Utilities

In early-April we upgraded the S&P utilities sector to a tactical (1-3 month) overweight courtesy of five key drivers that have now largely played out (please see our Weekly Report of April 3, 2017 for more details). As a result, we are booking modest profits and downgrading to a benchmark allocation. The composite ISM export index and our U.S. capex indicator, both indicators that have historically varied inversely with the utilities sector, have catapulted higher recently (second & third panels). Meanwhile, electricity production growth has crested and natural gas price inflation has rolled over, suggesting that pricing power gains have peaked. In sum, utilities leading profit indicators have crested and all five of the driving forces behind our tactical overweight recommendation have largely transpired. Downgrade to neutral. Book Profits In Utilities Book Profits In Utilities

Highlights Portfolio Strategy The latest wobble in the financials sector is a buying opportunity, with the exception of the defensive insurance index. Our tactical overweight in utilities has played out. Take profits and downgrade to neutral. Weak beverage operating metrics argue for a reduction in premium valuations. We recommend a full downgrade from overweight to underweight. Recent Changes S&P Utilities - Downgrade to neutral, locking in gains of 1% on this tactical position. S&P Soft Drinks - Downgrade to underweight. Table 1 Unfazed Unfazed Feature The S&P 500 remained undaunted in the face of a geopolitical firestorm last week. Instead, vibrant global growth and easy monetary conditions continue to underpin investor confidence in the durability of the earnings upcycle. Our thesis remains intact: a recovery in top-line growth, powered by both volume and pricing power gains, will generate sufficient profit growth to sustain the equity market overshoot. While actual inflation has surprised to the downside, weighing on inflation expectations (bottom panel, Chart 1), this has not translated into a loss of business sector pricing power. Corporate selling prices have diverged markedly from the Fed's preferred measure of inflation (middle panel, Chart 1), reflecting a goldilocks scenario where more restrictive monetary conditions will not impede the path to improved profitability. In recent research we showed that operating leverage in S&P 500 constituents runs at 1.4x. In other words, a 5% increase in sales results in a 7% rise in operating EPS, based on our regression analysis. While every cycle is different, when revenues initially recover from a slump, as is currently the case, operating leverage can be even higher, with profits often outpacing sales by two or even three times. Since mid-December, both the U.S. dollar and 10-year Treasury yields have fallen in tandem. As a result monetary conditions have eased, reversing the tightening that occurred in the second half of 2016. Our U.S. Monetary Indicator (USMI) and momentum in corporate profit margins are perfectly inversely correlated. The recent downswing in the USMI is bullish for S&P 500 margins (USMI shown inverted, bottom panel, Chart 2). True, a fall in bond yields can also be reflective of a deteriorating economy, such that investors should become worried about profitability. However, the stock-to-bond (S/B) ratio is not signaling any trouble ahead. History shows that the time to worry about the bond market's earnings message is when the S/B ratio contracts (see shaded areas, third panel, Chart 3). Chart 1Corporate Pricing Power Reigns Corporate Pricing Power Reigns Corporate Pricing Power Reigns Chart 2Easy Financial Conditions Boost Margins Easy Financial Conditions Boost Margins Easy Financial Conditions Boost Margins Chart 3Goldilocks Equity Scenario Goldilocks Equity Scenario Goldilocks Equity Scenario In addition, part of the decline in long-term interest rates also reflects a slower expected pace of fed funds rate increases. The bond market doubts the FOMC's 2.125% interest rate estimate for 2018, forecasting a fed funds rate roughly 63bps lower. If the bond market is accurate and the Fed recalibrates its 18-month rate outlook even modestly lower later this week, then the S/B ratio has more upside. This week we reiterate our recent financials sector upgrade to overweight, make two tweaks to our portfolio and downshift our defensive exposure another notch. Financials Are At A Critical Juncture Financials stocks have performed as if the U.S. economy is headed for a protracted slowdown, or even recession. Uncertainty with the U.S. Administration's ability to pass bills and enact reforms, a string of U.S. economic disappointments and related yield curve flattening, and sinking inflation expectations have all weighed on relative performance. Rather than extrapolate recent weakness, our inclination is to view the latest wobble as a buying opportunity. A number of forward looking loan growth indicators suggest that credit and capital formation are on an upward trajectory, which will support ongoing profit outperformance. Chart 4 shows that our U.S. capex indicator is an excellent leading indicator of loan growth, with a forty year track record. Soaring confidence implies a more expansionary mindset, and increased demand for external funds (third panel, Chart 4). Similarly, the ISM survey leads loan growth. Both the ISM manufacturing and services surveys are sending a positive signal (fourth panel, Chart 4). Specifically, our sister U.S. Bond Strategy's credit growth model captures all of these positive forces: the recent nascent recovery in bank credit growth should morph into a sustained recovery in the second half of 2017 (bottom panel, Chart 4). Meanwhile, financial conditions have continued to ease, aided by tightening credit spreads, a decline in oil prices, U.S. dollar softness and rise in equity prices (top panel, Chart 5). Easier monetary conditions should ensure that the recovery in overall corporate sector profits stays on track, thereby sustaining both consumer and corporate credit quality at high levels. It is notable that relative performance and the Bloomberg Financial Conditions Index are positively correlated (second panel, Chart 5). Credit quality is already showing signs of improvement: financials sector ratings migration has swung roughly 50 percentage points since last October (second panel, Chart 6). The implication is that reserve building should not become a profit drag over a cyclical investment horizon. Chart 4Credit Growth##br## Will Pivot Credit Growth Will Pivot Credit Growth Will Pivot Chart 5Easy Monetary Conditions ##br##Are A Boon For Financials Easy Monetary Conditions Are A Boon For Financials Easy Monetary Conditions Are A Boon For Financials Chart 6Financials Catch-Up##br## Phase Looms Financials Catch-Up Phase Looms Financials Catch-Up Phase Looms In sum, as long as the global economic expansion persists, as we expect, then the recent inflation expectations-related selloff in the sector should prove transitory. We continue to recommend above-benchmark exposure to areas with leverage to increased capital formation, with one notable exception in the sector's most defensive component: insurance. Continue To Avoid Insurers While financial companies levered to capital formation and credit creation are well positioned to thrive if the U.S. and global economies continue to improve, the same is not true for the broad S&P insurance index. This is a defensive group with a fairly stable recurring revenue stream that typically thrives when the economy is slowing, the yield curve is flattening and the U.S. dollar is on an upward trajectory. Relative performance has edged higher in concert with the recent yield curve flattening, but as detailed above, we don't expect the latter to continue. Ergo, the only external support for the group is likely to crumble, especially now that the U.S. dollar is softening (Chart 7). If the domestically-focused insurance index could not gain traction throughout the latest U.S. dollar bull market, what will happen if a mild currency depreciation occurs? Based on its own merits, the insurance industry likely heads toward a profit soft patch. The ebb and flow of overall business activity drives revenue growth, particularly in the interest rate-sensitive auto and housing sectors. Chart 8 combines sales growth for the latter two sectors into one series, which has recently slipped into negative territory, warning of a similar fate for insurance top-line growth. Consumer spending on insurance products is also contracting relative to total spending (Chart 8), corroborating the cautious message from housing and autos. There are also cracks forming in pricing power. The CPI for motor vehicle insurance remains robust, but that of household tenants insurance has sunk into the deflation zone. If the hard market turns soft, it will further undermine underwriting premium growth. To make matters worse, insurance companies have been on a hiring binge for the past several years. Headcount exploded higher beginning in 2014, and continues to make new highs. Rising cost structures coincided with the downturn in insurance book value growth (Chart 9). Book values have recently started to shrink, with little prospect for a reversal unless labor costs ease and/or underwriting activity revives. As a result, our preference is to focus exposure on non-insurance financials, as insurance remains a high-conviction underweight. Chart 7'Dollar ##br##Trouble' Dollar Trouble' Dollar Trouble' Chart 8Pricing ##br##Power Blues Pricing Power Blues Pricing Power Blues Chart 9Beware The Bull Market ##br## In Insurance Employment Beware The Bull Market In Insurance Employment Beware The Bull Market In Insurance Employment Book Profits In Utilities In early-April we upgraded the S&P utilities sector to a tactical (1-3 month) overweight courtesy of five key drivers that have now largely played out.1 As a result, we are booking profits of 1% and downgrading to a benchmark allocation. The U.S. economy is on the cusp of a capex revival. While Q1/2017 GDP growth was unduly weak, investment spending was a bright spot. Our U.S. Capex Indicator has accelerated sharply, signaling that investment should continue to gain traction. Historically, business spending and utilities relative performance have been inversely correlated (the Capex Indicator is shown inverted, top panel, Chart 10). Similarly, the composite ISM export index has recently catapulted to the highest level since the late-1990s. Should the U.S. dollar continue to depreciate, U.S. exporters will remain busy filling foreign orders. That is a relative performance drag for the domestically-exposed utilities sector (ISM exports shown inverted, bottom panel, Chart 10). Meanwhile, electricity production growth has crested and natural gas price inflation has rolled over, suggesting that pricing power gains have peaked (Chart 11). The implication is that there will be no earnings follow through to support the recent breakout attempt (third panel, Chart 12). Chart 10Capex Revival Is Bearish For Utilities Capex Revival Is Bearish For Utilities Capex Revival Is Bearish For Utilities Chart 11Soft Demand With Weak Selling Prices Soft Demand With Weak Selling Prices Soft Demand With Weak Selling Prices