1

WEEKLY REPORTRunning Into A Debt Wall?

May 16, 2016Periodical

In this Issue: F Pharmaceuticals Are A Portfolio Salve ...........4

F No Reprieve For The Tech Sector ................7

U.S. EQUITY STRATEGY

Editorial BoardDavid Abramson Director of Research

Matthew Pugsley Consulting Editor

Anastasios Avgeriou Managing Editor

Caroline Miller Managing Editor

Dulce Cruz Senior Analyst

EdgeThe interface of investment researchRESEARCH DISCOVERY ACTION

S&P SECTORS

SALES GROWTH (%)

EARNINGS GROWTH (%) IMPLIED

MARGIN GROWTHLEVEL RELATIVE* LEVEL RELATIVE*

Consumer Discretionary 5.84 2.04 12.76 5.81 6.54

Health Care 7.03 3.23 9.4 2.46 2.22

Telecom Services 4.24 0.44 3 -3.95 -1.19

Information Technology 4.15 0.35 7.95 1.01 3.65

Utilities 3.94 0.14 3.32 -3.63 -0.6

Consumer Staples 3.92 0.12 7.07 0.12 3.02

S&P 500 3.8 0 6.95 0 3.03

Financials 3.32 -0.48 5.86 -1.08 2.46

Industrials 1.59 -2.21 5.74 -1.2 4.09

Materials 0.99 -2.81 7.49 0.54 6.43

Energy -1.69 -5.49 -15.88 -22.82 -14.43

SOURCE: THOMSON REUTERS / IBES, 12-MONTH FORWARD GROWTH EXPECTATIONS. *RELATIVE TO THE S&P 500.

Table 1

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Portfolio Strategy F Drug prices are a hot political issue, but rising prices have yet to undermine consump-

tion, underscoring that pharmaceutical profits will remain on an outperformance track.

F The tech sector faces a dual valuation and profit margin squeeze, and there is no incentive to buy into recent weakness. Stay underweight.

Recent Changes F There are no changes to our portfolio this week.

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The current BCA House View Matrix will be published on the last page of all BCA reports from 13/05/16-19/05/16.

CHaRT 1

Beware Excess Leverage

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U.S. S&P BANKS / S&P 50040-WEEK MOVING AVERAGE

NON-FINANCIAL CORPORATE SECTOR: FREE CASH FLOW** (ADV, LS)

S&P 500 EPS (RS)

$Bn

S&P 500 (LS)NON-FINANCIALS: NET DEBT /

EBITDA* (INV, RS)

*SOURCE: THOMSON REUTERS**AFTER-TAX NET INCOME PLUS DEPRECIATION MINUS CAPEX

© BCA Research 2016

Stocks whipsawed violently last week. Vola-tility could intensify if recent whiffs of a

domestic economic slowdown proliferate and the Fed still adopts a more hawkish tone. Keep in mind that equities are losing steam even as the U.S. dollar stays soft, which is a tentative bearish correlation change.

Our reluctance to embrace the liquidity-driven spurt of share price strength over the last few months is based on our concerns about over-valuation, persistent global deflationary pres-sures, poor balance sheet health, low earnings quality and rising risk of domestic economic disappointment.

Cash flow generation is weakening but com-panies have continued to add leverage on the view that interest rates will stay low forever (Chart 1). Funds have not been used for pro-ductive investment, but rather to retire stock. While this dynamic has been a large support for earnings per share, it cannot continue forever amid the rapid decline in the quality of corpo-rate sector balance sheets. High leverage will become much more problematic should eco-nomic growth slow from already anemic rates.

Typically, as free cash flow declines and the non-financial corporate sector suffers through a painful increase in net debt/EBITDA (shown inverted, top panel, Chart 1), the stock market either corrects or has already entered a bear market, as risk premiums climb in anticipa-tion of a self-reinforcing economic and profit downturn.

