driven by ongoing relative pricing power declines and new order weakness. However, the sector has proven resilient, at least until recently, as a handful of stocks (the FANGs, excluding the consumer discretionary components) and the red-hot semiconductor group have provided support. Still, market euphoria aside, tech stocks thrive in a disinflationary/deflationary environment and suffer during inflationary periods; inflation is gradually rising after a prolonged disinflationary period (bottom panel, Chart 23). Valuations, while still in the neutral zone, have reached their highest level in a decade. This may prove risky should inflation mount faster than expected; a de-rating phase in technology would likely follow. Our TI is extremely overbought, though it has been at this high level for several years. Chart 22S&P Technology (Underweight, Upgrade ALert) S&P Technology (Underweight, Upgrade ALert) S&P Technology (Underweight, Upgrade ALert) Chart 23Inflation Is No Friend To Tech Inflation Is No Friend To Tech Inflation Is No Friend To Tech Size Indicator (Neutral Small Vs. Large Caps) Our size CMI (Chart 24) has fallen back to the boom/bust line. Keep in mind that this CMI is not designed as a directional trend predictor, but rather as a buy/sell oscillator; the current message is neutral. Small company business optimism is near modern highs, as pricing and consumption vigor push domestic revenues higher (top panel, Chart 25). A smaller government footprint, i.e. fewer regulatory hurdles, and tax relief will disproportionately benefit SMEs. Earlier this year, we downgraded our recommendation on small caps vs. large caps to a neutral allocation, based on a deterioration in small cap margins and too-high leverage.2 Recent NFIB surveys would suggest this move was prescient; firms reporting planned labor compensation increases have steadied near a two decade high, while price increases are trailing far behind (middle panel, Chart 25). With "quality of labor" having overtaken "taxes" as the single most important problem facing businesses, labor compensation growth seems likely to continue moving up at an elevated pace and small cap margins should likely continue to trail large cap peers (bottom panel, Chart 25). Valuations have improved and small caps are relatively undervalued, though our TI echoes a neutral message. Chart 24Size Indicator (Neutral Small Vs. Large Caps) Size Indicator (Neutral Small Vs. Large Caps) Size Indicator (Neutral Small Vs. Large Caps) Chart 25Small Businesses Remain Exceptionally Confident Small Businesses Remain Exceptionally Confident Small Businesses Remain Exceptionally Confident Chris Bowes, Associate Editor chrisb@bcaresearch.com 1 Please see BCA U.S. Equity Strategy Weekly Report, "Manic-Depressive?" dated February 12, 2018, available at uses.bcaresearch.com. 2 Please see BCA U.S. Equity Strategy Weekly Report, "Too Good To Be True?" dated January 22, 2018, available at uses.bcaresearch.com.

Highlights Portfolio Strategy The reward/risk profile of air freight & logistics is extremely attractive. Synchronized global growth, the capex upcycle, a falling dollar and secular advance in e-commerce compel us to add this unloved transportation sub-index to our high-conviction overweight list. Prepare to lock in gains in managed health care. The positive demand and pricing backdrops are already reflected in perky valuations. While homebuilders still have to contend with rising lumber prices and interest rates and the partial elimination of mortgage interest deductibility, the near 20% peak-to-trough drawdown suggests that all of the bad news is baked in relative share prices, warranting an upgrade alert. Recent Changes Add the S&P air freight & logistics index to the high-conviction overweight list. Put the S&P managed care index on downgrade alert. Set an upgrade alert on the S&P homebuilding index. Table 1 Bumpier Ride Bumpier Ride Feature Equities lost ground last week and flirted with the bottom part of the trading range established during the past two months, but held the 200-day moving average. Our view remains that the SPX is digesting the early-February swoon, and the buy-the-dip strategy is still appropriate for capital with a cyclical (9-12 month) time horizon as the probability of a recession this year is close to nil. Nevertheless, the recent doubling in the TED spread and simultaneous spike in financials investment grade bond spreads is slightly unnerving (second panel, Chart 1). Junk spreads also widened as investors sought the safety of the risk-free asset. What is behind this fear flare up propagating in risk sensitive assets? First, the Fed continued its tightening cycle last week, raising the fed funds rate another 25bps. As we have been writing in recent research Weekly Reports, rising interest rates go hand-in-hand with increasing volatility (please see Chart 1 from the March 5th Special Report on banks). Thus, as the Fed tightens monetary policy and continues to unwind its balance sheet, the return of volatility will become a key market theme (bottom panel, Chart 1). The implication is that a bumpier ride looms for equities, and the smooth and nearly uninterrupted rise that market participants have been conditioned to expect is now a thing of the past. With regard to the composition of equity returns in the coming year, rising