market phase cycle™ investing strategy · 2019-03-08 · market phase cycle™ investing strategy...

Bull markets die on euphoria, no one looks euphoric for this market

Bull Markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.- John Templeton

John Templeton was likely the first, and unsurprisingly one of the best, at summarizing what really drives market cycles. It is likely that Templeton would look at today’s market and not yet see the euphoria he referenced in the above quote.

He would not see euphoria from analysts. Analysts are forecasting as-reported EPS growth to slow from 26% last year to 11.3% this year. Certainly management teams are not yet showing euphoria in terms of interest in investing in their companies, with M&A spend almost $1tn lower in 2018 than at its 2015 peak. Nor would he see investors showing euphoria. As-reported P/E may look elevated at first glance at 19.7x, but this is slightly below average valuations for the current low-inflation, low-tax environment. For each of these metrics, UAFRS metrics tell similar stories.

This is not a young bull market. But markets do not die of old age, there needs to be a catalyst. Credit issues are generally that catalyst. However, credit spreads and credit fundamentals do not point to concerns in the next year, especially with high yield CDS at low 200bps levels, and investment grade CDS still at sub 50bps. Some credit signals may point to potential concerns 2 years down the road, but there are no catalysts to take us to euphoria and turn it into despair until those catalysts become more real.

The market continues to climb a wall of worry. And that is good for investors, because that worry tells us we are not yet at the euphoric stage. Because of that, the Market Phase Cycle points to reasons to continue being optimistic for equity market appreciation, and we continue to see compelling stock ideas to make investors money in the current market environment.

Joel LitmanChief Investment Strategist

[email protected]

Robert Spivey, CFADirector of Research

[email protected]

Valens Research Macro Investment Research110 Cambridge St.Cambridge, Massachusetts 02141+1 (646) 491 2601

February 2019

Market Phase Cycle™ Investing Strategy

Report Date: 2/21/2019

S&P 500 Level: $2,774.88

S&P 500 As-Reported P/E19.7x

S&P 500 Est. NTM Op. EPS Growth11.3%

US Market UAFRS Adjusted P/E20.1x

US UAFRS 2019 Est. Adj. EPS Growth10.0%

US UAFRS Adjusted ROA Trend

Investment Grade Credit Risk CDS iCDS

48bps 46bps

High Yield Credit Risk CDS iCDS

212bps 177bps

0%

5%

10%

15%

2015 2016 2017 2018E 2019E

Business Profitability

The underlying driver of stock price appreciation and market moves from skepticism, tooptimism, and eventually euphoria revolves around corporate earnings growth. Thereare multiple drivers to earnings growth. At its base, credit creation helps fuelinvestment, which can lead to earnings growth. Margin expansion and asset efficiencycan lead to earnings growth. And earnings growth ends up being one of the largestdrivers of stock market appreciation.

This understanding starts with understanding the trend in US corporate profitability.Using Uniform Accounting (UAFRS) metrics, the improving, but cyclical nature ofcorporate profitability in the US becomes apparent. Since the 1990s, the US has seenreturns improving from cycle to cycle. Returns rose from a peak of 8% in 2000, to apeak of 10% in 2005-2007, to a peak of 11% in 2010-2012, and now are forecast to riseto 12%-13% levels in 2018-2019.

Price

Name

Sector

Fiscal Year

Quarter

Year

Data Date

Data M

Data D

Data Y

Fiscal M

Fiscal D

Fiscal Y

Exchange

Ticker

Home Country

Filing Currency

Scenario

GDP Deflator

NI Estimates

Valuations

Current Price

EV/IC' Multiple

P/E' Multiple

DCF

11%9% 9%

8% 8%9% 8%

10%9%

6% 6% 7%

10%

7%

10%

6%3%

7% 6%5%

6%

0%

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 5YrCAGR

Asset'Growth

7%8% 8% 7% 7%

8% 9% 10% 10% 10% 10% 9%11% 11% 11% 10% 10% 10% 10% 11% 12% 13%

11%

0%

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15%

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25%

30%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E MktImp

ROA'

2.1

2.82.3 2.1

1.8 2.0 2.0 2.0 2.1 2.01.6 1.7 1.8 1.8 1.9

2.2 2.4 2.4 2.52.8 2.7

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

V/A'

27.430.8 29.5 29.5

20.5 20.6 18.8 18.2 18.8 19.716.6 15.2 14.9 15.3 17.2

21.024.2 21.9 20.7 21.6 20.1

0

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Fwd V/E'

Source: Capital IQ, Valens Research Analysis (2,767 US Corporation Aggregate) Data Date: 19-Feb-2019

Valens Research110 Cambridge St.

Cambridge, Massachusetts 02141+1 (646) 491 2601

February 2019

Market expectations for ROA’ are declining as ROA’ is accelerating

Exhibit 1: Returns have been accelerating, but the market is not factoring this in

This most recent cycle of improvement after the 2015 earnings recession has seenUAFRS-adjusted earnings grow by 14.6% in 2016, 18.1% in 2017, and 12.2% in 2018.Earnings growth hasn’t been as strong as the overstated 2018 26% as-reportedoperating EPS growth of the S&P 500, but has been robust. UAFRS-adjusted earningsgrowth is forecast to remain strong in 2019, at 10%.

A sure sign of the lack of euphoria in the market currently is how low marketexpectations are for returns going forward. While returns are forecast by analysts toexpand to 13% in 2019, at $2,774.88 for the S&P 500 the market is pricing returns todecline back to 11% levels going forward.

As the market comes to understand that adjusted earnings growth has been andremains strong, market perception and valuations are likely to change. Strong earningsgrowth powers equity appreciation.

Business Growth

The second driver of earnings growth, after return expansion, is growth in investment.Companies (and countries) that actively re-invest when returns are good, lead tocompounding of that return. Historically US corporate reinvestment, or adjusted Assetgrowth, has been in the high single digits. From 2000-2007, adjusted Asset growth wasnever below 8%. Even in 2008-2014, adjusted Asset growth was never below 6%.

Recently, adjusted Asset growth has been more middling, ranging from 3%-7% levels in2015-2017. The market is currently pricing in expectations for adjusted Asset growth toremain at those levels, and at the low end of historic levels. At current valuations, themarket is pricing adjusted Asset growth of 6% going forward.

However there are several reasons to think this understates what reinvestment ratescould be over the next two years. In particular, aging assets, elevated capacityutilization, and growing management confidence about investing point to reason foroptimism for growth in the coming quarters. While there were some short-term signalsof limited access to credit to fuel growth in Q4 2018, those clouds appear to also befading away, reducing the risks for growth.



Markets are also expecting middling growth, and this appears wrong

February 2019


Exhibit 2: Markets are expecting growth to remain low relative to history Price

Name

Sector

Fiscal Year

Quarter

Year

Data Date

Data M

Data D

Data Y

Fiscal M

Fiscal D

Fiscal Y

Exchange

Ticker

Home Country

Filing Currency

Scenario

GDP Deflator

NI Estimates

Valuations

Current Price

EV/IC' Multiple

P/E' Multiple

DCF

11%9% 9%

8% 8%9% 8%

10%9%

6% 6% 7%

10%

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10%

6%3%

7% 6%5%

6%

0%

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25%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 5YrCAGR

Asset'Growth

7%8% 8% 7% 7%

8% 9% 10% 10% 10% 10% 9%11% 11% 11% 10% 10% 10% 10% 11% 12% 13%

11%

0%

5%

10%

15%

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25%

30%

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E MktImp

ROA'

2.1

2.82.3 2.1

1.8 2.0 2.0 2.0 2.1 2.01.6 1.7 1.8 1.8 1.9

2.2 2.4 2.4 2.52.8 2.7

0.0

1.0

2.0

3.0

4.0

5.0

6.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

V/A'

27.430.8 29.5 29.5

20.5 20.6 18.8 18.2 18.8 19.716.6 15.2 14.9 15.3 17.2

21.024.2 21.9 20.7 21.6 20.1

0

10

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Fwd V/E'

Companies have discretion on when they spend on capex. Often, they will hold back oncapex spend, to milk their assets, when they do not see significant growth opportunitiesor are trying to conserve cash flows. A good proxy to identify this trend is the Net/GrossPP&E ratio, which shows how much PP&E has been depreciated. When Net/Gross PP&Eratios are falling, it signals management is underinvesting in their business, as appearsto have been happening recently.

However, this cycle of limiting capex can only go so far before a positive capex cycle isnecessary, just to prevent production from breaking down. We may have started to seethis moment in Q3 2018, when Net/Gross PP&E ratios finally inflected higher, for thefirst time in almost two years. Net/Gross PP&E ratios had reached historically low levelsby Q2 2018, falling from 57% levels in 2012-2013 to sub 55% levels by mid-2018 beforerising in Q3. If demand potentially picks up, management teams may finally start toinvest. If this trend continues, it is likely to fuel a broader investment cycle, and driveAsset growth higher than what the market is expecting.

Total Capacity Utilization trends show an incremental reason to think that a capex cycle,and therefore higher-than-expected Asset growth, is coming. Capacity Utilization levelshave reached levels approaching 78% that were at the high end of this cycle previously,in 2015, before the energy crisis. As capacity becomes more constrained, companieshave even less ability to limit their capex spend, and they need to invest in newequipment to meet customer demands.

At the same time, management teams appear to be growing more optimistic aboutinvesting, based on Valens’ proprietary Management Growth Confidence Index.



Old assets and growing demand point to a capex cycle

February 2019

All S&P 1500 Constituents, weighted by Gross PP&ESource: Valens Research Analysis Data Coverage: Quarterly from Q3 2001 to Q3 2018

Exhibit 3: Companies have old assets, but may be starting to re-invest

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Gross PP&E-Weighted Aggregate Net PP&E to Gross PP&E

Data Coverage: Quarterly from Q3 2001 to Q3 2018All S&P 1500 constituents, weighted by Gross PP&E Source: Valens Research Analysis

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Business Confidence Indicators: ECF™ Markers

HQ Q HC EXC

Data Coverage: Monthly from Jun-2010 to Jan-201919,000+ total earnings calls from U.S. Corporates, sampled from all sectorsSource: Valens Research Analysis

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Management Growth Confidence Index

(HC+EXC)/HQ

3-Month Wtd Moving Average

Data Coverage: Monthly from Jun-2010 to Jan-2019Source: Valens Research Analysis

Valens monitors management confidence on their earnings calls, identifying areas onearnings calls where management appears to be showing areas of caution, and areas ofoptimism. This analysis has been run on over 19,000 companies over the past 9+ years,and aggregating the data from the analyzed calls yields valuable insights onmanagement sentiment.

Over the past year, management’s level of confidence (the red line) has been well abovelevels seen through most of 2015-2017. This improving confidence trend is a potentialsign of management teams growing more confident in investing in their businesses, justas PP&E is aging and capacity utilization is growing constrained.

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U.S. Total Capacity Utilization and Yearly CPI Inflation

Total Capacity Utilization CPI inflation, YoY

Data Coverage: Monthly from Jan-1967 to Jan-2019Source: The Federal Reserve System, Valens Research Analysis



Constrained capacity and mgmt. confidence point to reinvestment

February 2019

Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Monthly from Jan-1967 to Jan-2019

Exhibit 4: Companies are becoming capacity constrained, and need to reinvest

Source: Valens Research Analysis Data Coverage: Monthly from Jun-2010 to Jan-2019

Exhibit 5: Management teams are growing more confident about investing in growth

Tellingly, this signal appears to be strongest in areas like Energy, Materials, andInformation Technology, industries that could drive significant investment spending.Information Technology is also one of the industries with the highest return in the US.

The market is pricing in expectations for declining returns and slowing growth, justwhen companies appear to be having accelerating returns, and reasons to increaseinvestment. The market is not high on euphoria, it remains pessimistic and set up forpositive surprises, not negative. This is likely to remain true as long as companies haveaccess to credit to invest.

Corporate Access to CreditThe one risk to a favorable capex cycle and investment by companies is if they do nothave access to credit to be able to invest.

The Senior Loan Officer Survey (SLOOS) reports trends in banks’ willingness to lend tocreditors. When the Senior Loan Officer Survey is negative, it means access to credit isgetting easier. When the SLOOS is positive, it means access to credit is growing morechallenging. One cause for concern recently has been that the SLOOS has just turnedpositive for the first time since early 2016. Tighter credit standards mean less ability forcompanies to invest in growth, which would limit earnings growth.

Not only were banks getting more stringent with their loan standards, but in Q4 2018,the level of demand for C&I (Commercial & Industrial) loans also fell, potentiallysignaling reduced demand.

This could potentially stifle growth if it continues. However, there are reasons to believethis may have been a short-term, as opposed to a longer-term issue.



Credit factors appear to be alright after a short-term pause

February 2019

Source: Senior Loan Officer Opinion Survey, US Federal Reserve Board Data Coverage: Quarterly from Q1 1990 to Q4 2018

Exhibit 6: Credit standards tightened in Q4 2018

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Credit Standards and the S&P 500

Recession S&P 500 Credit Standards

Source: Senior Loan Officer Opinion Survey, U.S. Federal Reserve Board Data Coverage: Quarterly from Q1 1990 to Q4 2018

Price

Name

Sector

Fiscal Year

Quarter

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Data Date

Data M

Data D

Data Y

Fiscal M

Fiscal D

Fiscal Y

Exchange

Ticker

Home Country

Filing Currency

Scenario

GDP Deflator

NI Estimates

Valuations

Current Price

EV/IC' Multiple

P/E' Multiple

DCF

11%9% 9%

8% 8%9% 8%

10%9%

6% 6% 7%

10%

7%

10%

6%3%

7% 6%5%

6%

0%

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 5YrCAGR

Asset'Growth

7%8% 8% 7% 7%

8% 9% 10% 10% 10% 10% 9%11% 11% 11% 10% 10% 10% 10% 11% 12% 13%

11%

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E MktImp

ROA'

2.1

2.82.3 2.1

1.8 2.0 2.0 2.0 2.1 2.01.6 1.7 1.8 1.8 1.9

2.2 2.4 2.4 2.52.8 2.7

0.0

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

V/A'

27.430.8 29.5 29.5

20.5 20.6 18.8 18.2 18.8 19.716.6 15.2 14.9 15.3 17.2

21.024.2 21.9 20.7 21.6 20.1

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Fwd V/E'

This tightening trend and slackening demand occurred just as the yield curve appearedto be approaching an inversion, and as equity markets were collapsing to end the year. Alook at the data from January offers reasons to have confidence that this trend hasalready started to reverse, similar to the quick reverse in 2012 from a similar spike.

Closely monitoring the C&I loan growth trend itself helps identify trends in demand forcredit. After seeing a pause late in 2018, C&I loan growth grew 4.7% Quarter overQuarter in January 2019. While volatility may have caused a pause in lending trends inQ4, by January this trend already appears to have re-engaged.

Corporate ValuationsOne concern regularly leveled at this market has been that it is not cheap, even if thefundamentals are favorable. The market seems to already be pricing in all the goodnews. With as-reported P/E of 19.7x, above long-run average P/E of 16.3x, that appearsto be the case initially. Several factors show that valuations are not overly extended, butare rather reasonable and even potentially too low currently.



Corporate valuations are muted, justifying upside

February 2019


Exhibit 7: Growth in C&I loans re-accelerated in January 2019

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Consumer and Commercial & Industrial Loans (US$mn)

Commercial and Industrial Loans Consumer Loans

Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Monthly from Jan-2007 to Dec-2018


Exhibit 8: Valuations are low relative to recent history, and at 20 -year averages

On a UAFRS basis, US corporate valuations are not extended at all. In fact, valuations arefar below where they were in 2013-2017, and are only at average valuations for the past20 years at a 20.1x multiple. Corporate valuations do not look expensive whenas-reported accounting distortions are removed.

