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9 July 2018

Asset Allocation

Strategy Update

Global Strategy

Asset AllocationDate9 July 2018

Deutsche BankResearch

Solid But In-Line Earnings Unlikely ToDispel Trade CloudWe expect a modest deceleration in headline S&P 500 EPS growth, with risingconsensus estimates pointing to an in-line quarter:

■ Despite the well-known overhang of concerns about peak earnings andthe escalation of trade frictions, consensus earnings estimates havecontinued to be upgraded in sharp contrast to typical behavior goinginto reporting season. The bottom-up consensus has moved up by 0.7%since early June (end of Q1 reporting). This marks the second quarter ina row of upgrades going into earnings season but it is very unusual andonly the 2nd time in 7 years. It contrasts with a typical cut of -3.1% fromthe end of the prior season. It is also noteworthy that upgrades going intothe last quarter were largely driven by the cut in the corporate tax rate,whereas this time they reflect other factors.

■ The upgrades have been broad based across sectors. Indeed Utilitieswere the only exception. They were led by the cyclical sectors: Materials,Consumer Discretionary, Financials, Energy and Tech.

■ The bottom-up consensus points to 24% growth in Q2, which wouldmark a modest deceleration from the 26.6% reported in Q1. Thebottom-up consensus estimates are for EPS growth of 20.2% in Q2.But historically earnings have beat on average by 3.4%, which impliesheadline growth of 24%. Median earnings growth (including a typicalbeat) is for a somewhat slower 20%, indicating the impact of outliers.In particular Energy earnings are expected to show very strong growth(+149%) on the back of higher oil prices. Ex Energy the consensus is for20% (median 19%). Apart from Energy, several sectors are expected topost very strong growth: Tech (30%), Materials (29%), Telecom (28%),Financials (24%), Consumer Staples (18%) and Consumer Discretionary(18%).

■ Sales growth is expected to be a robust 8.7% and margins 11.6%, bothslightly below that in Q1 before factoring in beats. A realization of theconsensus would put sales growth modestly below the 9.1% growth seenin Q1. Sales beats have been running around 1% in the last few quartersand a similar beat this quarter would put it at a new 7-year high. A typicalbeat on margins would take them to a new record. Survey data (NFIB)points to the share of firms raising selling prices rising sharply, with thegap to those raising wages continuing to shrink, and is supportive of afurther increase in margins.

Binky Chadha

Chief Strategist

+1-212-250-4776

Parag Thatte

Strategist

+1-212-250-6605

Christian Arita

Research Associate

+1-212-250-2964

Deutsche Bank Securities Inc.

Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should beaware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should considerthis report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONSARE LOCATED IN APPENDIX 1. MCI (P) 091/04/2018.

Distributed on: 09/07/2018 20:00:12 GMT

7T2se3r0Ot6kwoPa

mailto:[email protected]



9 July 2018

Asset Allocation

■ The top-down drivers point to an in-line quarter with typical beats:stronger US growth and higher oil prices offset by slower global growthand a smaller tailwind from the dollar. We model S&P 500 earningsgrowth as driven by US growth, global ex-US growth (PMIs) and bychanges in the US dollar. US growth accelerated in Q2 versus Q1,boosting EPS growth (+2pp), global growth decelerated (-3.5pp), whilethe dollar continued to help but less so (-1.5pp). On net the 3 key top-down drivers point to a modest deceleration (-3pp). Energy earnings areexpected to provide a boost to headline (+1pp) but Financials a drag (-2pp)relative to Q1. Our model points to EPS growth of 24% in Q2. So theearnings season should deliver beats in line with the historical average.Early reporters have shown very strong growth (32%) with somewhatabove average beats (4.5%).

■ In sum we expect solid double-digit underlying earnings growthexcluding the impact of the tax cut and higher oil prices. Excluding thetax cut benefit (+10pp), Q2 results point to underlying growth (i.e., ex-taxes, ex-Energy) in the double digits which, as we have noted previously,is the norm during cyclical expansions ( Settling Into A Historically TypicalDouble Digit Range—Q2 Earnings Preview, July 2017 ).

