Sectors

In late-January we put on a market, sector and subindustry neutral trade preferring homebuilders to home improvement retailers (HIR) as a way to benefit from the increase in residential construction at the expense of residential investment. This trade moved in the black from the get-go and is now generating alpha to the tune of 10% since inception, but more gains are in store in the coming months. President Trump’s hawkish tariff rhetoric should keep interest rates at bay, at least for a short while, and bond market nervousness is more of a boon to homebuilders than to HIR (top panel). The drop in the price of mortgage credit along with minor price concessions from homebuilders are causing sales of new homes to take off versus existing home sales (middle panel). Granted, bankers remain willing extenders of residential loans and the latest Fed Senior Loan Officer Opinion Survey revealed that demand for residential credit is making a comeback following a near yearlong decline (not shown). As a result, relative loan growth metrics also underpin the relative share price ratio (bottom panel). Bottom Line: Stick with a long S&P homebuilders/short S&P HIR pair trade and please see Monday’s Weekly Report for more details. The ticker symbols for the stocks in the S&P homebuilding and S&P HIR indexes are: BLBG: S5HOME – PHM, DHI, LEN and BLBG: S5HOMI – HD, LOW, respectively. Stick With Home Builders Over Home Improvement Retailers Stick With Home Builders Over Home Improvement Retailers    

While we remain bullish on global equities and other risk assets over 12 months, we went tactically short the S&P 500 last Friday following the market’s complacent reaction to the Trump Administration’s further tariffs increases on Chinese imports. While a moderate trade war would still produce more economic damage than standard economic models imply, this would be greatly mitigated by significant Chinese economic stimulus and a Fed that is in no hurry to raise rates and could even cut rates. Barring any further major developments, we recommend investors start increasing risk exposure if the S&P 500 falls to 2711. A dip in global bourses would also create an opportunity to go overweight EM/European equities. Favor gold over government bonds as a low-cost hedge against trade war risks for now.

A High-Octane Pair Trade Idea A High-Octane Pair Trade Idea While health care and tech stocks started the year on a similar footing, a wide gulf has opened that is likely to, at least partially, reverse in the back half of the year. This dichotomy is most evident at the subsector level where managed health care stocks are still down in absolute terms for the year, whereas chip stocks are up roughly 20% year-to-date. This is an exploitable gap and on Monday, we suggested a new pair trade: long S&P managed health care/short S&P semiconductors. With regard to relative macro drivers, managed health care has the upper hand. The chart at the side shows that relative demand dynamics clearly favor HMOs and are working against chip stocks. Non-farm payroll growth is trouncing global semi billings (second panel). The message from the small business sector is similar with the labor market upbeat compared with declining global semi revenues (third panel). Finally, on the relative pricing power gauge front, overall wage inflation is outpacing DRAM prices (bottom panel). Bottom Line: We initiated a long S&P managed health care/short S&P semis pair trade on Monday with a stop loss at the -7% mark; please see Monday’s Weekly Report for more details. The ticker symbols for the stocks in the S&P managed health care and S&P semi indexes are: BLBG: S5MANH – UNH, ANTM, HUM, CNC, WCG and BLBG: S5SECO – INTC, AVGO, TXN, NVDA, QCOM, MU, ADI, XLNX, AMD, MCHP, MXIM, SWKS, QRVO, respectively.