Chart 12Why Pay Up For Lack Of EPS Follow Through? Why Pay Up For Lack Of EPS Follow Through? Why Pay Up For Lack Of EPS Follow Through? Importantly, the total return of the bond-to-stock ratio continues to contract. While both stocks and bond prices have risen in tandem of late, persistent stock market outperformance warns that flows into this fixed income proxy will soon peter out (Chart 12). Thus, in the absence of an earnings acceleration, it will be difficult to sustain premium valuations (bottom panel, Chart 12). In sum, utilities leading profit indicators have crested and all five of the driving forces behind our tactical overweight recommendation have largely transpired. Bottom Line: Execute the downgrade alert and book 1% profits since our tactical overweight of the S&P utilities sector, initiated in early-April. Time To Liquidate Beverage Stocks Consumer staples equities in general and beverage stocks in particular have been stellar outperformers this year. Nevertheless, this strength may prove fleeting in the absence of a revival in relative profit fortunes. Since the mid-1990s, relative performance has followed the ebb and flow of relative forward profit estimates. However, a gap has opened, as analyst estimates have continued to drift lower as share prices have climbed (top panel, Chart 13). The gravitational pull from fading earnings confidence may be too powerful to overcome over the next six months, given that our leading profit indicators have all taken a decisive turn for the worse. There is a rising risk that premium valuations will normalize (bottom panel, Chart 13). Instead, household products and packaged foods stocks offer a better risk/reward tradeoff. The biggest risk that we first identified in March centers around beverage shipments. The top panel of Chart 14 shows that industry shipments have plunged on the back of anemic end-demand. Shipment weakness is cause for concern given the correlation with relative performance. Chart 13Mind The Gap Mind The Gap Mind The Gap Chart 14Beverage Deflation... Beverage Deflation… Beverage Deflation… Our beverage industry activity proxy confirms this bearish message: relative profitability is under attack (middle panel, Chart 14). Worrisomely, soft drink manufacturers have tried hard to arrest the fall in shipments via steep price concessions (third panel, Chart 14). Even price deflation has been unable to reverse the contraction in industry volumes. If S&P soft drink sales continue to soften on the back of both volume and price cuts, then profit margins will take a hit (third panel, Chart 15). True, input cost inflation remains well contained, as both ethylene and raw food commodity prices are non-threatening. Moreover, labor cost inflation is subdued. Still, history shows that deflation typically leads to a margin squeeze. There is some hope that the export relief valve may partially neutralize soft domestic consumption. Consumer goods exports have contracted, but the depreciation in the U.S. dollar, especially against emerging market (EM) currencies, provides a glimmer of light that a turnaround lies ahead (third panel, Chart 16). But we are reluctant to forecast an export resurgence, given that EM consumption growth has continued to ease. Chart 16 shows that beverage sales growth closely follows the trend in real Asian retail sales, and the current message is bearish. Chart 15Mind The Gap ...Will Weigh On Profit Margins ...Will Weigh On Profit Margins Chart 16Do Not Bet On An Export-Led Recovery Do Not Bet On An Export-Led Recovery Do Not Bet On An Export-Led Recovery Adding it up, leading indicators of beverage demand remain muted (second panel, Chart 16), at a time when industry price deflation has intensified. This is a toxic brew for profitability, and we recommend using recent outperformance and sell down positions to underweight. Bottom Line: Downgrade the S&P soft drinks index to underweight. 1 Please see BCA U.S. Equity Strategy Weekly Report "Great Expectations?", dated April 3, 2017, available at uses.bcaresearch.com Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

GAA DM Equity Country Allocation Model Update The model has increased its allocation to Netherland, Italy, France and Germany, the underweight in Australia is also reduced by half. All these are financed by a large reduction in the U.S. overweight, mostly due to the change in liquidity and technical indicators, compared to previous month as shown in Table 1 As shown in Table 2 and Charts 1, 2 and 3, Level 2 model ( the allocation among the 11 non-U.S. DM countries) outperformed its benchmark by 119 basis points (bps) in May, largely a result from the overweight of the euro area versus the underweight in Canada and Australia. Level 1 model, the allocation between U.S. and non-U.S., underperformed by 22 bps in May due to the large overweight in the U.S. Overall, the aggregate GAA model outperformed its MSCI World benchmark by 13 bps in May and by 157 bps since going live. Please see also on the website http://gaa.bcaresearch.com/trades/allocation_performance. For more details on the models, please see the January 29th, 2016 Special Report "Global Equity Allocation: Introducing the Developed Markets Country Allocation Model". http://gaa.bcaresearch.com/articles/view_report/18850. Table 1Model Allocation Vs. Benchmark Weights GAA Model Updates GAA Model Updates Table 2Performance (Total Returns In USD) GAA Model Updates GAA Model Updates Chart 1 GAA DM Model Vs. MSCI World GAA DM Model Vs. MSCI World Chart 2 GAA U.S. Vs. Non U.S. Model (Level1) GAA U.S. Vs. Non U.S. Model (Level1) Chart 3 GAA Non U.S. Model (Level 2) GAA Non U.S. Model (Level 2) GAA Equity Sector Selection Model The GAA Equity Sector Selection Model (Chart 4) is updated as of May 31, 2017. The model continues to overweight cyclical versus defensive sectors. However, the model has turned overweight utilities on the back of improved technicals. For more details on the model, please see the Special Report "Introducing The GAA Equity Sector Selection Model," July 27, 2016 available at https://gaa.bcaresearch.com. Chart 4Overall Model Performance Overall Model Performance Overall Model Performance Table 3Allocations GAA Model Updates GAA Model Updates Table 4Performance Since Going Live GAA Model Updates GAA Model Updates Xiaoli Tang, Associate Vice President xiaoli@bcaresearch.com Aditya Kurian, Research Analyst adityak@bcaresearch.com

Highlights Portfolio Strategy Upgrade packaged food stocks to overweight. Enough value creation has occurred to create an attractive entry point in this consumer goods sub-index. Our tactical overweight in the S&P utilities sector is beginning to bear fruit. Get ready to book profits. Resist the temptation to bottom fish in steel stocks. Tightening Chinese monetary and financial conditions along with domestic demand blues should weigh on steel profits. Recent Changes S&P Packaged Foods - Upgrade to overweight. S&P Utilities - Downgrade Alert. Table 1 Focus On Financial Conditions Focus On Financial Conditions Feature The market waffled last week, but quickly recovered. The upshot is that investors still appear content to look through the circus in Washington, focused instead on the positive reflationary dynamics supporting the corporate sector. Financial conditions have eased considerably ever since the Fed resumed its tightening campaign last December. Equity price gains, narrowing credit spreads and a weaker U.S. dollar have more than offset the negative impact of the back-up in bond yields. Cheap equity capital also remains easily accessible. While the labor market is tightening, BCA argues that the headline unemployment rate may understate slack given the large number of part-time workers that want to work full-time and prime-age workers that are still out of work. With core inflation surprising to the downside in recent months, there is no urgency for the Fed to slam the brakes. In other words, there is more than enough monetary fuel to sustain the equity overshoot. Easy financial conditions will allow investors to extrapolate the profit recovery (Chart 1), especially since it has been sales driven for the first time in years. It is notable that while consumer price inflation has softened, in aggregate, businesses are not feeling any renewed deflationary pressure. The depreciation in the U.S. dollar has been a critical support for U.S. businesses. Our corporate sector pricing power proxy continues to accelerate (Chart 1), arguing that revenue growth should persist. The combination of muted consumer price inflation yet positive corporate sector inflation is a stock market positive, all else equal. Digging beneath the surface, divergent sector inflation trends are increasingly evident. The commodity-linked energy and materials sectors have lost upward pricing power momentum (Chart 2), courtesy of the cooling in China. Technology sector selling prices are sinking deeper into deflationary territory, albeit the FANG juggernaut pays no attention to sector specific forces. Telecom services pricing power has also taken a header (Chart 2). On the plus side, other defensive sectors, including utilities, are still able to raise prices at a much greater rate than overall inflation. Even the pace of financial sector price hikes is at the top end of its long-term range (Chart 3). Chart 1Sustained Profit Expansion ##br##Requires Easy Financial Conditions Sustained Profit Expansion Requires Easy Financial Conditions Sustained Profit Expansion Requires Easy Financial Conditions Chart 2Some Softness In ##br##Cyclical Pricing Power... Some Softness In Cyclical Pricing Power... Some Softness In Cyclical Pricing Power... Chart 3...But Defensive Selling##br## Prices Are Resilient ...But Defensive Selling Prices Are Resilient ...But Defensive Selling Prices Are Resilient The upshot is that selectivity remains a critical portfolio input rather than simply tracking the broad S&P 500. These forces should allow the market to continue grinding higher into overshoot territory. The latter means that the market is increasingly vulnerable to minor external shocks. Ergo, we continue to recommend a selective weighting in some 'safe' areas, such as consumer staples, which are undervalued in relative terms and will buffet portfolios should volatility escalate further. This week we are taking advantage of the drubbing in food stocks to augment positions. Packaged Foods: Going Against The Grain After a surge to all-time relative performance highs in mid-2016, the S&P packaged foods index has deflated by roughly 20%. Two key reasons are behind the downdraft: the allure to hold stable cash flow companies has diminished since the November election, and weak industry-specific metrics - in particular pricing power and sales contraction amid private label competition. Despite these negatives, our sense is that enough value destruction has occurred to create an attractive entry point in this consumer goods sub-index. Relative valuations reflect most of these investor worries. The relative forward P/E ratio has de-rated to below the two-decade average, and our Valuation Indicator (VI) is near one standard deviation below the historical mean. In fact, every time the VI falls to such an undervalued extreme, relative