On the escalation of trade frictions, companies seem more concerned about alack of clarity on the rules of the game rather than actual tariff hikes:

■ Robust demand and pricing initiatives. Early reporters so far havecontinued to point to robust demand conditions, with pricing initiativeshelping to offset rising cost pressures;

■ Wait and watch mode. Companies have pointed to limited impacts fromthe tariffs that have been enacted so far but are obviously concernedabout further escalation. With clarity being very limited, they are in a waitand watch mode;

■ Robust demand conditions mean that companies are arguably moreconcerned about the lack of clarity than the actual tariff hikes. AsIngersoll Rand put it “I don't know what the rules of the game are goingforward. I think, what you need is certainty around the rules. And onecertainty we expect, I think, companies will make decisions about gettingoff the fence on where to locate capacity. If they need capacity, they'regoing to put it in the world where they need it; the fact is, they're goingto need capacity. It's just a matter of where they're going to locate it … .And companies aren't dealing with this in a political way, they are dealingwith it with the economics of the rules. And if you tell us what the rulesare, we'll determine the best way to position the capacity and to go aboutthe investment.”

■ Buybacks and dividends are ramping up. With very strong earnings andcash flows, companies have been ramping up payouts in the form ofboth buybacks and dividends. Buyback announcements year to date arerunning at $600bn, almost double the pace over the same period last year.Dividend announcements are also up 13% ytd, well above the 8% rateof last year.

Strategy: Three reasons to buy domestic- versus foreign-sales firmsEven as the S&P 500 has remained range bound since early February, as we havepointed out previously, two strategies have worked well: DB’s Alpha Buybacksbasket (DBUSALBBK), which benefits from surging buybacks ( Capturing The


https://research.db.com/Research/Document?rid=7d170d24-aaa8-4407-9cda-3dc28633d09e-604&kid=RP0001&documentType=R

https://research.db.com/Research/Document?rid=7d170d24-aaa8-4407-9cda-3dc28633d09e-604&kid=RP0001&documentType=R

https://research.db.com/Research/Document?rid=0900b8c08ac419aa&kid=RP0001&documentType=R

9 July 2018

Asset Allocation

Alpha In Buybacks, Feb 2016 ); and DB’s value basket (DBUSVALU) ( WhatValue Conundrum, June 2018 ). We highlight a third: a sector-neutral basketof companies with a high share of declared domestic sales has steadilyoutperformed those with a high share of foreign sales since March (+5.7%). Wesee this trend continuing on the back of a rising dollar, US growth outperformanceand persistent concerns around trade:

■ The relative performance of domestic- versus foreign-sales exposurecompanies has been tightly correlated (86%) to the US dollar. Indeed itis notable that domestic firms started outperforming as soon as the dollarstopped falling. With the Fed indicating steady rate hikes while othercentral banks, in particular the ECB, remaining committed to keepingrates on hold for an extended period, the rate differential will continue towiden in favor of the US dollar while positioning has moved from shortearlier this year back only to neutral. We see prospective moves in ratedifferentials as continuing to support if not pressure the dollar higher;

■ US growth continues to outpace growth in the rest of the world. We seeplenty of further upside from previously announced US stimulus (lowertaxes, higher fiscal spending, higher capex and higher rates);

■ Concerns around trade frictions. The cloud from the trade war is unlikelyto fade away anytime soon and inherently impacts internationally focusedcompanies rather than domestic ones.


https://research.db.com/Research/Document?rid=0900b8c08ac419aa&kid=RP0001&documentType=R

https://research.db.com/Research/Document?rid=a8f4d470-e321-4d66-8c74-875c85532de3-604&kid=RP0001&documentType=R

https://research.db.com/Research/Document?rid=a8f4d470-e321-4d66-8c74-875c85532de3-604&kid=RP0001&documentType=R