interest rates and volatility signal that the forward P/E multiple has likely crested for the cycle, leaving profits to do all the heavy lifting (Chart 2). Second, rising policy uncertainty (trade and Administration personnel related, please see Chart 1 from last week's publication) is muddying the short-term equity market outlook at the current juncture, and fueling the risk-off phase. However, synchronized global growth, a muted U.S. dollar and easy fiscal policy are a boon to EPS and signal that profit growth will reclaim the driver's seat in coming weeks. Stocks and EPS are joined at the hip and there are good odds that equities will vault to fresh all-time highs on the back of earnings validation as the year unfolds (Chart 3). Chart 1Closely Monitor These Spreads Closely Monitor These Spreads Closely Monitor These Spreads Chart 2EPS Doing The Heavy Lifting EPS Doing The Heavy Lifting EPS Doing The Heavy Lifting Chart 3Profits And Cash Flow Underpin Stocks Profits And Cash Flow Underpin Stocks Profits And Cash Flow Underpin Stocks Importantly, comparing net profit growth to cash flow growth rates is instructive, as SPX EBITDA is not affected by the new tax law. While EPS are slated to grow close to 20% in calendar 2018, the respective forward SPX EBITDA growth rate (based on IBES data) sports a more muted 10% per annum rate (second panel, Chart 4). Similarly, sell side analysts pencil in a visible jump in forward net profit margins, whereas the forward EBITDA margin estimate is stable (middle panel, Chart 4). The recent tax-related benefit is a one-time dividend to profits that will not repeat in 2019. Thus, the market will likely look through this one time effect and start to focus on the calendar 2019 EPS growth number that is a more reasonable 10%, and also similar to next year's EBITDA growth rate. Our sense is that this transition will also be prone to turbulence. Our EPS growth model corroborates this profit euphoria and is topping out near the 20% growth rate (Chart 5). While it will most likely decelerate in the back half of the year, as long as there is no relapse near the contraction zone à la late-2015/early 2016, the equity bull market will remain intact. Chart 4Investors Will See Through The Tax Cut Investors Will See Through The Tax Cut Investors Will See Through The Tax Cut Chart 5EPS Model Flashing Green EPS Model Flashing Green EPS Model Flashing Green As we showcased in the early February Weekly Report, four key macro variables are behaving as they have in four prior 20% EPS growth phases since the 1980s excluding the post-recession recoveries (please see the Appendix of the February 5th "Acrophobia" Weekly Report). Therefore, if history at least rhymes, the equity overshoot phase will resume. This week we add a neglected transportation group to the high-conviction overweight list, put a defensive index on the downgrade watch list and set an upgrade alert on a niche early cyclical group. Air Freight & Logistics: Prepare For Takeoff Last week we reiterated our overweight stance in the broad transportation space and today we are compelled to add the undervalued and unloved S&P air freight & logistics index to the high-conviction overweight list. Air freight services are levered to global growth. Currently, synchronized global growth remains the dominant macro theme. Firming export expectations suggest that global trade volumes will get a bump in the coming months (second panel, Chart 6). Importantly, U.S. manufacturers are also excited about exports; the latest ISM manufacturing export subcomponent hit a three decade high. While the specter of a global trade spat is disconcerting, our sense is that a generalized trade war will most likely be averted or, if the current executive Administration is to be believed, short-lived. The upshot is that air freight & logistics sales momentum will gain steam in the coming months (second panel, Chart 7). Chart 6Heed The Signals From Global Growth,##br## Capex And The Greenback Heed The Signals From Global Growth, Capex And The Greenback Heed The Signals From Global Growth, Capex And The Greenback Chart 7Domestic Demand##br## Is Also Firm Domestic Demand Is Also Firm Domestic Demand Is Also Firm Beyond euphoric survey data readings, hard economic data also corroborate the soft data message. G3 (U.S., the Eurozone and Japan) capital goods orders are firing on all cylinders and probing multi-year highs, underscoring that rising animal spirits are translating into real economic activity (third panel, Chart 6). Chart 8Mistakenly Unloved And Undervalued Mistakenly Unloved And Undervalued Mistakenly Unloved And Undervalued Tack on the near uninterrupted depreciation of the trade-weighted U.S. dollar and factors are falling into place for a relative EPS overshoot, given the large foreign sales component of this key transportation sub-group (bottom panel, Chart 6). Not only are air freight stocks' fortunes tied to the state of global trade, but this industry is also sensitive to capital outlays. A synchronized global capex cycle is one of the key themes we are exploring in 2018. The third panel of Chart 7 shows that our capex indicator points to a reacceleration in the corporate sales-to-inventories ratio. This virtuous capital spending upcycle, that would get a further lift were an infrastructure bill to be