Importantly, valuations also need to be looked at in context, whether they are UAFRSvaluation multiples, or as-reported valuation multiples. Two key factors directly impactvaluation multiples, inflation and tax rates. High inflationary environments and high taxenvironments lead to lower valuation multiples, as less real earnings power makes it tothe investor. Low inflation and low tax environments have the opposite effect.

Currently, we are in a low inflation environment, with inflation hovering around 2%.Also, we are currently in a low tax environment, with capital gains and dividend taxes atvery low levels relative to history. In this environment, the average P/E is 20.1x, abovecurrent 19.7x as-reported P/E. For the current market environment, P/Es are actuallyslightly too low, even before factoring in the strong earnings growth in the currentenvironment.

An obvious question that many might ask related to this is, “what happens if taxeschange with discussions of a wealth tax, 70% top income tax bracket, and other issues.”One important factor to note here is, the US Senate election for 2020 is veryunfavorable for Democrats to gain control of the Senate. Most prognosticators predict acontinued 2+ Republican majority in the Senate after 2020. In that environment, the riskof a tax hike is limited.

Fundamentals are strong for US corporates, there appears to be access to credit toinvest in growth, and yet valuations remain muted based on the market context. Again,it is unlikely that Templeton would point to this as a period of euphoria, but rather aperiod where there is still sufficient pessimism to make significant money investing inthe market.



Based on the market environment, higher multiples may be justified

February 2019

Source: CapitalIQ, Irrational Exuberance b Robert Shiller, Valens Research Analysis Data Coverage: Yearly from 1914-2019

Exhibit 9: Considering the fundamental environment, valuations are not expensive

Corporate Credit FundamentalsThe one fly in the ointment that does need to be monitored is corporate creditfundamentals. This is natural in a bull market that has run as long as this market has.Over the past several years, corporate credit fundamentals have gotten less favorable.They may be pointing to issues on the horizon, in two years or so, if something does notchange.

The 10-year and 3-month treasury yield, one of the surest predictors of a recession, hasgotten close to inverting. Importantly, it has not inverted. Since early January, thespread has widened again. However, once an inversion happens, on average it takes 18months for the US to enter a recession. As these approached an inversion in late 2018,many panicked about the potential impact on lending and on the outlook for the USeconomy.

Assuming the yield curve will eventually invert sometime later in 2019, potentially bylate Q1 or sometime in Q2, the risk for an economic downturn in late 2020 or early2021 does become clearer. This is not reason to avoid buying stocks now, but it is areason to monitor this factor.

Similarly, an analysis of corporate debt maturity headwalls highlights debt maturities arestacked in 2021. Cash flows alone exceed all obligations other than share buybacks in2019 and 2020. Companies have flexibility to manage obligations in those years, and alimited growth in debt maturities.



Intermediate-term credit signals to bear monitoring going forward

February 2019

Source: US Federal Reserve Data Coverage: Daily from Feb-2009 to Feb-2019

Exhibit 10: The yield curve is close to inverting – a warning sign for 2020?

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-10

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-10

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-11

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-11

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-11

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-19

10-Year Treasury Yield 3-Month Treasury Yield

Source: U.S. Federal Reserve Data Coverage: Daily from Feb-2009 to Feb-2019

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2018E 2019E 2020E 2021E 2022E

Obligation & DebtMaturity Schedule

Other Uses of Cash

Maintenance Capex

Pension Servicing Costs

R&D Maintenance

Dividends

Rental Maintenance

Interest Expense

Debt Maturities

Gross Cash Earnings'

Cash Available for Outlays

Data Date: As of 06-Feb-2019

Aggregate CCFP for the entire S&P 1000 with outstanding debt (excluding Financials)

Source: Capital IQ, Valens Research Analysis

However, in 2021, debt maturities do rise significantly for the S&P 1000 (the S&P 1500excluding the S&P 500). If there is an issue with an inverted yield curve and tougheningcredit standards based on the SLOOS by that point in time, it may be challenging formanagement teams to refinance that debt as they see fit. That increases the risk for acredit crunch in late 2020/early 2021, as these issues start to be discussed.

Analysis of corporate debt asset backing, such as distressed asset valuation analysis, andcash to debt metrics, highlight a similar decline in credit quality for US corporates, whichmay create issues in the coming years.

These corporate and macro credit risks do point to issues in the coming years iffundamentals do not change. However, with significant time between now and whenthese issues might come to pass, astute investors would avoid overreacting, and insteadwait for the data to confirm these signals. This is especially the case when all othernearer-term signals remain as favorable as they are for the market.

ConclusionJohn Templeton was a proponent of buying at points of maximum pessimism, andselling at points of maximum optimism. While the current market environment may notpoint to maximum pessimism, muted valuations, continued corporate access to credit,strong improving fundamentals the market is not pricing in, and the potential of assetgrowth the market is not pricing in all point to more pessimism than optimism. Whilecredit risks remain for the out-years, those factors help create the “wall of worry” forthe market to climb in the coming year, and the overall fundamentals of the marketpoint to reason for optimism and for equity upside.



Markets are pessimistic and fundamentals favorable, expect upside

February 2019

Source: CapitalIQ, Valens Research Analysis Data Date: As of 05-Feb-2019

Exhibit 11: US corporates have debt maturity headwalls in 2021 that need refinancing

Data Date: 21-February-2019Metrics for the financials are based on unadjusted ROE, P/B, and P/E

Valens Conviction Long Idea List – Highlighting FB, PINC, and WGO

February 2019



Each month, Valens includes a summary of the quarterly Conviction Long Idea List, to highlight thecompanies that appear most compelling based on the current Market Phase Cycle environment andour Uniform Accounting research.

Each month we also highlight 2-4 names from the Conviction Long Idea list that appear particularlycompelling today, and discuss them in more detail. This month, those companies are Facebook, Inc(FB), Premier, Inc (PINC), and Winnebago Industries, Inc (WGO).

TICKER COMPANY SECTOR

PRICE

($ )

MCAP

($bn)

ROA'

FY1 V/A' V/E' STYLE

INTRINSIC

PRICE RANGE COMMENTS

COF Capital One Financial

Corporation

Finance 82.07 38.4 17% 1.0 6.4 Deep Value $70 - $170 -

CRUS Cirrus Logic Inc. Info Tech 39.31 2.3 13% 1.5 14.2 Value $25 - $115 -

FB Facebook, Inc. Info Tech 160.04 456.8 49% 7.4 14.9 Value $130 - $400 -

WGO Winnebago Industries, Inc. Cons Disc 33.03 1.1 25% 2.5 9.8 Value $25 - $100 -

LRCX Lam Research Corporation Info Tech 178.82 27.3 29% 3.5 12.2 Value $120 - $400 -

GOOG.L Alphabet Inc. Info Tech 1104.21 765.1 24% 4.0 16.6 GARP $900 - $1,650 -

HIG The Hartford Financial

Services Group, Inc.

Finance 48.83 17.5 14% 1.5 8.9 Value $30 - $85 -

DHI DR Horton Inc. Cons Disc 40.27 15.0 13% 1.5 11.5 Value $30 - $105 -

EBAY eBay Inc. Cons Disc 36.98 33.8 12% 1.6 12.8 Value $20 - $90 -

FSLR First Solar, Inc. Info Tech 51.95 5.4 1% 0.8 21.7 Deep Value $50 - $120 -

MYL Mylan N.V. Healthcare 31.06 16.0 28% 3.2 10.3 Value $25 - $135 -

GRMN Garmin Ltd. Cons Disc 82.42 15.6 16% 2.9 17.5 GARP $55 - $120 -

NOV National Oilwell Varco,

Inc.

Energy 28.76 11.0 3% 1.2 40.7 GARP $22.5 - $105 -

THRM Gentherm Incorporated Cons Disc 41.76 1.5 10% 1.9 15.0 Value $30 - $125 -

PINC Premier, Inc. Healthcare 37.14 2.4 85% 8.8 10.2 Value $25 - $150 -

GILD Gilead Sciences, Inc. Healthcare 65.55 84.0 37% 3.4 9.3 Value $60 - $500 -

ASGN ASGN Incorporated Industrials 65.74 3.4 37% 6.6 16.6 GARP $40 - $125 -

CTXS Citrix Systems, Inc. Info Tech 104.99 13.8 28% 5.6 19.9 GARP $75 - $225 -

TPR Tapestry, Inc. Cons Disc 34.83 10.1 20% 3.4 14.9 Value $27.5 - $90 -

PLNT Planet Fitness, Inc. Cons Disc 58.25 5.1 84% 28.6 29.9 Growth $40 - $90 -

AMN AMN Healthcare Services,

Inc.

Healthcare 53.13 2.5 25% 5.2 19.7 GARP $40 - $125 -

BHC Bausch Health Companies

Inc.

Healthcare 23.51 8.2 49% 4.3 8.1 Value $10 - $210 -

FB is trading at a 14.8x Uniform P/E (Fwd V/E'). The market appears to expect Uniform Asset growth for the firm to decline to around 15% a year going forward, with ROA’ declining towards 20% levels over the next several years as the firm fails to maintain the robust returns from their investments, driven by higher costs and declining growth.

FB has done an excellent job of focusing on monetizing their business, before and after their IPO. Around the time of the IPO, the company was going through a transition from their prior desktop focus to a much stronger mobile focus that the market doubted. The company has successfully navigated this transition, seeing ROA’ robustly rebound from 2012 lows of 41% up to 60% in the four subsequent years, even as Uniform Asset growth remained robust at north of 30% every year.

The company has also done an excellent job of identifying potential disruptive technology ahead of peers and ahead of the market. This includes the acquisition of brands like Instagram, WhatsApp, and Oculus before they matured into high growth and profitable businesses. They have since transitioned those businesses, in particular Instagram, into profitable businesses offering further growth drivers for the company along with their base platform.

Facebook, Inc. (FB)

Current Stock Price: $160.04Market Cap: $456.6bn

Intrinsic Price Range$130 - $400

Valens Recommended Stop Loss$145

UAFRS Metrics:Forecast Adjusted ROA53.6%

Forecast 2 Year Adjusted EPS Growth12.4%

Adjusted Fwd P/E14.79x

Valens Top Stock Picks For February – Facebook, Inc (FB)

February 2019



http://app.valens-research.com/companies/FB/company-analysis/valens-equities/pvp-chart?p=3

The company has also consistently gotten better at leveraging their data to improve targeting, enabling them to take a larger share of advertising across their platforms, driving further growth. The market is currently focusing on the risks for Facebook, around increased regulatory oversight and costs, and slowing growth. However, they are not capturing how FB has repeatedly used those costs to drive incremental growth and innovation on their platform historically, a trend they are likely to continue.

Considering the growth drivers the company still has, including monetizing WhatsApp and Oculus, incremental monetization growth in Instagram and Facebook, and the aggregate growth of the online advertising market, FB appears to be well positioned for continued sustained growth and strong to even potentially expanding ROA’. This makes current expectations appear too negative.

For incremental context, at current valuations the market is expecting Asset’ growth below the company’s long-term revenue growth rate, meaning the company is likely to see steady to even potentially expanding Asset’ Turns, which should help the company maintain ROA’ at higher levels than what the market is expecting.

Management is forecasting operating margin to fall over the next few years from 47% last year to mid-30% levels due to higher costs. If we assume this is true and the company does not execute on monetizing these investments as they have before, a flat Asset’ Turns number and Earnings’ Margin declining by roughly 1,200bps translates into a decline in ROA from 65% last year to 52% in the coming years. This is a significantly lower slope of decline in returns than what the market is forecasting, with expectations that ROA’ will decline by 2/3 in the next few years.

Incentives Dictate Behavior™

Management’s compensation framework should focus them on sustaining their historical growth by increasing their user base and user engagement to drive revenue growth, while also trying to stabilize and improve ROA’ over time through improved capital expenditure efficiency. These indicate that expectations for slowing growth and sustained ROA’ compression are too negative.

Earnings Call Forensics™

Earnings Call Forensics™ of the Q4 2018 earnings call (1/30) highlights some continued favorable trends, but also some areas of near-term headwinds for the company. Management showed confidence about growth trends for their advertising business, and about the trend for adoption of marketing tools by smaller advertisers. They also showed confidence about the return in their capex investments, and the trends they are seeing in their Watch tab. Management continues to be confident about monetization trends for the business.


February 2019



On the other hand, management did show less confidence about monetization of their messaging services than they had previously. Also, management may be overstating confidence about sustaining overall revenue growth. Finally, management showed less confidence about being able to effectively invest in infrastructure for safety and security while using that same infrastructure to facilitate innovation.

Management is showing some concerns about continued near-term expense pressures, but their continued confidence about strong monetization and the intelligence about their investment strategies shows reason to believe the market is overly pessimistic about the company.

Conclusion

The market’s perception of FB having significant operating issues, powering very low valuations, combined with FB’s strong fundamental momentum and excellent execution, justifies equity upside.


February 2019



PINC currently trades at the low end of valuations since the IPO, at a 10.2x Uniform P/E (Fwd V/E’). At these low valuations, the market is pricing in Asset’ growth for the company to continue at the low end of historical levels at 10%, with ROA’ falling from 78% last year to 31% over the next several years, seeing returns cut by more than half. On the other hand, sell-side analysts, recognizing the building positive fundamentals for the business, are forecasting ROA’ to improve, rising to 85%, thanks to acceleration in the company’s various businesses.

The company has consistently been producing ROA’ above 50% level the past seven years, with steady 10%+ Asset’ growth for most of that period too. The company’s strong base return business comes from their legacy GPO (group purchasing organization) business, where they serve as an aggregator of purchasing power for hospitals and other health providers for durable medical equipment, pharmaceuticals, disposable supplies and other equipment, combined with the company’s innovative, Oracle-like strategy, of expanding to fill other niches of needs for their customers.

Premier, Inc. (PINC)



Valens Recommended Stop Loss$34.50




Valens Top Stock Picks For February – Premier, Inc (PINC)

February 2019



http://app.valens-research.com/companies/PINC/company-analysis/valens-equities/pvp-chart?p=3

The company has pursued a strategy similar to what Oracle did in the software market in the 2000s, by starting with the “utility” (database) part of the software market, and then acquiring higher value-added businesses (ERP, dashboarding, etc.) and selling that into current customers.

They have expanded from the GPO business into clinical informatics and pharmacy informatics, to support their customers in optimizing their processes, to lead to higher value add sales and increased wallet share. They have also expanded to support value-based care initiatives, innovating in technology in this area to further gain share in a growing area of the health care market. This helps defend their core business while also drive growth, through their expanded offerings, both from strategic acquisitions and organic growth.


Earnings Call Forensics™ of the Q2 2019 earnings call (2/5) highlights a continuation of bullish trends seen in the Q3 2018 - Q1 2019 calls. Management showed confidence in their strategy around bundled payments, their trend in growth across their segments, and in particular their revenue growth trends in their Supply Chain Services segment. Management also showed confidence in their recent acquisition of Stanson, how strong the performance of Stanson’s EHR notifications solution was, how Stanson fits into their efforts to differentiate themselves, and the people they have brought onboard to help to continue to drive their strategic initiatives. These markers were in line with confidence in Stanson, their revenue growth, and their overall outlook in prior calls.

Management may have some concerns about the impact of CMS proposals around Medicare Advantage to their business, around chronic drug shortages, and around hospital utilization trends impacting their business, however management’s continued confidence about revenue growth and initiatives to diversify their revenue sources and strengthen their relationships with clients point to continued strong fundamental tailwinds for the company.