performance stages a sizable comeback (Chart 4). Technical conditions are also washed out. Relative performance momentum has plunged to the lowest level in a decade, and likely fully reflects investor angst. Deeply oversold readings and undervaluation suggest that a full bearish capitulation has occurred, which is contrarily positive. Encouragingly, there is light at the end of the tunnel. Grain price deflation (shown inverted, third panel, Chart 4) suggests that industry input costs are well contained, and will underpin profit margins. It is normal for falling grain prices to coincide with upward revisions to analyst profit estimates (second panel, Chart 4). While industry sales are mired in deflation, there are high odds that top line growth will exit deflation by early 2018. Consumer outlays on food and beverages are brisk, and wholesale food manufacturing prices have recently reaccelerated. Chart 5 shows that industry revenues follow the trend in consumption and pricing power, underscoring that profitability is set to expand anew. True, private label competition and grocery store market share wars have put pressure on industry pricing power. But as long as food manufacturers can keep input costs under control, profit margins should remain wide. A simple industry profit margin gauge (PPI food manufacturing versus PPI crude food) gives us comfort that margins will remain resilient (bottom panel, Chart 5). Importantly, packaged food producers are well positioned to fight back against food retailers' demands for price concessions. Robust consumer outlays on food and beverages are corroborated by real retail sales at food stores, which are bucking the deceleration in overall retail sales (third panel, Chart 6). The hook up in food manufacturing hours worked confirms that industry activity is on the mend, which bodes well for productivity gains. Sell-side analysts have taken notice. Positive earnings revisions will continue to outstrip negative ones. Chart 4Buy Against The Grain Buy Against The Grain Buy Against The Grain Chart 5End Of The Revenue Lull... End Of The Revenue Lull... End Of The Revenue Lull... Chart 6...As Demand Recovers ...As Demand Recovers ...As Demand Recovers Finally, food and beverage exports have held onto recent double-digit growth gains despite the strong greenback. Now that the U.S. dollar is under some pressure, especially against the euro and emerging market currencies, foreign sales should provide a further relief valve should domestic pricing pressures persist for a little longer than we expect (second panel, Chart 6). In sum, while investors have rushed for the exits in the defensive S&P packaged foods index, a buying opportunity has emerged. Relative valuations have corrected to the lower end of their historic range and already reflect investor profitability worries. Our thesis is that a domestic demand-driven recovery has commenced and strict cost control, along with food commodity deflation, should sustain profit margins. Bottom Line: Start a buy program in the S&P packaged foods index, and boost exposure to overweight. The ticker symbols for the stocks in this index are: BLBG: S5PACK - MDLZ, SJM, KHC, CPB, MKC, CAG, TSN, MJN, GIS, HSY, HRL, K. Our Utilities Overweight Is Starting To Pay Off Our tactical overweight in the S&P utilities sector is beginning to bear fruit. Importantly, the five factors that drove this decision are starting to play out1, albeit in varying degrees of magnitude. Chart 7 shows that the U.S. economic soft patch has persisted. Hard data have not yet caught up to the surge in 'soft' data, such as sentiment and confidence surveys. The Citi Economic Surprise Index is inversely correlated with the relative share price ratio. Similarly, the ISM manufacturing index has crested. Our analysis shows that forward relative returns are strong after the ISM manufacturing survey hits extremely high levels, given that mean reversion ultimately occurs. The upshot is that utilities relative performance has more upside. The yield curve has also moved favorably for utilities stocks. The 10/2 Treasury curve has flattened since early January, as economic data continue to surprise to the downside, underscoring that the tactical utilities buy signal remains intact. The third reason to augment utilities exposure was the ebbing in inflation expectations. The latter continues unabated (Chart 7). Our recent Special Report highlighted that utilities suffer in times of inflation2. But the opposite is also true: utilities stocks outperform in times of disinflation/deflation. This reflects the stable rate of return regulated utilities enjoy, in addition to the increased appeal of dividend yields and cash flow during times of economic volatility and uncertainty. Finally, natural gas prices are firm. Utilities pricing power moves in lockstep with natural gas prices (middle panel, Chart 8). The latter are the marginal price setter for non-regulated utilities, and the recent price reacceleration could be a positive catalyst (bottom panel, Chart 8). Nevertheless, the utilities share price reaction has been more muted than we had expected, at least so far, perhaps reflecting the ongoing outperformance of stocks vs. bonds, and the weakness in electricity production growth (Chart 9). If the five factors begin to lose momentum, we will recommend booking profits in this tactical overweight position. Chart 7Prepare To Book Profits... Prepare To Book Profits... Prepare To Book Profits... Chart 8...When Utilities Turbocharge ...When Utilities Turbocharge ...When Utilities Turbocharge Chart 9Two Utilities Risks To Monitor Two Utilities Risks To Monitor Two Utilities Risks To Monitor Bottom Line: Stick with overweight exposure in the S&P utilities sector for now, but get ready to book profits in the coming weeks. Put utilities on downgrade alert. Rusting Steel Stocks Steel stocks have come full circle. Following the initial euphoria since the Trump election, the relative share price ratio is now roughly where it was in early November. There is more downside ahead. China is tapping the monetary brakes, attempting to contain the shadow banking system. However, it is difficult to target one segment of the economy through monetary policy. Tight policy is starting to backlash onto commodity prices, including steel and iron ore. A number of indicators suggest that China's internal dynamics will further undermine global steel share prices. The top panel of Chart 10 shows that the recent Chinese yield curve inversion is pointing toward more pain ahead for U.S. steel producers. Further, the Chinese credit impulse is waning. Historically, BCA's Chinese Credit Impulse Indicator (CII) has an excellent track record forecasting relative performance momentum. The latest grim CII reading warns that U.S. steel stocks have more downside (second panel, Chart 10). Slower Chinese credit creation will continue to weigh on infrastructure spending. Chinese capital expenditure and loan growth are joined at the hip. Feeble loan growth suggests that fewer projects will come to fruition (third panel, Chart 10). Sinking iron ore prices reflect this grim outlook. The implication is that overly optimistic relative profit estimates are vulnerable to disappointment (bottom panel, Chart 10). True, Chinese steel exports and domestic production have eased, which suggests that the risk of a steel inventory glut has receded. Nevertheless, U.S. steel imports have climbed anew, despite ongoing steel tariffs. As steel imports command a larger share of U.S. domestic production, price deflation is necessary to resolve this imbalance (Chart 11). This will cast a shadow on steel profit prospects. Steel industry troubles are not endemic to China. Worrisomely, U.S. steel demand dynamics remain unfavorable. Two key domestic end-markets are quickly losing steam. Commercial real estate and automobile excesses are starting to correct. Banks are reining in credit to both loan categories according to the Fed's latest Senior Loan Officer Survey (second panel, Chart 12). Simultaneously, within commercial real estate, construction and land development credit demand is also anemic. With regard to consumer loan categories, auto loan demand has registered the worst showing. Chart 10China Macro Weighs On Steel bca.uses_wr_2017_05_23_c10 bca.uses_wr_2017_05_23_c10 Chart 11Steel Deflation Looms Steel Deflation Looms Steel Deflation Looms Chart 12Weak Domestic End-Markets Provide No Relief Weak Domestic End-Markets Provide No Relief Weak Domestic End-Markets Provide No Relief Already, non-residential construction is flirting with contraction and light vehicle sales are sinking like a stone (third panel, Chart 12). As a result the steel industry's new orders-to-inventories ratio has come off the boil, exerting a gravitational pull on scrap steel prices (bottom panel, Chart 12). The implication is that steel price deflation will undermine industry profits. Adding it up, the U.S. steel industry's earnings hurdle is sky-high. Tightening Chinese monetary and financial conditions along with domestic demand blues signal that U.S. steel producers' profits will surprise to the downside. Bottom Line: Continue to avoid steel stocks. The ticker symbols for the stocks in the S&P 1500 steel index are: BLBG: S15STEL - TMST, ATI, CMC, X, AKS, CRS, HAYN, RS, ZEUS, WOR, SXC, STLD, NUE. 1 Please see BCA U.S. Equity Strategy Weekly Report, "Great Expectations?" dated April 3, 2017, available at uses.bcaresearch.com. 2 Please see BCA U.S. Equity Strategy Special Report, "Equity Sector Winners And Losers When Inflation Climbs," dated December 5, 2016, available at uses.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

Utilities stocks are gathering pace relative to the broad market, and there are good odds that the sector will break above key resistance at its 40-week moving average. The Economic Surprise Index is starting to roll over (shown inverted, top panel), which is putting a solid bid under the Treasury market. 10-year yields have additional downside as inflation expectations decelerate, given the valuation starting point. History shows that forward utilities returns are strong when Treasury yields retreat from undervalued levels. Importantly, sector pricing power has surged as a consequence of increased output, an upturn in utilization rates and stronger natural gas prices. We reiterate our recent upgrade to a tactical overweight stance. Utilities Are Charging Ahead Utilities Are Charging Ahead

A window has opened for a tradable utilities sector outperformance phase. This is a somewhat contrarian call. After all, the ISM index is well above the boom/bust line. However, a cycle-on-cycle analysis of relative utilities performance and the ISM manufacturing survey reveals that it pays to overweight utilities when the latter hits the current level. This has occurred seven times since the early 1990s, and the S&P utilities sector outperformed in the subsequent 3 and 6 months by an average of 3 and 5%, respectively, as depicted in the chart. Only one period generated negative returns. As economic indicators inevitably mean revert, the utilities sector tends to benefit. We expect a replay given that market-based inflation expectations have crested, aided by the dip in oil prices, the yield curve is slowly flattening and natural gas prices have surged on the back of expected supply cutbacks this year. In sum, we expect utilities stocks to enjoy a playable relative performance rally in the next 1-3 months. Please see yesterday's Weekly Report for more details. Utilities Are Powering Up Utilities Are Powering Up

