Media

Highlights The current burst of inflation in developed economies is due to a (negative) supply shock rather than a (positive) demand shock. Consumer complaints of “poor buying conditions” mean that higher prices will cause demand destruction. Hence, it is extremely dangerous for central banks to respond with the signalling of tighter policy that leads to higher bond yields. The upper limit to the 10-year T-bond yield is no higher than 1.8 percent. Hence, this yield level would be a good cyclical entry point into both stocks and bonds. Continue to underweight consumer discretionary versus the market, given the very tight connection between weaker spending on durables and the underperformance of the goods dominated consumer discretionary sector. Commodities whose prices have not yet corrected are at much greater risk than those whose prices have corrected. Hence a new cyclical recommendation is to go underweight tin versus iron ore. Fractal analysis: Netflix versus Activision Blizzard, and AUD/NZD. Feature Chart of the Week"Buying Conditions Are Poor" "Buying Conditions Are Poor" "Buying Conditions Are Poor" The current burst of inflation in developed economies is due to a (negative) supply shock rather than a (positive) demand shock. Getting this diagnosis right is crucial, because responding to supply shock generated inflation with tighter monetary policy is extremely dangerous. Responding to supply shock generated inflation with tighter monetary policy is extremely dangerous. The current burst of inflation cannot be due to a demand shock. If it was, aggregate demand would be surging. But it is not. For example, in the US, both consumer spending and income lie precisely on their pre-pandemic trend (Chart I-2). Furthermore, consumers are complaining that high prices for household durables, homes, and cars have caused “the poorest buying conditions in decades”, according to the University of Michigan’s latest consumer sentiment survey. If a positive demand shock was boosting incomes relative to prices, consumers would not be making this complaint. Given that they are making this complaint, there is the real risk of demand destruction. Meanwhile, employment remains far below its pre-pandemic trend. For example, in the US, by about 8 million jobs (Chart I-3). How can demand be on trend, but employment so far below trend? As an economic identity, the answer is that productivity has surged. Yet this should come as no surprise, because after recessions, productivity always surges. Chart I-2Demand Is On Trend... Demand Is On Trend... Demand Is On Trend... Chart I-3...But Employment Is Well Below Trend ...But Employment Is Well Below Trend ...But Employment Is Well Below Trend After Recessions, Productivity Always Surges As we explained in What The Olympics Teaches Us About Productivity Growth, productivity growth comes from better biology (which improves both our physical and intellectual capacity), better technology, and finding better ways to do the same thing. Of these three drivers, the first two are continuous processes but the third, finding better ways to do the same thing, is a step function whose up-steps come after disruptive changes in the economy such as recessions (Chart I-4). Chart I-4After Recessions, Productivity Always Surges After Recessions, Productivity Always Surges After Recessions, Productivity Always Surges To do things better, a recession is the necessary catalyst for the wholesale adoption of an existing technology. For example, the mass manufacturing of autos already existed well before the Great Depression, but the Depression catalysed its wholesale adoption. Likewise, word processors existed well before the dot com bust, but the 2000 recession finally killed the office typing pool. In the same way, the technology for remote meetings and online shopping has been around for years, but the pandemic has catalysed its wholesale adoption. Of course, it is sub-optimal to meet people remotely or shop online all the time. But it is also sub-optimal to do these things in-person all the time. The most productive way is some hybrid of remote and in-person, which will differ for each person. The pandemic has given us the opportunity to find this personally optimal hybrid, and thereby to boost our productivity. The current boost to productivity could be larger than those after previous recessions because the pandemic has reshaped the entire economy. The current boost to productivity could be larger than those after previous recessions because the pandemic has forced us all to challenge our best practices. This is different from previous post-recession periods where transformations were focussed in one sector. For example, the 80s recession reshaped manufacturing, the dot com bust changed the technology sector, and the 2008 recession transformed the financial sector. By comparison, the current transformation is reshaping the entire economy. Yet, if productivity is booming, why has inflation spiked? The answer is that we have experienced a massive and unprecedented (negative) supply shock. It’s A Supply Shock, Not A Demand Shock To repeat, there has been no positive shock in aggregate demand. Yet there has been a massive shock in the distribution of this demand. Pandemic restrictions on socialising, interacting, and movement meant that leisure, hospitality, in-person shopping, and travel services were unavailable. As spending on services slumped, consumers shifted their firepower to items that could be enjoyed within the pandemic’s confines; namely, durable goods (Chart I-5). Chart I-5A Massive Displacement In The Distribution Of Demand Led To Supply Shocks A Massive Displacement In The Distribution Of Demand Led To Supply Shocks A Massive Displacement In The Distribution Of Demand Led To