Conclusion

The market’s exaggerated concerns about PINC’s legacy business, combined with management’s smart strategic expansion strategy into areas with secular growth trend, strong overall positioning for the company, and growing management confidence about their outlook for the business all point to significant potential equity upside.

Valens Top Stock Picks For February – Premier, Inc (PINC)

February 2019



WGO is trading at a 9.2x Uniform P/E (Fwd V/E’), at the low end of historical valuations. The market is expecting 4% Uniform Asset (Asset’) growth going forward, toward the lower end of historical Uniform Asset growth levels. The market also expects Uniform ROA to be at 10% levels over the next several years, even though analysts expect ROA’ to sustain at current 27% levels in the next several years.

Before the Great Recession, WGO was consistently a double-digit ROA’ business. WGO regularly generated a 13%+ ROA’ with steady Uniform Asset growth, underlying the strong fundamentals of the business in a normal cycle. This is also highlighted by how well the company has rebounded since the Great Recession.

WGO also has several key factors that position it well in the current environment. The firm has age-wave tailwinds, with many baby boomers entering retirement, growing their potential addressable market. Historically, the largest buyer of Winnebago’s products has been retirees in the U.S. As this market grows, demand for Winnebago’s offerings are likely to grow, Winnebago is likely to see rising sales even if they do not take market share.

Winnebago Industries, Inc. (WGO)



Valens Recommended Stop Loss$26.50




Valens Top Stock Picks For February – Winnebago Ind., Inc (WGO)

February 2019



http://app.valens-research.com/companies/WGO/company-analysis/valens-equities/pvp-chart?p=3

Also, WGO recently has strategically used their limited leverage to make a smart strategic acquisition, acquiring SunnyBrook RV to help grow their footprint. This should help the company continue to drive growth, and their ability to improve this business as they have improved their own should create further value. Specifically, this acquisition has led to a significant transformation of the profitability of the business, more towards THO and other peers, that have historically had much stronger returns than WGO. This can partially be attributable to growth in WGO moving into a more diversified offering in the space, with the acquisition powering a significant expansion into the Towables market.

Incentives Dictate Behavior™

Management is actively incentivized to focus on improving ROA’, with short-term compensation focused on ROA and net income, while long-term compensation is focused on ROE. The short-term ROA and net income compensation metrics are likely to drive management to focus on improving both parts of the DuPont formula, margins and asset utilization. This should drive ROA’ higher over time, contrary to market expectations. Also, the focus on an ROE metric means that management will not necessarily shy away from using leverage to grow the business, if it makes sense to, which is a positive for the company’s ability to find growth capital.

Members of management are also material owners of the company. Several members of the management team own an excess of 1.1x their average compensation, favorably aligning them with investors. Management would also be well compensated in a change in control. This increases the likelihood management would sell the company, a further possible catalyst.


Also, during the Q1 2019 earnings call (12/19), management continued to show the positive inflection they saw in Q3 2018 and Q4 2018. Management showed confidence in their strong organic revenue growth, and about their success in normalizing inventory levels. They were also confident that they’re not having similar inventory issues to Thor, and that they can manage their variable costs. Management also showed confidence that they are seeing success in their expanded product lines.

This is in line with management’s confidence in the Q2 2018 - Q4 2018 calls about controlling costs and their confidence in their backlog. While management may be concerned about the rental side of the business, their confidence in the strong fundamental momentum of the company signals that fundamentals continue to be robust, even as the market is acting as though the sky is falling.

Conclusion

WGO’s strong long-term macro tailwinds, which the market undervalues, strong management alignment, and growing confidence about business tailwinds and growth justify equity upside.

Valens Top Stock Picks For February – Winnebago Ind., Inc (WGO)

February 2019



Summary of Contents

Business Profitability and Valuation

• Page 23 – U.S. Aggregate Performance and Valuation Prime™

• Page 24 – Aggregate Net/Gross PP&E

• Page 25 – U.S. Total Capacity Utilization

• Page 27 – Inflation and Capital Gains Taxes

Market Phase Cycle™

Sentiment: Investors, Consumers, Institutions, and Management

• Page 30 – Consumer Confidence

• Page 31 – Wall Street Sentiment: Equity Allocation Survey

• Page 32 – Investor Sentiment: Equity Fund Flows

• Page 33 – Investor Sentiment: Margin Debt Levels

• Page 34 – Investor Sentiment: Investor Credit Balances

• Page 35 – Investor Sentiment: Correlation in Market Indices

• Page 36 – Investor Sentiment: Dispersion in Market Indices

• Page 37 – Investor Sentiment: Short Interest

• Page 39 – Investor Sentiment: Net Positions Held

• Page 40 – Investor Sentiment: Implied Correlation

• Page 41 – Management Sentiment: Insider Activity

• Page 42 – Management Sentiment: Buyback Activity

• Page 44 – Management Sentiment: Aggregate ECF™

• Page 45 – Management Sentiment: Sector

• Page 46 – Institution Sentiment: Macro ECF™

Government Policy and Intervention

• Page 51 – The Unemployment Rate

• Page 52 – Housing Prices vs. DJIA

• Page 53 – Inflation Sentiment: Inflation Expectations

Summary of Contents

Market Phase Cycle™

Corporate Credit Availability

• Page 57 – Reserves vs. Loans

• Page 58 – Investor Sentiment: Total Bond Flows

• Page 60 – Household Debt Service Payments & Yield Curves

• Page 61 – Inverted Yield Curves & Recessions

Corporate Credit Willingness

• Page 63 – Credit Standards vs. S&P 500

• Page 65 – CDS: Movements in Credit Risk

Corporate Credit Worthiness

• Page 72 – Cash Holdings & Aggregate Recovery Rates

• Page 73 – Corporate Cash to Short-Term Debt

• Page 75 – Debt Headwalls: Aggregate CCFP

• Page 77 – Credit Integrity: Provisions for Losses & Bad Loan Charge-Offs

Corporate Credit Issuance / Usage

• Page 79 – Corporate & Consumer Credit

• Page 81 – Credit Usage: Manufacturing Activity

• Page 83 – Historical Inflation & M2 Velocity

• Page 85 – Money Velocity: Treasury Yields

Corporate Credit Macro View

Summary of Contents

[email protected] ■ TEL +1 (646) 491 2601 ■ www.valens-research.com

Copyright 2014, Valens Research. All Rights Reserved. Please refer to the last page.

Market Phase Cycle™Joel Litman

Chief Investment [email protected]

+1 (646) 491 2601

Business Profitability and Valuation





+1 (646) 491 2601

Price

Name

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Fiscal Year

Quarter

Year

Data Date

Data M

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Fiscal Y

Exchange

Ticker

Home Country

Filing Currency

Scenario

GDP Deflator

NI Estimates

Valuations

Current Price

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P/E' Multiple

DCF

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6%

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 5YrCAGR

Asset'Growth

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8% 9% 10% 10% 10% 10% 9%11% 11% 11% 10% 10% 10% 10% 11% 12% 13%

11%

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5%

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E 2019E MktImp

ROA'

2.1

2.82.3 2.1

1.8 2.0 2.0 2.0 2.1 2.01.6 1.7 1.8 1.8 1.9

2.2 2.4 2.4 2.52.8 2.7

0.0

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1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

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2018 ROA’ is projected to be 12%, and grow to 13% in 2019. Current market expectations are for ROA’ toreturn to trough 11% level, with Asset’ growth in the middle of recent levels, at 6%. Considering ROA’and growth trends and expectations, U.S. markets appear inexpensively valued. If corporations canmaintain forecast profitability, it warrants equity upside.• This analysis uses UAFRS-adjusted ROA (ROA′) and adjusted Asset growth (Asset′ Growth) for aggregate

analysis, using the data from the Valens Research application, which gives an improved view ofcorporate profitability after taking into account both automatic and manual adjustments

• U.S. corporate profitability had been improving on a cyclical basis over the past 20 years, rising frompeaks of 8% to 10%-11% levels in 2011-2014. Analysts expect ROA′ to reach new highs in 2018-2019,increasing to 13%+ levels thanks to strong economic conditions and tax code changes. Markets are notexpecting this to be sustainable, expecting ROA’ to return to 10% levels assuming a 4.8% discount rate

• Asset’ growth has been accelerating recently after several years of subdued growth. Markets expectgrowth to remain at prior low levels, below longer-term historical rates. As management teams gainmore confidence and potential government actions help fuel growth, this may be too pessimistic

• With valuations relative to assets declining from 2017, but ROA’ expanding, UAFRS-adjusted P/E (V/E′)has actually fallen recently to below 20x multiple, showing expectations for declining fundamentals

Macro Environment: U.S. Aggregate Performance and Valuation Prime™

Data Date: As of 19-Feb-2019Source: Capital IQ, Valens Research Analysis

Performance and Valuation Prime™ Analysis2,767 U.S. companies (non-financial)

http://app.valens-research.com/companies?p=3





+1 (646) 491 2601

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Gross PP&E-Weighted Aggregate Net PP&E to Gross PP&E

Data Coverage: Quarterly from Q3 2001 to Q3 2018All S&P 1500 constituents, weighted by Gross PP&E Source: Valens Research Analysis

• Following Aggregate Net/Gross PP&E over time can be a good test to understand when companies havebeen “milking” their balance sheets or ramping up investment in the face of expected growthopportunities. When Net/Gross PP&E ratios dramatically rise (as they did in 2005-2007), it means thatmanagement teams are aggressively investing in their assets to drive growth. When Net/Gross PP&Efalls, management teams are instead deferring maintenance capex and managing cash flows

• Net/Gross PP&E ratio bottomed out at 56.4% in 2010 during the Great Recession, as companies beganspending on necessary maintenance capex while the economy recovered from the recession. Firmsrebuilt Net/Gross PP&E levels to near historical average levels until the middle of 2013. Soon after,companies have again started showing reluctance to further expand spending on maintenance capex,leading to declines in Net/Gross PP&E

• In 2014, incremental capex spending initially started climbing, though it has subsequently fallendramatically. Capital spending is likely to begin to accelerate if management teams continue to showconfidence in investing in growth

• The Net/Gross PP&E ratio has experienced continuous declines since Q3 2014, but recently showedrecovery in Q3 2018. This may be a sign that management teams are starting to have a bullish outlookon demand such that they are becoming more aggressive in investing for growth. With Net/Gross PP&Eratios now at multi-quarter lows and at a slight recovery in the latest quarter, this may function as acatalyst for increased spending, as firms will need to spend on maintenance capex to keep fixed assetsat current capacity and production levels

Macro Environment: Aggregate Net/Gross PP&E





+1 (646) 491 2601

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Total Capacity Utilization CPI inflation, YoY

Data Coverage: Monthly from Jan-1967 to Jan-2019Source: The Federal Reserve System, Valens Research Analysis

U.S. Total Capacity Utilization

• The U.S. Total Capacity Utilization (TCU) rate is used to determine how much slack is currently in thesystem in terms of capacity to increase volumes without spending on capex. The Fed uses this metric tosee whether there is room to grow the economy without causing inflationary pressures. A TCU rateexceeding 85% is thought to be inflationary

• For December 2018, the TCU rate is 78.73%, an incremental increase from 78.6% during November.Capacity utilization has improved from 2015-2016 levels and has maintained at this level year to date.While the TCU rate has been growing gradually, concerns for possible overheating seems to be minimalas current levels are a far cry from the inflationary 85%+ levels





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Data Coverage: Monthly from Jan-1999 to Jan-2019Source: Valens Research Analysis

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2

201

3

201

4

201

5

201

6

201

7

201

8

201

9


Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Monthly from Jan-1999 to Jan-2019Source: The Federal Reserve System, Valens Research Analysis


• During the 2008-2009 recession, capacity utilization fell to historically low levels. It improved towardspre-recession levels, nearly having breached 80% in 2014. This improvement appeared to be a signalthat investment would need to pick up in order to capitalize on the growing demand in the economy.Right after nearly breaching the 80% level, capacity utilization began falling, continuing through 2016,reducing the need for capex, likely because of weakness in the energy sector and related demand inparticular. However, recently capacity utilization rates have again begun recovering, in particular in late2017

• Total capacity utilization has risen from the lower end of the recent range, having stabilized above 75%,and trending towards 80%, potentially signalling renewed reason for capex in the intermediate term





+1 (646) 491 2601

0

5

10

15

20

25

30

35

40

45

1914 1929 1944 1959 1974 1989 2004 2019

Pri

ce /

Ear

nin

gs (

Trai

lin

g)

S&P 500 Price / EarningsHigh Inflation P/E

Low Inflation P/E

Deflation P/E

High Inflation Average P/E

Average P/E

Deflation Average P/E

Deflation:

19.2x

Average P/E :

16.3x

High Inflation : 11.5x

Inflation and Capital Gains Taxes

• The U.S. is currently in a low (but rising) inflation environment, coupled with low dividends and capitalgains tax rates relative to historical rates that are likely to persist. The market’s current average trailingas-reported earnings multiple of 19.7x is near median valuations, assuming low inflation and low taxrates. Valuations are trading at a premium based on the current market context, approaching levels notseen other than in the tech bubble of the late 1990s

• Forward P/E of 16.1x, assuming earnings growth continues and the market does not appreciate, isbelow the average valuations for the current market context. This highlights that with earnings growth,valuation-based upside is warranted

Source: Capital IQ, Irrational Exuberance by Robert Shiller, Valens Research Analysis

Data Coverage: Monthly from Jan-1914 to Feb-2019

Data Coverage: Yearly from 1914 to 2018

InflationDividend and Capital

Gains TaxYears Average P/E

>4%Low Tax 5 14.4x

High Tax 26 11.2x

0%-4%Low Tax 24 20.1x

High Tax 33 16.3x

<0%Low Tax 9 22.3x

High Tax 5 12.4x





+1 (646) 491 2601

Wilso

n

Wilso

n

Hard

ing

Co

olidge

Ho

ove

r

Ro

osevelt

Ro

osevelt

Ro

osevelt

Trum

an

Trum

an

Eisen

how

er

Eisen

how

er

Ken

ned

y

Joh

nso

n

Nixo

n

Nixo

n

Carte

r

Reagan

Reagan

Bu

sh

Clinto

n

Clinto

n

Bu

sh

Bu

sh

Ob

ama

Ob

ama

Trum

p

Presidencies

6

8

1 0

1 2

1 4

1 6

1 8

2 0

2 2

2 4

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1914 1921 1928 1935 1942 1949 1956 1963 1970 1977 1984 1991 1998 2005 2012 2019

Pe

rce

nt

Taxes on Qualified Dividends and Capital Gains Taxes

CG Tax min Div tax max Div tax

Source: U.S. Department Of Labor Bureau of Labor Statistics, taxfoundation.org, Valens Research Analysis Data Coverage: Monthly from Jan-1914 to Feb-2019

S&P500 P/E

per tax level

>23% Tax:

15.0x

Average :

16.3x

<23% Tax:

19.3x

6

8

10

12

14

16

18

20

22

24

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1914 1921 1928 1935 1942 1949 1956 1963 1970 1977 1984 1991 1998 2005 2012 2019

Pe

rce

nt

Taxes on Qualified Dividends and Capital Gains Taxes

CG Tax min Div tax max Div tax

Source: U.S. Department Of Labor Bureau of Labor Statistics, taxfoundation.org, Valens Research Analysis Data Coverage: Monthly from Jan-1914 to Jan-2019

S&P500 P/E per tax level

>23% Tax: 15.0x

Average : 16.3x

<23% Tax: 19.3x

0

5

10

15

20

25

30

35

40

45

1914 1921 1928 1935 1942 1949 1956 1963 1970 1977 1984 1991 1998 2005 2012 2019

Pri

ce /

Ear

nin

gs (T

rail

ing)


Low Inflation P/E

Deflation P/E


Average P/E


Deflation: 19.2x

Average P/E : 16.3x


Inflation and Capital Gains Taxes

0

5

10

15

20

25

30

35

40

45

1914 1929 1944 1959 1974 1989 2004 2019

Pri

ce /

Ear

nin

gs (

Trai

lin

g)


Low Inflation P/E

Deflation P/E


Average P/E


Deflation:

19.2x

Average P/E :

16.3x


-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

1914 1922 1930 1938 1946 1954 1962 1970 1978 1986 1994 2002 2010 2018

Pe

rce

nt

CPI Change YoY





+1 (646) 491 2601

Sentiment: Investors, Consumers, Institutions,

and Management





+1 (646) 491 2601

500

1,000

1,500

2,000

2,500

3,000

3,500

0

20

40

60

80

100

120

140

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

S&P

50

0C

on

sum

er

Co

nfi

de

nce

Ind

ex

U.S. Consumer Confidence

Consumer Confidence Index

S&P 500

Consumer Confidence Survey®Source: The Conference Board

Data Coverage: Monthly from Feb-2004 to Jan-2019

• There is a strong relationship between the stock market and the consumer confidence index (CCI), asseen above. The CCI is a leading indicator of market movements because it is a general signal ofconsumer demand based on their perception of the current business and employment conditions, andtheir expectations for these conditions for the next six months. Movements in CCI also signal creditexpansion, as demand for credit increases with consumer demand

• The latest data suggests consumer optimism is regressing from historical highs. The ConsumerConfidence Index decreased further in January 2019 to 120.2, from a 126.6 reading in December 2018.Consumer expectations for economic activity over the next six months fell to 87.3 from 97.7. The surveyalso showed that the proportion of consumers claiming jobs are “plentiful” stagnated at around 46%-47% levels. Furthermore, the percentage of those who think jobs are “hard to get” increased to 12.9%from 12.2%

Consumer Confidence





+1 (646) 491 2601

600

1,100

1,600

2,100

2,600

3,100

0

20

40

60

80

100

120

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

S&

P 5

00

NA

AIM

Exp

osu

re In

dex

1-m

on

th A

vg.