signed into law, is a boon to air cargo services. In addition, as the secular advance in e-commerce continues to make inroads in the bricks-and-mortar share of total retail dollars spent, demand for delivery services will continue to grow smartly, underpinning industry selling prices (bottom panel, Chart 7). As a result, we would look through recent softness in industry pricing power that has weighed on relative performance. Indeed, transportation & warehousing hours worked have recently spiked, corroborating the message from global revenue ton miles (not shown), rekindling industry net earnings revisions (second panel, Chart 8). Importantly, relative valuations are discounting a significantly negative profit backdrop, with the relative price/sales ratio at its lowest level since 2002 (third panel, Chart 8). Similarly, the index is trading at a 10% discount to the broad market's forward P/E multiple or the lowest level since the turn of the century (not shown). Finally, technical conditions are washed out offering a compelling entry point for fresh capital (bottom panel, Chart 8). The implication is that the group is well positioned to positively surprise. Bottom Line: The S&P air freight & logistics index has a very attractive reward/risk profile and if we were not already overweight, we would take advantage of recent underperformance to go overweight now. Therefore, we are adding it to our high-conviction overweight list. The ticker symbols for the stocks in this index are: BLBG: S5AIRF - UPS, FDX, CHRW, EXPD. Downgrade Alert: Managed Health Care Managed health care stocks have been stellar outperformers not only versus the overall market, but also compared with the broad S&P health care sector. Since the April 2016 inception of our overweight recommendation, they have added considerable alpha to our portfolio to the tune of 21 percentage points above and beyond the SPX's rise (Chart 9). While most of the factors underpinning our sanguine view for health insurers remain intact, from a risk management perspective we are compelled to put them on downgrade alert. Most of the good news is likely baked into relative prices and valuations (bottom panel, Chart 9). In the coming weeks, we will be on the lookout for an opportunity to pull the trigger and crystalize gains and downgrade to a benchmark allocation, especially if defensive equities catch a bid on the back of the current mini risk off phase. Namely, recent inter-industry M&A euphoria is a key catalyst to lighten up on this health care services sub-sector (Chart 10). While regulators have disallowed intra-industry consolidation over the past few years, the M&A premia remained and now the proposed CVS/AET and CI/EXPR deals could be a harbinger of petering out relative valuations and share prices. Chart 9Prepare To Book Gains Prepare To Book Gains Prepare To Book Gains Chart 10M&A Frenzy M&A Frenzy M&A Frenzy True, melting health care inflation is likely a secular theme that is in the processes of reversing three decades worth of health care industry, in general and pharma in particular, pricing power gains. While this is a dire backdrop for drug manufacturers - which remains a high-conviction underweight - it is a clear benefit to HMOs (Chart 11). Health insurance labor costs are also well contained: the employment cost index for this industry is probing multi-year lows (bottom panel, Chart 12). The upshot is that profit margins are on a solid footing. Chart 11Operating Metrics Suggest... Operating Metrics Suggest… Operating Metrics Suggest… Chart 12...To Stay Overweight A While Longer …To Stay Overweight A While Longer …To Stay Overweight A While Longer Meanwhile, the overall U.S. labor market is on fire. Last month NFPs registered a month-over-month increase of 300K for the first time in four years and unemployment insurance claims are perched near five decade lows. This represents an enticing demand backdrop for managed health care companies, especially when the economy is at full employment and the government is easing fiscal policy (bottom panel, Chart 11). Despite the still appealing demand and pricing backdrop, the flurry of M&A deals will likely serve as a catalyst to lock in gains and move to a benchmark allocation in the coming weeks as this health care sub-index is priced for perfection. Bottom Line: Stay overweight the S&P managed health care index, but it is now on downgrade alert. The ticker symbols for the stocks in this index are: BLBG: S5MANH - UNH, AET, ANTM, CI, HUM, CNC. Upgrade Alert: Homebuilders Showing Resiliency In late-November 2017 when we launched our 2018 high-conviction call list, we downgraded the niche S&P homebuilding index to underweight (Chart 13). Our thesis was that the trifecta of rising lumber prices, mortgage interest deductibility blues and rising interest rate backdrop, a key 2018 BCA theme, would weigh on profit margins and, thus, profits would underwhelm. Since then we have monetized gains of 10% versus the SPX and removed this early-cyclical index from the high-conviction underweight list.1 Today we are putting it on upgrade alert. As a reminder, this was not a call based on a souring residential housing view. In fact, we remain housing bulls and expect more gains for the still recovering residential housing market that moves in steady prolonged multi-year cycles (Chart 