Consensus Survey

Sector Strategy Report Thu. May 28, 2009 Strategas Research Partners, LLC Nicholas Bohnsack (212) 906-0132 Chris Verrone (212) 906-0135

[email protected] [email protected]

Contrarians Note: It’s Getting Awfully Consensus that Market Has Made Its Cycle Low Consensus looks to be establishing the view that the equity rally from the March 9th low is the start of a new bull market. A survey we took of our lunch guests yesterday in Connecticut is the fifth investor survey over the last month to exhibit similar sentiment to this point. While lack of institutional participation could help the market melt higher from here, our contrarian instincts make us wary over the long-term sustainability of this rally. Despite a market that has stalled throughout much of May (S&P 500 up +2%), our survey results have moved increasingly bullish over the last month. Strategas Institutional Investor Survey Date

Event

Apr. 28th

Has the S&P 500 made its final low at 666.79 on March 6th, 2009? Yes

No

New York Research Dinner

12

3

May. 7th

Texas Investor Lunch

9

5

May. 20th

Connecticut Research Lunch

16

2

May. 26th

New York Policy Dinner

12

1

May. 27th

Connecticut Research Lunch

10

1

SUM

59

12

Strategas Connecticut Research Lunch Survey Results (Next 12 Months) High

Low

Average

S&P 500

1,220

750

1,040

10-Year Yield

4.3%

3.3%

3.8%

Crude Oil

$83

$45

$65

$1,050

$800

$936

Gold

1 of 8

Don’t Buy the Headfake in Multiples, Period of Secular Contraction Still in its Middle-Innings We would be among the first to admit that earnings multiples are a poor timing tool – either for a specific stock or the market as a whole – rather, they can help to frame the longer trend. A look at the 12-month trailing multiple of the S&P 500 following World War II shows four such clearly defined trends. Two periods of multiple expansion (1942-61 and 1979-99) – broadly linear in orientation, generally characterized as periods of “financial asset” outperformance and interesting to the extent that the quality of earnings declined; and, two periods of multiple contraction (1961-79 and the current period beginning in 1999). Multiples during the ’61-’79 period and this decade have been sideways in orientation, “real assets” have outperformed, and the quality of earnings has improved. What’s interesting to us, if not the order of magnitude of the ’61-’79 compression, is the trajectory. Aside from the triple threat of rising budget deficits, higher inflation and the prospect of higher interest rates – all defining elements of the ’70s – what stands out is the +74% increase in earnings from ’75 to ’79. The takeaway for investors with longer-term time horizons is that the macro headwinds seen three decades ago may be forming again and could restrain the markets ability to further discount a recovery in profits. S&P 500 Trailing P/E (1942 to 1961)

25x

25x

Multiple Expansion

20x

20x

1 5x

1 5x

1 0x

1 0x

5x

`

S&P 500 Trailing P/E (1961 to 1979) Interest Rates Inflation Deficits Taxes Multiples

5x '42

'45

'48

'51

'54

'57

S&P 500 Trailing P/E (1979 to 1999)

30x

20x

1 5x

1 5x

1 0x

1 0x

5x

5x '83

'87

'67

'7 0

'7 3

'7 6

'7 9

25x

20x

'7 9

'64

S&P 500 Trailing P/E (1999 to 2008)