Equity Allocation Survey and the S&P 500

S&P 500 Survey Score moving avg. Survey Score

Traditional Benchmark Equity Allocation: 60% to 65%

Source: National Association of Active Investment Managers Data Coverage: Monthly from Jan-2010 to Feb-2019

2/13/2019: 82.01%

Wall Street Sentiment: Equity Allocation Survey

• The National Association of Active Investment Managers member firms are asked each week to providea number that represents their total overall equity exposure at the market close on a specific day of theweek. Responses can vary widely from 200% leveraged Short, to 200% leveraged Long

• Early in 2016, equity allocation plunged back to the low end of levels while the market entered anothercorrection, remaining there for much of the 1st quarter. Equity allocation recovered robustly untilSeptember. However, through October and early November, equity allocation levels declined into theelection period. After the election, equity allocation levels rose robustly, as markets reacted todiscussions about infrastructure stimulus, tax cuts, and other growth-creating initiatives. For the mostpart, equity allocation levels remained elevated through the rest of 2017

• Equity allocation levels have been more volatile in 2018, falling to sub-50% levels in April beforerecovering to 90% levels through the summer into fall, and then declining significantly to recent lowlevels of 30%, highlighting a rapid shift to a significantly more “risk off” approach – signaling investorswere becoming overly risk-focused before the recent rebound. In Q4 2018, equity allocation continueto alternate between the 30% lows and average equity allocation levels of 60%, a more risk aversepositioning compared to allocation levels seen in 2017, though this has rebounded slightly to start 2019,with the survey level now above the long-run average at 82.01%





+1 (646) 491 2601

0

500

1,000

1,500

2,000

2,500

3,000

-100,000

-80,000

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

2011 2012 2013 2014 2015 2016 2017 2018 2019

S&P

50

0Eq

uit

y Fu

nd

Flo

ws

Equity Fund Flows

Equity Fund Flows in US$mn S&P 500

Source: Investment Company Institute Data Coverage: Monthly from Jan-2011 to Jan-2019

Investor Sentiment: Equity Fund Flows

• The old adage of buying low and selling high is statistically far from investor reality. Data from theInvestment Company Institute shows that historically, investors pull out from equities at times whenstock prices are relatively discounted

• 2013 equity funds totaled net inflows of $159.57bn, in which Jan. 2013 garnered the highest net inflowfor a single month since 2008 with $37.57bn. 2014 faced an 84% decline from the previous year but stillrendered positive flows of $25.46bn. The succeeding years saw a return to net outflows

• December 2018 is estimated to have the largest ever net outflow for a single month with $83.04bn,indicating elevated concerns on global equity, primarily in developed markets. However as the newyear began, the stock market quickly recovered its 2018 year-end losses





+1 (646) 491 2601

0

100

200

300

400

500

600

700

800

0

500

1,000

1,500

2,000

2,500

3,000

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Margin

De

bt

S&P

50

0

Margin Debt and the S&P 500

Margin Debt in US$bn S&P 500

Data Coverage: Monthly from Jan-1997 to Dec-2018Source: FINRA, Valens Research Analysis

Investor Sentiment: Margin Debt Levels

• Margin debt is capital borrowed from brokers to buy a security. This is known to have a high correlationand an almost direct relationship with the S&P 500 since investors are willing to take more risk in goodeconomic times. Therefore, changes in margin debt levels can serve as an indicator of marketexpectations. However, it is prudent to deflate the margin debt data relative to changes in the S&P 500to gauge if margin debt levels are spiking independently

• In May 2018, margin debt reached its highest level ever achieved, amounting to $668.94bn.Nonetheless, the months after had shown continuous decline. As of December 2018, margin debt levelsare at $554.29bn from $593.59bn the previous month. This continuous decline on leverage activityindicates the less aggressive stance of investors to take on risk and possibly tying their bearish marketexpectation with the S&P 500 wiping out 2018 gains

• Controlling for increases in the S&P 500 further highlights how far current levels of margin debtdeclined, having actually fallen to the low level of the market’s range since 2006, pointing to investorsthat consistently grew more passively positioned through 2018

0.0

1.0

2.0

3.0

4.0

5.0

0

500

1,000

1,500

2,000

2,500

3,000

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

S&P

50

0 M

argin D

eb

t Ind

ex

S&P

50

0

Indexed Margin Debt Levels and the S&P 500

Indexed Margin Debt S&P 500

Source: FINRA, Valens Research Analysis Data Coverage: Monthly from Jan-1997 to Dec-2018





+1 (646) 491 2601

-400

-300

-200

-100

0

100

200

300

0

500

1,000

1,500

2,000

2,500

3,000

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Inve

stor C

red

it Balan

ceS&

P 5

00

Nominal Investor Credit Balance and the S&P 500

Positive Credit Balance (in US$bn)

Negative Credit Balance (in US$bn)

S&P 500

Investor Sentiment: Investor Credit Balances

-300

-200

-100

0

100

200

300

400

0

500

1,000

1,500

2,000

2,500

3,000

3,500

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Ind

exe

d In

vesto

r Cre

dit B

alance

S&P

50

0

Indexed Investor Credit Balance and the S&P 500

Positive Credit Balance Index

Negative Credit Balance Index

S&P 500

Source: FINRA, Valens Research Analysis Data Coverage: Monthly from Jan-1997 to Dec-2018

• Investor Credit Balances (Credit Balances in Margin Accounts + Free Credit Cash Accounts - MarginDebt) have historically been positive during bear cycles and negative during bull cycles. The S&P500-indexed balances are currently at -$162.43bn as of December 2018, from -$216.78bn

• Investor credit balances are currently above levels seen in the most recent cycle and the highs relativeto the 1999-2000 period, highlighting investors are growing more bullish, but the recent pullback showsa pause in positive trends for investor sentiment

• While investor credit balances have grown elevated, there still remains significant investor assetsallocated to low-to-negative interest rate bonds, and if allocated to equities could lead to furtherdemand driven upside





+1 (646) 491 2601

600

1,100

1,600

2,100

2,600

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Mar

-00

Feb

-01

Jan

-02

Dec

-02

No

v-0

3

Oct

-04

Sep

-05

Au

g-0

6

Jul-

07

Jun

-08

May

-09

Ap

r-1

0

Mar

-11

Feb

-12

Jan

-13

Dec

-13

No

v-1

4

Oct

-15

Sep

-16

Au

g-1

7

Jul-

18

S&P

50

0S&

P 5

00

Co

rre

lati

on

Correlation between the S&P 500 and its constituents

S&P 500 Correlation Min Max Average

All S&P 500 constituents, 30 Trading day correlationSource: Capital IQ, Valens Research Analysis

Data Coverage: Daily from Mar-2000 to Feb-2019

250

350

450

550

650

750

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Dec

-10

Mar

-11

Jun

-11

Sep

-11

Dec

-11

Mar

-12

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-14

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

Mar

-17

Jun

-17

Sep

-17

Dec

-17

Mar

-18

Jun

-18

Sep

-18

Dec

-18

S&P

15

00

S&P

15

00

Co

rre

lati

on

Correlation between the S&P 1500 and its constituents

S&P 1500 Correlation Min Max Average

Data Coverage: Daily from Dec-2010 to Feb-2019All S&P 1500 constituents, 30 Trading day correlationSource: Capital IQ, Valens Research Analysis

Investor Sentiment:Correlation in Market Indices

The correlation between the S&P 1500 and its constituents was highly volatile in 2018, with its sharpdecline during the rally through the summer and early fall reversing recently in the market correction,however the recent subsequent decline may be a sign of a reduced “risk off” approach:

• Correlation has fallen to 46.2%, below its six-year average of 50.9%, and above the30%-45% range seen since the U.S. election in November 2016

• As of February 15, 2019, correlation between the S&P 1500 and its constituents declined by 1.4% WoW,by 21.6% MoM, and increased by 9.9% YoY

• As of February 19, 2019, S&P 500 correlation declined by 2.9% WoW, 25.0% MoM, and increased 12.2% YoY

• Correlation currently measures at 48.7%, slightly above the long-term average of 47.7%





+1 (646) 491 2601

0

500

1,000

1,500

2,000

2,500

3,000

3,500

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

18.0%

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

S&P

50

0D

isp

ers

ion

Market Dispersion - 1994 to 2018

Dispersion S&P 500

Source: Valens Research Analysis Data Coverage: Monthly from Apr-1994 to Feb-2019

1,800

2,000

2,200

2,400

2,600

2,800

3,000

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

Apr-18 May-18 Jun-18 Jul-18 Aug-18 Sep-18 Oct-18 Nov-18 Dec-18 Jan-19 Feb-19

S&P

50

0D

isp

ers

ion

Market Dispersion - Trailing 12 Months

Dispersion S&P 500

Source: Valens Research Analysis Data Coverage: Daily from Apr-2018 to Feb-2019

• Dispersion, or cross-sectional portfolio volatility, measures diversity by quantifying how much theindividual assets of an index perform differently compared to the average. Low dispersion periodssignify that active investors would find it difficult to create a portfolio that would beat the index whilehigh dispersion periods signify the potential for a wide range or spread of returns

• After a historically high dispersion environment during the Great Recession, dispersion has remainedlow and consistent as the S&P 500 steadily trended upward. Observing the year 2018, the trailing 12months portfolio volatility has crept up around the end of October with signs of dwindling in December.In January 2019, volatility regained steam as the S&P 500 recovers. This seems to mirror the recentturbulence in the economy as expressed by the S&P 500, signifying opportunities to earn positive alphareturns

Investor Sentiment:Dispersion in Market Indices





+1 (646) 491 2601

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Ma

rket Va

lue Sh

ort $R

uss

ell 1

00

0 V

alu

e

Russell 1000 Short Interest

Russell 1000 Short Interest Russell 1000 Value

Source: Valens Research Analysis Data Coverage: Monthly from Jan-2006 to Jan-2019

0

100,000

200,000

300,000

400,000

500,000

600,000

700,000

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Ma

rket Va

lue Sh

ort $R

uss

ell 1

00

0 V

alu

e

Russell 1000 Market Value Short

Market Value Short (in millions) Russell 1000 Value

Source: Valens Research Analysis Data Coverage: Monthly from Jan-2006 to Jan-2019

• Short interest highlights that when adjusted for higher equity prices, short interest has been relativelystable the last year after falling in late 2016 and then again mid-2018

• From 2012 through mid-2016, short interest levels were trending mostly higher. However, since thatperiod, the main trend in short interest levels has been down, signaling investors who are deployingmore capital and less focused on downside risk

Investor Sentiment: Short Interest

• Market Value Short steadily increased from April 2009 until late 2015, before plateauing and thenaccelerating again in 2017. From a long-term perspective, the amount that investors are short is at highlevels, though this is partially driven by higher equity prices

• Over the past year, Market Value Short levels had mostly remained level before retracting in Q4 2018





+1 (646) 491 2601

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Russell 1000 Volume of Shares Sold Short

Shares Sold Short (in millions) Russell 1000 Value

Ru

ssel

l 100

0 V

alue

Sha

re V

olum

e(in

millions)

Data Coverage: Monthly from Jan-2006 to Jan-2019Source: Valens Research Analysis

Investor Sentiment: Short Interest

• Total shares sold short in the Russell 1000 index had been rising steadily since 2011, with anaccelerated increase to peak levels from the middle of 2015 to 12.8 billion shares in early 2016. Thesewere at levels above any time including the 2008-2009 bear market period, a sign of substantialinvestor pessimism. However, the levels of shares sold short came significantly off of these highsthrough early 2017. Subsequently, shares short increased, and they rose back to peak levels in late2017, before again falling in early 2018 and remaining at lower levels





+1 (646) 491 2601

1000

1500

2000

2500

3000

3500

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

2012 2013 2014 2015 2016 2017 2018

VIX Futures (Net Position/Open Interest)

Net Position/Open Interest S&P 500 Data Coverage: Daily from Jun-2012 to Dec-2018Source: CFTC, Valens Research Analysis

Investor Sentiment: Net Positions Held

Optimism among investors has been declining in the past year. While the S&P 500 is reaching new highs,the reduced optimism evidenced by net long positions in VIX futures may imply expectations for themarket to remain range-bound without a catalyst for corporate earnings to improve. Interestingly, afternet long positions approached cycle highs in 2014-2015, they subsequently came back down to lowerlevels, implying investor concern about risk was declining. Recently, this trend has been very volatile,with a spike then decline in VIX futures open interest, related to the recent correction. That being said,the overall trend remains the same.