14). Keep in mind that housing starts are still running below household formation and the job market is heating up. The implication is that the U.S. housing market rests on solid foundations. Chart 13Bounced Off Support Line Bounced Off Support Line Bounced Off Support Line Chart 14Housing Fundamentals Are Upbeat Housing Fundamentals Are Upbeat Housing Fundamentals Are Upbeat While interest rates and rising house prices are denting affordability (second and fourth panels, Chart 15), homebuilders share prices have been resilient recently and have smartly bounced off their upward sloping support trend line (Chart 13). Indeed, interest rates may continue to rise from current levels, but as we have highlighted in recent research, there is a self-limiting aspect to the year-over-year rise in the 10-year yield near the 100bps mark. Put differently, any rise above 3.05% on the 10-year Treasury yield in a short time frame would likely prove restrictive for the U.S. economy.2 Encouragingly, the mortgage application purchase index has well absorbed the selloff in the bond market, unlike its sibling mortgage application refinance index, signaling that there is pent up housing demand (second panel, Chart 16). New home sales are expanding anew as price concessions have likely been sufficient to compete with existing homes for sale (top panel, Chart 16). Chart 15Get Ready To Upgrade... Get Ready To Upgrade… Get Ready To Upgrade… Chart 16...Given Receding Profit Margin Risks …Given Receding Profit Margin Risks …Given Receding Profit Margin Risks On the lumber front, prices have gone parabolic year-to-date courtesy of trade war talk and a softening U.S. dollar. However, lumber inflation cannot continue at a 50%/annum pace indefinitely (third panel, Chart 16). While higher lumber prices are a de facto negative for homebuilding profit margins, we deem they are now well reflected in compelling relative valuations (bottom panel, Chart 15). In addition, if we are correct in assessing that housing demand remains upbeat, this will give some breathing room to homebuilders to partly pass on some of this input cost inflation to the consumer. Bottom Line: The S&P homebuilding index remains an underweight, but it is now on our upgrade watch list. The ticker symbols for the stocks in this index are: BLBG: S5HOME-DHI, LEN, PHM. Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com 1 Please see BCA U.S. Equity Strategy Insight Report, "Housekeeping In Turbulent Times," dated February 9, 2018, available at uses.bcaresearch.com. 2 Please see BCA U.S. Equity Strategy Weekly Report, "Reflective Or Restrictive?" dated March 12, 2018, available at uses.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor value over growth. Stay neutral small over large caps (downgrade alert).

Underweight Last week we downgraded the S&P consumer discretionary index to a below benchmark allocation on the back of three key factors: a rising fed funds rate, quantitative tightening and higher prices at the pump. One of the charts we published, and are reprinting today, caught the attention of our good friend, who I refer to as the "smartest man in California", and he suggested a few of interesting tweaks to drive a point home. First, he recommended to switch the fed funds rate to the shadow fed funds rate, or the Wu-Xia model, in order to better capture the fact that the Fed was still easing monetary policy below the zero line post December, 2008 and until December, 2015 via QE (top panel). Second, if we were to exclude AMZN from the day the S&P included it in the SPX and the S&P 500 consumer discretionary index (November 21st, 2005), then the chart would highlight that the vast majority of consumer discretionary stocks are actually following the typical historical relationship with the Fed's tightening cycle (top panel). Finally, while AMZN has a heavy weight in the broad consumer discretionary index (21%), its earnings weight is quite low (1.5%). Thus, overall consumer discretionary profits are indeed following the Fed's historical tightening path (second panel). Bottom line: We reiterate our underweight stance in the S&P consumer discretionary sector. Category: Consumer Discretionar Skating On Thin Ice Skating On Thin Ice

Underweight Declining share of the consumer's wallet has been the narrative for media stocks for several years (top panel). Millennials, currently the largest U.S. age cohort, have been "cord cutting" and preferring competitive "on demand" services, largely explaining the near collapse in media spending. As a result, industry pricing power is under attack with relative sales and profit expectations steadily sinking (second and third panels). These bleak spending patterns are not isolated in the S&P movies and entertainment index, they have also infiltrated the S&P cable & satellite media sub-index. Even extremely resilient cable TV pricing power is losing its luster on the back of shrinking industry demand, as cable price hikes can no longer keep up with overall inflation (bottom panel). Given the high capital intensity of these firms, tightening margins will eventually translate into cash flow compression. Bottom Line: Downgrade the S&P movies & entertainment and S&P cable and satellite indexes to underweight and see this week's Weekly Report for more details. The ticker symbols for the stocks in the S&P movies & entertainment and S&P cable and satellite indexes, are BLBG: S5MOVI - DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. Exit Stage Right Exit Stage Right