Highlights The trade war escalation is just the catalyst and not the cause of the market correction. This year’s absolute double-digit returns have most likely already been made during the early-2019 star alignment of near-perfect conditions for investors. The remainder of the year is likely to be a much tougher going for all the major asset-classes. Short a 30:60:10 portfolio of equities, bonds, and oil, setting the profit target and stop-loss at 3 percent. In the second half of the year, the big story will be sector rotation. Healthcare is likely to flip from underperformer to outperformer versus technology. Given their sector skews, it follows that European equities are likely to outperform Chinese equities. Feature A star alignment of near-perfect conditions lifted the entire financial market complex in the early part of the year. For investors, pretty much everything that could go right did go right! (Chart of the Week). Chart of the WeekIn Near-Perfect Conditions, European Equities Performed Very Well... But Chinese Equities Performed Even Better In Near-Perfect Conditions, European Equities Performed Very Well... But Chinese Equities Performed Even Better In Near-Perfect Conditions, European Equities Performed Very Well... But Chinese Equities Performed Even Better The Federal Reserve stopped hiking interest rates; the ECB and other major central banks also pivoted to dovish; Brexit was delayed; the Italy versus Brussels spat over fiscal policy de-escalated; the drag from new emissions standards on German auto production eased; the trade war threat seemed to recede; and crucially, economic activity accelerated sharply (more about this later). A Rare Star Alignment… Which Cannot Last There was another rare star alignment: equities, bonds, and crude oil generated simultaneous strong rallies (Chart I-2). Such a star alignment is almost unheard of, because there are no set of economic circumstances that should benefit all three asset-classes at the same time. For example, if the oil price surge is inflationary – or at least less deflationary – then it should hurt bonds; if the surge is deflationary on real demand, then it should hurt equities. Equities, bonds, and oil should not surge together. Equities, bonds, and oil should not surge together, and on the extremely rare occasions they do, the simultaneous rally soon breaks down. Consider a €100 investment portfolio consisting of €30 equities, €60 long-dated bonds, and €10 crude oil. At the start of this year, the portfolio returned 10 percent in just three months. This is extremely rare, and has happened on only two other occasions in the past 25 years, in 2009 and 2016 (Chart I-3). Chart I-2A Rare Star Alignment:##br## Equities, Bonds, And Oil Surged ##br##Simultaneously A Rare Star Alignment: Equities, Bonds, And Oil Surged Simultaneously A Rare Star Alignment: Equities, Bonds, And Oil Surged Simultaneously Chart I-3A Rare Star Alignment: A 30:60:10 Portfolio of Equities: Bonds: Oil Gained 10 Percent In 3 Months A Rare Star Alignment: A 30:60:10 Portfolio of Equities: Bonds: Oil Gained 10 Percent In 3 Months A Rare Star Alignment: A 30:60:10 Portfolio of Equities: Bonds: Oil Gained 10 Percent In 3 Months On both previous occasions, the simultaneous rally broke down, and the portfolio went on to lose a large chunk of its 10 percent gain. Hence, at our quarterly webcast last week, we initiated a new investment recommendation: to short a 30:60:10 portfolio of equities, bonds, and oil, setting the profit target and stop-loss at 3 percent.1 When conditions are perfect, they are vulnerable to the tiniest setback. But the vulnerability emanates from the fragility of the perfect conditions, and not the precise setback. As an analogy, visualize a tree bedecked in its beautiful foliage in the autumn, and imagine you gently shake the tree. The gentlest of shakes will make the leaves collapse. At first glance, your shake caused the collapse, but in truth, your shake was just the catalyst; the underlying cause was the fragility of the autumnal foliage. Another catalyst, say a puff of wind, could have equally triggered the same collapse. When conditions are perfect, they are vulnerable to the tiniest setback. The re-escalation of the trade war has dominated the recent column inches and investment analyst missives. But just like the gentle shake of the tree, it is just a catalyst for the market correction. The underlying cause was that the simultaneous and strong rallies in all financial assets, based on a star alignment of near-perfect conditions, was vulnerable to the first blemish to the perfection. And the blemish could have been