9 July 2018

Asset Allocation

Figure 1: Consensus estimates for Q2 earnings have been rising going intothe reporting season

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Source: Bloomberg Finance LP, Haver, Factset, Deutsche Bank

Figure 2: The norm is for consensus estimates to fall going into earningsseason

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S&P 500 EPS Consensus (Normalized)Q1 2014 Q2 2014 Q3 2014 Q4 2014 Q1 2015Q2 2015 Q3 2015 Q4 2015 Q1 2016 Q2 2016Q3 2016 Q4 2016 Q1 2017 Q2 2017 Q3 2017Q4 2017 Q1 2018 Q2 2018 Avg since 2014

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9 July 2018

Asset Allocation

Figure 3: This is only the second time in 7 years that consensus estimateshave gone up going into earnings season

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Avg: -3.1%

Tax cut for Q1

Q2 2018 S&P 500 earnings est from end of Mar 2018 to date vs comparable periods for prev qtrs (%)


Figure 4: Upgrades have been broad based across sectors

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9 July 2018

Asset Allocation

Figure 5: Assuming a typical beat, Q2 earnings growth (24%) would only bemodestly lower than the extremely robust pace of Q1 (26.6%)

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* Q2 growth assumes cos that are to report beat earnings at historic beat rate of 3.4%

Source: ISM, FRB, Markit, Bloomberg Finance LP, Haver, Factset, Deutsche Bank

Figure 6: Across sectors, while Energy sticks out, several sectors areexpected to post very strong growth

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9 July 2018

Asset Allocation

Figure 7: With a typical beat, sales growth will be at a new cyclical high…

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Figure 8: …as will margins

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* Q2 margin assumes cos that are to report beat earnings at historic beat rate of 3.4% and sales at

recent beat rate of 1%



9 July 2018

Asset Allocation

Figure 9: The share of firms raising prices is rising sharply, shrinking the gapto the share of those raising wages

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Firms raising wages over past 3 months (net %, 3m ma, NFIB survey, lhs)

Firms raising avg selling prices (net %, 3m ma, NFIB survey, rhs)

Correl: 63%

Source: NFIB, Haver, Deutsche Bank

Figure 10: Amongst the top-down drivers, US growth accelerated in Q2 …

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9 July 2018

Asset Allocation

Figure 11: … but global growth has slowed …

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Figure 12: … and the dollar will be less of a tailwind-10

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Source: FRB, Haver, Deutsche Bank


9 July 2018

Asset Allocation

Figure 13: The top-down drivers together point to a deceleration in growthcompared to Q1

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RecessionFittedS&P 500 ex FEM Earnings Growth (% yoy)

Ex FEM Earnings (% yoy) = 8.2 + 2.1 * US PMI (dev from avg) + 2.34 * RoW

PMI dev (unexplained by US PMI dev) - 0.41 * Broad USD (% yoy)

R-Sq: 59.4% Smpl: Q3 1999 to Q4 2014

Model

implied

Consensus

* Q2 growth assumes cos that are to report beat at historic beat rate of 3.4%

Source: Markit, ISM, FRB, Bloomberg Finance LP, Haver, Factset, Deutsche Bank

Figure 14: Higher oil prices will boost Energy earnings

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Source: Haver, Deutsche Bank


9 July 2018

Asset Allocation

Figure 15: Our model suggests beats this earnings season but in line with thehistorical average

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Source: Markit, ISM, FRB, Bloomberg Finance LP, Haver, Factset, Deutsche Bank

Figure 16: Double-digit earnings growth has been the norm during cyclicalrecoveries

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Source: Bloomberg Finance LP, Haver, Deutsche Bank


9 July 2018

Asset Allocation

Figure 17: The S&P 500 has been in a range for the last 5 months

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Figure 18: There have been very few episodes in the last 8 years when themarket remained range bound for an extended period

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LogLog S&P 500



9 July 2018

Asset Allocation

Figure 19: Markets have remained range bound this year despite very strongearnings