Underweight In mid-January we put the S&P consumer discretionary sector on downgrade alert as our EPS model had rolled over. Combined with BCA's high interest rate theme for 2018, it is time to execute the alert and cut the S&P consumer discretionary sector to a below benchmark allocation. Fed tightening, from both higher rates and a balance sheet unwind, is negative for these extremely interest rate-sensitive equities. Both the household financial obligation ratio and household debt service payments have bottomed and are actually increasing. A higher interest rate backdrop will sustain the upward pressure on both and likely weigh on consumer discretionary relative share prices (both series shown inverted, second and third panels). Our Consumer Drag Indicator (bottom panel) captures this, as well as other factors, and sends a clear message that relative share price momentum will dwindle in the coming months. As such, we recommend a below benchmark allocation in the S&P consumer discretionary index; please see yesterday's Weekly Report for more details. Trim Consumer Discretionary To Underweight Trim Consumer Discretionary To Underweight

Highlights Portfolio Strategy Quantitative tightening, a rising fed funds rate and higher prices at the pump are all bearish consumer discretionary stocks. Downgrade exposure to underweight. We are executing this interest rate-sensitive sector downgrade by reducing the S&P movies & entertainment and S&P cable & satellite sub-indexes to underweight. A downbeat industry spending backdrop and fading pricing power paint a gloomy EPS picture. Recent Changes S&P Consumer Discretionary - Downgrade to underweight today. S&P Movies & Entertainment - Trim to underweight today. S&P Cable & Satellite - Downgrade to underweight today. Table 1 Reflective Or Restrictive? Reflective Or Restrictive? Feature Equities are still in the recovery ward and the consolidation/absorption phase in place since the February 5th crack has yet to fully run its course. According to our "buy the dip" cycle-on-cycle analysis, a retest of the recent lows typically occurs in the first month following the initial shock, suggesting that the market is already out of the woods (Chart 1A). However, the return of vol may keep a lid on the SPX for a while longer (Chart 1B). Our strategy in place since February 8th is to buy this dip as we do not foresee an end to the business cycle in 2018.1 Chart 1ABuy This Dip Worked Out Nicely... Buy This Dip Worked Out Nicely... Buy This Dip Worked Out Nicely... Chart 1BBut The Return Of Vol May Spoil The Party But The Return Of Vol May Spoil The Party But The Return Of Vol May Spoil The Party Recent tariff news has dominated the media, however, our sense is that a full blown retaliatory trade war is a low probability outcome. Keep in mind, that the average U.S. tariff rates have drifted lower during the past three decades and, according to the World Bank, are now 1.6%, one of the lowest in the world2 (third panel, Chart 2). And as for concerns that the rhetoric surrounding trade will lead to a surge in the U.S. dollar, we note that the last two times there was a trade spat of sorts the U.S. dollar actually depreciated, both in the early-2000s and in the early-to-mid 1990s (Chart 2). Tack on the recent euphoria surrounding manufacturing exports - which just hit a 30-year high - and it is likely that deep cyclical EPS would overshoot were a trade war to ensue (bottom panel, Chart 2). Such a weak U.S. dollar policy is also a boon for overall SPX profits, if history at least rhymes (Chart 3). Chart 2Tariffs Don't Matter Tariffs Don't Matter Tariffs Don't Matter Chart 3SPX EPS Would Get a Boost From A Tariff War SPX EPS Would Get a Boost From A Tariff War SPX EPS Would Get a Boost From A Tariff War Importantly, synchronized global growth and the selloff in the bond markets remain the dominant macro themes. Last week we showed that since the GFC, empirical evidence suggests that the U.S. economy can withstand a tightening of roughly 125bps in a short time span (please see Chart 3B from the March 5th Special Report). This week we add two components to our interest rate analysis and increase the dataset range back to the 1960s. We compare cyclical momentum in the SPX with the annual change in the 10-year Treasury yield, and also document the shifting correlation between these two asset classes. We then filter for a minimum year-over-year (yoy) 100bps tightening in the 10-year Treasury yield and a clear indication of a negative correlation between the two variables, i.e. a deceleration or straight up contraction in the SPX annual percent change. In other words, we are searching for tightness in monetary conditions that cause equity market consternation, excluding recessions. Table 2 summarizes our results. While cyclical stock momentum and changes in the 10-year Treasury yield have been a near carbon copy since the late-1990s (Chart 4), according to our analysis there have been five iterations when rising bond yields proved restrictive for equities: once in each of the 1960s, 1970s and 1990s and twice in the 1980s. Table 2SPX Returns In Times Of ##br##Restrictive 10-Year UST Selloffs Reflective Or Restrictive? Reflective Or Restrictive? Chart 4The Great ##br##Moderation Years The Great Moderation Years The Great Moderation Years In the mid-1960s, the U.S. deployed troops in Vietnam and the Fed also tightened monetary policy by enough to invert the yield curve (Chart 5). During the mid-1970s episode, fresh off the first oil shock-induced recession, the Fed started tightening monetary policy in 1977 in order to contain inflation and never looked back. Eventually, the Fed inverted the yield curve in late-1978 before the second oil shock hit that morphed into the early-1980s recession (Chart 6). Chart 5100bps Tightening... 