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This cycle, a massive divergence has opened up, as any concerns about rising debt stress have been trumped by the view that low inter-est rates and abundant central bank liquidity will support asset prices indefinitely. That is unsustainable, because debt must be repaid at some point, and the longer that this gap grows, the greater the vulnerability to share prices. This underscores why a global growth recovery, i.e. better cash flow, is paramount to lessening downside equity market risks.

In the interim, evidence is slowly emerging that debt excesses are causing economic backlash. Credit standards have tightened, loan loss provisions are creeping higher and corporate bond spreads appear to have troughed for the cycle. Keep in mind that our research shows that balance sheet deterioration extends well beyond the energy sector (please see the Feb-ruary 2016 Special Report published by the Bank Credit Analyst).1

Credit concerns likely explain the inability of banks to participate in the latest equity rally. In fact, bank relative performance tends to lead overall debt servicing deterioration. In past cycles, the inability of bank stocks to partici-pate has been a warning for the broad market (Chart 1), implying that the latest downturn should not be lightly dismissed.

Similarly, the persistent bid under defensive equities signals a peaking process not a breakout. Relative performance breadth and momentum are strongest in non-cyclical sec-tors, and comparatively weak in cyclical and interest rate-sensitive sectors (Chart 2). The

CHaRT 2

Market Forces Are Not Bullish

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S&P INTEREST RATE SENSITIVES***% %

S&P DEEP CYCLICALS**% %

U.S. S&P GROUPS WITH POSITIVE:52-WEEK RATE-OF-CHANGE(For Last 3 Panels)

S&P DEFENSIVES*

% %

U.S. S&P 500200-DAY MOVING AVERAGE

*INCLUDES: CONSUMER STAPLES, HEALTH CARE, TELECOM & UTILITIES**INCLUDES: TECH, INDUSTRIALS, ENERGY & MATERIALS***INCLUDES: CONSUMER DISCRETIONARY & FINANCIALS

© BCA Research 2016

Weak

Weak

1 Please see The Bank Credit Analyst Special Report titled “Secular Stagnation And The Medium-Term Outlook For Bonds”, published on February 25, 2016, available at bca.bcaresearch.com

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CHaRT 3

Biotech And Pharma Are Diverging

2.0

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2015 2016

.31

.30

.29

.28

.27

JAN APR JUL OCT JAN APR JUL

U.S.NASDAQ BIOTECH / S&P 500 (LS)S&P PHARMA / S&P 500 (RS)

© BCA Research 2016

latter is disconcerting given that the Fed has not slammed on the brakes and bond yields remain historically low, reflecting deflationary global undertones.

Adding it up, we continue to foresee more downside than upside risks to stocks at current levels, and remain committed to our defensive sector portfolio positioning.

Pharmaceuticals Are A Portfolio Salve Pharmaceutical stocks are staging a comeback after a difficult end to 2015. The group was caught up in political fear mongering and also suffered some backlash from the bursting of the biotech bubble. However, the investment characteristics of the two industries are vastly different and we expect the budding share price divergence to persist (Chart 3), with pharma-ceuticals fully recouping last year’s slide and heading to new cyclical relative performance highs.

True, as the U.S. election campaign heats up in the autumn and candidates vie for votes by at-tacking easy targets, such as high prescription drug prices, share price volatility could re-intensify. Nevertheless, the political bark is typically far more painful than its bite, and we reiterate that our concerns about excessive drug pricing will only materialize when there is evidence that drug consumption patterns are changing.

So far, there is scant evidence of higher prices choking consumption. Consumer spending on drugs is hitting new highs. That is true in both real and nominal terms, underscoring that higher outlays are not simply a reflection of rising drug prices (Chart 4). Nor is higher consumer spending on drugs a function of an increase in overall expenditures, as drug spending is also hitting new highs relative to total spending.

While the growth rate of drug consumption may slow, pent up demand from years of medical procedure deferral following the Great Recession will take time to play out. Leading indicators remain upbeat.