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Earnings Season S&P 500

4.9%

return3.6%

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North Korea

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Figure 20: With strong earnings and a range-bound S&P 500, the marketmultiple has de-rated significantly

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Recession S&P 500 Trailing P/E +/- 1 SD

Current LTM PE: 18.6



9 July 2018

Asset Allocation

Figure 21: With strong earnings and cash flow but elevated uncertainty, wesee buyback announcements continuing to ramp up

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S&P 500 Buybacks ($bn)Announced (3m sum)

Actual Gross Buybacks (Qtrly)

Correl: 85%

Source: Bloomberg Finance LP, Compustat, Deutsche Bank

Figure 22: The DB Alpha Buybacks basket has outperformed this year,especially during earnings seasons

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Earnings Season DBUSALBK/S&P 500

0.2%

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return1.7%

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Source: Bloomberg Finance LP, Deutsche Bank


9 July 2018

Asset Allocation

Figure 23: The DB Value basket has been outperforming since last September

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DBUSVALU basket performance relative to S&P 500

Source: Bloomberg Finance LP, Deutsche Bank

Figure 24: Companies that have a high share of domestic sales haveoutperformed those with high foreign sales since March on a rising dollar,faster US growth and rising trade concerns

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Rel perf of domestic/foreign exposure companies (100

on Nov 8, 2016)

Dollar (lhs)

Domestic/Foreign (lhs)

Correl: 86%

Bottom quintile / top quintile by foreign sales exposure per geographical distrbution in company filings;

Source: Factset, Deutsche Bank


9 July 2018

Asset Allocation

Figure 25: With the Fed continuing to hike while other central banks remainon hold, rate differentials will continue to move in favor of the dollar

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Dec-1

5

Dec-1

6

Dec-1

7

Dec-1

8

Dec-1

9

Fitted value

EURUSD

Using mkt pricing

of Fed rate: 1.11

in Dec 2018 and

1.12 in Dec 2019

Using FOMC exp of

Fed rate: 1.10 in Dec

2018 and 1.08 in Dec

2019

EURUSD = 1.348 + 0.055*(EUR-US 12m rate diff)

(t-stat) (1076.8) (50.21)

R-sq = 50%; Smpl: 11/2004-5/2014

Source: FRB, Bloomberg Finance LP, Haver, Deutsche Bank

Figure 26: Dollar positioning has just turned slightly long with plenty of roomto move higher

65.0

70.0

75.0

80.0

85.0

90.0

95.0

-60

-40

-20

0

20

40

60

80

100

Jan-1

0

Jun-1

0

No

v-1

0

Ap

r-11

Sep

-11

Feb

-12

Jul-12

Dec-1

2

May-1

3

Oct-

13

Mar-

14

Aug

-14

Jan-1

5

Jun-1

5

No

v-1

5

Ap

r-16

Sep

-16

Feb

-17

Jul-17

Dec-1

7

May-1

8

Trade wtd dollar F&O positions vs USTWI

Non commercial net long contracts (thous, lhs) USTWI (rhs)

Source: CFTC, FRB, Haver, Deutsche Bank


9 July 2018

Asset Allocation

Appendix 1

Important Disclosures

*Other information available upon request

*Prices are current as of the end of the previous trading session unless otherwise indicated and are sourced fromlocal exchanges via Reuters, Bloomberg and other vendors . Other information is sourced from Deutsche Bank, subjectcompanies, and other sources. For disclosures pertaining to recommendations or estimates made on securities other thanthe primary subject of this research, please see the most recently published company report or visit our global disclosurelook-up page on our website at https://research.db.com/Research/Disclosures/CompanySearch. Aside from within thisreport, important risk and conflict disclosures can also be found at https://research.db.com/Research/Topics/Equities?topicId=RB0002. Investors are strongly encouraged to review this information before investing.