Supply Shocks The problem is that modern supply chains have few, if any, built-in redundancies. They are always working ‘just in time’ and cannot cope with any surge in demand. To make matters worse, the type of goods in high demand also shifted: for example, from electronic goods during full lockdown – to cars when lockdowns eased, and people required local mobility. These shifting spikes in demand stressed and indeed snapped fragile supply chains, resulting in skyrocketing prices for durables. To assess the contribution to overall inflation, we need to gauge the deviation from the pre-pandemic trend. Relative to where they would have been, prices are higher by 0.5 percent for services, 1 percent for non- durables, but by a staggering 10 percent for durables. It follows that most of the current burst of inflation is due to the supply shock for durables (Chart of the Week). But now, consumer complaints that “buying conditions are poor” imply that high prices risk demand destruction as people wait for better conditions (lower prices) to make non-essential purchases. In any case, as we learn to live with the pandemic, the shock in the distribution of demand is easing. Meaning that the abnormally high spending on durable goods has a long way to fall. Furthermore, supply bottlenecks always clear as output responds with a lag. This risks unleashing a flood of supply just as higher prices have destroyed demand. Add to this mix a slowdown, or worse a slump, in China’s real estate and construction sector as we highlighted last week in The Real Risk Is Real Estate (Part 2). And the irony is that, for many global sectors, there could be a demand shock after all but it would be a negative demand shock. Three Investment Recommendations As consumers’ current complaints of poor buying conditions testify, the higher prices that come from a supply shock eventually lead to demand destruction. Hence, it is extremely dangerous for central banks to respond with tighter policy, including the signalling of tighter policy that leads to higher bond yields. The higher bond yields will, with a lag, choke demand just as the supply bottlenecks ease and unleash a flood of supply. Resulting in a deflationary shock for the economy, stock market, and commodities (Chart I-6). Chart I-6When Supply Shocks Ease, Prices Slump When Supply Shocks Ease, Prices Slump When Supply Shocks Ease, Prices Slump On this basis, we are making three investment recommendations: The upper limit to the 10-year T-bond is no higher than 1.8 percent, as we detailed in Stocks, Not The Economy, Will Set The Upper Limit To Bond Yields. Hence, this yield level would be a good cyclical entry point into both stocks and bonds. Continue to underweight consumer discretionary plays versus the market, given the very tight connection between spending on durables and the relative performance of the goods dominated consumer discretionary plays in the stock market. As supply shocks always ultimately ease, those commodities whose prices have not yet corrected are at much greater risk than those commodities whose prices have corrected. Specifically, the price of industrial metals such as tin are at their most stretched versus iron ore in a decade (Chart I-7). Moreover, this fragility is confirmed by fractal analysis (Chart I-8 and Chart I-9). Chart I-7Tin Is Very Stretched Versus Iron Ore Tin Is Very Stretched Versus Iron Ore Tin Is Very Stretched Versus Iron Ore Chart I-8Tin Is Fragile Tin Is Fragile Tin Is Fragile Chart I-9Tin Versus Iron Ore Is Fragile Tin Versus Iron Ore Is Fragile Tin Versus Iron Ore Is Fragile Hence, as a new cyclical recommendation, go underweight tin versus iron ore. Netflix Versus Activision Blizzard, And AUD/NZD Are Susceptible To Reversal In pure entertainment plays, the strong outperformance of Netflix versus Activision Blizzard has been fuelled by the delta wave of the virus, which helped Netflix, combined with the Chinese crackdown on gaming companies, which weighed down the whole gaming sector including Activision. The gaming company was also hit by a discrimination lawsuit, which it has now settled. Fractal analysis suggests that this strong outperformance is now fragile. Accordingly, the recommended trade is to short Netflix versus Activision Blizzard, setting a profit target and symmetrical stop-loss at 10 percent (Chart I-10). Chart I-10Netflix Versus Activision Blizzard Is Susceptible To Reversal Netflix Versus Activision Blizzard Is Susceptible To Reversal Netflix Versus Activision Blizzard Is Susceptible To Reversal Meanwhile, in foreign exchange, the recent sell-off in AUD/NZD has reached fragility on the 130-day dimension which has reliably signalled previous reversal points (Chart I-11). Hence, the recommended trade is long AUD/NZD, setting a profit target and symmetrical stop-loss at 2 percent. Chart I-11AUD/NZD Is Likely To Rebound AUD/NZD Is Likely To Rebound AUD/NZD Is Likely To Rebound   Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Fractal Trading System Fractal Trades 6-Month Recommendations Structural And Thematic Recommendations Closed Fractal Trades   Indicators To Watch - Bond Yields Chart II-1Indicators To Watch - Bond Yields ##br##- Euro Area Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Euro Area Chart II-2Indicators To Watch - Bond Yields ##br##- Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Chart II-3Indicators To Watch - Bond Yields ##br##- Asia Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Asia Chart II-4Indicators To Watch - Bond Yields ##br##- Other Developed Indicators To Watch - Bond Yields - Other Developed Indicators To Watch - Bond Yields - Other Developed   Indicators To Watch - Interest Rate Expectations Chart II-5Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations  