• During the two market corrections over the past year, net long positions held declined, signifying thatinvestors expect stock prices to increase, but there is less optimism compared to positions held in 2009.That being said, even as the market has continued to rally further in 2017, VIX positions flipped to NetShort levels, signifying that investors see lower volatility and equity upside going forward

• A net short position in VIX means that investors are heavily betting on higher stock prices while a netlong position points to expectations for increased volatility and lower stock prices. Net long positionsincreased during the second half of 2014 and shortly after the market traded in a range-bound market

• Interest in volatility trading grew after the financial crisis in 2008. This was when investors started toappreciate volatility’s negative correlation to both equity and commodity markets. The correlationbetween the VIX and the S&P 500 is about -0.8 which means that the VIX can sometimes diverge frommovements in the S&P 500





+1 (646) 491 2601

2100

2200

2300

2400

2500

2600

2700

2800

2900

20

25

30

35

40

45

50

55

S&P 500 Implied Correlation Index

KCJ Index S&P 500

Data Coverage: Daily from Nov-26-2018 to Feb-5-2019Source: CBOE, Capital IQ

S&P

50

0K

CJ

Ind

ex

Investor Sentiment: Implied Correlation

The KCJ (CBOE S&P 500 implied Correlation Index) creeped up in the month of December with signs ofthe index trending lower as the S&P 500 slowly returns to the 2800 level

• The KCJ Index is one of the CBOE’s Implied Correlation Indices and uses the Option Prices of the S&P andthe 50 largest companies in the S&P 500 Index with a Jan 2020 maturity

• When the implied Correlation Index declines, investor sentiments are positive and are perceived to bemore inclined to take on risky investments. Inversely, when the index rises, this would indicate negativesentiments surrounding the U.S. stock market, potentially driving a sell off

• The CBOE S&P 500 implied Correlation Index has recently been stagnating at around 45%-50% levelswith a slight downward trend, reflecting the gradual recovery of investors outlook





+1 (646) 491 2601

• It is notable that during the past several market corrections, insiders continued to boost buying. Thisdisplays management teams’ positive outlook, highlighting that while the stock market is underpressure, management teams do not appear concerned about their companies’ underlyingfundamentals

• In late March, July, October, and again at the end of the year in December, insider buying picked up andtrended above the longer-term average levels for most of the month. Insiders, who tend to be valuebuyers, took advantage of the weakness to buy, showing their confidence in the fundamentals of theirbusinesses

• Recent data show insider buy/sell ratio trending down towards the longer-term average levels after adramatic rise in December, as the NASDAQ rises since the last week of December

Management Sentiment: Insider Activity

Source: secform4

1,800

2,000

2,200

2,400

2,600

2,800

3,000

Feb-17 May-17 Aug-17 Nov-17 Feb-18 May-18 Aug-18 Nov-18 Feb-19

S&P 500

Data Coverage: Monthly from Feb-2017 to Feb-2019Source: Capital IQ





+1 (646) 491 2601

0

500

1,000

1,500

2,000

2,500

3,000

3,500

0

50,000

100,000

150,000

200,000

250,000

S&P

500 Price

Shar

e R

ep

urc

has

e (U

S$m

n)

Share Repurchases S&P 500

0

20

40

60

80

100

120

140

160

180

200

• There are 83 companies in the S&P 500 with share buyback amounts in Q3 2018 larger than the netincome they generated in the same period, down from the 120 companies in the previous quarter

Management Sentiment: Buyback Activity

Source: Capital IQ, Valens Research Analysis Data Coverage: Quarterly from Q1 2005 to Q3 2018

Source: Capital IQ, Valens Research Analysis Data Coverage: Quarterly from Q1 2005 to Q3 2018

Companies that Spent More on Buybacks than Net Income Generated

Share Buyback Activities in the S&P 500

• Companies in the S&P 500 spent $118.0bn on share repurchases during Q2 2018, which represented a27.0% increase year-over-year and a quarter-on-quarter decrease of 6.3%. 2018 quarterly buybacklevels are above where levels have averaged the last three years, likely because of a surge in cash flowfrom the recent tax reform





+1 (646) 491 2601

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

Buyback Spending Net Income Buyback as a Portion of Net Income

Data Coverage: Yearly from 2005 to 2018ESource: Capital IQ, Valens Research Analysis

Company buybacks generally indicate that management teams think that their shares are undervalued.However, companies that continue to boost buybacks in an environment of low earnings growth thatcould also indicate that those companies are running out of investment opportunities.

• Buyback spending makes up 50.9% of net income generated in 2017. Buyback spending in 2016 madeup 58.0% of net income generated, far from levels seen in 2008 when buybacks made up 97.1% of netincome

• While share repurchases in 2015 reached record levels, the rate of share buybacks declined in 2016 andcontinued to decline in 2017. In 2017, the rate of share buybacks has fallen to 50% of net income butrecovered in 2018

• The substantial decline in share buybacks as a portion of net income, when not driven by a decline inearnings also, is a sign that management teams are choosing to use their earnings in other ways, inparticular around investing in growth

Management Sentiment: Buyback Activity

Buyback Spending as a Portion of Net Income





+1 (646) 491 2601

0

5

10

15

20

25

30

Jun

-10

Sep

-10

Dec

-10

Mar

-11

Jun

-11

Sep

-11

Dec

-11

Mar

-12

Jun

-12

Sep

-12

Dec

-12

Mar

-13

Jun

-13

Sep

-13

Dec

-13

Mar

-14

Jun

-14

Sep

-14

Dec

-14

Mar

-15

Jun

-15

Sep

-15

Dec

-15

Mar

-16

Jun

-16

Sep

-16

Dec

-16

Mar

-17

Jun

-17

Sep

-17

Dec

-17

Mar

-18

Jun

-18

Sep

-18

Dec

-18


HQ Q HC EXC

Data Coverage: Monthly from Jun-2010 to Jan-201919,000+ total earnings calls from U.S. Corporates, sampled from all sectorsSource: Valens Research Analysis

5

10

15

20

25

30

35

Jun

-10

Au

g-1

0O

ct-1

0D

ec-1

0Fe

b-1

1A

pr-

11

Jun

-11

Au

g-1

1O

ct-1

1D

ec-1

1Fe

b-1

2A

pr-

12

Jun

-12

Au

g-1

2O

ct-1

2D

ec-1

2Fe

b-1

3A

pr-

13

Jun

-13

Au

g-1

3O

ct-1

3D

ec-1

3Fe

b-1

4A

pr-

14

Jun

-14

Au

g-1

4O

ct-1

4D

ec-1

4Fe

b-1

5A

pr-

15

Jun

-15

Au

g-1

5O

ct-1

5D

ec-1

5Fe

b-1

6A

pr-

16

Jun

-16

Au

g-1

6O

ct-1

6D

ec-1

6Fe

b-1

7A

pr-

17

Jun

-17

Au

g-1

7O

ct-1

7D

ec-1

7Fe

b-1

8A

pr-

18

Jun

-18

Au

g-1

8O

ct-1

8D

ec-1

8

Management Growth Confidence Index

(HC+EXC)/HQ

3-Month Wtd Moving Average

Data Coverage: Monthly from Jun-2010 to Jan-2019Source: Valens Research Analysis

Management Sentiment: Aggregate ECF™

The trend over the last several quarters show management confidence has been increasing, a sign thatcompanies are seeing better profitable opportunities• Management confidence levels appear to be gaining positive momentum, particularly in the last year.

While the ratio dipped in August/September 2018 and again in January 2019, the ratio has not fallenback to 2016-2017 levels, pointing to management teams confidence in their operations that willinduce further capex spending and fuel growth

• The largest positive inflections currently driving this improvement appear to be from the Healthcare,Energy, Materials, and Information Technology sectors in particular






+1 (646) 491 2601

30405060708090100110120130

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan-

15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan-

17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan-

19

Cons. Discretionary Management Growth Confidence

Consumer Discretionary Consumer Discretionary Select Sector SPDR Fund

20

25

30

35

40

45

50

55

60

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan

-19

Cons. Staples Management Growth Confidence

Consumer Staples Consumer Staples Select Sector SPDR Fund

20

30

40

50

60

70

80

90

100

110

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Oct

-11

Mar

-12

Au

g-1

2

Jan-

13

Jun

-13

Nov

-13

Ap

r-1

4

Sep

-14

Feb

-15

Jul-

15

Dec

-15

May

-16

Oct

-16

Mar

-17

Au

g-1

7

Jan-

18

Jun

-18

Nov

-18

Energy Management Growth Confidence

Energy Energy Select Sector SPDR Fund

1012141618202224262830

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan-

12

May

-12

Sep

-12

Jan-

13

May

-13

Sep

-13

Jan-

14

May

-14

Sep

-14

Jan-

15

May

-15

Sep

-15

Jan-

16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan

-19

Financials Management Growth Confidence

Financials Financial Select Sector SPDR Fund

25

35

45

55

65

75

85

95

0.000.100.200.300.400.500.600.700.800.901.00

Ma

y-1

1

Oct

-11

Mar

-12

Au

g-1

2

Jan

-13

Jun

-13

No

v-1

3

Ap

r-1

4

Sep

-14

Feb

-15

Jul-

15

Dec

-15

Ma

y-1

6

Oct

-16

Mar

-17

Au

g-1

7

Jan

-18

Jun

-18

No

v-1

8

Healthcare Management Growth Confidence

Health Care Health Care Select Sector SPDR Fund

25

35

45

55

65

75

85

0.000.100.200.300.400.500.600.700.800.901.00

Ma

y-1

1

Sep

-11

Jan

-12

Ma

y-1

2

Sep

-12

Jan

-13

Ma

y-1

3

Sep

-13

Jan

-14

Ma

y-1

4

Sep

-14

Jan

-15

Ma

y-1

5

Sep

-15

Jan

-16

Ma

y-1

6

Sep

-16

Jan

-17

Ma

y-1

7

Sep

-17

Jan

-18

Ma

y-1

8

Sep

-18

Jan

-19

Industrials Management Growth Confidence

Industrials Industrial Select Sector SPDR Fund

20

30

40

50

60

70

80

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan-

16

May

-16

Sep

-16

Jan-

17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan

-19

Info. Technology Management Growth Confidence

Information Technology Technology Select Sector SPDR Fund

2025303540455055606570

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan-

12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan-

18

May

-18

Sep

-18

Jan-

19

Materials Management Growth Confidence

Materials Materials Select Sector SPDR Fund

15

20

25

30

35

40

0.00

0.20

0.40

0.60

0.80

1.00

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan

-19

Communication Services Management Growth Confidence

Communication Services iShares U.S. Telecommunications ETF

25

30

35

40

45

50

55

60

0.000.100.200.300.400.500.600.700.800.901.00

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18

Jan

-19

Utilities Management Growth Confidence

Utilities Utilities Select Sector SPDR Fund

Source: Valens Research Analysis

Management Sentiment: Sector ECF™

Data Frequency: Monthly - as of November 2018





+1 (646) 491 2601

Institution Sentiment: Macro ECF™

ECB President Draghi at the September 2018 ECB Press Conference• Earnings Call Forensics™ of the September Press Conference highlighted concerns about changes in the

global environment, structural reforms, and shadow banking• He was confident about the need in building up the fiscal buffers, and the resilience of the economy to

withstand and reduce downside risks• However, the highly questionable markers imply that he may be concerned about the sufficiency of the

current structural reforms that the Euro area countries have in place• Additionally, he also appears to be concerned about their ability to strengthen regulation outside of

banks, particularly on shadow banking• Moreover, he may be concerned about the external environment given the increasing protectionism,

vulnerabilities of emerging markets, and risks from monetary policy changes of countries

ECB President Draghi at the October 2018 ECB Press Conference• Earnings Call Forensics™ of the October Press Conference highlighted concerns about growth

momentum, interest rates, and the effectiveness of their policies• President Draghi generated an excitement marker when saying that QE is a monetary policy measure

and was confident in their expectation for underlying inflation to pick up towards the end of FY 2018.• However, he may be concerned about the weaker growth momentum in most Eurozone countries, and

the impact of higher interest rates to the Italian economy. In addition, he may lack confidence in thesustainability of their extraordinary export performance in FY 2017, and may be exaggerating thecapability of the economy to absorb financial shocks

• He may also lack confidence in their ability to reap the full benefits from their monetary policymeasures, and in the ability of the OMT undertaking to not prejudge the monetary policy for the wholeEuro area. Moreover, he may be concerned in their ability to choose the appropriate instruments todeliver their price stability mandate, and the concerns on the use of capital key methodology todetermine the purchasing size per EU country member

ECB President Draghi at the December 2018 ECB Press Conference• Earnings Call Forensics™ of the December Press Conference highlighted concerns on inflation, monetary

policy tools, wages, emerging market conditions, and bank profitability• President Draghi was highly confident when saying that broad money (M3) growth grew by 3.9% in

October from 3.6% in September• However, he may lack confidence in their ability to stabilize inflation levels near 2%, and may be

concerned about wages increasing prices. Additionally, he may have concerns about the ability tosustain wage increases, and may be exaggerating how widespread it has been across the EU

• Also, he may have concerns about the ability of existing measures to sustain credit access, and may beoverstating the legal legitimacy of Quantitative Easing

• Moreover, he may be have concerns about downside risks stemming from uncertainties in geopolitics,trade, emerging markets, and financial markets





+1 (646) 491 2601


ECB President Draghi at the April 2018 ECB Press Conference• Earnings Call Forensics™ of the March Press Conference highlighted concerns about monetary policy

tools, financial stability, and economic condition• President Draghi was confident about their continued dedication to the €30bn net asset purchases.

However, he appears to be concerned about the economy’s capacity to face less accommodativeenvironment in the near-term

• He may be exaggerating the progress they have achieved in inducing borrowing and spending and maybe downplaying concerns on the sudden drop in momentum of growth from broad-based indicators. Hemay also be downplaying concerns about the potential direct effect of the trade war from the U.S. andappears to be concerned about this external interference to its current policy implementation

• Vice-President Constâncio was confident about the evolution of monetary policy over time given theshift in overall capital structure towards equity financing and may lack confidence about theadaptability of their monetary policy toolkit

ECB President Draghi at the June 2018 ECB Press Conference• Earnings Call Forensics™ of the June Press Conference highlighted concerns on geopolitical and trade

uncertainties, principal reinvestment plan, and their inflation targeting progress• President Draghi generated excitement markers when talking about the important implications the

decision they will be making on the principal reinvestments plan, and when assuring their plans of nofurther rate hike at least through the summer of 2019, given no changes to inflation trajectory

• Also, he may be concerned about rising domestic uncertainties given the higher geopoliticaluncertainties and trade tensions, and may be exaggerating the upside from the higher uncertainty level

• Moreover, he may be downplaying concerns about the decision-making process with respect topossible extension of the principal reinvestment policy, and also on the potential abrupt halt of principalreinvestments

ECB President Draghi at the July 2018 ECB Press Conference• Earnings Call Forensics™ of the July Press Conference highlighted concerns on inflation weakness, trade

uncertainties, and TARGET2 movement• President Draghi may be downplaying concerns about the growth moderation in Q1 2018, and may be

concerned about continued declines in inflation ex oil and food• Moreover, he may be concerned about the sustainability of wage growth improvement, and about

increases in the uncertainty component of the term structure related to trade concerns• Furthermore, he may lack confidence in the ECB’s ability to produce decisive policies to raise long term

growth, and may be exaggerating the effectiveness of enhanced forward guidance• Finally, he appears to have concerns about movements in TARGET2 liabilities, and may be concerned

about the impact of political uncertainty being reflected by these liabilities





+1 (646) 491 2601


Fed Chair Jerome Powell at the September 2018 FOMC Press Conference• Earnings Call Forensics™ of the September Press Conference highlighted concerns about prices, federal

funds rate, and employment• Chair Powell is confident that emerging markets are vulnerable to risks such as high inflation, budget

deficits, and significant external borrowings• However, they may have concerns about the significance of oil price movement to their inflation

targeting progress, and may lack confidence in sustaining inflation at a rate close to 2%• Furthermore, they may have been overstating that a single rate hike would not have a big effect on the

economy• Additionally, they may lack confidence in sustaining the long-run flattish trend of the labor force

participation rate, and in sustaining a wage growth greater than 3%

Fed Chair Jerome Powell at the December 2018 FOMC Press Conference• Earnings Call Forensics™ of the December Press Conference highlighted concerns about the labor

market, interest rates and inflation, bank regulations, and the economic outlook• Chairman Powell is confident in effectively having the balance sheet runoff on automatic pilot and use

monetary and rate policy to adjust to incoming data and normalize policy• However, they may be concerned about the sustainability of a tight labor market and increases in

wages and compensation• Furthermore, they may be overstating the ability of their monetary policy tools in times of financial

instability, and may be downplaying concerns about the risks of above-neutral interest rates• Finally, he may be concerned about achieving continued positive economic performance next year, and

may be downplaying concerns about the potential impact of tariffs





+1 (646) 491 2601


Fed Chair Jerome Powell at the March 2018 FOMC Press Conference• Earnings Call Forensics™ of the March Press Conference highlighted concerns about persistent low

wage increase, unemployment rate, monetary policy, and their balance sheet normalization programflexibility

• Chair Powell appears concerned about the trade-off between the increasingly hawkish monetary policyand the wage increases. He may also be concerned about wages not growing at a faster pace to offsetthe effects of higher inflationary environment

• Moreover, he may also be concerned about the aging population of the economy and its potentialeffect on the participation rate in the long-term. Additionally, he lacks confidence in theirunemployment rate projections and may be concerned about finding the right balance between wageinflation and unemployment rate

• He may also lack confidence about their decision to increase rates further and may be downplayingtheir ability to switch back to an accommodative policy when necessary

Fed Chair Jerome Powell at the June 2018 FOMC Press Conference• Earnings Call Forensics™ of the June Press Conference highlighted concerns about the positive health of

the economy, upward changes in projections, and their policy actions progress• Chair Powell is confident that there is no significant credit issues in the economy, particularly in

households which was a major player in the 2008 Financial Crisis• Also, he may be concerned about the sustainability of inflation, and may also be downplaying concerns

on overshooting the inflation target of 2.0%• Moreover, he may lack confidence about predicting the longer-run GDP growth rates trajectory and

wage behavior given the improving labor market• Furthermore, he may be concerned about possible interference in their policy progress to move the

economy to a more self-sustaining condition, and may be downplaying concerns on the impact of tradepolicy to the economy’s recovery





+1 (646) 491 2601

Government Policy and Intervention





+1 (646) 491 2601

0%

2%

4%

6%

8%

10%

12%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Unemployment Rate Since the End of Last Recession

Source: The Federal Reserve System

The Unemployment Rate

Unemployment rate and labor force participation signals an improving, healthy labor market.