anything. Economic Activity Has Undoubtedly Accelerated… One of the things that drove up equity markets was the acceleration in economic activity. This acceleration is beyond doubt: euro area GDP prints show that growth picked up to 1.6 percent in the first quarter of 2019 from a low of 0.6 percent in the third quarter of 2018 (Chart I-4). Given the openness of the euro area economy, it is inconceivable that this growth pick-up does not reflect a more generalized acceleration in global activity.2 Chart I-4Euro Area GDP Growth Accelerated To 1.6 Percent Euro Area GDP Growth Accelerated To 1.6 Percent Euro Area GDP Growth Accelerated To 1.6 Percent The trouble is that we do not receive these GDP prints in real-time. From the mid-point of the quarter to which the GDP prints refer to their release date around one month after the quarter end, there is a two and a half month delay. To proxy activity in real-time, we must look at current activity indicators (CAIs) which gauge GDP growth, but are available without much of a delay. While several such indicators exist, we have found that the ZEW economic sentiment indicator (not to be confused with the current situation indicator) does the job extremely well in real-time. Current activity indicators do not help equity investors. Having said that, current activity indicators do not help equity investors. The simple reason is that the equity market is a current activity indicator itself, and it would be absurd to expect one CAI to predict another CAI! In fact, the best current activity indicator is not the equity market taken as a whole. This is because the aggregate equity market can move as a result of drivers other than current economic activity, most notably central bank policy. Therefore, it turns out that the very best current activity indicator is found within the equity market: specifically, the performance of economically sensitive equity sectors – such as industrials and financials – relative to the aggregate market (Chart I-5 and Chart I-6). Both this and the ZEW economic sentiment indicator confirm that economic activity has accelerated sharply since late last year, but has suffered a slight setback in the last month. Chart I-5The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors Chart I-6The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors The Best Current Activity Indicator Is The Relative Performance Of Economically Sensitive Equity Sectors …But Can The Acceleration In Economic Activity Continue? To be crystal clear, let’s repeat the crucial point. Economically sensitive investments do not move on the level of GDP growth; economically sensitive investments move on the real-time change in GDP growth. The simple reason is that profits growth is highly leveraged to economic growth. Hence when GDP growth picks up, the embedded ‘g’ used to calculate the present value of the investment rises very sharply, which means that today’s price also rises very sharply; and vice versa when GDP growth declines. But once GDP growth stabilizes, even at a high level, there is no further meaningful change in ‘g’, or in the price. For any remaining sceptics, Chart I-7 shows that for many years, the big moves in the Euro Stoxx 50 have resulted from the changes in euro area GDP growth.   Chart I-7The Euro Stoxx 50 Moves On Changes In GDP Growth The Euro Stoxx 50 Moves On Changes In GDP Growth The Euro Stoxx 50 Moves On Changes In GDP Growth   It follows that what investors really need is not a current activity indicator, but a future activity indicator (FAI). If investors could reliably predict the change in economic activity, then they could also reliably allocate between economically sensitive and defensive investments, as well as to the equity market as a whole.   We have found that a future activity indicator for Europe would contain three components: The domestic 6-month credit impulse. The international 6-month credit impulse, and specifically the 6-month credit impulse in China given the large volume of European exports that head to the largest emerging economy. The crude oil price 6-month impulse, where a price decline constitutes a positive impulse given Europe’s dependence on energy imports. Chart I-8The Drivers Of Europe's Future Activity Indicator Are Losing Momentum The Drivers Of Europe's Future Activity Indicator Are Losing Momentum The Drivers Of Europe's Future Activity Indicator Are Losing Momentum Today, we find that the 6-month credit impulse both in the euro area and in China have lost momentum; meanwhile, given the rebound in the oil price, the crude oil price 6-month impulse has clearly faded (Chart I-8). Hence, our future activity indicator suggests that in the second half of this year, euro area GDP growth is unlikely to accelerate much from the current 1.5-2 percent clip.  