Highlights Portfolio Strategy As growth becomes scarce, investors flock to sectors that are slated to outgrow the broad market and shy away from the ones that are forecast to trail the SPX’s growth rate. This week we rank sectors and subsectors by EPS growth in our universe of coverage, and identify sweet and trouble spots. Fired up crack spreads, firming refining industry operating metrics, reaccelerating exports along with washed out technicals and compelling valuations, all signal that the time is ripe to buy into refining weakness. The cable industry’s demand headwinds are reflected in depressed relative valuations at a time when industry pricing power is trying to stage a comeback and a drifting lower greenback may also provide positive profit offsets. Stick with a benchmark allocation. Recent Changes Boost the S&P Oil & Gas Refining & Marketing index to overweight all the way from underweight today, locking in relative profits of 21%. Table 1 Awaiting Validation Awaiting Validation Feature Equities broke out last week and surpassed the upper band of their recent trading range, despite economic data releases that continued to surprise to the downside. Two weeks ago, we cautioned investors not to put cash to work as a tactical indigestion period loomed, with the SPX facing stiff resistance near the 2,800 level. In addition, we posited that most of the good news related to the U.S./China trade spat front was reflected in the S&P 500’s V-shaped recovery (top panel, Chart 1). In relative terms, the bottom panel of Chart 1 confirms that the easy money has already been made on the assumption of a positive resolution to the U.S./China trade dispute. Chart 1Trade Deal Priced In Trade Deal Priced In Trade Deal Priced In Going forward, the earnings juggernaut will have to remain in place in order for stocks to vault to fresh all-time highs, likely in the back half of the year. The Trump administration’s massive fiscal stimulus artificially fueled profit growth last year both by lowering the corporate tax rate and by encouraging overseas cash repatriation. The latter boosted share buybacks to an all-time record. Despite 24% EPS growth and $1tn in equity retirement, the SPX ended 2018 6% lower. Why? It became clear that EPS growth was headed lower. In order to gauge trend EPS growth we opt to use EBITDA, a cash flow proxy measure that strips out the direct impact of last year’s fiscal easing. Chart 2 clearly shows that trend growth took a step down following the positive base effects of the GFC-induced collapse and averaged close to 5%/annum from 2012 to 2014. Subsequently, the late-2015/early-2016 manufacturing recession sunk EBITDA into contraction, but the euphoria surrounding the newly elected President pushed trend EBITDA growth to near 10%/annum for two full years in 2017 and 2018. Chart 2Return To 5% Growth? Return To 5% Growth? Return To 5% Growth? Since the late-2018 peak, 12-month forward EBITDA growth continues to drift lower and is now hovering just shy of 3%. Our sense is that 5% organic profit growth is consistent with nominal GDP printing 4%-4.5% at this stage of the business cycle, signaling that a return to the 2012-2014 growth backdrop is likely later in the year. As a reminder, positive profit growth in calendar 2019 remains one of the three pillars underpinning stocks that we have highlighted since the beginning of this year. Stocks have come full circle recovering all of last December’s losses, but in order to make fresh all-time highs, profits will have to deliver. We deem that an earnings validation phase is transpiring and there are early signs that profit growth will trough sometime in the first half of the year. Not only has EBITDA breadth put in a bottom (Chart 2), but also economically hypersensitive indicators suggest that forward EBITDA growth will soon tick higher. Namely, the ISM manufacturing new orders component has perked up on a year-over-year basis. The trough in lumber futures momentum corroborates this message, as does the tick higher in the U.S. boom/bust indicator (Chart 3). Chart 3Growth Green-shoots Growth Green-shoots Growth Green-shoots Given the current macro backdrop and awaiting the profit validation, when growth becomes scarce investors flock to sectors that are outgrowing the broad market and shy away from ones that trail the SPX’s growth rate. Typically, in recessionary times that would equate to investors bidding up defensive sectors that command stable cash flow businesses and avoiding highly cyclical industries. But, BCA does not expect a recession in the coming year. Thus, in order to identify high growth sectors that should outperform during the current soft patch and growth laggards that should underperform, we compiled a table with the GICS1 sectors and all the subsectors we cover. First, we rank the GICS1 sectors and then within each sector we rank the subsectors, both times by absolute 12-month forward EPS growth using I/B/E/S/ data (see second columns, Table 2). We aim to reproduce this table once a quarter. Table 2Identifying S&P 500 Sector EPS Growth Leaders And Laggards Awaiting Validation Awaiting Validation The third columns in Table 2 show the sector growth rate relative to the SPX. The final columns in Table 2 highlight the trend in relative growth. In more detail, they compare the current relative growth rate to that of three months ago: a positive sign indicates an upgrade in analysts’ relative estimates and a negative sign a downgrade in analysts’ relative estimates. Industrials and financials (we are overweight both) are leading the pack outpacing the broad market by 410bps and 350bps, respectively, and enjoy a rising profit trend. On the flip side, energy (overweight) and real estate (underweight) trail the broad market by 490bps and 1480bps, respectively, and