For instance, employment at hospitals, physicians’ offices and even medical device companies, continues to boom, even as overall employment growth cools. Health care procedures require hu-man capital, underscoring that staff levels rise and fall with demand for medical services. The message from booming health care services employment is that the reacceleration in pharmacy

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CHaRT 4

No Sign That High Prices Are Choking Consumption

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U.S. NUMBER OF FDANEW DRUG APPROVALS****

U.S. OPERATING MARGINS***:HEALTH CARE FACILITIES (LS)MANAGED HEALTH CARE (RS)

% %

PHAR. & DRUG STORES: RETAIL SALES (LS)HEALTH CARE EMPLOYMENT PROXY** (RS)

Ann%Chg

Ann%Chg

U.S. CONSUMER SPENDING ON DRUGS* / TOTAL:IN REAL TERMSNOMINAL TERMS

% %

U.S. S&P PHARMA / S&P 50040-WEEK MOVING AVERAGE

*PRESCRIPTION AND NON-PRESCRIPTION DRUGS, SMOOTHED**EMPLOYMENT IN HOSPITALS, OFFICES OF PHYSICIANS & MEDICAL EQUIPMENT***SMOOTHED****SHOWN AS A 12-MONTH MOVING TOTAL

© BCA Research 2016

New highs

Solid

Pipelines are full

drug store sales is a durable trend (Chart 4), which bodes well for drug consumption, and by extension, pricing power.

Moreover, health insurers and other large drug buying groups continue to post strong earn-ings and robust profit margins (Chart 4). The message is that higher costs are still being successfully passed through. If these groups begin to suffer margin compression, then they would likely ratchet up the pressure on drug manufacturers.

In the interim, soaring pharmaceutical ship-ments should be interpreted as demand-driven. While manufacturer and wholesale drug inventories are rising steadily, that is mostly a function of higher inventory values as a consequence of price increases. In real terms (i.e. volumes), producer inventories are shrinking. Moreover, inventory-to-sales (I/S) ratios have fallen throughout the supply chain (Chart 5), in marked contrast with overall I/S ratios, reinforcing that few barriers to price increases exist.

If drug companies continue to successfully move compounds through the FDA drug ap-proval process (Chart 4), then the justification for higher drug prices will remain intact.

All of these industry specific factors provide us with confidence that drug earnings will continue to outperform.

Importantly, an additional boost from exter-nal factors is forthcoming. Overall corporate sector profits are suffering from the global deflationary backlash. While recent U.S. dollar softness has eased some of the stress, survey results show that businesses are still unable to raise selling prices (Chart 6, second

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CHaRT 5

Inventories Remain LeanDiscover what you can do with BCA Analytics.

7

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U.S. PHARMA: PPI*Ann%Chg

Ann%Chg

U.S. PHARMA*:MANUF. INVENTORIES / SHIPMENTS (LS)WHOLESALE INVENTORIES / SALES (RS)

U.S. PHARMA: REAL MANUFACTURINGINVENTORIES**

% %

U.S. PHARMA: MANUFACTURINGSHIPMENTS*

Ann%Chg

Ann%Chg

U.S. S&P PHARMA / S&P 500200-DAY MOVING AVERAGE

*SMOOTHED**SHOWN AS A 3-MONTH RATE-OF-CHANGE, ANNUALIZED, SMOOTHED

© BCA Research 2016

CHaRT 6

Bullish External Forces

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U.S. :NFIB* REPORTED PRICE CHANGES (INV, LS)RELATIVE FORWARD EPS** (RS)

%

U.S. S&P PHARMA / S&P 500 (LS)U.S. 10-YEAR TREASURY YIELD (INV, RS)

%

*SOURCE: NATIONAL FEDERATION OF INDEPENDENT BUSINESS**SOURCE: THOMSON REUTERS / IBES, S&P PHARMA / S&P 500

© BCA Research 2016

panel). When contrasted against burgeoning pharmaceuticals pricing power, the message is bullish for relative profit performance.

Market forces are also lined up positively. Pharmaceuticals are one of the longest du-ration equity groups, owing to the recurring nature and predictability of future cash flows, underscoring that the decline in long-term Treasury yields is supportive of a valuation expansion (Chart 6, top panel).