Highlights Portfolio Strategy A window has opened up for utilities outperformance. Upgrade to overweight on a short-term (1-3 month) view. Leading indicators of beverage sales have improved, heralding an upgrading in depressed expectations. Stay overweight. The pullback in consumer finance stocks appears to be contagion from the overall financial sector selloff than a reflection of deteriorating industry-specific fundamentals. Buy on weakness. Recent Changes S&P Utilities - Boost to overweight from neutral on a tactical basis. Table 1 Great Expectations? Great Expectations? Feature Our view remains that stocks are in a consolidation phase, waiting for economic/profit confirmation that earnings will grow into the latest valuation expansion. Thin equity market risk premia can be justified if the economy has embarked on an extended and strong non-inflationary growth path that will spawn robust corporate profitability. Chart 1A Second Half Squeeze? A Second Half Squeeze? A Second Half Squeeze? On this note, the third mini-economic up-cycle since the Great Recession has been underway since last year. The first two bursts of economic strength fizzled quickly, eventually requiring a new dose of stimulus to reinvigorate growth. The current up-cycle may have more legs given that the rest of the world is now participating and the U.S. economy at full employment, but it would be dangerous to become complacent. The stock-to-bond ratio has crested on a growth rate basis, and its mean reversion properties suggest that key macro gauges such as the ISM index may cool as the year progresses (Chart 1). Odds of growth-propelling fiscal stimulus, that equities have already bought and paid for, may now fade following Congress' failure to move on health care reform. Total bank credit growth is decelerating on a broad basis. Chart 1 shows that of the 8 major bank loan categories, only 1 has a positive credit impulse (the annual change in the 52-week rate of change), the other 7 are negative, i.e. it isn't simply C&I loan weakness driving the credit deceleration. Traditionally, credit and economic growth move together, so the current gap warrants close attention. Meanwhile, the reflationary impulse over the past 18 months from China is set to fade as the authorities tap the brakes, particularly in the housing market, which may throw a wrench into new construction. Chinese property prices have been especially correlated with global economic up-cycles. Real estate inflation downturns have been important global economic signals (Chart 1). Consequently, the second half of the year may 'feel' slower from a growth perspective and challenge the reflation hypothesis. Some trepidation about the durability/breadth of the economic expansion is becoming evident in internal market behavior. Our Intermediate Equity Indicator (IEI) has continued to weaken as breadth and participation thin (Chart 2). If the IEI drops below zero, the odds of a meaningful pullback will rise substantially. Keep in mind there is a lot of air between the S&P 500 index and its 40-week moving average. The number of S&P 500 groups with a positive 52-week rate of change has pulled back to post-Great Recession lows (Chart 2). Last week we showed a composite of relative industry and sector performance that also heralded a choppy period ahead for the broad averages. All of these factors suggest that a tactical consolidation needs time to play out, especially with first quarter reporting season fast approaching and optimism in the outlook bursting at the seams. While trading sentiment is not overly stretched, the truest measure of sentiment is asset valuations and expectations. On this front, our Global Economic Sentiment Index, which contrasts equity and government bond valuations in the major economies, has reached the 'extreme optimism' zone (Chart 3, middle panel). Such a reading does not automatically foretell of an imminent major equity peak, but reinforces that there is little margin for disappointment. Chart 2Deteriorating Internals Deteriorating Internals Deteriorating Internals Chart 3Early Signs Of Overconfidence? Early Signs Of Overconfidence? Early Signs Of Overconfidence? In addition, the trend in analyst earnings expectations is also consistent with an overriding theme of exuberance. Cyclical earnings estimates have tentatively peaked after a steep upgrade over the last few quarters, and are now sitting below 5-year growth expectations, suggesting overwhelming confidence in the longevity of the expansion. The last three times that cyclical (12-month) profit growth estimates diverged negatively from lofty long-term estimates was in 2000, 2007 and 2015 (Chart 3). Each episode coincided with ebullient global economic sentiment, and heralded market turbulence, with varying lags. The point is that when financial conditions tighten enough to undermine the cyclical growth outlook but fail to dent conviction in the long-term outlook, it is a signal of overconfidence. The good news is that financial conditions have remained historically easy and should only tighten gradually, such that the risk of a policy-induced slowdown is not acute. In sum, we expect the tactical consolidation phase to persist, especially if economic momentum cools. Exuberant expectations argue for a digestion phase, which should continue to broadly support defensive over cyclical sector positioning, a stance that has paid off nicely since late last year. We may look to selectively increase cyclical and financial sector exposure in the coming weeks if the U.S. dollar remains tame and inflation expectations perk back up, but for now, we are making a tactical addition to the defensive side of the ledger. Utilities Are Powering Up We booked sizable gains in the S&P utilities index and downgraded to neutral last summer, because of our view that bond yields were bottoming on the back of economic stabilization. Since then, relative performance collapsed by 20%, but it has recently started showing some signs of life. Is it time to re-enter this overweight position on a tactical basis? The short answer is yes. There are five reasons to buy utilities at the current juncture with a tactical (1-3 month) time horizon. A possible cooling in economic momentum will redirect capital into the sector. Last week we highlighted that the economically-sensitive transportation index may be heralding mean reversion in key activity gauges, such as the ISM manufacturing index (Chart 4). If the run of positive economic surprises reverses, utilities stocks should receive a sizeable relative performance boost. Transport stock underperformance typically means utility stock outperformance (Chart 4, bottom panel). A cycle-on-cycle analysis of relative utilities performance and the ISM manufacturing survey reveals that is pays to overweight utilities when the latter hits the current level. This has occurred seven times since the early 1990s, and the S&P utilities sector outperformed in the subsequent 3 and 6 months by an average of 3 and 5%, respectively. Only one period generated negative returns (Table 2). Chart 4Utilities Win When Transports Lose Utilities Win When Transports Lose Utilities Win When Transports Lose Table 2Contrary Alert: Buy Utilities Great Expectations? Great Expectations? Market-based inflation expectations have crested, aided by the dip in oil prices. Relative share prices have been inversely correlated with inflation expectations, owing to the link to long-dated Treasury yields. Importantly, the University of Michigan's survey inflation expectations, both short and long term, have been drifting lower signaling that the recent backup in CPI headline inflation will likely prove transitory (inflation expectations shown inverted, Chart 5). The flattening yield curve is also sending a tactical buy signal for utilities stocks (shown inverted, Chart 5). Natural gas prices are strengthening. Nat gas prices are the marginal price setter for non-regulated utilities, and the recent price spike has boosted utilities pricing power. Sell-side analysts have taken notice, aggressively ratcheting EPS numbers higher. Nevertheless, the relative EPS growth bar still remains low, signaling that a relative profit outperformance period looms (Chart 6). Chart 5External Support As... External Support As... External Support As... Chart 6... Earnings Recover ... Earnings Recover ... Earnings Recover One risk to our tactically bullish utilities view is stagnant electricity generation growth. However, if overall output growth recedes in the next quarter or two, then the non-cyclical power demand profile will shine through, offsetting low utility utilization rates in absolute terms. Bottom Line: There is scope for a playable relative performance rally in the coming one-to-three months. Boost the niche S&P utilities sector to overweight. Soft Drinks Are About To Pop Indiscriminate selling of all consumer staples immediately after the Trump victory restored value in a number of defensive consumer groups. They have stealthily outperformed for most of this year. Chart 7 shows a number of valuation yardsticks. Soft drink stocks are yielding more than both 10-year Treasurys and the broad market. Similarly, the relative P/S and P/E ratios have dipped comfortably below their respective historical means. From a technical standpoint, relative share price momentum has been pushed to a bearish extreme (Chart 7). Against this valuation and technical backdrop, any whiff of operating traction should trigger a playable outperformance phase. Industry pricing power has rebounded smartly, exiting the deflation zone (Chart 8). This firming in selling prices appears to be demand driven. Growth in relative consumer outlays on food and non-alcoholic beverages has improved. Actual industry sales growth has returned to positive territory and beverage output growth is outpacing other non-durable goods industries (Chart 8). While export trends have been a sore spot for beverage companies, the tide should soon turn. The greenback has depreciated versus emerging market (EM) currencies since mid-December, permitting EM central banks to ease monetary policy. That heralds a recovery in consumer goods exports and a reversal of negative translation FX effects (Chart 9, middle panel). Chart 7Cheap And Washed Out Cheap And Washed Out Cheap And Washed Out Chart 8Inflection Point Inflection Point Inflection Point Chart 9Export Drag Should Reverse Export Drag Should Reverse Export Drag Should Reverse The improvement in top-line leading indicators is particularly noteworthy given that cost inflation remains muted. Food input prices are contracting and ethylene prices, a primary packaging ingredient, are also deflating. With headcount under control (Chart 9, bottom panel), there is scope for margin expansion at a time when overall profit margins face a steady squeeze from rising wage inflation. This brightening