showcase a deteriorating EPS trend. With regard to energy, we first identified that analysts are really punishing this sector in the January 22 Weekly Report and the sector’s 2019 EPS contribution was and remains negative.1 Our overweight call will be offside if oil prices suffer a new setback, but our Commodity & Energy strategy service remains bullish on oil, implying relative EPS outperformance in 2019. Year-to-date, energy has bested the SPX by 170bps. This week, we make an energy sector subsurface tweak, and also update a communication services subgroup. Light My Fire Last summer we took refiners down to a below benchmark allocation as all of the good news was perfectly reflected in soaring relative share prices (top panel, Chart 4), at a time when cracks were forming. Now we are compelled to book gains of 21% and boost exposure all the way to overweight. Chart 4Crack Spreads Are On Fire Crack Spreads Are On Fire Crack Spreads Are On Fire Today, refiners paint a near exact opposite picture compared with last July. Relative share prices are no longer rising by 50%/annum. Instead, momentum has collapsed and is now contracting (middle panel, Chart 4). Sell-side analyst exuberance has turned into outright pessimism: refiners’ profits are expected to trail the broad market in the coming year. By comparison, last summer they were penciled in to beat the market by 30 percentage points (bottom panel, Chart 4). Granted M&A activity had also added fuel to the fire, but now all the hot air has come out of the refining industry, and then some. Refiners’ riches move in tandem with crack spreads. When refining margins widen, profits excel and vice versa. Now that refining margins are in a slingshot recovery, refining ills will turn into fortunes (bottom panel, Chart 4). Importantly, wide Brent-WTI spreads underpin crack spreads. Moreover, the crude oil versus refined product inventory backdrop currently reinforces a widening in refining margins. In absolute terms, gasoline stockpiles are being worked off (gasoline inventories shown inverted, bottom panel, Chart 5) and grinding higher demand for refined petroleum products (top panel, Chart 5) will further tighten the industry’s inventory outlook. Chart 5Healthy Supply/Demand Backdrop Healthy Supply/Demand Backdrop Healthy Supply/Demand Backdrop One way domestic refiners are taking advantage of the still wide Brent-WTI differential is via the export markets. Net refined products exports are running at over 3mn barrels/day (bottom panel, Chart 6), and the softening greenback since November will further boost profits with a slight lag as U.S. refining exports will grab an even larger slice of the global pie (U.S. dollar shown inverted and advanced, middle panel, Chart 6). Chart 6U.S. Dollar Softness Is A Boon To Refining Profits U.S. Dollar Softness Is A Boon To Refining Profits U.S. Dollar Softness Is A Boon To Refining Profits On the valuation front, both the relative forward P/E and P/S have undershot their respective historical means and EPS breadth is as bad as it gets, offering investors an excellent entry point in the pure-play oil & gas refining industry (Chart 7). Chart 7Extreme Analyst Pessimism Reigns Extreme Analyst Pessimism Reigns Extreme Analyst Pessimism Reigns In sum, fired up crack spreads, firming refining industry operating metrics, reaccelerating exports along with washed out technicals and compelling valuations, all signal that the time is ripe to buy into refining weakness. Bottom Line: Lift the S&P oil & gas refining & marketing index to overweight all the way from a below benchmark allocation, crystalizing 21% in relative profits since last summer’s inception. The ticker symbols for the stocks in this index are: BLBG: S5OILR – PSX, MPC, VLO, HFC. Cable’s Down But Not Out Cable & satellite stocks had been in an uninterrupted run from the depths of the Great Recession until the peak in relative share prices in August 2017. Since then, cord cutting news and the proliferation of on demand streaming services have wreaked havoc on the industry and cable stocks have trailed the market by over 33% from peak to the most recent trough (top panel, Chart 8). Chart 8Cable Signals Are… Cable Signals Are… Cable Signals Are… This deteriorating demand backdrop more than offset the industry’s reaction function, which has been intra and inter-industry M&A. Now that the M&A dust has settled, what is next in store for the industry? We reckon that leading profit indicators are a mixed bag and we continue to recommend a benchmark allocation in this niche communications services subgroup. The top panel of Chart 8 shows that relative outlays on cable are on a slippery slope, and will continue to weigh heavily on relative share prices for the coming quarters. Nevertheless, the ISM services survey ticked higher recently and is on the cusp of making fresh recovery highs, unlike its sibling the ISM manufacturing survey. This is encouraging news for cable executives and suggests that demand for cable services may not be as moribund as the PCE release is projecting (second panel, Chart 9). Chart 9..A Mixed… ..A Mixed… ..A Mixed… While the cable demand backdrop is unclear, industry pricing power has managed to exit deflation. Cable selling prices have been positive for the better part of the past decade, but starting in late-2017 they collapsed by roughly 600bps relative to overall inflation. True, this deflationary impulse dented profit margins, but currently the industry’s selling prices – and to a much lesser extent profit margins – are in a V-shaped recovery mostly courtesy of base effects (middle & bottom panels, Chart 8). Absent a sustained hook up in cable demand, selling price inflation will prove fleeting and the recent margin expansion phase will also