• Declining unemployment rates may be an indicator of an improving economy. However, lowunemployment rates could also be a cautionary signal to the market as recessions typically occur shortlyafter the unemployment rate stabilizes at a low

• The unemployment rate started the year 2019 with 4.0% in January, from a 2018 year-end of 3.9%.Relative to historical rates, unemployment rate is low and stable, signifying potential wage inflation andpushing current aggregate price levels higher

• Recent data also reveal that the January participation rate was flattish at a 63.2%, a 10 bps increasefrom 63.1% of the previous month. The indicator has shown stable improvement in the previousmonths that could break off the declining labor participation trend since before the Great Recession. Animproving labor participation rate can mean higher potential output or higher GDP growth rate

50%

52%

54%

56%

58%

60%

62%

64%

66%

68%

70%

0%

2%

4%

6%

8%

10%

12%

1948 1955 1962 1969 1976 1983 1990 1997 2004 2011 2018

Labo

r Force

Particip

ation

Rate

Un

em

plo

yme

nt

Rat

e

Civilian Unemployment Rate and Participation

Recession Indicator

Unemployment Rate

Labor Force Participation

Data Coverage: Monthly from Jan-1948 to Jan-2019Source: The Federal Reserve System





+1 (646) 491 2601

0

1

2

3

4

5

6

7

8

9

10

$1

$10

$100

$1,000

$10,000

$100,000

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

U.S. Housing vs. Stock Market Nominal Appreciation

Relative Out/Underperformance Stock Market Housing

Housing Prices vs. the Dow Jones Industrial Average

• In real terms, $100 invested in the U.S. housing market in 1900 would only have been worth $172 in1900 dollars in 2018. Investing the same amount similarly in the stock market would have yielded a realreturn of $1,491 in 2018

0

1

2

3

4

5

6

7

8

9

10

$1

$10

$100

$1,000

$10,000

1900 1905 1910 1915 1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

U.S. Housing vs. Stock Market Real Appreciation

Relative Out/Underperformance Stock Market Housing

Data Coverage: Monthly from Jan-1900 to Sep-2018Source: Federal Reserve System, Valens Research Analysis





+1 (646) 491 2601

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Long-Term Expected Inflation Rates (%)

10-Year Break-Even

5-Year/5-Year Forward Inflation Expectation

Cleveland Fed Estimate of Inflation Expectations (10-year)

1.87%

2.04%

2.09%

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

Intermediate-Term Expected Inflation Rates (%)

5-Year Break-Even


2.02%

1.72%

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

1-Yr Inflation Rate Expectations (%)

University of Michigan Consumer Inflation Expectations©

Atlanta Fed Business Inflation Expectations



2.70%

2.35%

1.98%

Data Coverage: Monthly from Jan-2009 to Jan-2019

Inflation Sentiment: 10-Year, 5-Year, and 1-Year Inflation





+1 (646) 491 2601

0.0

1.0

2.0

3.0

Jan

-13

Mar

-13

May

-13

Jul-

13

Sep

-13

No

v-1

3

Jan

-14

Mar

-14

May

-14

Jul-

14

Sep

-14

No

v-1

4

Jan

-15

Mar

-15

May

-15

Jul-

15

Sep

-15

No

v-1

5

Jan

-16

Mar

-16

May

-16

Jul-

16

Sep

-16

No

v-1

6

Jan

-17

Mar

-17

May

-17

Jul-

17

Sep

-17

No

v-1

7

Jan

-18

Mar

-18

May

-18

Jul-

18

Sep

-18

No

v-1

8

Jan

-19

10-Year Inflation Expectations from 10 Years Past vs. Actual Inflation

10-Year Breakeven

5-Year/5-Year Forward Inflation Expectation

Cleveland Fed Estimate (10-year)

Actual Inflation (PCE)

Data Coverage: Monthly from Jan-2013 to Feb-2019Source: University of Michigan, FRED, Capital IQ, Valens Research Analysis

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18


5-Year Breakeven

Cleveland Fed Estimate (5-Year)


Source: University of Michigan, FRED, Capital IQ, Valens Research Analysis Data Coverage: Monthly from Jan-2009 to Dec-2018

Inflation Tracker Precision

• The expected breakeven inflation rate from 10 years ago and the 5yr/5yr inflation forward inflationexpectations have deviated significantly to other inflation forecasts since the month of September

• Inflation expectations from the breakeven, FED-estimates, and 5yr/5yr inflation swaps can be tested forprecision by taking the expectations from 10 years ago and comparing them to actual inflation today. Inpractice, the data shows that 10-year expectations yield imprecise estimates, with expectations from 2004missing by almost a full percentage point

• The 10-year breakeven inflation rate represents the rate that would make the 10-year TIPS as attractive as(break even with) a nominal fixed-rate 10-year treasury, while the 5yr/5yr inflation swap represents aswap that would begin in five years and mature rate is the five years after, where fixed payments on anominal amount are made by one party in exchange for an inflation-indexed rate on a nominal amount

• The Cleveland Fed Estimate uses a model that combines information from several sources: Blue Chipeconomic forecasts, the forecasts of the Survey of Professional Forecasters (SPF), and inflation swaps

• Inflation expectations from five years past seem more accurate than their 10-year counterparts. Barringthe realization of tail risks, the Cleveland Fed Estimate seems to be accurate. Moreover, the 5-yearbreakeven (the Euro version being the ECB’s preferred market-driven measure of medium-term inflationexpectations) seems to be susceptible to market-induced volatility. The sharp breakdown in inflation forDecember 2012 as expected from December 2007 failed to materialize

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18

Jan

-19


5-Year Breakeven

Cleveland Fed Estimate (5-Year)


Source: University of Michigan, FRED, Capital IQ, Valens Research Analysis Data Coverage: Monthly from Jan-2009 to Jan-2019





+1 (646) 491 2601

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

201

9

1-Year Inflation Expectations Last Year vs. Actual Inflation

University of Michigan Inflation Expectations©

Cleveland Fed Estimate (1-year)


Source: University of Michigan, FRED, Capital IQ, Valens Research Analysis Data Coverage: Monthly from Jan-1984 to Jan-2019

Tracking the Inflation Trackers

• The 1-year Inflation Expectation data goes back to 1984 and shows several recessionary periods. TheUniversity of Michigan Consumer Inflation Expectations measure comes from their Surveys ofConsumers. None of the disinflationary pressures induced in recessions were expected by surveyparticipants, as evidenced by the stable or even rising survey measures one year prior to eachrecession, though the measures reacted sharply in periods such as the start of the 2008 financial crisis.Moreover, Consumer Inflation Expectations seem to overestimate inflation in most periods





+1 (646) 491 2601

Corporate Credit Availability





+1 (646) 491 2601

0.0%

50.0%

100.0%

150.0%

200.0%

250.0%

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

Jan

-09

Ap

r-0

9

Jul-

09

Oct

-09

Jan

-10

Ap

r-1

0

Jul-

10

Oct

-10

Jan

-11

Ap

r-1

1

Jul-

11

Oct

-11

Jan

-12

Ap

r-1

2

Jul-

12

Oct

-12

Jan

-13

Ap

r-1

3

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4

Jul-

14

Oct

-14

Jan

-15

Ap

r-1

5

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6

Jul-

16

Oct

-16

Jan

-17

Ap

r-1

7

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8

Jul-

18

Oct

-18

Jan

-19

Loa

ns-to

-Reserves R

atio

Agg

rega

te D

epo

sito

ry R

eser

ves

(US$

Mil

lio

ns)

Aggregate Depository Institution Reserves

Reserves Commercial & Industrial Loans Loans-to-Reserves

Source: The Federal Reserve System Data Coverage: Semi-monthly from Jan-2009 to Jan-2019

Risk-aversion hampered lending beginning in October 2008, as banks built up reserves in response to therecession. It was only in late February 2011 that lending reached an inflection and started increasing. Theequity market turned bullish six months later.

• In October 2008, commercial banks cut down on their lending while the Fed started driving sizablereserves into bank assets in response to the recession. The decline in total loans continued until itreached its lowest point in September 2010. There was little loan growth and reserve growth in 2011

• It was only in late February 2011 that commercial banks slowly began lending once more, signalling thestart of a potential equity bull market. Loan growth has picked up since then, climbing to as fast as 1.4%WoW in February 2012

• Loans-to-reserves ratio averaged 87% in 2016 compared to 71% in 2015. The rise of the ratio is a resultof the continued momentum on lending, which averaged $2.06 trillion in 2016 compared to $1.89trillion in 2015. Meanwhile, bank reserves demonstrated a minimal decrease, which averaged $2.37trillion in 2016 compared to $2.67 trillion in 2015

• As of January 23, 2019, loans-to-reserve ratio stands at 139.0% YTD

Reserves vs. Loans





+1 (646) 491 2601

0

20

40

60

80

100

120

140

160

-80,000

-60,000

-40,000

-20,000

0

20,000

40,000

60,000

Jan

-20

11

Ap

r-2

01

1

Jul-

201

1

Oct

-20

11

Jan

-20

12

Ap

r-2

01

2

Jul-

201

2

Oct

-20

12

Jan

-20

13

Ap

r-2

01

3

Jul-

201

3

Oct

-20

13

Jan

-20

14

Ap

r-2

01

4

Jul-

201

4

Oct

-20

14

Jan

-20

15

Ap

r-2

01

5

Jul-

201

5

Oct

-20

15

Jan

-20

16

Ap

r-2

01

6

Jul-

201

6

Oct

-20

16

Jan

-20

17

Ap

r-2

01

7

Jul-

201

7

Oct

-20

17

Jan

-20

18

Ap

r-2

01

8

Jul-

201

8

Oct

-20

18

Jan

-20

19

20

-Year Trea

sury B

on

d Fu

nd

Tota

l Ta

xab

le a

nd

Mu

nic

ipal

Bu

nd

Flo

ws

U.S. Total Taxable and Municipal Bond Flows

Total Bond Flows in US$mn 20-Year Treasury Bond Fund

Source: Investment Company Institute, Valens Research Analysis Data Coverage: Monthly from Jan-2011 to Jan-2019

Investor Sentiment: Total Bond Flows

• Data from the Investment Company Institute shows that historically, investors typically redeem theirbond holdings from mutual funds at times when the expected interest rate environment is unfavorable

• While there were massive withdrawals in September and December of 2014, net bond fund inflowsremained positive at $35bn for the year, compared to an average $188bn of inflows for the five yearsprior

• Fund flows were robust in the first half of 2015, with $53.9bn of inflows. The third quarter, however,showed a series of outflows totaling $51.7bn, almost wiping out the inflows registered during the firsthalf of 2015. The first month of the fourth quarter displayed signs of recovery from the recent massiveoutflows. However, while the Fed finally began the “normalization” of interest rates in December, netselling of U.S. bond funds for this period totaled $27.2bn, the largest monthly outflow for the year 2015

• Inflows since 2016 wiped out the prior outflows as investors flocked to safe havens, a potential sign thatinvestors were not expecting interest rates to rise as fast as previously believed. Likewise, it may alsoreflect low sovereign yields in other parts of the globe





+1 (646) 491 2601

0

2

4

6

8

10

12

14

16

18

20

2

3

4

5

6

7

8

9

1955

1956

1958

1960

1962

1964

1966

1967

1969

1971

1973

1975

1977

1978

1980

1982

1984

1986

1988

1989

1991

1993

1995

1997

1999

2000

2002

2004

2006

2008

2010

2011

2013

2015

2017

Fed P

olicy R

ateLN(S

&P

50

0)

The Federal Policy Rate

S&P 500 Fed Policy Rate

Source: Capital IQ, The Federal Reserve System

S&P 500 and the Federal Policy Rate

• Both short-term Fed policy and long-term interest rates may support capital expansion as their lowlevels incentivize corporations to borrow at low market rates. Additionally, a low inflation environmentand stable capital gains tax rate are accommodative of a multiple expansion going forward. With thefederal funds rate hike being a key focus for the markets, the Fed emphasized that they will remainaccommodative for quite some time after the initial increase

Data Coverage: Monthly from Jul-1954 to Dec-2018





+1 (646) 491 2601

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

9%

10%

11%

12%

13%

14%

198

2

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

5

201

6

201

7

Household Debt Service Payments as a Percent of Disposable Personal Income

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5

-2%

0%

2%

4%

6%

198

2

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

5

201

6

201

7

201

8

10-Year Treasury Yield Less 3-Month Treasury Yield

Source: The Federal Reserve System Data Coverage: Daily from Jan-1982 to Jan-2019

Household Debt Service Payments and Yield Curves

• The Household Debt Service Payments measure is one of two parts of the household Debt Service Ratio(DSR), a ratio of total required household debt payments to disposable income. The household debtservice payments measure consists of payments from revolving debt and types of closed-end debt. Thisis a useful yardstick of the household debt service burden, where lower burdens mean potentiallyhigher levels of consumption from households who do not have to service their credit

• Household Debt Service Payments jumped recently but remain near their lowest levels in 32 years. Thisis a positive both in terms of freed-up discretionary spending and the additional flexibility of those whohold those loans in their balance sheets





+1 (646) 491 2601

The difference between long-term and short-term interest rates shows a negative relationship with realeconomic activity in ensuing periods.