Meanwhile, the steady flow of M&A activity should have a dual benefit, namely injecting a

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CHaRT 7

Cheap, But Not For Long

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U.S. :S&P PHARMA SHARES OUTSTANDING (LS)BIOTECH INITIAL PUBLIC OFFERINGS* (RS)

BnUS$

U.S. PHARMA:FREE CASH FLOW YIELD**CORPORATE BOND YIELD***

% %

U.S. PHARMA:BCA VALUATION INDICATOR (LS)M&A ANNOUNCED DEALS* (RS)

Bn$

U.S. S&P PHARMA / S&P 50040-WEEK MOVING AVERAGE

*SMOOTHED**SOURCE: THOMSON REUTERS***SOURCE: BARCLAYS, YIELD TO WORST

© BCA Research 2016

Too cheap

Bullish gap

takeover premium and further reducing shares outstanding. With biotech IPOs also on the downswing, capital should funnel into tradi-tional pharma instead (Chart 7, bottom panel).

The outlook is upbeat for both ongoing M&A activity and equity repurchases, as the phar-maceutical industry’s free cash flow yield is rising anew, reopening the gap with the cost of capital, as proxied by the corporate bond yield (Chart 7, third panel).

Bottom Line: The S&P pharmaceuticals index (The ticker symbols for the stocks in this in-dex are: BLBG: S5PHAR – JNJ, PFE, MRK, BMY, AGN, LLY, ZTS, MYL, PRGO, MNK, ENDP) should enjoy the rare combination of bullish industry, external and market factors over the next while. As such, it remains a core overweight within our high-conviction overall health care sector overweight call.

No Reprieve For The Tech Sector Two months ago we outlined our top ten reasons why the tech sector would under-perform. Since then, a raft of poor earnings, particularly from several tech heavyweights, has caused the share price ratio to break below its 40-week moving average, to levels that should provide near-term support.

But rather than view weakness as a buying opportunity, we identify several forces that warn of additional downside risk.

The tech sector has delivered about 70% outperformance vs. the broad market since 2012, but none over the past year. Relative returns were fairly evenly distributed between valuation expansion and EPS outperformance

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CHaRT 8

Rolling Over...

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U.S. S&P TECH RETURN SINCEJAN 1, 2012 EXPLAINED BY:

FORWARD P/E* EXPANSIONFORWARD EPS* GROWTH

% %

U.S. S&P TECH:RETURN SINCE JAN 1, 2012

% %

U.S. S&P TECH / S&P 500200-DAY MOVING AVERAGE

*SOURCE: THOMSON REUTERS / IBES

© BCA Research 2016

(Chart 8). Going forward, we can envision both earnings and valuation pressure as this broad topping process morphs into underper-formance.

Tech balance sheets are no longer bulletproof, owing to a surge in debt issuance and declin-ing return on capital. As outlined in our March 7th Weekly Report,2 our tech sector Corporate Health Monitor has moved deep into deterio-rating health territory, reflecting massive debt issuance and declining return on capital. This will prompt investors to demand higher equity risk premiums.

As large tech companies have matured, margins have expanded. The ability to use options-based compensation plans has also likely fueled margin expansion, because companies have avoided cash compensation expenses (please see the Bi-Weekly Report3 written by our Senior Technology Strategist on options accounting in the tech sector, despite the dry topic it is an excellent read). Higher margins warrant higher valuations, and vice versa.

However, to the extent that weaker balance sheets undermine share repurchase flexibility, then labor expenses may climb, to the detri-ment of profit margins. The sector’s two heavy-weights, hardware and software, are already both experiencing margin compression, which bodes poorly for the broad sector (Chart 9). Semi and semi equipment margins shouldn’t be far behind, based on our analysis (please see the April 18th Weekly Report).4

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2 Please see U.S. Equity Strategy Weekly Report titled “Long-Term Multiple Compression”, published on February 7, 2016, available at uses.bcaresearch.com

3 Please see Technology Strategy Bi-Weekly Report titled “Tech Company Red Flags Part 1: Stock-Based Compensation”, published on March 29, 2016, available at tech.bcaresearch.com

4 Please see U.S. Equity Strategy Weekly Report titled “Is Sentiment Truly Bearish?”, published on April 18, 2016, available at uses.bcaresearch.com

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CHaRT 9

...As Margins Compress...