30x

Multiple Expansion

25x

'61

'60

'91

Strategas Research Partners

'95

'99

'99

www.strategasrp.com

'02

'05

'08

'1 1

'1 4

'1 7

'20

2

Don’t Buy the Headfake in Multiples, Period of Secular Contraction Still in its Middle-Innings In the post-World War II environment recession-related profit declines and recoveries have been V-shaped in orientation – averaging 6 quarters from peak to trough and 6 quarters from trough to previous peak. The magnitude of decline has averaged -18% from peak to trough, requiring a +36% increase in earnings to climb the “V.” This has largely been possible due to two drivers: 1) productivity gains; and 2) financial leverage. (We’ll leave the productivity argument aside for a moment. Our Chief Economist, Don Rissmiller, has written about the long-term pressure on productivity gains.) On the leverage front, companies that employ greater risk generally garner lower multiples. To the extent they are replaced in the Index by companies employing less risk (and garnering a higher P/E), the net effect is for aggregate multiples to increase – this along with a absolute decline in “E” accounts for the sideways progression of valuations. In this cycle, S&P profits peaked in 2Q ’07 – 8 quarters on, earnings are lower by nearly -50%. We are of the view that earnings will decline through 3Q ’09, good for a 9 quarter retracement. In order for this profit cycle to “V” profits will need to double in the ensuing 9 quarters. This could be tough to come by. Given that: 1) Financials now represent a smaller portion of the Index (roughly 13%, down from 22% in ’06); 2) their earnings power is impaired; and 3) their usage of leverage is curtailed (at least for the moment), the recovery in Index profits will likely take far longer than many investors would estimate – remember, it took over 4 years for earnings to increase +75% in the late-’70s under similar macro conditions.

S&P 500 Earnings & Multiples $45

$50

$55

$60

$65

$70

12x

540

600

660

720

780

840

13x

585

650

715

780

845

910

14x

630

700

770

840

910

980

15x

675

750

825

900

975

1050

16x

720

800

880

960

1040

1120

17x

765

850

935

1020

1105

1190

18x

810

900

990

1080

1170

1260

Strategas Research Partners

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3

Industry Group Absolute Multiples For trend watchers, we have broken the S&P 500 down into Industry Groups benchmarking multiples at 5 and 1 year ago to today. For many groups, the sharp contraction of earnings and the recent run in share prices have left things looking a little expensive. The question to ask is, with the market rallying +35% in three months, will investors continue to pay up for an uncertain profit picture. S&P 500 Industry Group Forward P/E 5-Years Ago

1-Year Ago

Present

10-Year Avg.

Diversified Financials Materials Banks Energy Retailing Consumer Durables & Apparel Real Estate

12.4 16.0 11.5 14.7 18.2 12.3 27.7

12.1 15.1 15.2 11.2 15.1 18.3 31.1

20.6 21.6 20.5 14.8 17.9 20.4 32.8

13.2 16.1 12.4 14.8 19.3 13.4 29.6

S&P 500

16.9

14.5

14.0

17.9

Commercial & Professional Svc. Telecommunications Services Consumer Services Capital Goods Technology Hardware & Equipment Pharmaceuticals Biotech & Life Scn. Food & Staples Retailing Transportation Household & Personal Products Food Beverage & Tobacco Software & Services Insurance Media Health Care Equipment & Services Utilities

18.2 17.5 19.4 17.6 22.9 17.9 21.0 19.9 21.4 16.3 22.2 11.9 25.0 18.6 13.3

13.5 13.9 16.5 14.0 16.9 12.9 16.0 17.6 16.9 16.3 17.4 9.6 14.9 14.4 15.5

13.0 13.1 14.9 12.7 14.9 10.6 12.8 14.2 13.4 12.9 13.6 7.4 11.2 10.8 10.7

17.5 17.6 18.0 17.2 25.8 19.3 18.0 17.7 19.8 16.5 26.0 12.6 29.8 18.5 13.7

Strategas Research Partners

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4

Industry Group Relative Multiples S&P 500 Industry Group Forward P/E Relative S&P 500 P/E Diversified Financials Materials Banks Energy Retailing Consumer Durables & Apparel Real Estate Commercial & Professional Svc. Telecommunications Services Consumer Services Capital Goods Technology Hardware & Equipment Pharmaceuticals Biotech & Life Scn. Food & Staples Retailing Transportation Household & Personal Products Food Beverage & Tobacco Software & Services Insurance Media Health Care Equipment & Services Utilities S&P 500

Strategas Research Partners

5-Years Ago 0.73

0.95 0.68 0.87 1.08 0.73 1.64 1.08 1.04 1.15 1.05 1.36 1.06 1.24 1.18 1.27 0.96 1.32 0.71 1.48 1.10 0.79 --

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1-Year Ago

Present

10-Year Avg.