lose steam. Meanwhile, cable stocks and the U.S. dollar enjoy a positive correlation as most of the constituents’ earnings are derived domestically (Chart 10). The recent U.S. dollar softness will, at the margin, weigh on relative profits and thus relative share prices, especially if the Fed stays pat and refrains from raising rates for the rest of the year as the bond market currently expects. Chart 10…Bag …Bag …Bag Finally, earnings breadth continues to fall, but relative valuations are still well below the historical mean (third & bottom panels, Chart 9). Netting it all out, cable’s demand headwinds are well reflected in depressed relative valuations at a time when industry pricing power is trying to stage a comeback and a drifting lower greenback may both provide positive profit offsets. Bottom Line: Remain on the sidelines in the S&P cable & satellite index. The ticker symbols for the stocks in this index are: BLBG: S5CBST – CMCSA, CHTR, DISH.   Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com   Footnotes 1      Please see BCA U.S. Equity Strategy Weekly Report, “Dissecting 2019 Earnings” dated January 22, 2019, available at uses.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor value over growth Favor large over small caps

Neutral The battle of the titans of the U.S. media sector for control of Sky PLC was resolved over the weekend, with Comcast emerging victorious, besting 21st Century Fox's bid for the pay-TV firm. While increasing global diversification and a larger distribution channel are good things, we are somewhat skeptical of the victory for two reasons. First, the battle was settled in a blind auction and Comcast's £17.28 offer beat Fox's £15.67 effort by 10% and their own previous £12.50, made in February, by 38%. This could imply some vastly greater synergies identified over the past 7 months and more than Fox, which already owned 39% of Sky. However, it more likely is an extremely expensive tactic to block Disney, who has already pledged to buy Fox's existing stake, which doesn't bode well for the durability of the goodwill acquired. Our second hesitation with this deal is related to its composition, namely all-cash. We estimate an incremental U.S. $47 billion of net debt added to Comcast's balance sheet but analysts estimate Sky will generate only U.S. $3.8 billion of EBITDA next year, suggesting the index's deleveraging is reversing course. This increased risk has clearly been reflected by Comcast investors, who have wiped 6.5% off the stock's market cap. Bottom Line: We think this deal may be the strategic best case for Comcast but is tremendously expensive. Given that it has already been reflected in the stocks, our neutral recommendation remains unchanged. Sky-High Deals In Cable Sky-High Deals In Cable

Neutral The specter of Netflix, as well as other tech giants circling the space, has accelerated an inter- and intra-industry consolidation (second panel). We were well positioned for this shake up in the space as we went underweight the media complex in early March. But now, we deem that the easy money has been made and most of the negative narrative is reflected in bombed out relative valuations (bottom panel). While our sense is that pipelines (S&P cable & satellite index) are the likely losers and content providers (S&P movies & entertainment) are the likely winners from the ongoing broad media deck reshuffling, the way we are executing the S&P media upgrade to neutral is by lifting both the S&P cable & satellite and S&P movies & entertainment sub-indexes to neutral. Bottom Line: We booked relative profits of 13.5% in the S&P cable & satellite index and a relative loss of 8.3% on the S&P movies & entertainment index when we moved both to a benchmark allocation on Monday. Please see our Weekly Report for more details. The ticker symbols for the stocks in the S&P cable & satellite and S&P movies & entertainment indexes are: BLBG: S5CBST - CMCSA, CHTR, DISH and BLBG: S5MOVI - DIS, FOXA, FOX, VIAB, respectively. New Media Landscape New Media Landscape

Highlights Portfolio Strategy Selling in the S&P cable & satellite index is overdone. Recession type valuations fully reflect the acquirer discount heavyweight CMCSA is still commanding. Lift exposure to neutral. Content providers' assets are highly coveted, and these firms remain in play as media is undergoing a tectonic shift. The industry's demand backdrop is also on the rise, signaling that it no longer pays to underweight the S&P movies & entertainment index. Increasing construction expenditures, ballooning balance sheets, soft relative selling prices and a rising U.S. dollar all suggest that restaurant profits will underwhelm. Downgrade to underweight. Recent Changes Raise the S&P cable & satellite index to neutral today. Lift the S&P movies & entertainment index to a benchmark allocation today. Act on the downgrade alert and trim the S&P restaurants index to underweight today. Table 1 Has The Reward/Risk Tradeoff Changed? Has The Reward/Risk Tradeoff Changed? Feature Geopolitical risks held equities hostage last week as President Trump toughened his tariff rhetoric toward China. While the risk of a global trade spat remains acute, the market is becoming desensitized to daily trade-related headlines and remains resilient. Given the plethora of political risks and upcoming midterm elections, I look forward to hearing Greg Valliere's keynote speech in BCA's Toronto Investment Conference on September 24-25. Importantly, last week rising protectionism along with "Three Policy Puts Going Kaput" compelled BCA's Global Investment Strategy service to turn more cautious toward global risk assets over its 6 to 12 month cyclical horizon, prompting them to downgrade global equities from overweight to a neutral stance.1 We