backdrop, especially in relative terms, has not yet been embraced by the analyst community. Not only are earnings slated to trail the broad market by 7% in the coming year, but 5-year relative EPS growth has plummeted to all-time lows. Such pessimism is unwarranted. All of this implies that while recent beverage shipment growth has been soft, a recovery is likely as the year progresses. That will set the stage for a series of positive surprises, supporting share price outperformance. Bottom Line: The compellingly valued S&P soft drinks index has troughed and has a very attractive reward/risk profile. Were we not already overweight, we would lift exposure to above benchmark today. The ticker symbols for the stocks in the S&P soft drinks index are: BLBG: S5SOFD-KO, PEP, MNST, DPS. Consumer Finance: Cast Aside, But For No Good Reason Like all financials, consumer finance stocks have underperformed the broad market in recent weeks. High intra-financial sector correlations are understandable early in a corrective phase, especially given the magnitude of the initial post-election rally. However, as time passes, correlations should recede because significant discrepancies exist among industry profit drivers. For instance, any meaningful broad market correction could undermine capital markets activity via reduced appetite for new equity issues, less M&A activity and smaller trading fees, taking a bite out of investment banking profits. Elsewhere, banks have been riding hopes for higher net interest margins and an easing regulatory burden. However, without any corresponding improvement in credit growth they are now giving back those gains because bond yields have stalled, the yield curve has narrowed and expectations for deregulation are being watered down to a dilution of terms These factors justify the pullback in both banks and capital markets stocks, even if temporary. On the flipside, the consumer finance group has also been dragged down, even though leading indicators of profitability have continued to improve. As shown in past research, the credit card interest rate spread has low sensitivity to shifts in the yield curve. As such, receivables growth matters more to profits than the slope of the yield curve. Whether consumers embark on debt-financed consumption is heavily dependent on job security, debt-servicing costs, and household wealth. When consumer comfort rises, the personal savings rate tends to decline, indicating a greater propensity to spend. Household net worth has set a new all time high on the back of buoyant financial markets and recovery in house prices (Chart 10). Debt service payments remain historically depressed as a share of disposable income, underscoring that the means to re-leverage exist (Chart 10). Typically credit card charge-offs stay muted until well after debt servicing requirements hit a much higher level, either through reduced incomes or higher interest rates, or a combination of the two. At the moment, both are working in favor of credit quality, not against it. In fact, house prices have reaccelerated sharply in the past few months, which heralds share price outperformance (Chart 11, top panel). Moreover, the steady increase in housing starts bodes well for additional gains in outlays on durable goods, a positive omen for consumer credit demand. Chart 10Credit Quality Remains Strong Credit Quality Remains Strong Credit Quality Remains Strong Chart 11Bullish Leading Indicators Bullish Leading Indicators Bullish Leading Indicators The latter is already growing at a solid clip, in contrast with other lending categories such as C&I loan growth (Chart 11), which is weak and dragging down total bank credit. The surge in consumer income expectations points to an expanded appetite for debt (Chart 11). Consequently, the sell-off in the S&P consumer finance index should be treated as indiscriminate contagion from the rest of the financials sector rather than a reflection of deteriorating fundamentals. Recent value creation represents a buying opportunity. Bottom Line: Stick with a high-conviction overweight in the S&P consumer finance index. The ticker symbols for the stocks in the S&P consumer index are: BLBG: S5CFINX-AXP, COF, DFS, SYF, NAVI. Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

Highlights Key Portfolio Highlights Improved world economic growth and rising inflation expectations have buoyed global equities (Chart 1). The downside is that financial conditions are tightening and U.S. dollar-based liquidity is contracting, which is growth restrictive (Chart 2). The massive outperformance of the financials and industrials sectors since the U.S. election implies that U.S. markets have been largely politically-motivated. Positive economic surprises remain mostly sentiment/confidence driven, rather than from upside in hard economic data (Chart 3). That unusually large gap implies that a big jump in 'hard data' surprises is already discounted and represents a latent risk, as it did in the spring of 2011 just before the summertime equity market swoon. Federal income tax receipts are contracting, suggesting that an economic boom is not forthcoming (Chart 4). In fact, there has never been a contraction in tax receipts without a corresponding slump in employment growth. Corporate sector pricing power gains have not been evenly distributed. Deep cyclicals gains came off a low base and may already be experiencing a relapse. Conversely, defensive and interest rate-sensitive sectors are demonstrating the most strength (Chart 5). Our macro models are not signaling that investors should position as if robust and self-reinforcing economic growth lies ahead. Our Deep Cyclical indicators are the weakest, while defensive and interest rate-sensitive models are grinding higher (Chart 6). Deep cyclical sectors are very overvalued and overbought, while defensives are deeply undervalued and oversold (Charts 7 and 8). Mean reversion is an apt theme for the next few months. The most attractive combination of macro, valuation and technical readings are in the consumer staples, health care sectors. The financials sector is a close second, but it is overbought. The least attractive combinations are in energy, materials and industrials. Prospects for elevated market volatility, stronger economic growth in developed vs developing economies, a tighter Fed and expensive U.S. dollar are consistent with maintaining a largely defensive portfolio structure (Charts 9-12). Chart 1Pricing Power Revival... Pricing Power Revival... Pricing Power Revival... Chart 2... But A Liquidity Drain ... But A Liquidity Drain ... But A Liquidity Drain Chart 3Show Me The Money Show Me The Money Show Me The Money Chart 4Yellow Flag Yellow Flag Yellow Flag Chart 5Pricing Recovery Is Not Broad Based Pricing Recovery Is Not Broad Based Pricing Recovery Is Not Broad Based Chart 6Indicator Snapshot Indicator Snapshot Indicator Snapshot Chart 7Focus On Value Focus On Value Focus On Value Chart 8Mean Reversion Ahead Mean Reversion Ahead Mean Reversion Ahead Chart 9Fundamentals Favor Defensives... Fundamentals Favor Defensives... Fundamentals Favor Defensives... Chart 10... As Do Market Signals ... As Do Market Signals ... As Do Market Signals Chart 1112-Month Performance After Fed Hikes Cyclical Indicator Update Cyclical Indicator Update Chart 1224-Month Performance After Fed Hikes Cyclical Indicator Update Cyclical Indicator Update Chart 13Staples Will Cushion A Volatility Resurgence Staples Will Cushion A Volatility Resurgence Staples Will Cushion A Volatility Resurgence Chart 14Media Stocks Like A Strong Currency Media Stocks Like A Strong Currency Media Stocks Like A Strong Currency Chart 15Unduly Punished Unduly Punished Unduly Punished Chart 16Strong Fundamental Support Strong Fundamental Support Strong Fundamental Support Chart 17Less Production... Less Production... Less Production... Chart 18... Means More Rigs ... Means More Rigs ... Means More Rigs Chart 19End Of Sugar High End Of Sugar High End Of Sugar High Chart 20A Toxic Mix A Toxic Mix A Toxic Mix Chart 21Tech Stocks Don't Like Inflation Tech Stocks Don't Like Inflation Tech Stocks Don't Like Inflation Chart 22Time To Disconnect Time To Disconnect Time To Disconnect Feature S&P Consumer Staples (Overweight - High Conviction) The Cyclical Macro Indicator (CMI) has been grinding higher for several months, even climbing through last year's share price shellacking. The CMI has been supported by the uptrend in relative consumer spending on essential items and consumer preference for saving vs. spending. More recently, a pricing power recovery in a number of groups has provided an assist as has a rebound in staples export growth. Booming consumer confidence and business confidence have held the CMI in check. The strong U.S. currency, particularly bilaterally against China, also implies a reduction in the cost of imported goods sold, and has also been an indication of relative valuation expansion because it often signals increased financial market volatility (Chart 13 on page 6). The attractive valuation starting point this cycle, and historic outperformance when the Fed raises interest rates (Chart 13 on page 6), were key factors behind our upgrade to high conviction status in January. Technical conditions are completely washed out. Sector breadth and momentum have reached oversold extremes. That signals widespread bearishness, which is positive from a contrary perspective. Chart 23 S&P Consumer Staples S&P Consumer Staples S&P Consumer Discretionary (Overweight) Our CMI is forming a tentative trough, supported by rebounding relative outlays on media services, low prices at the pump, a budding recovery in mortgage equity withdrawal and firming wage growth. The biggest drags over the past few months have come from higher Treasury yields and consumers increased propensity to save. However, rising job certainty and a vibrant residential real estate market suggest that consumers should loosen their purse strings. The VI has deflated toward the neutral zone, although remains moderately expensive from a long-term perspective. Our TI started to rebound from oversold levels. History shows that a recovery in the TI from one standard deviation below the mean has heralded a playable relative performance rally. Overweight positions should remain concentrated in housing-related equities and the media space, both of which benefit from U.S. dollar appreciation (Chart 14 on page 6). Chart 24 S&P Consumer Discretionary S&P Consumer Discretionary S&P REITs (Overweight - High Conviction) Our new REIT CMI has ticked lower, but the share price ratio has over-exaggerated this small move down. REITs have traded as if the back up in global bond yields will persist indefinitely, and that they are the only factor that drives relative performance. Improving cash flows and cheap valuations suggest that REITs can decouple from bond yields. Banks have tightened standards on commercial real estate loans, but this appears more likely to limit supply growth than create a slowdown. Commercial property prices are hitting new highs and our REIT Demand Indicator (RDI) has climbed into positive territory, signaling higher rental inflation. The latter is already outpacing overall CPI by a wide margin (Chart 15 on