100bps Tightening... 100bps Tightening... Chart 6...Can Hurt Equities... ...Can Hurt Equities... ...Can Hurt Equities... In the 1980s, following the double dip recession, Fed Chairman Paul Volcker started lifting interest rates as the economy was recovering, and similarly in 1987 the Fed was aggressively tightening monetary policy up until the "Black Monday" crash (Chart 7). Finally, in 1994 the Fed doubled interest rates in a span of nine months and in December of that year Mexico had to devalue the peso and the "Tequila effect" gripped Asia and Latin America. Such abrupt tightening caused a mild indigestion in the stock market (Chart 8). Chart 7...When The Stock-To-Bond Yield Correlation... ...When The Stock-To-Bond Yield Correlation... ...When The Stock-To-Bond Yield Correlation... Chart 8...Turns Negative ...Turns Negative ...Turns Negative On average, the SPX drawdown from peak-to-trough during these five iterations was 19% and lasted 6.5 months. Currently, in order for interest rates to turn from reflective of growth to restrictive and cause a sizable pullback in the SPX, we calculate that the 10-year Treasury yield would have to rise above 3.05% by September 2018. Simultaneously, the correlation between stocks and bond yields would have to sink into negative territory. Nevertheless, given the steepness of the recent selloff in bonds, in order for the yoy 100bps rule of thumb to remain in place, post September the 10-year Treasury yield should continue to gallop higher and end the year near 3.5%, and further rise to 3.94% in early 2019. While this is possible, we assign low odds to such an outcome. As a reminder, BCA's higher interest rate view calls for a selloff in the 10-year Treasury bond near 3.25% by year-end 2018, a level that both the economy and the SPX will likely be able to shake off (Chart 4). This week we act on our mid-January alert and downgrade an interest rate-sensitive sector to underweight. Trim Consumer Discretionary To Underweight In mid-January we put the S&P consumer discretionary sector on downgrade alert heeding the anemic signal from our EPS growth model and also owing to BCA's high interest rate theme for 2018. We are now acting on the alert and cutting exposure and moving the S&P consumer discretionary sector to a below benchmark allocation. At this stage of the cycle, when the Fed is on track to continue to steadily lift interest rates in the coming two years as the economy heats up, investors should lighten up on consumer discretionary stocks (Chart 9). In addition, this cycle the Fed is orchestrating dual tightening as it is simultaneously unwinding the size of its balance sheet. Quantitative tightening is also bearish discretionary stocks (Chart 10). Chart 9Mind The Fed Funds Rate Mind The Fed Funds Rate Mind The Fed Funds Rate Chart 10Quantitative Tightening Also Bites Quantitative Tightening Also Bites Quantitative Tightening Also Bites This rising short-term interest rate backdrop is not conducive to owning extremely interest rate-sensitive equities. Both the household financial obligation ratio and household debt service payments have bottomed and are actually increasing. A higher interest rate backdrop will sustain the upward pressure on both and likely weigh on consumer discretionary relative share prices (both series shown inverted, Chart 11). The U.S. consumer has been firing on all cylinders with PCE growing 4% in real terms last quarter and contributing positively to overall real output growth (Chart 12). Chart 11Household Financing ##br##Costs Have Troughed Household Financing Costs Have Troughed Household Financing Costs Have Troughed Chart 124% Real PCE Growth Is##br## Unsustainable Absent Wage Inflation 4% Real PCE Growth Is Unsustainable Absent Wage Inflation 4% Real PCE Growth Is Unsustainable Absent Wage Inflation However, such a breakneck pace is unsustainable without wage inflation follow through. Worrisomely, the personal savings rate has been depleted to the point where the consumer appears tapped out. Historically, consumer confidence and the savings rate have been perfectly inversely correlated (Chart 13). Sky high sentiment and almost zero savings suggest that the consumer has to resort to credit card debt in order to finance outlays in the absence of wage inflation. Revolving credit is soaring, but worryingly credit card delinquency and chargeoff rates at small commercial banks are at recession type levels, warning that this credit outlet may be drying up (Chart 14). Chart 13Depleted Savings Are Problematic Depleted Savings Are Problematic Depleted Savings Are Problematic Chart 14Early Signs Of Trouble? Early Signs Of Trouble? Early Signs Of