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S&P SEMIS (LS)S&P SEMI EQUIPMENT (RS)

% %

S&P TECH HS&P* (LS)S&P SOFTWARE** (RS)

% %

U.S. OPERATING MARGINS:(All Panels)

S&P TECH

% %

*HARDWARE, STORAGE & PERIPHERALS**SMOOTHED

© BCA Research 2016

Thus, the tentative cresting in overall sector margins is likely to accelerate, particularly if sales growth continues to slide.

Revenue trends influence profits and valu-ations heavily (Chart 10). Top-line growth generates higher quality earnings than cost cutting. Thus, the steady erosion in technol-ogy sales growth is a red flag.

CHaRT 10

...And Sales Falter

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SALES GROWTH* (LS)VALUATION INDICATOR** (RS)%

U.S. S&P TECH / S&P 50040-WEEK MOVING AVERAGE

*SHOWN AS A 6-MONTH RATE-OF-CHANGE, ANNUALIZED**CALCULATED ON A RELATIVE BASIS

© BCA Research 2016

Soft revenue will squeeze multiples

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Consumer spending on technology products and services has climbed as a share of total outlays (Chart 11, second panel), but the sector is not receiving support from other sources of final demand.

Businesses are being forced to retrench. Prof-its are under pressure while balance sheets are increasingly debt-laden. As a result, executives are unable to pursue expansion. Companies have spent the bulk of the money raised to repurchase shares rather than to invest. Why would that improve if the gap between the return on and cost of capital continued to close, as is currently the case?

Both our capital spending model and the nar-rowing gap between the return on and cost of capital warn that business investment on tech goods is headed south (Chart 11).

The financials sector has been a key support for tech demand, but it is already laying out an historically high portion of its sales on capital spending. Moreover, financial sector investment is likely to be reined in now that the credit cycle has taken a turn for the worse and more money needs to be set aside for bad loans (Chart 11, bottom panel), which will re-move another support for tech final demand.

While the sector is accustomed to operat-ing in a deflationary environment, the scope of the loss of pricing power globally has engulfed technology companies. Plunging exports in tech-intensive Asian manufacturers signal that deficient final demand is forcing a liquidation phase (Chart 12, second panel). That is confirmed by deflation in U.S. con-sumer goods import prices and fresh contrac-tion in U.S. technology new orders (Chart 12).

CHaRT 11

Stumbling Tech Demand

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FINANCIALS CAPEX / SALES*** (LS)FINANCIAL RATINGS

MIGRATION**** (ADV, RS)

% Bn$

TECH BUSINESS INVESTMENT** (LS)GAP BETWEEN RETURN ON AND REAL

COST OF CAPITAL (ADV, RS)

Ann%Chg

%

U.S. TECH BUSINESS INVESTMENT** (LS)U.S. BCA CAPEX INDICATOR (ADV, RS)

Ann%Chg

U.S. CONSUMER SPENDING:TECH / TOTAL*

% %

U.S. S&P TECH / S&P 50040-WEEK MOVING AVERAGE

*TOTAL DURABLE GOODS**SMOOTHED***SOURCE: THOMSON REUTERS****UPGRADES AS A % OF TOTAL RATINGS, SOURCE: MOODY'S

© BCA Research 2016

Up, but...