• A yield curve inversion has preceded every recession on record. An interesting point to note – theapparent “false positive” generated in 1967 was a period when the U.S. economy experienced a creditcrunch and a marked decline in industrial production, but was not classified by the NBER as a recession

• Currently the signal remains well below probability levels that have historically pointed to a recessionbeing imminent

Inverted Yield Curves and Recessions

Treasury Spread: 10-Year Bond Rate minus 3-Month Bill Rate

Probability of U.S. Recession Predicted by Treasury Spread

Data Coverage: Yearly from 1959 to 2018Source: Federal Reserve Bank of New York

Data Coverage: Yearly from 1959 to 2018Source: Federal Reserve Bank of New York





+1 (646) 491 2601

Corporate Credit Willingness





+1 (646) 491 2601

-40

-20

0

20

40

60

80

100

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,0001

990

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

Ne

t pe

rcen

tage o

f ban

ks tighte

nin

g stand

ards fo

r C&

I lo

ans to

large an

d m

idd

le-m

arket firm

sS&

P 5

00

Credit Standards and the S&P 500

Recession S&P 500 Credit Standards

Source: Senior Loan Officer Opinion Survey, U.S. Federal Reserve Board Data Coverage: Quarterly from Q1 1990 to Q4 2018

Overall credit standards for commercial and industrial (C&I) loans tightened to a net percentage of 2.8 inQ4 2018. While most firms had not changed their lending standards over the past quarter, there was anincrease in banks that have increased premiums charged on riskier loans.

• The respondents that tightened their lending standard have provided diverse reasons for increasingpremiums charged such as less favorable or more uncertain economic outlook, reduced tolerance forrisk and increased concerns about the effects of legislative changes, supervisory actions, and changes inaccounting standards. Whereas bank respondents that have eased standards continue to cite increasedcompetition from other banks or nonbank lenders as their significant motive to lax lending

• For the months of October to December 2018, the Federal Reserve Board surveyed 73 domestic banksand 22 U.S. branches and agencies of foreign banks. The Senior Loan Officer Opinion Survey on BankLending Practices covered changes in the standards and terms of the banks’ lending and the changes inthe supply of and demand for bank loans to companies and households. The survey also containedspecial questions that asked respondents to describe the current level of lending standards at theirbank, rather than changes in standards over the survey period

• A positive percentage in credit standards means that more banks have tightened their credit standardsfor approving applications for C&I loans or credit lines. Tightening occurs when there is increasedeconomic uncertainty, and banks decide to limit the financing available to borrowers. The previousthree recessions since 1990 have been accompanied by a tightening in credit standards

• A negative percentage in credit standards means that more banks have eased their credit standards forapproving applications, mostly for C&I loans. This relaxing appears to be a signal for a growing economyand a bullish equity market where abundant financing is available

Credit Standards vs. S&P 500





+1 (646) 491 2601

Quarterly Survey Results

Banks Percent Banks Percent Banks Percent Banks Percent

Tightened considerably 0 0.0 0 0.0 0 0.0 1 1.4

Tightened somewhat 0 0.0 0 0.0 0 0.0 3 4.3

Remained basically unchanged 69 97.2 73 96.1 65 91.5 55 78.6

Eased somewhat 2 2.8 3 3.9 6 8.5 11 15.7

Eased considerably 0 0.0 0 0.0 0 0.0 0 0.0

Total 71 100 76 100 71 100 70 100

Credit standards -2.8 -3.9 -8.5 -10.0

Quarterly Survey Results

Banks Percent Banks Percent Banks Percent Banks Percent

Tightened considerably 0 0.0 0 0.0 0 0.0 0 0.0

Tightened somewhat 1 1.4 1 1.4 3 4.3 5 6.9

Remained basically unchanged 61 85.9 56 81.2 52 75.4 64 88.9

Eased somewhat 9 12.7 12 17.4 14 20.3 3 4.2

Eased considerably 0 0.0 0 0.0 0 0.0 0 0.0

Total 71 100 69 100 69 100 72 100

Credit standards -11.3 -15.9 -15.9 2.8

Q3 2017 Q4 2017

Q3 2018 Q4 2018

Q1 2017 Q2 2017

Q1 2018 Q2 2018

• The Senior Loan Officer Opinion Survey is conducted such that the results will be available in time for thequarterly Federal Open Market Committee meetings. As of January 2019, there was an increase in bankrespondents that reported generally no change to their credit standards, while banks that reported aneasing of standards dropped to 4.2% overall from 20.3% in the previous survey period and 6.9% of theparticipants have tightened their standards

• Demand for loans: C&I and CRE loans demand continues to show weakness in the quarter. Reasons forweaker C&I loan demand were that the decreases in customers’ needs to finance mergers and acquisitionsas well as investment in plants and equipment contributed to weaker demand, as did a shift in customers’borrowing toward other bank or nonbank sources.

• Levels of Lending Standards: Standards on C&I loan to large and middle-market firms tightenedparticularly by foreign banks and on riskier loans. Signs of easing still exist in the quarter as moderate netshares of the largest banks cited to have increased in maximum credit lines, laxed loan covenants, andoffered narrower loan rate spreads over costs of funds. For CRE loans, standards on construction and landdevelopment loans continue to tighten, and also for nonfarm nonresidential properties loans

Data Coverage: Q4 2016 to Q4 2018

Credit Standards

Source: Senior Loan Officer Opinion Survey, U.S. Federal Reserve Board

Credit Standards





+1 (646) 491 2601

T - (Y-1) T - (Q-1) T - (M-1)T - (W -1) Total

<100 BPS

+

100 - 300 BPS

300 - 600 BPS

600 - 1000 BPS

1000+ BPS

413-10 153-50

66

12

2

6

-9 -3

0 0 1

2 0-2

-1 -3 -2

30

5

-4

1

4

0

50

100

150

200

250

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

0

50

100

150

200

250

0

50

100

150

200

250

0

50

100

150

200

250

0

50

100

150

200

250

The cost of insuring against credit risk has been rising over the past quarter and year, as the number ofcompanies with access to sub 100bps CDS is falling.

• CDS bucket counts detail the historical distribution of corporate debt based on their perceived creditrisk

• In 2008, the number of IG-rated companies significantly declined, recording a decade-low number ofonly 20 companies in that bucket in December 2008. Within six months, however, the number returnedto its pre-recessionary level of around 100+ companies in the IG bucket

• 50 companies were removed from the basket of IG-rated companies over the last year while 10companies were removed over the last quarter. The lowest total number of companies in this bucketwas 140 in 2018

• While the movement between CDS buckets was volatile over the past months and quarters, thenumber of IG-rated companies is still high and is at near pre-recession levels, representing a low-credit-risk environment

CDS: Movements in Credit Risk

Source: Capital IQ, Valens Research Analysis Data Coverage: Weekly from Jan-2005 to Jan-2019





+1 (646) 491 2601

0%

50%

100%

150%

200%

250%

300%

350%

0

50

100

150

200

250

300

Jan

-04

Ap

r-0

4Ju

l-0

4O

ct-0

4Ja

n-0

5A

pr-

05

Jul-

05

Oct

-05

Jan

-06

Ap

r-0

6Ju

l-0

6O

ct-0

6Ja

n-0

7A

pr-

07

Jul-

07

Oct

-07

Jan

-08

Ap

r-0

8Ju

l-0

8O

ct-0

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n-0

9A

pr-

09

Jul-

09

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-09

Jan

-10

Ap

r-1

0Ju

l-1

0O

ct-1

0Ja

n-1

1A

pr-

11

Jul-

11

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-11

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-12

Ap

r-1

2Ju

l-1

2O

ct-1

2Ja

n-1

3A

pr-

13

Jul-

13

Oct

-13

Jan

-14

Ap

r-1

4Ju

l-1

4O

ct-1

4Ja

n-1

5A

pr-

15

Jul-

15

Oct

-15

Jan

-16

Ap

r-1

6Ju

l-1

6O

ct-1

6Ja

n-1

7A

pr-

17

Jul-

17

Oct

-17

Jan

-18

Ap

r-1

8Ju

l-1

8O

ct-1

8Ja

n-1

9

Equ

ity Re

turn

s (Ind

exe

d)

# o

f Fi

rms

wit

h C

DS

<=1

00

bp

s

# Firms with CDS <= 100bpsIG Indexed ReturnsS&P500 Indexed ReturnsHY Indexed Returns

Source: Valens Research Analysis Data Coverage: Weekly from Jan-2014 to Feb-2019

Specifically monitoring investment grade firms, the lion’s share of the S&P 500, the credit marketprovides an early but short-term signal at the top of the equity market, before heading into a bear.However, going into a bull market, it is a lagging indicator.

• The chart above is a long-term indicator of the relationship between the number of firms with CDS lessthan or equal to 100bps and the returns for selected indices. The middle (black) line is the S&P 500.Over the past several years, there has been a strong relationship between movements in the S&P 500and changes in the number of companies with high quality credit

• In late 2011, the number of companies with the highest quality (<=100bps) credit dramatically fell. TheS&P 500 also corrected, though not as steeply, implying that the equity markets believed this was anoverreaction. As the number of companies has again started to recover, equity markets have alsorecovered faster

• The number of companies with the highest quality (<=100bps) credit had fallen in 2015. Meanwhile,the number recovered to more normal levels in 2016. Yields moved in the same directiondemonstrating their strong relationship

Corporate & Consumer Credit Since 2004

CDS: Relationship Between IG CDS and S&P 500





+1 (646) 491 2601

0

200

400

600

800

1,000

1,200

1,400

Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14 Mar-15 Sep-15 Mar-16 Sep-16 Mar-17 Sep-17 Mar-18 Sep-18

bp

s

IG XO HY

Valens Custom Aggregate CDS Index

Data Coverage: Weekly from Mar-2010 to Feb-2019Source: Valens Research Analysis

0

200

400

600

800

1,000

1,200

1,400


bp

s

IG XO HY

Valens Custom Aggregate iCDS Index


CDS: Relationship Between iCDS and CDS

The Custom Aggregate CDS reflects that credit risk is substantially below the elevated risk as recently as 2012.Recently iCDS levels for HY and XO had been moving higher, however an inflection lower in CDS levels, and iniCDS for HY has brought iCDS and CDS in line for XO and HY. Both iCDS and CDS levels remain very low,signaling safer credit than seen from 2008-2012:

• While the Aggregate CDS Index shows the credit riskiness of companies as traded in the credit market, theAggregate iCDS Index shows what the CDS should be

• After a period of high credit risk coming out of the 2008 crisis, the HY CDS dropped from 660bps inSeptember 2012 to 390bps in just six months. Its further decline to 243bps in March 2014 emphasizes thatthe risk of default for companies is nowhere near the recessionary levels that the market once perceived

• HY iCDS generally increased in 2015, approaching 2013 levels and higher in comparison to levels maintainedin 2014. Subsequently HY iCDS levels fell back towards safe 2014 levels, before rising recently back towards300bps+ levels

• From early to late 2018, HY and XO iCDS levels and CDS levels were both rising. However, these trendsreversed early in 2019, with HY and XO CDS falling, and HY iCDS also declining, signaling credit risk is beingfairly valued across the credit markets





+1 (646) 491 2601

0

200

400

600

800

1,000

1,200

1,400


bp

s

IG XO HY

Valens Custom Aggregate CDS Index with RFR


0

200

400

600

800

1,000

1,200

1,400


bp

s

IG XO HY

Valens Custom Aggregate iCDS Index with RFR


CDS: Relationship Between iCDS and CDS

Custom Aggregate CDS + RFR shows the impact of the risk-free rate on the total cost of debt for UScorporations. This analysis shows that while HY and XO CDS have remained low, with the move higher inthe risk free rate, cost to borrow has risen back to 2015 levels for both. Cost to borrow has also beenrising significantly for IG CDS, to levels not seen since 2011, and has led to a rise in fundamental cost toborrow for all tranches of credit risk to levels not seen in several years.

• Accounting for the risk-free rate in the aggregate credit spreads, the cost of debt for companies is stillnear levels seen in early 2013

• After the election in early November, CDS index levels with the risk-free-rate have begun to rise, asconcerns about higher interest rates due to more inflationary actions increase





+1 (646) 491 2601

0

50

100

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450

500

Mar-10 Nov-10 Jul-11 Mar-12 Nov-12 Jul-13 Mar-14 Nov-14 Jul-15 Mar-16 Nov-16 Jul-17 Mar-18 Nov-18

bp

s

IG iCDS + RFR IG CDS + RFR

0

100

200

300

400

500

600


bp

s

XO iCDS + RFR XO CDS + RFR

0

200

400

600

800

1,000

1,200

1,400

1,600


bp

s

HY iCDS + RFR HY CDS + RFR


CDS: Relationship of RFR-adjusted iCDS and CDS





+1 (646) 491 2601

0

100

200

300

400

500

600


bp

s

IG XO HY

Aggregate Markit CDX North America

Source: Capital IQ, Valens Research Data Coverage: Weekly from Mar-2010 to Feb-2019

CDS: Markit CDX North America

Based on the Markit CDS indices, the overall credit quality and direction of the HY and XO basketsapproached the peak levels of 2010 and 2011 in late 2015/early 2016, but has since moderated again.

• The indices are made up of entities with the most liquid assets in the CDS market, updated semi-annually and published by Markit North America. The Markit North American High Yield CDX Index iscomposed of 100 liquid North American entities with HY credit ratings trading in the CDS market whilethe Markit North American Investment Grade CDX Index is composed of 125 of the most liquid NorthAmerican entities with IG credit ratings trading in the CDS market

• This index shows that HY credit markets approached more distressed levels in February 2016, thoughIG credits still remain safe, highlighting why market commentators were overstating credit risk earlierthis year. Notably, trading volumes in the CDS market increased earlier this year, though they remainbelow the prime levels in 2008. This data point helps explain market concerns, though Valens’proprietary indices show that the risk being expressed here is overstated





+1 (646) 491 2601

Corporate Credit Worthiness





+1 (646) 491 2601

4%

5%

6%

7%

8%

9%

10%

11%

12%

13%

14%

-0.1

0.4

0.9

1.4

1.9

2.4

Cash as % of Total A

ssetsCa

sh &

Inve

stm

ents

(US$

Tri

llion

s)

Corporate Cash Holdings

Cash and ST Investments (USD Trillions) Cash as % of Total Assets

Source: Capital IQ, Valens Research Analysis1,000 largest U.S. companies by market cap. each year (ex financials, utilities, and insurance) Cash includes short- and long-term marketable securities

Data Range: 1994 to 2018E

0%

20%

40%

60%

80%

100%

120%

Reco

vera

ble

Ass

ets

/ To

tal D

ebt

Aggregate Recovery Rate

Source: Capital IQ, Valens Research Analysis1,000 largest U.S. companies by market cap. (ex financials, utilities, and insurance)Recovery Rate as defined by (1*Cash + 0.8*Total. Rec + 0.6*Inventory + 0.6*Other CA - 1*CL + 0.4*GPPE + 1*Other LT Investments) / Total Adjusted Debt

Data Range: 1994 to 2018E

• Total cash and cash equivalents reported on the balance sheets of non-farm, non-financial corporationsreached a historical high in 2016-2017, and has subsequently declined. The Aggregate Recovery Rate showsfirms’ ability to cover debt payments using their asset base, and has been worsening since 2015. Cashliquidity remains robust, but overall asset quality is declining.

Corporate Credit: Cash Holdings & Aggregate Recovery Rates





+1 (646) 491 2601

0

2

4

6

8

10

12

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

S&P

50

0 A

ggre

gate

In

tere

st R

ate

Co

vera

ge

Aggregate EBITAP/Interest Expense


0

50

100

150

200

250

300

350

400

450

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Nu

mb

er

of

Firm

s in

S&

P 5

00

wit

h M

ore

Cas

h a

nd

ST

In

vest

me

nts

th

an F

Y+1

to

FY

+3 D

eb

t

Firms with more Cash than FY+1 to FY+3 Debt

Cash > FY1 Debt Cash > FY1 to FY2 Debt Cash > FY1 to FY3 Debt

0

2

4

6

8

10

12

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

S&P

50

0 A

ggre

gate

In

tere

st R

ate

Co

vera

ge

Aggregate EBITAP/Interest Expense


Cash levels relative to near-term debt maturities have been declining from 2010-2014 peaks but remainstrong as seen by the FY2017 and forecast 2018 levels, limiting risk for a cash crunch. Also, while InterestCoverage ratios have declined since 2014, stronger EBITDAP mean they’ve recently improved.