page 7). While REITs are back to fair value from a long-term perspective, on a shorter term basis the sector is very undervalued (Chart 15 on page 7), particularly with Treasury yields now in undervalued territory. Our REIT TI is extremely oversold, at a point which forward relative returns typically shine on a 12 and 24 month basis, even excluding the dividend yield kicker. Chart 25 S&P Real Estate S&P Real Estate S&P Health Care (Overweight) Our CMI continues to grind higher, opening a massive divergence with relative performance. This gap can be explained by the political attack on the pharmaceutical industry, the sector's heavyweight, rather than by a downturn in relative earnings drivers. Pharmaceutical shipments are hitting new highs and pricing power continues to grow at a robust mid-single digit rate. Future pricing gains may slow if government gets more heavily involved in setting prices, but this is already discounted. Pricing power in the rest of the sector remains strong, while wage inflation is tame. Health care spending is still growing as a share of total spending, but the pace is decelerating. Typically, this backdrop signals outperformance for health care insurers, who may also receive a risk premium reduction from a potential revamp of the Affordable Care Act, albeit the timing will likely be drawn out. Relative valuations are very attractive. The sector has been used as a source of capital to fund purchases in areas expected to benefit from increased fiscal stimulus. That is an overreaction, and flows should be restored to reflect the sector's appealing investment profile, particularly given the sector's track record during Fed tightening cycles (Chart 16 on page 7). The TI is deeply oversold. Breadth measures are beginning to recover from completely washed out levels. These conditions reinforce that an exploitable undershoot has occurred. Chart 26 S&P Health Care S&P Health Care S&P Financials (Neutral) Our Financial CMI has surged, underscoring that the advance in relative performance reflects more than just a reaction to anticipated sector deregulation by the Trump Administration. Leading indicators of capital formation, such as the stock-to-bond ratio, have jumped sharply. Moreover, the yield curve has steepened in recent months, bolstering the CMI. An improvement in overall profit growth and the tight labor market suggest that the credit cycle may not become a profit drag until the economy begins to cool. While not yet evident, the restrictive move in oil, the dollar and bond yields warn that disappoint may emerge in the coming months. It is notable that bank loan growth has dropped to nil over the last 3 months. C&I loan growth is contracting over that time period. Banks are hiring more aggressively, yet are tightening lending standards, suggesting productivity disappointment ahead. Despite the share price jump, value remains attractive after 8 years of financial repression. Our TI is overbought and breadth is beginning to recede, which is often a precursor to a consolidation phase. We are not willing to move beyond a market weight allocation at this juncture. Chart 27 S&P Financials S&P Financials S&P Energy (Neutral) Our CMI has plunged, probing all-time lows. Rising oil inventories and spiking wage inflation are exerting severe gravitational pull on the CMI, more than offsetting the budding recovery in domestic production. Refining margins are probing six year lows as the Brent/WTI spread has evaporated. Nevertheless, OPEC is finally curtailing production, joining non-OPEC producers (Chart 17 on page 8), which should ultimately help eat into excess global oil supply. History shows that once supply growth peaks, the rig count typically firms. That is a plus for energy services (Chart 18 on page 8), even though rising oil production will prove self-limiting for oil prices. High yield spreads have narrowed significantly from nosebleed levels, but industry balance sheets remain bruised. Net debt is historically elevated, EBITDA has yet to return to its glory days, and interest coverage remains anemic and vulnerable to any downside energy price surprises. The surge in our VI reflects depressed cash flow, and is overstating the degree of overvaluation. The TI has returned to the neutral zone, and will need to hold at current levels otherwise a relapse in the share price ratio toward previous lows is probable. Selectivity is still warranted in the energy complex. We remain underweight refiners and overweight the energy services index. Chart 28 S&P Energy S&P Energy S&P Utilities (Neutral) Our utilities sector CMI is stabilizing. That is a surprise, given the rebound in inflation expectations and firming global leading economic indicators, which are typically bearish for this defensive, fixed-income proxy. The latter negative exogenous factors are being offset by falling wage inflation, better pricing power and rising electricity output growth. Power demand is linked with manufacturing activity, underscoring that there is an element of cyclicality to sector profits. The share price ratio has held up better than most other defensive sectors since the U.S. election, perhaps on the hope that an overhaul of the tax code will benefit this domestic sector. Regardless, valuations have retreated from the extremely expensive zone where we took profits and downgraded to neutral last summer, but are not yet at a level that warrants re-establishing overweight positions. An upgrade could occur once our TI becomes fully washed out, provided that occurs within the context of additional CMI strength and a peak in global growth and inflation momentum. Chart 29 S&P Utilities S&P Utilities S&P Industrials (Underweight - High Conviction) The CMI has edged lower after a modest recovery in recent months. The strong U.S. dollar, relapse in short-term pricing power measures and sector productivity contraction are offsetting improvement in global PMI surveys. The lack of confirmation of an industrial sector revival from emerging markets is also holding back the CMI. There continues to be a deflationary undercurrent in the form of more rapid capacity than industrial sector output growth, suggesting that durable pricing power gains may remain elusive (Chart 19 on page 9). The post-election surge in share prices is slowly being unwound, as the sector was quick to discount expectations for massive domestic fiscal stimulus. Our valuation gauge is not at an extreme, although a number of individual groups are trading at historically rich multiples, such as machinery and railroads. Participation is beginning to fray around the edges, as our relative advance/decline line has rolled over, as has breadth. Our TI is pulling back from overbought levels, warning that a further correction in the share price ratio looms. It would be nearly unprecedented for the share price ratio to trough before our TI hits oversold levels. Industrials fare poorly when the Fed tightens. Chart 30 S&P Industrials S&P Industrials S&P Materials (Underweight) The CMI has nosedived, reflecting China's diminishing fiscal thrust and the recent tightening in monetary policy. Commodity price inflation peaked in mid-December concurrent with the Fed raising rates, signaling that emerging markets end-demand, in general and Chinese in particular, is likely past its prime. The nascent rebound in EM currencies represents a positive offset, but not by enough to turn around the CMI. Select heavyweight EM manufacturing PMIs are still below the boom/bust line. Relative valuations are becoming extended according to our VI, and stretched technical conditions are waving a red flag. Keep in mind the materials sector has an abysmal performance history after the Fed starts tightening (Chart 20 on page 9). The heavyweight chemical index (75% of the sector) bears the brunt of the downside risks owing to excess capacity (Chart 20 on page 9). On the flipside, overweight exposure in gold mining (via the GDX:US ETF) and the niche containers & packaging sub-indexes is recommended. Chart 31 S&P Materials S&P Materials S&P Technology (Underweight) The CMI has rolled over, driven lower by contracting relative pricing power, decelerating new orders-to-inventories growth, lack of capital expenditure traction and the appreciating greenback. Tech stocks thrive in a disinflationary/deflationary environment and suffer during inflationary periods (Chart 21 on page 10). Inflation is making a comeback, so it will be an uphill battle for tech companies to successfully raise selling prices at a fast enough pace to keep profits on a par with the broad corporate sector. While a capital spending cycle would be a welcome development, the narrowing gap between the return on and cost of capital warns against extrapolating improvement in business sentiment just yet. Our S&P technology operating profit model warns that tech profits are likely to trail the broad market as the year progresses, a far cry from what is embedded in analysts' forecasts. The good news is that valuations are not demanding nor are technical conditions overbought, which should cushion the magnitude and sharpness of downside risks. Chart 32 S&P Technology S&P Technology S&P Telecom Services (Underweight) Our CMI for telecom services has gained ground of late, primarily on the back of a sharp decline in wage inflation. However, we recently downgraded exposure to underweight, because of a frail spending backdrop. Our telecom services sales model is extremely weak (Chart 22 on page 10). Softening outlays on telecom services have reinvigorated the industry price war, and our pricing power gauge is sinking like a stone (Chart 22 on page 10). Telecom carrier capital expenditures have been running at a healthy clip, which could further pressure profit margins. Undervaluation exists, but this has been a chronic feature for the sector over the past decade, and does not foretell of cyclical upside or downside risks. Our TI has plunged into the sell zone, but remains above levels that would signal that a countertrend rally is imminent. Chart 33 S&P Telecommunication Services S&P Telecommunication Services Size Indicator (Overweight Small Vs. Large Caps) The small/large cap ratio is correcting short-term overbought conditions. The dip in the U.S. dollar has provided a fundamental reason for corrective action in this domestically-oriented asset class. However, we doubt a trend change is at hand. Our style CMI is climbing steadily. Small company business optimism has soared, partly because of an increase in planned price hikes, but also from an anticipated reduction in the regulatory burden. If small company price hikes persist, then rising labor costs will be more easily absorbed. That is critical to narrowing the profit margin gap between small and large firms. A stronger domestic vs. global economy and the potential for trade barriers is also unambiguously positive for small firms that do the bulk of their business at home. Despite the surge in the share price ratio post-U.S. election, our valuation gauge is not yet at an overvalued extreme. The lack of extreme overvaluation suggests that positive momentum will persist, perhaps similar to the 2004-2006 period, when the share price ratio stayed in overbought territory for years. Chart 34 Size Indicator (Small Vs. Large Caps) Size Indicator (Small Vs. Large Caps)