Trouble? All of this is taking place at a time when bankers are still not willing extenders of consumer installment credit, according to the Fed's latest Senior Loan Officer Survey. The implication is that even a modest tick down in consumer confidence and simultaneous rebuilding of savings will likely, at the margin, dent consumer spending. Another macro headwind the consumer has to contend with is higher prices at the pump. BCA's constructive crude oil view suggests that increasing gasoline prices will continue to eat into consumer discretionary spending power. Taken together, these macro headwinds will dampen consumer discretionary outlays. Our Consumer Drag Indicator captures these forces and is signaling that relative share price momentum will dwindle in the coming months (Chart 15). Under such a backdrop, while consumer discretionary EPS can expand modestly, they will trail the broad market that is slated to grow profits close to 20% in calendar 2018. Relative performance will likely converge lower to falling relative profitability (top panel, Chart 16). We currently side with the sell-side community and expect a contraction in relative profit growth. Therefore, not only are we unwilling to pay an 18% premium valuation to own this interest rate-sensitive sector, but we would also sell into strength given our view of a derating phase taking root in the coming months (bottom panel, Chart 16). Our Cyclical Macro Indicator confirms this downbeat relative EPS growth outlook, and underscores that the path of least resistance is lower for consumer discretionary stocks (Chart 15). Chart 15Models Say Sell Models Say Sell Models Say Sell Chart 16Unsustainable Divergence Unsustainable Divergence Unsustainable Divergence Finally, a few words on AMZN.3 Cracks have already formed in relative share prices ex-AMZN (top panel, Chart 11). The AMZN juggernaut has masked the true consumer discretionary picture given its hefty market cap weight in the index (20%) that will only increase in late-summer following the already announced S&P index composition changes. Accordingly at that time, we will also make changes to our portfolio. While we maintain a neutral exposure to the S&P internet retail index, that AMZN dominates4 and that we recently initiated coverage on, the way we are executing the S&P consumer discretionary downgrade to underweight is by trimming the media index to a below benchmark allocation. Media: Exit Stage Right Since the late 1970s the media complex's fortunes have been joined at the hip with the U.S. dollar. When the greenback is roaring, investors pile into media shares and vice versa. While media outlets do have international sales exposure, it is small and significantly trails the overall market's foreign revenue exposure. Thus, the mostly domestic nature of media stocks explains the positive correlation with the U.S. dollar (Chart 17). This multi-decade relationship remains in place, and given the sizable losses in the trade-weighted U.S. dollar since the December 2016 peak, the relative share price ratio will remain under intense pressure. On the operating front, shifting consumer spending trends are weighing on relative performance. The top panel of Chart 18 shows that relative media outlays have been in a free fall. Millennials, currently the largest U.S. age cohort, have been "cord cutting" and preferring competitive "on demand" services, largely explaining the near collapse in media spending. Chart 17Joined At The Hip Joined At The Hip Joined At The Hip Chart 18Bearish Operating Metrics Bearish Operating Metrics Bearish Operating Metrics As a result, industry pricing power is under attack with relative sales and profit expectations steadily sinking (middle & bottom panels, Chart 18). Nevertheless, media barons have awakened to the threats engulfing this industry and are scrambling to fight back. The knee-jerk reaction in the movies & entertainment subindustry has been to seek intra-industry buyout candidates (Chart 19). Inter-industry M&A is also ongoing with the AT&T/Time Warner and Justice Department trial still pending, the tie-up between Disney and Fox and the competitive bids for Sky plc from Fox and Comcast. However, media consolidation is not a sustainable way forward for profit growth. Organic EPS growth remains anemic and the visible breakdown in the correlation between consumer confidence and relative share prices since early 2016 represents a yellow flag (top panel, Chart 20). Chart 19M&A Nearly Exhausted M&A Nearly Exhausted M&A Nearly Exhausted Chart 20Unnerving Breakdown In Correlations Unnerving Breakdown In Correlations Unnerving Breakdown In Correlations Similar to consumer confidence, the ISM non-manufacturing composite is also probing cycle highs, however, industry spending is now outright contracting and steeply diverging from the upbeat ISM services survey. Tack on rising gasoline prices and the news is grim for S&P movies & entertainment profitability (Chart 20). These bleak spending patterns are not isolated in the S&P movies and entertainment index, they have also infiltrated the S&P cable & satellite media sub-index. Chart 21 shows that relative consumer outlays on cable services have taken a plunge, warning that relative share prices will likely suffer the same fate in the coming quarters. Even extremely resilient cable TV