have sympathy for this view and acknowledge that the risks to our still sanguine U.S. equity market view, which we have been flagging in recent publications, have increased a notch. We are especially worried about the greenback's appreciation and increasing potential to infiltrate SPX EPS in calendar 2019 (please see Chart 2 and Chart 4 from the June 4th Weekly Report). Given that technology has the highest foreign sales exposure (58% of total sales) among GICS1 sectors, and a 26% market cap weight, we are closely monitoring leading indicators for tech profits. Indeed, for calendar 2019 the S&P tech sector's contribution to S&P 500 profit growth is the highest at 21%, with financials right on its tail at 20% (Chart 1). Energy sector EPS base effects are filtered out in 2019, but industrials, that have a 37% foreign sales exposure and are at the epicenter of President Trump's tariff rhetoric, also explain 13% of SPX EPS growth in calendar 2019 (Chart 1). Chart 1Contribution To S&P 500 2019 EPS Growth Has The Reward/Risk Tradeoff Changed? Has The Reward/Risk Tradeoff Changed? In fact, over a structural (2-3 year) time horizon we are aligned with BCA's more bearish equity outlook. We have been advocating this longer term thesis in our travels visiting BCA clients (please download our latest marketing slide deck here that highlights our bearish secular equity market view). Importantly, the three signposts we are monitoring to help us time the end of the business cycle, and thus equity bull market, are: a yield curve inversion (leading indicator), doubling in year-over-year oil prices based on monthly dataset (coincident indicator) and a mega-merger announcement either in tech or biotech space (confirming anecdotal indicator). There are currently no ticks in any of these three boxes, and we conclude that the S&P 500 has yet to peak for the cycle (Chart 2). Crucially, the Fed is inflating a massive bubble by staying too easy for too long. It is rather obvious to us that the U.S. economy is firing on all cylinders with real non-residential investment growing near 10% in Q1, but the real fed funds rate is still near the zero line (Chart 3). In addition, recent Fed minutes signaled that the Fed is willing to take some inflation risk, which will further push equity markets into steeper disequilibrium. It would be unprecedented for the cycle to end with the real fed funds rate glued to zero (Chart 3). Chart 2Recession Indicators Recession Indicators Recession Indicators Chart 3Real Fed Funds Rate Is Still Zero! Real Fed Funds Rate Is Still Zero! Real Fed Funds Rate Is Still Zero! Moreover, the U.S. economy just received a two year fiscal stimulus injection which is rare in both duration and magnitude during the late stages of the expansion and thus inherently inflationary. Worrisomely, the last time this happened was in the mid-to-late 1960s that led to the inflationary 1970s (please see Chart 1 and Table 2 from our October 9th "Can Easy Fiscal Offset Tighter Monetary Policy?" Weekly Report). Tack on the starting point of a World War-like debt-to-GDP ratio and the only regulatory mechanism for government profligacy is the bond market (Chart 4). Chart 4Interest Rates Have Nowhere To Go But Up Interest Rates Have Nowhere To Go But Up Interest Rates Have Nowhere To Go But Up Another way to make the debt arithmetic work is if one believes the White House's real GDP projections of 3%+ as far as the eye can see, which stand in marked contrast to the IMF's, the CBO's and the Fed's own projections (Chart 5). Therefore, the path of least resistance for interest rates is higher as a way to slow down the economy and also rein in debt excesses. Typically, this overheating late in the cycle is synonymous with a blow off phase in equities (Chart 6), before the bottom falls out. Chart 5Don't Believe The White House Don't Believe The White House Don't Believe The White House Chart 6Blow Off Phase Blow Off Phase Blow Off Phase In sum, while BCA downgraded global equities to neutral last week on a cyclical time horizon, we are deviating from the BCA House View and still believe that the S&P 500 will make new all-time highs in absolute terms before the next recession hits. This week we are making a few subsurface changes to the S&P consumer discretionary sector, but we maintain an underweight allocation to this interest rate-sensitive sector. New Media Landscape: (Pipelines Vs. Content Providers) Vs. Netflix At last count Netflix broke into the top 25 largest companies (market cap based) in the S&P 500, and if it keeps up its frenetic pace it is on track to surpass Boeing. While legacy media giants had a chance to scoop up Netflix in the past few years, its current stratospheric valuation makes it uneconomical and nonsensical. Instead, the specter of Netflix, as well as other tech giants circling the space, has accelerated an inter- and intra-industry consolidation (bottom panel, Chart 7). Why? Because Netflix not only went straight to the consumer on a new medium, the internet, and sped up cord cutting, but also blurred industry lines by becoming a content provider producing its own original content in addition to offering third party content. The media landscape is thus still trying to adjust to the Netflix induced "creative destruction" and media executives are scrambling to compete with/protect legacy franchises from Netflix. The recently cleared AT&T/Time Warner merger has intensified the bidding war of remaining crown jewel assets in the legacy content media world. We were well positioned for this shake up in the space as we went underweight the media complex in early March.2 But now, we deem that the easy money has been made and most of the negative narrative is reflected in bombed out relative valuations despite depressed