...no support elsewhere

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CHaRT 12

Deflation Has IntensifiedCHaRT 13

Brutal Breadth

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U.S. TECH: NEW ORDERS****Ann%Chg

Ann%Chg

U.S. TECH: CAPACITYU.S. TECH: INDUSTRIAL PRODUCTION

Ann%Chg

Ann%Chg

U.S. S&P TECH SALES* (LS)U.S. IMPORT PRICES*** (RS)% Ann%

Chg

U.S. S&P TECH SALES* (LS)EM ASIAN EXPORTS** (RS)% Ann%

U.S. S&P TECH / S&P 500

*SHOWN AS A 6-MONTH RATE-OF-CHANGE, ANNUALIZED**INCLUDES CHINA, KOREA AND TAIWAN, SMOOTHED***FOR CONSUMER & CAPITAL GOODS, SMOOTHED****SMOOTHED

Chg

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U.S. S&P TECH GROUPS:WITH POSITIVE 52-WEEK RATE-OF-CHANGE*

% %

U.S. S&P TECH / S&P 500:ADVANCE / DECLINE LINE

U.S. S&P TECH / S&P 500200-DAY MOVING AVERAGE

*SMOOTHED

© BCA Research 2016

Deflationary

© BCA Research 2016

As a result, there will be less business for tech factories. Output growth is likely to move well below the rate of capacity growth. That is highly deflationary, and will ensure that downward pressure on profit margins persists.

The implication is that major fundamental forces are working against the tech sector, and warrant caution from an investment standpoint.

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In terms of timing, technical readings are equally worrying. Chart 13 shows that the number of technology industry groups with positive momentum has rolled over, from already weak levels. Im-portantly, the tech sector’s resilience has been very narrowly based. Our relative advance/decline line, which comprises roughly 60 technology stocks, is flirting with new lows. Narrow participation is a serious risk to the overall sector, particularly given spreading profit challenges.

Bottom Line: The tech sector (BLBG: S5INFT) remains a candidate for incremental underperfor-mance, fueled by the dual threat of earnings and valuation compression.

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Current Recommendations

SECTOR

OVER

WEI

GHT

NEuT

RAL

uNDE

RWEI

GHT

OVERWEIGHT NEuTRAL uNDERWEIGHT

S&P TELECOMMuNICATION SERVICESNovember 9, 2015

Integrated Telecom Services - Nov 9, 2015

S&P uTILITIES August 3, 2015 Electric Utilities - Aug 3, 2015

S&P CONSuMER STAPLESFebruary 2, 2015

Hypermarkets - Apr 11, 2016Drug Retail - Nov 16, 2015Retail (Food Chains) - Jun 15, 2015 Soft Drinks - Apr 23, 2015 Household Products - Mar 23, 2015

Packaged Foods - Sep 8, 2015Tobacco - May 29, 2007

S&P HEALTH CARESeptember 8, 2014

Managed Health Care - Apr 4, 2016Pharmaceuticals - Jan 26, 2015Health Care Facilities - Oct 21, 2013Health Care Equipment - Sep 27, 2004

Biotechnology - Jan 7, 2013

S&P ENERGYApril 18, 2016

Oil & Gas Exploration & Production – Apr 18, 2016

Energy Equipment & Services – Oct 7, 2015 Coal & Consumable Fuels - Dec 8, 2014Integrated Oil & Gas – Dec 8, 2014

Oil & Gas Refining And Marketing – Sep 28, 2015

S&P INDuSTRIALSFebruary 16, 2016

Electrical Components & Equipment - Feb 16, 2016Defense - Dec 7, 2015Construction & Engineering - Jan 12, 2015

Railroads - Feb 16, 2016Machinery - Feb 1, 2016

Aerospace - Dec 7, 2015Air Freight & Logistics - Sep 14, 2015 Airlines - May 4, 2015

S&P FINANCIALS April 25, 2016

REITs - Aug 10, 2015 Consumer Finance - Aug 25, 2014Insurance (Composite) - Jul 21, 2014

Banks - Apr 25, 2016Investment Banking & Brokerage - Nov 30, 2015Asset Management & Custody Bank Index - Nov 30, 2015

S&P TECHNOLOGYJanuary 19, 2016 Communications Equipment - Aug 17, 2015 Data Processing - Feb 16, 2016

Software - Jan 19, 2016

Technology Hardware, Storage & Peripherals - Aug 17, 2015 Semiconductor Equipment - Feb 23, 2015Semiconductors - Dec 15, 2014