For investors, this means that this year’s absolute double-digit returns have most likely already been made during the early-2019 star alignment of near-perfect conditions. And the remainder of the year is likely to be much tougher going for all the major asset-classes.  Still, there are always double-digit returns to be found somewhere in the investment landscape. In the second half of the year, the big story will be sector rotation. For example, in recent reports, we highlighted that healthcare is likely to flip from underperformer to outperformer versus technology. Given their sector skews, it follows that European equities are likely to outperform Chinese equities. Fractal Trading System* This week’s recommended trade is based on an oddity. While the majority of stock markets have suffered corrections, New Zealand’s NZX 50 has escaped relatively unscathed so far, making it vulnerable to a corrective underperformance one way or another. Hence, short the NZX 50 versus the FTSE100, and set the profit target and stop-loss at 2 percent. In other trades, short China versus Japan quickly achieved its profit target. Long Nikkei 225 versus Hang Seng was also closed in profit at the end of the 65 day maximum holding period. Against these two profitable trades, long SEK/NOK was closed at its stop-loss. This leaves the Fractal Trading System with four open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment’s fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-9 NZX 50 VS. FTSE100 NZX 50 VS. FTSE100 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. *  For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com. Dhaval Joshi, Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 The precise mix of the portfolio is 29% MSCI World $, 29% German 30-year bund, 29% U.S. 30-year T-bond, 13% WTI. Please see a replay of the webcast ‘From Sweet Spot to Weak Spot’ available at eis.bcaresearch.com. 2  Quarter-on-quarter real GDP growth at annualized rates. Fractal Trading System Recommendations Asset Allocation Equity Regional and Country Allocation Equity Sector Allocation Bond and Interest Rate Allocation Currency and Other Allocation Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields   Interest Rate 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 Firming relative demand and input cost dynamics, the Medicare For All (MFA)-induced panic selling in HMOs coupled with 5G euphoria buying in semis have set the stage for an exploitable pair trade opportunity: long S&P managed health care/short S&P semiconductors. Relative supply/demand dynamics, crumbling lumber prices, lower interest rates and compelling valuations and technicals all suggest that the long homebuilding/short home improvement retail pair trade is in the early innings. Recent Changes Initiate a long S&P managed health care/short S&P semiconductors trade today, with a tight stop loss at -7%. Table 1 On Edge On Edge Feature Equities hit a speed bump last week, as President Trump’s trade related tweets instilled some fear back into the markets. Investor complacency reigned supreme and, given the liquidity crunch, risk premia exploded higher with the VIX more than doubling from the recent lows. Historically, a parabolic rise in policy uncertainty is synonymous with an equity market selloff and a widening in risk premia; last week was no different (economic policy uncertainty shown inverted, second panel, Chart 1). Adding insult to injury, given that the forward P/E multiple expansion explained all of the equity market’s advance year-to-date as we highlighted three weeks ago, the trade-related melt up in policy uncertainty caused a mini meltdown in the forward multiple as financial conditions tightened (financial conditions shown inverted, third panel, Chart 1). The implication is that short-term equity market caution is still warranted as we have been writing over the past few weeks, at least until the U.S./China trade dispute dust settles. Chart 1Caution Still Warranted Caution Still Warranted Caution Still Warranted Chart 2Tenuous Trio Tenuous Trio Tenuous Trio The recent simultaneous rise of three asset classes, that we call “the tenuous trio”, warned that something had to give: stocks, bond prices and the trade-weighted U.S. dollar cannot all go up in tandem for an extended period of time. When this happens it is typically a forewarning of an equity market snap (Chart 2). One simple explanation is that a rising greenback comes back and haunts equities via a negative