President-elect Trump and the specter of his spendthrift policy proposals have generated significant client interest/inquiries on equities and inflation - not asset prices, but of the more traditional kind: consumer price inflation. Chart 1 shows that a little bit of inflation would be positive for the broad equity market, further fueling the high-risk, liquidity-driven blow off phase. However, when inflation has reached 3.7%-4% in the past, the broad equity market has stumbled (Chart 2). Sizeable tax cuts, increased infrastructure and defense spending (i.e. loose fiscal policy), protectionism and a tougher stance on immigration are inherently inflationary policies (and bond price negative) ceteris paribus. Chart 1A Whiff Of Inflation##br## Is Good For Stocks... bca.uses_sr_2016_12_05_c1 bca.uses_sr_2016_12_05_c1 Chart 2...But Too Much ##br##Is Restrictive ...But Too Much Is Restrictive ...But Too Much Is Restrictive However, our working assumption is that in the next 9-12 months, CPI headline inflation will only renormalize, rather than surge. Importantly, the magnitude and timing of the implementation of Trump's policy pledges is unknown. Moreover, the Fed's reaction function is also uncertain, and the resulting economic growth and U.S. dollar impact will be critical in determining whether any lasting inflation acceleration occurs. Table 1 Equity Sector Winners And Losers When Inflation Climbs Equity Sector Winners And Losers When Inflation Climbs For global inflation to take root beyond the short term, Europe and Japan would also have to follow Canada's and America's fiscal largesse to swing the global deflation/inflation pendulum toward sustained inflation. The Fed's Reaction Function Our sense is that a Yellen-led Fed will allow for some inflation overshoot to materialize. This view was originally posited in her 2012 "optimal control"1 speech and more recently reiterated with her mid-October speech emphasizing "temporarily running a "high-pressure economy," with robust aggregate demand and a tight labor market."2 The Fed has credible tools to deal with inflation. If economic growth does not soar, but rather sustains its post-GFC steady 2-2.5% real GDP growth profile as we expect, then taking some inflation risk is a high-probability. The implication is that the Fed will likely not rush to abruptly tighten monetary policy, a view confirmed by the bond market , which is penciling in only 40bps for 2017 (Chart 3). A sustainable breakout in bond yields would require inflation (and to a lesser extent real GDP growth) to significantly surprise to the upside and thus compel the Fed to aggressively raise the fed funds rate. Is that on the horizon? While wage inflation has perked up, unit labor cost inflation has a spotty track record in terms of leading core consumer goods prices. Why? About 20% of the CPI and PCE inflation baskets are produced abroad, underscoring that domestic costs are not a factor in setting prices. There is a tighter correlation between unit labor costs and service sector inflation, but even here there is not a consistent relationship (Chart 4). Consequently, there is minimal pressure on the Fed to get aggressive, suggesting that most of the cyclical back up in long-term yields may have already occurred. Chart 3Fed Will Be Late, As Always bca.uses_sr_2016_12_05_c3 bca.uses_sr_2016_12_05_c3 Chart 4Wage And CPI Inflation Often Diverge Wage And CPI Inflation Often Diverge Wage And CPI Inflation Often Diverge The 1960s Analogy The 1960s period provides an instructive guide for today. Then, an extremely tight labor market and a positive output gap was initially ignored by the Fed, i.e. the economy was allowed to overheat (Chart 5). This ultimately led to the surge of inflation in the 1970s, especially given the then highly unionized labor market (see appendix Chart A1). While there are similarities between the current backdrop and the 1960s, namely an extended business cycle, full employment, narrowing output gap, easy monetary and a path to easing fiscal policies, and rising money multiplier, there are also striking differences. At the current juncture, wage inflation is half of what it was in the mid-1960s. Even unit labor costs heated up to over 8% back then, nearly four times the current level. Chart 5The 1960's... bca.uses_sr_2016_12_05_c5 bca.uses_sr_2016_12_05_c5 Chart 6... And Today bca.uses_sr_2016_12_05_c6 bca.uses_sr_2016_12_05_c6 Full employment has only been recently attained (Chart 6) and in order to pose a long-term inflation worry, it would have to stay near 5% for another three years. True, the output gap is almost closed, and is forecast to turn marginally positive in 2017/2018, but much will depend on the timing of fiscal stimulus. Industrial production has diverged negatively from the output gap of late, suggesting that excess capacity still lingers in some parts of the economy (Chart 7). The upshot is that inflationary pressures may stay contained for some time, especially if the U.S. dollar continues to firm. The global environment remains marked by deficient demand, not scarce resources. Chart 8 shows that the NFIB survey of the small business sector has a good track record in leading core inflation. The survey shows that businesses are still finding it difficult to lift selling prices. That is confirmed by deflation in the retail price deflator. Chart 7Divergent Economic Slack Messages bca.uses_sr_2016_12_05_c7 bca.uses_sr_2016_12_05_c7 Chart 8Pricing Power Trouble bca.uses_sr_2016_12_05_c8 bca.uses_sr_2016_12_05_c8 Finally, while the money multiplier has troughed, it would have to jump to a level of 4.9 to parallel the 1960s (Chart 9). This is a tall order and it would really require the Fed to very aggressively wind down its balance sheet. Chart 9Monitoring The Money Multiplier bca.uses_sr_2016_12_05_c9 bca.uses_sr_2016_12_05_c9 Therefore, a 1960s repeat would be a tail risk, and not our base case forecast. What About The Greenback? Chart 10 shows that inflation decelerates during U.S. dollar bull markets. Our Foreign Exchange Strategy service believes that the currency has more cyclical upside3, given that it has not yet overshot on a valuation basis and interest rate differentials will favor the U.S. for the foreseeable future. Accordingly, it may be difficult for inflation to rise on a sustained basis. Chart 10Appreciating Dollar Is##br## Always Disinflationary Appreciating Dollar Is Always Disinflationary Appreciating Dollar Is Always Disinflationary So What? Accelerating inflation is a modest risk, but not our base case forecast. Nevertheless, for investors that are more worried about the prospect of higher inflation, the purpose of this Special Report is to serve as an equity sector positioning roadmap if inflationary pressures become more acute sooner than we anticipate. Historically, inflation has been synonymous with an aggressive Fed and hard asset outperformance, suggesting that deep cyclical sectors would be primary beneficiaries. Table 1 on Page 2 shows that over the last six major inflationary cycles, energy, materials, real estate and health care have been consistent outperformers. Utilities, tech and telecom have been clear underperformers. The remaining sectors have been a mixed bag. However, this cycle, potential growth is much lower than in the past, underscoring that the hit to overall profits from tighter monetary policy could be pronounced, potentially undermining equity market risk premiums. If inflation rises too quickly and the Fed hits the economic brakes, then it is hard to envision cyclical sectors putting in a strong market performance, especially given their high debt loads and shaky balance sheets, i.e. they are at the epicenter of corporate sector vulnerability if interest rates rise too quickly. Owning shaky balance sheets in a sluggish global economy is a strategy fraught with risk. On the flipside, the recent knee jerk sell off in more defensive sectors represents a reversal of external capital flows, and is not representative of an underlying vulnerability in their earnings prospects. As a result of this shift, valuations now favor more defensive sectors by a wide margin. Ultimately, we expect relative profit trends to dictate relative performance on a cyclical investment horizon, and are not rushing to position our portfolio for accelerating inflation. Anastasios Avgeriou, Vice President Global Alpha Sector Strategy anastasios@bcaresearch.com 1 https://www.federalreserve.gov/newsevents/speech/yellen20120411a.htm 2 https://www.federalreserve.gov/newsevents/speech/yellen20161014a.htm 3 https://fes.bcaresearch.com/articles/view_report/20812 Health Care (Overweight) Health care stocks have consistently outperformed during the six inflationary periods we studied. Over the long haul it has paid to overweight this sector given the structural uptrend in relative share prices. Spending on health care services is non-cyclical and demand for such services is also on a secular rise around the globe: in the developed markets driven largely by the aging population and in the emerging markets by the adoption of health care safety nets (Chart 11). Health care pricing power is expanding at a healthy clip, outshining overall CPI. Importantly, recent geopolitical uncertainty had cast a shadow on the sector's pricing power prospects that suffered from a constant derating. Now that political and pricing power uncertainty is lifting, a rerating looms. Finally, the health care sector's dividend yield allure is the lowest among defensive sectors and remains 44bps below the broad market, somewhat insulating the sector from the inflation driven selloff in the bond market (Chart 12). Chart 11Health Care bca.uses_sr_2016_12_05_c11 bca.uses_sr_2016_12_05_c11 Chart 12Health Care bca.uses_sr_2016_12_05_c12 bca.uses_sr_2016_12_05_c12 Consumer Staples (Overweight) Similar to the health care sector, consumer staples stocks have been stellar outperformers over the past 55 years. The sector's track record during the six inflationary periods we studied is split down the middle. Most consumer staples companies are global conglomerates and their efforts have been focused on building global consumer brands, allowing them to implement a stickier pricing strategy. As a result, overall inflation/deflation pressures are more benign (Chart 13). Relative consumer staples pricing power is expanding and has been in an uptrend for the past five years. As the U.S. dollar has been in a bull market since 2011, short-circuiting the commodity super cycle, consumer staples manufacturers have been beneficiaries of falling commodity input costs. The implication is that profit margins have been expanding due to both rising pricing power and lower input costs (Chart 14). Chart 13Consumer Staples bca.uses_sr_2016_12_05_c13 bca.uses_sr_2016_12_05_c13 Chart 14Consumer Staples bca.uses_sr_2016_12_05_c14 bca.uses_sr_2016_12_05_c14 Telecom Services (Overweight - High Conviction) Relative telecom services performance and inflation appear broadly inversely correlated since the early 1970s, underperforming 60% of the time when core PCE prices accelerate. Importantly, in two of the periods we studied (during the