Analyst Certification

The views expressed in this report accurately reflect the personal views of the undersigned lead analyst(s). In addition,the undersigned lead analyst(s) has not and will not receive any compensation for providing a specific recommendationor view in this report. Binky Chadha, Parag Thatte, Christian Arita

Equity Rating Key Equity rating dispersion and banking relationships

Buy: Based on a current 12- month view of total share-holderreturn (TSR = percentage change in share price from currentprice to projected target price plus pro-jected dividend yield ) ,we recommend that investors buy the stock.Sell: Based on a current 12-month view of total share-holderreturn, we recommend that investors sell the stock.Hold: We take a neutral view on the stock 12-months out and,based on this time horizon, do not recommend either a Buyor Sell.

Newly issued research recommendations and target pricessupersede previously published research.


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https://research.db.com/Research/Topics/Equities?topicId=RB0002

https://research.db.com/Research/Topics/Equities?topicId=RB0002

9 July 2018

Asset Allocation

Additional Information

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Asset Allocation

?Macroeconomic fluctuations often account for most of the risks associated with exposures to instruments that promiseto pay fixed or variable interest rates. For an investor who is long fixed-rate instruments (thus receiving these cashflows), increases in interest rates naturally lift the discount factors applied to the expected cash flows and thuscause a loss. The longer the maturity of a certain cash flow and the higher the move in the discount factor, thehigher will be the loss. Upside surprises in inflation, fiscal funding needs, and FX depreciation rates are among themost common adverse macroeconomic shocks to receivers. But counterparty exposure, issuer creditworthiness, clientsegmentation, regulation (including changes in assets holding limits for different types of investors), changes in taxpolicies, currency convertibility (which may constrain currency conversion, repatriation of profits and/or liquidation ofpositions), and settlement issues related to local clearing houses are also important risk factors. The sensitivity of fixed-income instruments to macroeconomic shocks may be mitigated by indexing the contracted cash flows to inflation, toFX depreciation, or to specified interest rates – these are common in emerging markets. The index fixings may – byconstruction – lag or mis-measure the actual move in the underlying variables they are intended to track. The choice ofthe proper fixing (or metric) is particularly important in swaps markets, where floating coupon rates (i.e., coupons indexedto a typically short-dated interest rate reference index) are exchanged for fixed coupons. Funding in a currency that differsfrom the currency in which coupons are denominated carries FX risk. Options on swaps (swaptions) the risks typical tooptions in addition to the risks related to rates movements.??Derivative transactions involve numerous risks including market, counterparty default and illiquidity risk. Theappropriateness of these products for use by investors depends on the investors' own circumstances, including theirtax position, their regulatory environment and the nature of their other assets and liabilities; as such, investors shouldtake expert legal and financial advice before entering into any transaction similar to or inspired by the contents of thispublication. The risk of loss in futures trading and options, foreign or domestic, can be substantial. As a result of thehigh degree of leverage obtainable in futures and options trading, losses may be incurred that are greater than theamount of funds initially deposited – up to theoretically unlimited losses. Trading in options involves risk and is notsuitable for all investors. Prior to buying or selling an option, investors must review the "Characteristics and Risks ofStandardized Options”, at http://www.optionsclearing.com/about/publications/character-risks.jsp . If you are unable toaccess the website, please contact your Deutsche Bank representative for a copy of this important document.??Participants in foreign exchange transactions may incur risks arising from several factors, including the following: (i)exchange rates can be volatile and are subject to large fluctuations; (ii) the value of currencies may be affected by numerousmarket factors, including world and national economic, political and regulatory events, events in equity and debt marketsand changes in interest rates; and (iii) currencies may be subject to devaluation or government-imposed exchange controls,which could affect the value of the currency. Investors in securities such as ADRs, whose values are affected by thecurrency of an underlying security, effectively assume currency risk.?

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Asset Allocation

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Asset Allocation

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Asset Allocation

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David Folkerts-LandauGroup Chief Economist and Global Head of Research

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Research

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Global Head of Economics

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Equity Research

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Equity Research

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