P&L hit, albeit with a lagged effect. Irrespective of where the U.S. dollar will move in the coming months, it will continue to weigh on EPS as the surge in the greenback took root from April to November last year. Thus, with a six-to-nine month lag it will continue to infiltrate EPS and Q2 – which the sell-side already expects to barely breach year ago levels – will also feel the U.S. dollar’s wrath. Were the dollar to continue its ascent from current levels, it would put in jeopardy the back half of this year’s EPS growth numbers, especially Q4/2019 that sell-side analysts forecast to jump to 8%, according to I/B/E/S data. This week we recommend putting on a new pair trade involving an unloved health care subgroup and a mighty tech sector subindex but with a tight stop, and also update an intra-consumer discretionary market-neutral housing-levered pair trade. Importantly, the 12-month forward EPS number is artificially rising. Chart 3 shows that calendar 2019 and 2020 EPS estimates continue to build a base, but the 12-month forward number has been rising since early-February. What explains the increase in the 12-month forward estimate is arithmetic. In other words, despite a multi-month downgrading of calendar 2019 and 2020 EPS, the first two quarters of next year are forecast to come in significantly higher than 2019’s first six months. As the latter roll off and the former get added to the 12-month forward EPS number, a deceiving jump occurs. For next year, we continue to expect $181 EPS, and we would lean against the double-digit EPS growth in 2020 that the sell-side currently forecasts. Our top down macro S&P 500 EPS model softened anew recently, warning that mid-single digit growth, at best, is more likely than low double-digit growth (Chart 4).   Chart 3Artificial EPS Rise Artificial EPS Rise Artificial EPS Rise Chart 4SPX Macro EPS Model Forecasts Softness SPX Macro EPS Model Forecasts Softness SPX Macro EPS Model Forecasts Softness Finally, one of the tech sector’s invincible subgroups is cracking with the S&P semis relative performance hitting a wall both versus the broad market ex-TMT and versus the NASDAQ 100. This is significant not only from a sentiment perspective, but also because semis have high international sales exposure in general and China in particular (Chart 5). Chart 5Vertigo Warning Vertigo Warning Vertigo Warning This week we recommend putting on a new pair trade involving an unloved health care subgroup and a mighty tech sector subindex but with a tight stop, and also update an intra-consumer discretionary market-neutral housing-levered pair trade. New High-Octane Pair Trade Idea While health care and tech stocks started the year on a similar footing, a wide gulf has opened that is likely to, at least partially, reverse in the back half of the year. This dichotomy is most evident at the subsector level where managed health care stocks are still down in absolute terms for the year, whereas chip stocks are up roughly 20% year-to-date (Chart 6). This is an exploitable gap and today we suggest a new pair trade: long S&P managed health care/short S&P semiconductors. Chart 6Exploitable Reversal Looms Exploitable Reversal Looms Exploitable Reversal Looms Bernie Sanders’ revamped MFA bill sent the managed health care group to the ER. While there is heightened uncertainty surrounding MFA and we are working on a joint Special Report with our sister Geopolitical Strategy service due on June 3rd, this is likely a 2022 story. Not only will Sanders have to win the Democratic candidacy and subsequently the Presidential election, but also the GOP would have to lose the Senate. This is an extremely low probability event that has dealt a massive blow to HMO stocks. On the flip side, semis are priced for perfection. The recent catalyst for this group’s stratospheric rise was Apple’s patent settlement with Qualcomm that set in motion a 5G-related euphoria. Again 5G is a late-2021 story and a lot of good news is already priced in to semis stocks. Moreover, historically, semi cycles last four-to-five quarters and investors’ neglect of the semi downcycle is puzzling as we have recently concluded just two down quarters. Explicitly, what is truly baffling is that 12-month forward EPS are slated to contract in absolute terms and forward sales are hovering near the zero line, yet the Philly SOX index recently vaulted to all-time highs. Taken together, we would lean toward health care insurers at the expense of semiconductor stocks. Netting it all out, relative demand and input cost dynamics, the MFA-induced panic selling in HMOs coupled with 5G euphoria buying in semis have set