late-70s and the TMT bubble) the drawdowns were massive, skewing the mean results portrayed in Table 1 on page 2. This fixed income proxy sector tends to suffer in times of inflation as competing assets dilute its yield appeal and vice versa (Chart 15). Telecom services pricing power has been declining over time as the government deregulated this once monopolistic industry. As more entrants forayed into the sector boosting competition, pricing power erosion accelerated. While relative sector pricing power has been mostly mired in deflation with a few rare expansionary spurts, there is an offset as the industry has entered a less volatile selling price backdrop: communications equipment costs are also constantly sinking (they represent a major input cost), counterbalancing the industry's profit margin outlook (Chart 16). Chart 15Telecom Services bca.uses_sr_2016_12_05_c15 bca.uses_sr_2016_12_05_c15 Chart 16Telecom Services bca.uses_sr_2016_12_05_c16 bca.uses_sr_2016_12_05_c16 Consumer Discretionary (Overweight) While the overall trend in consumer discretionary stocks has been higher since the mid-1970s, relative performance mostly declines during inflationary times. Consumer spending takes the backseat as a performance driver when interest rates rise on the back of higher inflation. In addition, previous inflationary periods have also coincided with surging energy prices, representing another source of diminishing consumer discretionary purchasing power (Chart 17). Consumer discretionary selling prices are expanding relative to overall wholesale price inflation, but they have been losing some steam of late. Were energy prices to sustain their recent cyclical advance, as BCA's Commodity & Energy Strategy service expects, that would represent a minor headwind to discretionary outlays. True, the tightening in monetary conditions could also be a risk, but we doubt the Yellen-led Fed would slam on the brakes at a time when the greenback is close to 15 year highs. The latter continues to suppress import prices and act as a tailwind to consumer spending and more than offsetting the energy and interest rate headwinds (Chart 18). Chart 17Consumer Discretionary bca.uses_sr_2016_12_05_c17 bca.uses_sr_2016_12_05_c17 Chart 18Consumer Discretionary bca.uses_sr_2016_12_05_c18 bca.uses_sr_2016_12_05_c18 Real Estate (Overweight) REITs have been outperforming the overall market during the five inflationary periods we analyzed, exemplifying their hard asset profile. While the 1976-81 iteration skewed the mean results, REITs still come out with the third best showing among the top eleven sectors even on median return basis (see Table 1 on page 2). Real estate prices tend to appreciate when inflation is accelerating, because landlords have consistently raised rents at least on a par with inflation (Chart 19). REITs pricing power has outpaced overall CPI. Apartment REITs rental inflation has been on a tear since the GFC, and the multi-family construction boom will eventually act as a restraint. The selloff in the bond market represents another risk to REITs relative returns as this index falls under the fixed income proxied equity basket, but the sector is now attractively valued (Chart 20). Chart 19Real Estate bca.uses_sr_2016_12_05_c19 bca.uses_sr_2016_12_05_c19 Chart 20Real Estate Real Estate Real Estate Energy (Neutral) The energy sector comes out on top of the median relative return results in times of inflation, and second best in average terms (Table 1 on page 2). Oil price surges are typically synonymous with other forms of inflation. During the six inflationary periods we analyzed, all but one period were associated with relative share price outperformance. Oil producers in particular benefit from the increase in the underlying commodity almost immediately (assuming little to no hedging), which also serves as an excellent inflation hedge (Chart 21). While relative energy pricing power had stabilized following the tumultuous GFC, Saudi Arabia's decision in late 2014 to refrain from balancing the oil market triggered a plunge in oil prices, similar to the mid-1980s collapse. The OPEC deal reached last week to curtail oil production should rebalance the market more quickly, assuming OPEC cheating will be limited, removing downside price risks. Nevertheless, any oil price acceleration to the $60/bbl level will likely prove self-limiting, as supply will come to the market and producers would rush to lock in prices by hedging forward (Chart 22). Chart 21Energy Energy Energy Chart 22Energy Energy Energy Financials (Neutral) Financials relative returns are neither hot nor cold when inflation rears its ugly head. In fact they sit in the middle of the pack in terms of relative median and mean returns. This lack of consistency reflects different factors that exerted significant influence in some of these inflationary periods. Moreover, Chart 23 shows that relative share prices have been mean reverting since the 1960s, likely blurring the inflation influence. Ultimately, the yield curve, credit growth and credit quality determine the path of least resistance for the relative share price ratio of this early cyclical sector. Financials sector pricing power has jumped by about 400bps over the past 18 months. Given the recent steepening of the yield curve, the odds are high that sector pricing power will remain firm via rising net interest margins. Any easing in the regulatory backdrop could also provide a fillip to margins (Chart 24). Chart 23Financials Financials Financials Chart 24Financials Financials Financials Utilities (Neutral) Utilities relative returns during inflationary bouts are the second worst among the top eleven sectors on an average basis and dead last on a median return basis. In five out of the six inflationary phases we examined, utilities stocks suffered a setback. The industry's lack of economic leverage and fixed income attributes anchor the relative share price ratio during inflationary times (Chart 25). Our utilities sector pricing power proxy has sprung to life recently moderately outpacing overall inflation. Natural gas prices, the industry's marginal price setter, have experienced a V-shaped recovery since the March trough, as excess inventories have been whittled down, signaling that recent pricing power gains have more upside. Nevertheless, the recent inflation driven jack up in interest rates has dealt a blow to this high dividend yielding defensive sector. Barring a sustained selloff in the bond market at least a technical rebound in relative share prices is looming (Chart 26). Chart 25Utilities Utilities Utilities Chart 26Utilities Utilities Utilities Tech (Underweight) Technology stocks have underperformed every time inflation has accelerated with two exceptions, in the mid-to-late 1960s and mid-to-late 1970s. Creative destruction forces in the tech industry are inherently deflationary. As a result, tech business models have evolved to thrive during disinflationary periods. Moreover, tech stocks have become more mature than typically perceived, having more stable cash flows and paying dividends. The implication is that the negative correlation with inflation will likely remain in place (Chart 27). Tech companies are constantly mired in deflation. While relative pricing power has been in an uptrend since 2011, it has recently relapsed into the deflationary zone. Worrisomely, deflation pressures are likely to intensify as the U.S. dollar appreciates, eating into the sector's earnings growth prospects. Finally, as a reminder, among the top eleven sectors tech stocks have the highest international sales exposure (Chart 28). Chart 27Tech Tech Tech Chart 28Tech Tech Tech Industrials (Underweight - High Conviction) The industrials sector tends to outperform during inflationary periods. In fact, relative share prices have risen 50% of the time since the mid-1960s when inflation was accelerating. The two oil shocks in the 1970s raised the profile of all commodity-related sectors as investors were scrambling to find reliable inflation hedges (Chart 29). Industrials pricing power is sinking steadily, weighed down by the multi-year commodity plunge on the back of China's economic growth deceleration, rising U.S. dollar and increasing supplies. While infrastructure spending is slated to increase at some point in late-2017 or early-2018, we doubt a lot of shovel ready projects will get off the ground quickly enough to satisfy the recent spike in expectations. We are in a wait and see period and remain skeptical that all this fiscal spending enthusiasm will translate into a sustainable earnings driven outperformance phase (Chart 30). Chart 29Industrials Industrials Industrials Chart 30Industrials bca.uses_sr_2016_12_05_c30 bca.uses_sr_2016_12_05_c30 Materials (Underweight) Materials equities have a tight positive correlation with accelerating inflation. Resource-related stocks are the closest representation of hard assets, given their ability to store value among the eleven GICS1 sectors. As inflation takes root and commodity prices rise, materials sales and EPS growth get a boost with relative share prices following right behind (Chart 31). From peak-to-trough relative materials prices collapsed by over 35 percentage points and only recently have managed to stage a modest comeback. Our relative pricing power gauge is flirting with the zero line, but may not move much higher. Deleveraging has not even commenced in the emerging markets, and the soaring U.S. dollar is highly deflationary. It will be extremely difficult for materials prices to advance sustainably if EM financial stress intensifies, given the inevitable backlash onto regional economic growth (Chart 32). Chart 31Materials bca.uses_sr_2016_12_05_c31 bca.uses_sr_2016_12_05_c31 Chart 32Materials bca.uses_sr_2016_12_05_c32 bca.uses_sr_2016_12_05_c32 Appendix Chart A1 bca.uses_sr_2016_12_05_c33 bca.uses_sr_2016_12_05_c33 Chart A2 bca.uses_sr_2016_12_05_c34 bca.uses_sr_2016_12_05_c34 Chart A3 bca.uses_sr_2016_12_05_c35 bca.uses_sr_2016_12_05_c35 Chart A4 bca.uses_sr_2016_12_05_c36 bca.uses_sr_2016_12_05_c36 Chart A5 bca.uses_sr_2016_12_05_c37 bca.uses_sr_2016_12_05_c37 Chart A6 bca.uses_sr_2016_12_05_c38 bca.uses_sr_2016_12_05_c38

Fixed income proxies have been pummeled recently, with the S&P utilities underperforming the S&P 500 by nearly 14% since the mid-year relative performance peak, on a mere 32bps jump in 10-year U.S. Treasury yields (UST). Since 2010 there have been three iterations of meaningful bond market selloffs, with yields rising by an average of 120bps (see table). Relative utilities returns in these iterations fell by an average of over 18% (top three panels). Utilities have already sold off by nearly 75% of the average bond yield selloff, even though long-term yields have barely budged. The implication is that a large yield back up has already been discounted and now is not the time to rush for the exits. In fact, our inclination is to look for buying opportunities, given that we do not envision much upside in government bond yields. Stay neutral, but look to buy when value improves. bca.uses_in_2016_10_06_002_c1 bca.uses_in_2016_10_06_002_c1 Table 1 Utilities Selloff: The Worst Is Behind Them Utilities Selloff: The Worst Is Behind Them