relative profit and sales growth estimates (second & third panels, Chart 7). As a result we recommend lifting exposure back to benchmark in the broad S&P media index. Beyond these industry related intricacies, the macro backdrop is starting to turn in favor of media outfits, warning that it no longer pays to be bearish. Chart 8 shows that relative consumer outlays on media have spiked recently. The implication is that industry revenue growth has more upside. BCA's ad spending indicator also corroborates this firming top line growth message, as does the latest ISM services survey that remains squarely above the 50 boom/bust line on a broad array of measures. Unsurprisingly, this budding demand recovery has translated into a pick up in industry pricing power with our media selling price gauge even surpassing overall inflation. The implication is that media profits could surprise to the upside. Chart 7M&A Frenzy Continues M&A Frenzy Continues M&A Frenzy Continues Chart 8Overlooked Demand Recovery Overlooked Demand Recovery Overlooked Demand Recovery While our sense is that pipelines (S&P cable & satellite index) are the likely losers and content providers (S&P movies & entertainment) are the likely winners from the ongoing broad media deck reshuffling, the way we are executing the S&P media upgrade to neutral is by lifting both the S&P cable & satellite and S&P movies & entertainment sub-indexes to neutral. On the cable front, M&A activity is weighing heavily on relative share prices as index heavyweight Comcast is a possible acquirer of the Murdoch empire assets. However, this bellwether company is not a pure pipeline play and were it to win the FOX-related assets bidding war, it would further diversify its cash flow. Monetizing those assets involves execution risk, especially as the legacy cable business is wrestling with decelerating selling prices and still has to contend with cord cutting (top & middle panels, Chart 9). Encouragingly, the bottom panel of Chart 9 shows that likely all the negative news flow is already baked into compelling relative valuations. With regard to the content providers, not only are some of these assets currently caught up in a bidding war, but every remaining independent content provider is now in play, and deal hungry investment bankers are aggressively pitching M&A to media (and likely other industry) CEOs. Macro headwinds are also morphing into tailwinds for the S&P movies & entertainment group. Consumer confidence is pushing multi decade highs and given the fact that the economy is at full employment any increase in discretionary consumer incomes will likely further boost recreation outlays (Chart 10). Industry pricing power is also expanding at a healthy clip at a time when industry executives are showing labor restraint (Chart 11). If selling prices stay firm on the back of improving demand as we expect, then movies & entertainment profit margins will enter an expansion phase (middle panel, Chart 10). Chart 9Cable's Blues Are ##br##Well Discounted Cable's Blues Are Well Discounted Cable's Blues Are Well Discounted Chart 10Firming ##br##Recreation Outlays... Firming Recreation Outlays... Firming Recreation Outlays... Chart 11And Recovering Operating Metrics##br## Remain Underappreciated And Recovering Operating Metrics Remain Underappreciated And Recovering Operating Metrics Remain Underappreciated None of this rosy outlook is reflected in cyclically low S&P movies & entertainment relative valuations (bottom panel, Chart 10). Bottom Line: Book relative profits of 13.5% in the S&P cable & satellite index since inception and lift to neutral. Boost the S&P movies & entertainment index to a benchmark allocation for a relative loss of 8.3% since the early March inception. As a result the broad S&P media index also commands a neutral weighting. The ticker symbols for the stocks in the S&P cable & satellite and S&P movies & entertainment indexes are: BLBG: S5CBST - CMCSA, CHTR, DISH and BLBG: S5MOVI - DIS, FOXA, FOX, VIAB, respectively. Portion Control In Restaurants Restauranteurs are eternal optimists; at least that is the lesson we take from the National Restaurant Association's Restaurant Performance Index (RPI) which only rarely dips below the expansion line (Chart 12, second panel). However, changes in this overly optimistic sentiment survey are useful as they closely lead the S&P restaurants index's relative performance. This indicator has recently rolled over and we think the timing is right to turn negative on restaurants (Chart 12, bottom panel). The recent evaporation of industry pricing power echoes the RPI's early indications of a downturn (Chart 13, second panel). In view of how tightly it moves with relative industry sales, the growth outlook for restaurants has darkened considerably. The underlying driver of weakening pricing power is the industry's collapsing share of the consumer's wallet over the past two years, which has been at least as destructive to industry growth as the Great Recession (Chart 13, bottom panel). While both relative consumption and sales, which move in lockstep, have been staging a recovery in 2018, they both remain firmly in deflationary territory. Meanwhile, industry wages - the largest input cost - have been expanding above trend for the better part of the past four years (Chart 14, second panel). Though restaurant wage growth has recently slowed considerably it has not been enough to bring our margin proxy out of negative territory, implying sliding relative earnings growth is set to continue (Chart 14, bottom panel). Chart 12Optimism Reigns In Restaurants Optimism Reigns In Restaurants Optimism Reigns In Restaurants Chart 13Falling Pricing Should Weigh On Sales Falling Pricing Should Weigh On Sales Falling Pricing Should Weigh On Sales