the stage for an exploitable pair trade opportunity: long S&P managed health care/short S&P semiconductors. With regard to relative macro drivers, managed health care has the upper hand. Chart 7 shows that relative demand dynamics clearly favor HMOs and are working against chip stocks. Non-farm payroll growth is trouncing global semi billings. The message from the small business sector is similar with the labor market upbeat compared with declining global semi revenues. Finally, on the relative pricing power gauge front, overall wage inflation is outpacing DRAM prices. On all three fronts, the message is to expect a mean reversion higher in the relative share price ratio. Chart 7Buy Managed Health Care… Buy Managed Health Care… Buy Managed Health Care… Chart 8…At The Expense… …At The Expense… …At The Expense… Input cost/inventory dynamics suggest that HMOs also have the advantage. The health care insurance employment cost index is growing on a par with inflation, but semi industry employment is climbing at a rate over 5%/annum (bottom panel, Chart 8). Taking stock of medical cost inflation, costs are still melting, however global semi inventories are expanding. The upshot is that relative share prices have ample upside (middle panel, Chart 8). Finally, the previous relative valuation overshoot has returned to the neutral zone and, encouragingly, relative technicals are probing multi-year lows near one standard deviation below the historical mean. Importantly, over the past two decades every time our Technical Indicator has hit such a depressed level, a playable rebound in relative share prices has ensued (bottom panel, Chart 9). Chart 9…Of… …Of… …Of… Chart 10…Semis …Semis …Semis Nevertheless, this highly volatile market-neutral trade faces one big risk we previously alluded to: relative profit expectations are extended. In other words, the bombed out S&P semiconductor forward EPS and revenue projections are masking the relative profit and revenue backdrop (Chart 10). Netting it all out, relative demand and input cost dynamics, the MFA-induced panic selling in HMOs coupled with 5G euphoria buying in semis have set the stage for an exploitable pair trade opportunity: long S&P managed health care/short S&P semiconductors. Bottom Line: Initiate a long S&P managed health care/short S&P semis pair trade today with a stop loss at the -7% mark. The ticker symbols for the stocks in the S&P managed health care and S&P semi indexes are: BLBG: S5MANH – UNH, ANTM, HUM, CNC, WCG and BLBG: S5SECO – INTC, AVGO, TXN, NVDA, QCOM, MU, ADI, XLNX, AMD, MCHP, MXIM, SWKS, QRVO, respectively. Homebuilding/Home Improvement Retail Pair Trade Update In late-January we put on a market, sector and subindustry neutral trade preferring homebuilders to home improvement retailers (HIR) as a way to benefit from the increase in residential construction at the expense of residential investment. This trade moved in the black from the get-go and is now generating alpha to the tune of 7% since inception, but more gains are in store in the coming months. President Trump’s hawkish tariff rhetoric should keep interest rates at bay, at least for a short while, and bond market nervousness is more of a boon to homebuilders than to HIR (top panel, Chart 11). The drop in the price of mortgage credit along with minor price concessions from homebuilders are causing sales of new homes to take off versus existing home sales (middle panel, Chart 11). Granted, bankers remain willing extenders of residential loans and the latest Fed Senior Loan Officer Opinion Survey revealed that demand for residential credit is making a comeback following a near yearlong decline (not shown). As a result, relative loan growth metrics also underpin the relative share price ratio (bottom panel, Chart 11). Chart 11Still In Early Innings Still In Early Innings Still In Early Innings In sum, relative supply/demand dynamics, crumbling lumber prices, lower interest rates and compelling valuations and technicals all suggest that the long homebuilding/short HIR pair trade is in its early innings. Importantly, the new/existing home sales–to-inventory ratio is an excellent leading indicator of relative share prices and is currently emitting an unambiguously bullish signal for homebuilders at the expense of HIR (Chart 12). Chart 12Supply/Demand Backdrop Says Stick With This Pair Trade Supply/Demand Backdrop Says Stick With This Pair Trade Supply/Demand Backdrop Says Stick With This Pair Trade Chart 13Relative Sales ##br##Expectations… Relative Sales Expectations… Relative Sales Expectations… Examining the relative demand backdrop reveals that homebuilders will