S&P MATERIALSJune 2, 2014

Agricultural Chemicals - May 9, 2016Gold Miners Index - Mar 7, 2016 Containers & Packaging - May 9, 2016 Steel - Mar 14, 2016

Chemicals - Aug 11, 2014

S&P CONSuMER DISCRETIONARYDecember 10, 2012

Cable & Satellite - Apr 4, 2016Leisure Products - Oct 19, 2015Homebuilding - Oct 20, 2014

Movies & Entertainment - Apr 25, 2016Home Improvement Retail - Dec 7, 2015Computer & Electronics Retail - Jul 22, 2013Publishing & Printing - May 14, 2012Advertising - May 14, 2012

Hotels - Dec 21, 2015Restaurants - Nov 2, 2015Auto Components - Dec 15, 2014 Retailing - Jan 22, 2013Household Appliances - Mar 4, 2004

DENOTES UPGRADE IS PROBABLE DENOTES DOWNGRADE IS PROBABLE

U.S. eqUity Strategy - Weekly report May 16, 2016BCa reSearCh inC.

14editor@bcaresearch.com • www.bcaresearch.com • Copyright © 2016 BCA Research Inc. All Rights Reserved. Refer to last page for important disclaimer.

Current Trades

TOP HIGH-CONVICTION CALLS FOR 2016 BLOOMBERG TICKERS

RETuRN (%)* SINCE JAN. 11, 2016

OVERWEIGHTS

S&P 500 Leisure Products / S&P 500 S5LEPR <Index> / SPX 12.1

S&P 500 Telecom Services / S&P 500 S5TELS <Index> / SPX 8.8

S&P 500 Soft Drinks / S&P 500 S5SOFD <Index> / SPX 2.5

S&P 500 Health Care / S&P 500** S5HLTH <Index>SPX 1.9

S&P 500 Insurance / S&P 500 S5INSU <Index> / SPX 1.5

S&P 500 Drug Retail / S&P 500 S5DRUG <Index> / SPX -0.1

uNDERWEIGHTS

S&P 500 Oil & Gas Refining & Marketing / S&P 500 S5OILR <Index> / SPX 21.5

S&P 500 Airlines / S&P 500 S5AIRL <Index> / SPX 18.0

S&P 500 Semiconductors / S&P 500 S5SECO <Index> / SPX 6.2

S&P 500 Capital Markets / S&P 500 S5CAPM <Index> / SPX 5.5 * RETURNS ARE UNIFORM ACROSS OVERWEIGHTS AND UNDERWEIGHTS. A POSITIVE NUMBER INDICATES A PROFIT AND A NEGATIVE NUMBER SIGNIFIES A LOSS. ** AS OF MARCH 31 2016.

OPEN LONG / SHORT POSITIONS BLOOMBERG TICKERS

INITIATION DATE

RETuRN (%)

S&P 500 Utilities / S&P 500 Materials S5UTIL <Index> / S5MATR <Index> 16-JUN-14 24.4

S&P 1500 Health Care Facilities / S&P 500 Biotech S15HCFA <Index> / S5BIOTX <Index> 03-FEB-14 3.8

S&P Consumer Finance / S&P Banks S5CFINX <Index> / S5BANKX <Index> 21-MAR-16 2.5

S&P 500 / S&P 600 SPX <INDEX> / SML <Index> 28-JUL-14 0.9

S&P 500 Health Care Facilities / S&P 500 Managed Health Care S5HCFA<Index> / S5MANH <Index> 02-MAR-15 -1.0

S&P 500 Oil & Gas E&P / S&P 500 Energy Services S5OILP <Index> / S5ENRE <Index> 30-MAR-15 -12.0

S&P 500 Industrials / S&P 500 Consumer Discretionary S5INDU <Index> / S5COND <Index> 04-MAR-13 -12.1

CLOSED TRADES S&P 500 SECTOR RETuRNS

CLOSING DATE POSITION OPENRETuRN

(%)