Chart 14Labor Costs Are A Profit Headwind Labor Costs Are A Profit Headwind Labor Costs Are A Profit Headwind A rising U.S. dollar is an additional profit headwind for this heavily internationally-geared consumer discretionary sub-index. Despite dollar strength offering an input cost tailwind via lower food commodity costs, declining translation of foreign profits will likely swamp those gains. McDonald's and Starbucks, which together represent 80% of the weight of the S&P restaurants index, had 62% and 49%, respectively, of their locations outside the U.S. at the end of last year. To compensate for a tough profit outlook, restaurants have embarked on a construction spending spree that shows no signs of abating (Chart 15, second panel). The predictable result has been a near-doubling of leverage ratios over the past three years (Chart 15, bottom panel). A weak profit backdrop signals that relief from these levels will be hard to find. Chart 15Restaurants Are Binging On Debt Restaurants Are Binging On Debt Restaurants Are Binging On Debt Chart 16Valuations Do Not Reflect Risks Valuations Do Not Reflect Risks Valuations Do Not Reflect Risks Valuations have been treading water at above-normal levels for several years (Chart 16, second and third panels). Perky valuations seem poised for a fall given the cloudy profit outlook and the higher risk premium that recently geared up balance sheets typically command. Bottom Line: Still-high valuations are not supported by falling returns in an increasingly capital intensive industry. Accordingly, we are pulling the trigger on last month's downgrade alert on the S&P restaurants index and moving to an underweight allocation. The ticker symbols for the stocks in this index are: BLBG: S5REST - MCD, SBUX, YUM, DRI, CMG. What Does All This Mean For The S&P Consumer Discretionary Index? Chart 17Stay Underweight Consumer Discretionary Stay Underweight Consumer Discretionary Stay Underweight Consumer Discretionary Despite the S&P media's heavy weighting in the broad consumer discretionary sector, our S&P restaurants downgrade sustains the below benchmark allocation in the S&P consumer discretionary sector. Importantly, the three key factors weighing on this early-cyclical sector we identified in early March remain intact: rising fed funds rate, quantitative tightening and higher prices at the pump (Chart 17). Meanwhile, were we 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 vast majority of consumer discretionary stocks are actually following the typical historical relationship with the Fed's tightening cycle (middle panel, Chart 17). Put differently, the equal weighted S&P consumer discretionary relative share price ratio is indeed following the Fed's historical tightening path (bottom panel, Chart 17). Bottom Line: Earnings underperformance will eventually result in relative share price underperformance. Stay underweight the S&P consumer discretionary index. Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com 1 Please see BCA Global Investment Strategy Special Report, "Three Policy Puts Go Kaput: Downgrade Global Equities To Neutral," dated June 19, 2018, available at gis.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 Favor large over small caps

Underweight (Upgrade Alert) The narrative for the S&P cable & satellite index this year has been an ongoing (and accelerating) loss of share of the consumer's wallet (second panel) as over-the-top providers continue to steal customers. The subscriber losses in the industry are perhaps best evidenced by the divergence of rising prices and falling revenues (third panel). The reaction has been explosive vertical acquisitions between content providers and delivery; this week's failure of the Department of Justice to block AT&T's bid to acquire Time Warner stands as tacit approval of more of the same. Though it may be counterintuitive, we are softening our stance on the S&P cable & satellite index. Merger mania and fears of a balance sheet blowout have decimated the index's relative performance over the past year (top panel), which is now fully reflected in rock bottom valuations (bottom panel). While more shoes may drop in the bidding wars to come, we think we are very close to the worst being priced in. Accordingly, we are adding an upgrade alert to the S&P cable & satellite index to protect the 16% relative gains we have made since our underweight recommendation earlier this year. The ticker symbols for the stocks in the cable & satellite index are BLBG: S5CBST - CMCSA, CHTR, DISH. Acquisitions Go Vertical In Cable Acquisitions Go Vertical In Cable

Underweight The S&P cable & satellite index was under intense pressure last week as the quarterly release of subscriber churn numbers for the constituent companies came out worse than expected. In particular, CHTR saw its stock fall by nearly 12% when it reported a subscriber loss nearly triple what analysts had forecast. Cord cutting is far from a new theme and investors have grown accustomed to subscriber losses, though the trend clearly appears to be accelerating. This is in spite of price inflation, which had been the savior of cable & satellite P&L's last year, falling off a cliff (bottom panel). The logical conclusion is to expect continued top line declines and margin contraction amplifying the downward trend for sector earnings. With the broad market posting prime time earnings, the S&P cable & satellite index should be moving to an unappealing slot; stay underweight. The ticker symbols for the stocks in the cable & satellite index are BLBG: S5CBST - CMCSA, CHTR, DISH. Cable And Satellite Are Coming Unplugged Cable And Satellite Are Coming Unplugged

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

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).