continue to outshine HIR. Current readings in the NAHB home sales survey versus the remodeling survey and future expectations both point to more gains in the relative share price ratio (Chart 13). The felling in lumber prices also represents a benefit to homebuilders to the detriment of HIR. Lumber is a key building input cost in new home construction so any price liquidation is a boon for homebuilding margins. In contrast, HIR makes a set margin on lumber sales, therefore deflating lumber prices cut HIR profits (Chart 14). Chart 14…Felling Lumber Prices And … …Felling Lumber Prices And … …Felling Lumber Prices And … Chart 15…Bombed Out Valuations Signal More Relative Share Price Gains …Bombed Out Valuations Signal More Relative Share Price Gains …Bombed Out Valuations Signal More Relative Share Price Gains Finally, on the relative valuation and technical fronts, there is anything but froth. In fact, the relative price to book ratio is perched near an all-time low and relative momentum has only recently troughed and has yet to reach the neutral zone (Chart 15). In sum, relative supply/demand dynamics, crumbling lumber prices, lower interest rates and compelling valuations and technicals all suggest that the long homebuilding/short HIR pair trade is in its early innings.       Bottom Line: Stick with a long S&P homebuilders/short S&P HIR pair trade. The ticker symbols for the stocks in the S&P homebuilding and S&P HIR indexes are: BLBG: S5HOME – PHM, DHI, LEN and BLBG: S5HOMI – HD, LOW, respectively.   Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com   Current Recommendations Current Trades Size And Style Views Favor value over growth Favor large over small caps

Overweight (Downgrade Alert) When we moved to an overweight recommendation on the S&P airlines index in the fall of last year, we noted three pillars supporting the onset of an earnings outperformance: a drubbing in oil prices significantly lowered the key input cost while rebounding consumer spending supported higher ticket prices and soaring consumer confidence encouraged expanding volumes.  The latter two of these pillars remain robust (third and bottom panels) while the former has given up much of its benefit (jet fuel shown inverted, second panel).  Intense Competition Hurts Airlines Intense Competition Hurts Airlines We had further noted that the major carriers had shelved plans to expand their domestic capacity which reduced the risk of a profit-destroying fare war. However, news reports have been highlighting intensifying competition on the key domestic transcontinental market, driven by excess capacity being deployed by all major transcon carriers. The Wall Street Journal reported this week that the premium cabin on these routes was selling for as little as 20% of the transatlantic fare. While passengers should be celebrating, investors should take a much dimmer view of this level of discounting. Bottom Line: Though consumer confidence remains near all-time highs, rising fuel prices and fare competition could put our S&P airlines relative earnings outperformance thesis offside. We are adding a downgrade alert to our overweight recommendation today. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, UAL, AAL and ALK.    

Protect Gains In Software Protect Gains In Software ​​​​​​​Overweight (High conviction) We have had a high conviction overweight recommendation on the S&P software index since the end of 2017 and the position has made handsome returns in excess of 27% since its inception. The macro view continues to support our bullish stance on the index as capital outlays on software have sustained their double-digit increases in 2019 (middle panel). Considering the tight correlation between capital outlays on software and industry profitability (bottom panel), the inference is that profit growth is set to reaccelerate. Nonetheless, as highlighted in yesterday’s Insight report, rising policy uncertainty and investor complacency sustained our cause for concern for the broad market, on a tactical perspective. Accordingly, this morning we suggest that clients institute a stop in this high-conviction call at the 17% relative return mark. We believe this is an appropriate risk management policy in our cyclically positive view on the S&P software index as rising odds of a material SPX drawdown could have outsized impacts on this relative high-flyer. Bottom Line: We reiterate our high-conviction overweight recommendation on the S&P software index, but recommend a 17% stop. The ticker symbols for the stocks in this index are: BLBG: S5SOFT – MSFT, ORCL, ADBE, CRM, INTU, ADSK, RHT, CDNS, SNPS, ANSS, SYMC, CTXS, FTNT.