S&P Software / S&P 500 Jan 19/16 Overweight To Neutral 14

S&P Banks / S&P 500 Jan 19/16 Overweight To Neutral 7

S&P Financials / S&P Consumer Staples Jan 19/16 Closed Pair Trade 6

S&P Software / S&P Data Processing Jan 19/16 Closed Pair Trade -1

S&P Growth / S&P Value Jan 25/16 Overweight To Neutral 10

S&P Machinery / S&P 500 Feb 1/16 Underweight To Neutral 19

S&P Managed Health Care / S&P 500 Feb 8/16 Underweight To Neutral -7

S&P Data Processing / S&P 500 Feb 16/16 Overweight To Neutral 23

S&P Railroads / S&P 500 Feb 16/16 Overweight To Neutral -5

S&P Energy / S&P 500 Apr 28/16 Underweight To Neutral 14

S&P 500 Media / S&P 500 Apr 25/16 Out High-Conviction Underweight -2

S&P Movies & Entertainment / S&P 500 Apr 25/16 Underweight To Neutral -1

S&P Agricultural Chemicals / S&P 500 May 9/16 Underweight To Overweight 34

S&P Containers & Packaging / S&P 500 May 9/16 Overweight To Neutral 2

U.S. eqUity Strategy - Weekly report May 16, 2016 BCa reSearCh inC.

15editor@bcaresearch.com • www.bcaresearch.com • Copyright © 2016 BCA Research Inc. All Rights Reserved. Refer to last page for important disclaimer.

Favor large over small caps and stay neutral growth over value.

Size And Style Views

Recent Insights

May 10

F Trim Containers & Packaging

F It’s Time For Agricultural Chemicals To Grow Anew: Upgrade

May 11

F Higher Pharmaceutical Pricing Is Not Choking Consumption

F Air Freight Stocks Have Grim Revenue Prospects

May 12

F Insurance Stocks Are Quietly Outperforming

F Computer Hardware Is An Easy Sell

May 13, 20166-12 MONTHS 2-3 YEARS

U.S. EQUITIES Flat underlying trend, medium conviction. Moves beyond the range of the past year will be hard to sustain. Profit outlook remains poor but odds of recession are low.

Flat, medium conviction. Our long-term expectation is for 5-6% returns per year.

U.S. TREASURY BONDS Neutral duration, medium conviction. Value is roughly neutral for long-dated Treasurys, though the near-term risk for yields is to the upside.

Structurally bullish bias, medium conviction. Lower U.S. potential growth means Treasury yields will not sustainably trade above current levels discounted in the forward curve. Beyond this horizon, the increasing incentive for policymakers to boost inflation expectations poses Treasury-bearish risks.

U.S. DOLLAR Flat, medium conviction. The dollar has downside over the next few months, especially against the euro, but the staying power of any decline should will be constrained by economic fragility outside the U.S.

Up, medium conviction. U.S. growth outlook is “less bad” than the rest of the world.

CHINA Positive, medium conviction. Chinese economy is in a mini-cycle upturn due to policy reflation, the sustainability of which is questionable. Premature tightening remains the key risk for growth.

Positive, medium conviction. Structural reforms bode well for Chinese growth and asset prices but the authorities have been backtracking.

EUROPE Equities should fare better than other regions. Government bonds are fully valued, but supported by the continued absence of inflation.

Bullish, medium conviction. Equity valuations are at fair value, assuming no euro breakup.

JAPAN Neutral on Nikkei in dollar terms. Nikkei and yen will continue to be “mirror images”.

Bullish bias (equities). Authorities will use weak yen to soften the blow of Abenomics structural reforms. Debt monetization is the endgame.

© BCA Research 2016

BCA House View Matrix

Geopolitical factors to monitor:

F East Asia tensions: tensions between China, the U.S., and neighbors are mounting. F EM domestic politics: Brazil now has to show actual reforms, Chinese reaction-function is still in question. F DM: BREXIT end game is near, polls are close; U.S. election is heating up and policy uncertainty is high. F Oil supply: Non-OPEC supply bears the brunt of oil-market rebalancing, which will bring supply in line with

demand in 2016Q3.

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