pricing power is losing its luster on the back of shrinking industry demand, as cable price hikes can no longer keep up with overall inflation (bottom panel, Chart 21). The implication is that sales are at risk of further steep deceleration. Given that cable providers have to continually upgrade their networks in order to keep up with ever increasing bandwidth demand, tightening margins will eventually translate into cash flow compression (Chart 22). Chart 21Demand And Prices Are Deflating Demand And Prices Are Deflating Demand And Prices Are Deflating Chart 22Margin Trouble Margin Trouble Margin Trouble Bottom Line: Downgrade the S&P movies & entertainment and S&P cable and satellite indexes to underweight. This also pushes our exposure to the broad S&P consumer discretionary sector to the underweight column. The ticker symbols for the stocks in the S&P movies & entertainment and S&P cable and satellite indexes, are BLBG: S5MOVI - DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com 1 Please see BCA U.S. Equity Strategy Insight, "Buy The Dip," dated February 8, 2018, available at uses.bcaresearch.com. 2 https://data.worldbank.org/indicator/TM.TAX.MRCH.WM.AR.ZS?locations=US 3 Please see BCA U.S. Equity Strategy Special Report, "Internet Retail: Dialed Up," dated February 26, 2018, available at uses.bcaresearch.com. 4 Ibid. Current Recommendations Current Trades Size And Style Views Favor value over growth. Stay neutral small over large caps (downgrade alert).

Underweight As with other metals-consuming industries, stocks in both the S&P auto components and S&P autos indexes have traded sharply lower following the announcement of the proposed steel and aluminum tariffs (top panel). With roughly a quarter share of domestic steel consumption, autos are second only to the construction industry in terms of exposure to higher steel prices. Fears of higher prices are amplified as new vehicle sales growth appears to be petering out. We think fears are well-founded but not because of higher steel prices but rather from a contraction in credit growth (second panel). Tighter lending standards (third panel) have followed a glut of subprime lending with rising defaults (bottom panel) that are only now working their way through lenders' balance sheets. A backdrop of potentially higher prices only fuels the flames on this negative story; stay underweight. The ticker symbols for the stocks in the S&P auto components index are: BLBG: S5AUTC - APTV, BWA, GT. Steel Yourself For Weaker Auto Components Steel Yourself For Weaker Auto Components

Neutral (Downgrade Alert) Comcast shareholders were surprised earlier this week with the announcement that they were making an offer to purchase British satellite broadcaster Sky, besting an offer from 21st Century Fox for the 61% it doesn't already own. The announcement raises the specter of both an expensive bidding war for these assets as well as a potential bidding war for 21st Century Fox which is itself subject to a pending takeover from Disney. Overall, it appears that media distribution assets are being consolidated at high (and rising) valuations. Such consolidation is logical for U.S. media interests; pricing power has been negative for the past year (second panel) and relative EPS growth has flat lined (third panel). These conditions have been partially reflected in valuation multiples which are already well below normal (bottom panel). Should a bidding war emerge, balance sheets will get stretched resulting in higher risk premiums and deteriorating EPS, both of which mean valuations sink further. Altogether, we are adding a downgrade alert to our neutral rating on media stocks. The ticker symbols for the stocks in the movies & entertainment and cable & satellite indexes (collectively the media indexes) are BLBG: DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. Is It Time To Roll Credits On Media? Is It Time To Roll Credits On Media?

Neutral While internet retail moved to the mainstream more than a decade ago, it continues to capture the lion's share of retail growth and investors' imaginations along with it. Further, the philosophy of "profits don't matter" in pursuit of explosive growth has been replaced with more sustainable models. The consumer is gradually becoming more aware that the intangible benefits of convenience and comparison information and tangible benefits including transportation and time expenses should mean that internet retail should be able to command greater pricing power than physical peers. As such, an eventual convergence between bricks and mortar and online retail margins looks to be in the offing. Still, despite a market full of eye-watering valuations, the S&P internet retail index stands out as expensive; expectations appear to have overreached. Further, one of BCA's themes for 2018 is higher interest rates; with the Fed poised to increase rates at least three times this year, our style preference favoring value stocks over growth seems well supported. Bottom Line: We initiate coverage of the S&P internet retail index with a neutral weight. Please see yesterday's Special Report for more details. The ticker symbols for the stocks this index are: BLBG: S5INRE - AMZN, NFLX, PCLN (changing to BKNG, effective February 27, 2018), EXPE, TRIP. Internet Retail - Dialed Up Internet Retail - Dialed Up