0.83 1.05 1.05 0.77 1.04 1.27 2.15 0.94 0.96 1.14 0.97 1.17 0.89 1.10 1.22 1.17 1.13 1.20 0.66 1.03 1.00 1.07 --

1.47 1.54 1.46 1.06 1.28 1.45 2.34 0.93 0.93 1.06 0.90 1.06 0.75 0.91 1.01 0.96 0.92 0.97 0.53 0.80 0.77 0.76 --

0.75 0.92 0.73 0.82 1.08 0.80 1.91 0.99 0.97 1.04 0.96 1.40 1.06 1.03 1.03 1.13 0.95 1.40 0.69 1.55 1.04 0.80 --

5

Looking Ahead to 2010, Risk to Our Profit Forecast is Probably to the Upside The relatively conservative economic inputs we’re using below suggest that the risk to our 2010 profit forecast could actually be an upside earnings surprise along with some modest margin improvement.

Productivity

2.00%

+Employment Growth Real GDP

Sales (Costs) Income Margin

Wages

2.00%

0.00%

(Productivity)

2.00%

2.00%

Unit Labor Costs

0.00%

Real Output

2.00%

Unit Labor Costs

0.00%

Total Costs

2.00%

2009

2010

$100.00

$103.00

3.00%

Revenue Gain*

$95.90

$97.82

2.00%

Cost Increase

$4.10

$5.18

26.3%

Earnings Gain

4.1%

5.0%

A 26% increase off our 2009 estimate of $51.75 would imply earnings of roughly $65 in 2010. We are currently forecasting $59.25 for 2010.

Strategas Research Partners

*Strategas 2010 nominal GDP forecast, 3.0%

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6

Technical Tearsheet: Golden Cross Marks Significant Inflection Point for Technology Sector S&P 500 Technology Sector with 50 & 200 Day Moving Averages 450

Downside Golden Cross Downside Golden Cross

400

350

300

Upside Golden Cross

250

Tech Sector On Verge of Upside Golden Cross – 50 Day Avg. Breaking Through 200 Day Avg – Could Suggest Further Upside Potential. Stay Tuned.

200

1 50 '06

'07

'08

'09

S&P 500 Technology Sector Performance Through First 5 Months of Each Year 3 0% 2 0%

Tech is off to its best start in years, and has resumed its leadership 17.5% status over the last several weeks. 16.4%

20.1% 12.0%

1 0%

4.2%

0% -2.6%

-1 0%

-4.3%

-4.6%

'05

'06

-7.6%

-2 0%

-4.6%

-17.7% -22.1%

-3 0% '9 8

'9 9

Strategas Research Partners

'00

'01

'02

'03

'04

www.strategasrp.com

'07

'08

'09

7

Underweight

Market Weight

Overweight

Strategas Sector Scorecard Index Weight

Strategas Weight

+ or Diff

Inception Date

Absolute Performance

Relative Performance

Materials

3%

6%

3%

1/26/09

18.1%

11.3%

Energy

13%

15%

2%

1/26/09

-2.0%

-8.7%

Staples

12%

13%

1%

7/10/08

-16.6%

12.1%

Industrials

11%

11%

0%

5/13/09

0.3%

-0.7%

Financials

13%

13%

0%

1/26/09

31.8%

25.1%

Technology

17%

17%

0%

3/26/09

7.9%

0.7%

Telecom

4%

3%

-1%

9/16/08

-17.0%

9.4%

Discretionary

9%

8%

-1%

7/10/08

-16.2%

12.6%

Health Care

14%

12%

-2%

5/13/09

-1.1

-2.2%

Utilities

4%

2%

-2%

7/23/08

-32.3%

-1.9%

* Performance measured from Strategas position inception date.

Strategas Research Partners

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8