• Firms in the S&P 500 have minimal liquidity concerns and are more capable of servicing short-termobligations

• A higher ratio means that companies are able to service their interest expenses, and are not asburdened by debt expense than if they had a lower ratio. Some of the rise in aggregate EBITAP/Interestcoverage stems from the falling cost of interest. With all things equal, corporate debt interest ratesshould rise as the Fed begins to raise rates. However, this does not sidestep the fact that corporatecredit is at its healthiest in decades

Corporate Credit: Corporate Cash to Short-Term Debt

Data Coverage: 12 years through 2018

Firms with More Cash than FY+1 to FY+3 DebtFirms with more Cash than FY+1 to FY+3 Debt





+1 (646) 491 2601

65%

70%

75%

80%

85%

90%

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

201

6

201

7

201

8

Corporate Cash to Short Term Debt

Percentage of Firms in S&P 500 with

More Cash than FY+1 Debt


Corporate Credit: Corporate Cash to Short-Term Debt

Companies had high levels of Cash-to-ST-Debt after the global financial crisis hit in 2007. This shows thatin the event of cash flow weakness, companies have enough cash to avoid a liquidity crunch. The ratio’sdecline from 2013 to 2018, however, may be a sign that management teams have begun to deploycapital in areas like M&A and share buybacks, even with limited capex spending.

• A significantly larger amount of cash compared to short-term debt in FY 2009 through 2012 suggeststhat corporate balance sheets are intact and that firms have the ability to cover debt in the event of adefault

• The lower amount of cash from 2013 to 2018 suggests that between returning capital to shareholders,raising debt and deploying capital, management teams are beginning to use excess liquidity. However,these are still higher than the average levels before the recession, so the negative sentiment overdefault risk may be unwarranted

Data Coverage: Yearly from 1995 to 2015Data Coverage: Yearly from 1995 to 2018E

Corporate Cash to Short-Term Debt






+1 (646) 491 2601

0

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

2018E 2019E 2020E 2021E 2022E


Other Uses of Cash

Maintenance Capex


R&D Maintenance

Dividends

Rental Maintenance

Interest Expense

Debt Maturities



0

200,000

400,000

600,000

800,000

1,000,000

1,200,000

2018E 2019E 2020E 2021E 2022E


Other Uses of Cash

Maintenance Capex


R&D Maintenance

Dividends

Rental Maintenance

Interest Expense

Debt Maturities



• The S&P 1500 firms with the weakest cash levels do not look as healthy as the entire S&P 1500.However, when looking at debt maturities and maintenance capex, cash flow exceed operatingobligations each year for these 560 companies or 47% of the S&P 1500 non-financial companies. It isonly when forecasted discretionary share buybacks are included that cash flows fall below obligations

• This is the group that is naturally the most at risk of a cash crunch, and could have the biggest issues ifthey have a debt maturity headwall coming in the near term. If there was a group in this analysis thatcould be the catalyst for refinancing issues and/or a credit destruction, it would be this group; however,with the flexibility to reduce share buybacks, this does not appear to be a major risk

Debt Headwalls:Aggregate CCFP




• The S&P 1500 has no material debt maturity headwalls over the next five years that would causeconcerns about refinancing risk. Debt maturities are relatively stable over the next several years, cashflows consistently match operating and debt obligations and forecasted share buybacks, and cash onhand levels offer a strong cushion on top of that. There appears to be no catalyst for credit destructionfor the S&P 1500

Aggregate CCFP for the entire S&P 1500 with total debt greater than current cash on hand

Data Date: As of 06-Feb-2019Source: Capital IQ, Valens Research Analysis





+1 (646) 491 2601

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

2018E 2019E 2020E 2021E 2022E


Other Uses of Cash

Maintenance Capex


R&D Maintenance

Dividends

Rental Maintenance

Interest Expense

Debt Maturities



Debt Headwalls:Aggregate CCFP




If the largest companies are removed from the analysis, new insights might be gained. Also, considering thatthe smaller companies in the S&P 1000 have less ability to access markets due to their smaller size, debtmaturity headwalls for them are a likely larger issue than they are for the large-cap names that dominate theS&P 1500.• It is somewhat expected that the S&P 1500, mostly composed of S&P 500 names when all the companies are

aggregated, would not have material credit risk. Companies with larger market capitalization inherently havelower credit risk, and tend to have stronger cash flows, which drive their higher valuations

• When looking at the mid-cap and small-cap names in the S&P 1000, a debt maturity headwall emerges in2021. Debt service including debt maturities grows faster than Gross Cash Earnings′ and while cash flowexceed all obligations in 2020 other than share buybacks, by 2021 companies will need to look to reduceobligations or refinance to avoid issues. However, this issue is still three years away and cash flow and cash onhand together are projected to handle all obligations until beyond 2022

• Significantly, in the most recent fiscal year companies have continued to execute on a prior trend ofconsistently rolling out their next 3-year maturities, pushing off their debt maturity headwall. In 2017,companies refinanced a significant amount of their 2020 debt maturity headwall, lowering that headwall tolevels where it is no longer the concern it was previously





+1 (646) 491 2601

0

500

1,000

1,500

2,000

2,500

3,000

Q1

198

5

Q1

198

6

Q1

198

7

Q1

198

8

Q1

198

9

Q1

199

0

Q1

199

1

Q1

199

2

Q1

199

3

Q1

199

4

Q1

199

5

Q1

199

6

Q1

199

7

Q1

199

8

Q1

199

9

Q1

200

0

Q1

200

1

Q1

200

2

Q1

200

3

Q1

200

4

Q1

200

5

Q1

200

6

Q1

200

7

Q1

200

8

Q1

200

9

Q1

201

0

Q1

201

1

Q1

201

2

Q1

201

3

Q1

201

4

Q1

201

5

Q1

201

6

Q1

201

7

Q1

201

8

S&P 500


0.0

0.5

1.0

1.5

2.0

2.5

3.0

Q1

19

85

Q4

19

85

Q3

19

86

Q2

19

87

Q1

19

88

Q4

19

88

Q3

19

89

Q2

19

90

Q1

19

91

Q4

19

91

Q3

19

92

Q2

19

93

Q1

19

94

Q4

19

94

Q3

19

95

Q2

19

96

Q1

19

97

Q4

19

97

Q3

19

98

Q2

19

99

Q1

20

00

Q4

20

00

Q3

20

01

Q2

20

02

Q1

20

03

Q4

20

03

Q3

20

04

Q2

20

05

Q1

20

06

Q4

20

06

Q3

20

07

Q2

20

08

Q1

20

09

Q4

20

09

Q3

20

10

Q2

20

11

Q1

20

12

Q4

20

12

Q3

20

13

Q2

20

14

Q1

20

15

Q4

20

15

Q3

20

16

Q2

20

17

Q1

20

18

Ch

arge

-Off

Rat

e (

%)

C&I Loan Charge-Off Rate and Recessions

Data Coverage: Daily from Q1 1985 to Q3 2018Source: Federal Deposit Insurance Corporation, Valens Research Analysis

• Consumer and Industrial Loan Charge-offs appears to be a lagging indicator of recessions. Charge-offsdue to C&I loans had been trending downwards and remain at very low levels; however, a reversal ofthe recent declining trend could be a worrisome sign for the U.S. economy

Credit Integrity: Provisions for Losses and Bad Loan Charge-Offs

Date Coverage: Quarterly from Q1 1985 to Q3 2018

Date Coverage: Quarterly from Q1 1985 to Q3 2018





+1 (646) 491 2601

Corporate Credit Issuance/Usage





+1 (646) 491 2601

$200,000

$700,000

$1,200,000

$1,700,000

$2,200,000

$2,700,000

Jan

-80

Jan

-81

Jan

-82

Jan

-83

Jan

-84

Jan

-85

Jan

-86

Jan

-87

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

Jan

-17

Jan

-18

Jan

-19




0200400600800

1,0001,2001,4001,6001,8002,0002,2002,4002,6002,8003,0003,200

Jan

-80

Jan

-82

Jan

-84

Jan

-86

Jan

-88

Jan

-90

Jan

-92

Jan

-94

Jan

-96

Jan

-98

Jan

-00

Jan

-02

Jan

-04

Jan

-06

Jan

-08

Jan

-10

Jan

-12

Jan

-14

Jan

-16

Jan

-18

S&P 500

Data Coverage: Daily from Jan-1980 to Jan-2019

Commercial loan growth has re-accelerated recently, continuing its upward trend after a short slowdownin Q2 2017 to Q2 2018.

• Commercial and industrial (C&I) loans are not clear indicators going into a bear cycle but are leadingindicators going into a bull cycle. Recently, C&I loan growth has slowed, meaning it may no longer be anincremental tailwind to the bull market

• Looking at both charts, there appears to be some correlation between the trend in C&I loans and theS&P 500. Given how the U.S. economy relies heavily on credit, loans, and the banking system, one mustbe vigilant of these trends in the credit markets

The Importance of Corporate & Consumer Credit






+1 (646) 491 2601

$1,000,000

$1,200,000

$1,400,000

$1,600,000

$1,800,000

$2,000,000

$2,200,000

$2,400,000

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Sep

-18



Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Monthly from Jan-2007 to Dec-2018

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

2,600

2,800

3,000

3,200

Jan

-07

Jul-

07

Jan

-08

Jul-

08

Jan

-09

Jul-

09

Jan

-10

Jul-

10

Jan

-11

Jul-

11

Jan

-12

Jul-

12

Jan

-13

Jul-

13

Jan

-14

Jul-

14

Jan

-15

Jul-

15

Jan

-16

Jul-

16

Jan

-17

Jul-

17

Jan

-18

Jul-

18

Jan

-19

S&P 500

Data Coverage: Daily from Jan-2007 to Jan-2019Source: Capital IQ, Valens Research Analysis

These charts give a close-up view of the trend in commercial credit, which grew 4.7% QoQ in January 2019.

• Commercial and industrial (C&I) loans are continuing its positive YoY trend in the last 36 months, in themore recent periods until the current quarter, growth had appeared to stall, before appearing to now bere-accelerating again

• Consumer loans have slowly and steadily increased in the last six years. The steady increase implies thatconsumption spending is picking up. Most consumers seem to have improved financial positions and haverecovered from the effects of the financial crisis. Overall, this indicates that GDP may improve further if themomentum continues and if overall positive sentiment does not wane

Corporate & Consumer Credit






+1 (646) 491 2601

3

4

5

6

7

8

9

20

30

40

50

60

70

80

Jan

-80

Jan

-81

Jan

-82

Jan

-83

Jan

-84

Jan

-85

Jan

-86

Jan

-87

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

Jan

-17

Jan

-18

Jan

-19

S&P

50

0P

MI

Co

mp

osi

te I

nd

ex

ISM Manufacturing: PMI Composite Index

Recession

PMI Composite Index

S&P 500 (log)

Source: Institute for Supply Management, Valens Research Analysis Data Coverage: Monthly from Jan-1980 to Jan-2019

$200,000

$700,000

$1,200,000

$1,700,000

$2,200,000

$2,700,000

Jan

-80

Jan

-81

Jan

-82

Jan

-83

Jan

-84

Jan

-85

Jan

-86

Jan

-87

Jan

-88

Jan

-89

Jan

-90

Jan

-91

Jan

-92

Jan

-93

Jan

-94

Jan

-95

Jan

-96

Jan

-97

Jan

-98

Jan

-99

Jan

-00

Jan

-01

Jan

-02

Jan

-03

Jan

-04

Jan

-05

Jan

-06

Jan

-07

Jan

-08

Jan

-09

Jan

-10

Jan

-11

Jan

-12

Jan

-13

Jan

-14

Jan

-15

Jan

-16

Jan

-17

Jan

-18

Jan

-19




Credit Usage: Manufacturing Activity

• The combination of high growth in C&I loans with a corresponding stagnation in manufacturing activity(above 50 levels, yet with declining peaks) seems to characterize most bull markets. The PMI compositeindex is highest in recoveries just after the end of the corresponding recessions and seems to be aconcurrent leading indicator of recessions and turns in the market

• The index registered from 54.3 in December 2018 to 56.6 in January 2019





+1 (646) 491 2601

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

450,000

500,000

Financials C. Discretionary C. Staples Materials Healthcare Telecom Svcs Energy Info Tech Utili ties Industrials

U.S. M&A Value by Sector (in US$mn)

2010 2011 2012 2013 2014

2015 2016 2017 2018

Source: Capital IQ, Valens Research Analysis Data: As of 6-Feb-2019

-

500,000

1,000,000

1,500,000

2,000,000

2,500,000

3,000,000

3,500,000

4,000,000

4,500,000

5,000,000

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018

Global M&A (Nominal US$mn)

Global M&A U.S. M&A


M&A in 2018 remained around levels seen since 2016. Worldwide M&A totaled $3.6 trillion in 2018.Recently, M&A activity in the Energy sector has been relatively higher than its recent years and tops yearto date among the sectors in terms of transaction value.

• The strategic acquirer nature of the current acquisition environment is generally a sign of a transitioninto a growth market. When financial acquirers (i.e. PE firms) begin to take share in the acquisitionmarket, it is a reason to be concerned, as this tends to be a contrarian indicator. A high M&A activitycan be a sign of management teams seeking to deploy capital even as they cannot find organic growthopportunities

• That being said, the deceleration in both U.S. and global M&A from 2015 levels signals a pause inwillingness to deploy capital in this way

M&A and Private Equity Activity

Data: As of 6-Feb-2019Source: Capital IQ, Valens Research Analysis





+1 (646) 491 2601

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

Jan

-03

Jun

-03

No

v-0

3

Ap

r-0

4

Sep

-04

Feb

-05

Jul-

05

Dec

-05

May

-06

Oct

-06

Mar

-07

Au

g-0

7

Jan

-08

Jun

-08

No

v-0

8

Ap

r-0

9

Sep

-09

Feb

-10

Jul-

10

Dec

-10

May

-11

Oct

-11

Mar

-12

Au

g-1

2

Jan

-13

Jun

-13

No

v-1

3

Ap

r-1

4

Sep

-14

Feb

-15

Jul-

15

Dec

-15

May

-16

Oct

-16

Mar

-17

Au

g-1

7

Jan

-18

Jun

-18

M2 Velocity

Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Quarterly from Q1 2003 to Q3 2018

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Jan

-03

May

-03

Sep

-03

Jan

-04

May

-04

Sep

-04

Jan

-05

May

-05

Sep

-05

Jan

-06

May

-06

Sep

-06

Jan

-07

May

-07

Sep

-07

Jan

-08

May

-08

Sep

-08

Jan

-09

May

-09

Sep

-09

Jan

-10

May

-10

Sep

-10

Jan

-11

May

-11

Sep

-11

Jan

-12

May

-12

Sep

-12

Jan

-13

May

-13

Sep

-13

Jan

-14

May

-14

Sep

-14

Jan

-15

May

-15

Sep

-15

Jan

-16

May

-16

Sep

-16

Jan

-17

May

-17

Sep

-17

Jan

-18

May

-18

Inflation Measures - YoY Change

CPI Core CPI

PCE Core PCE

Historical Inflation and M2 Velocity

• Declining money velocity is characteristic of a period of recovery following a recession. Historically,money velocity would slow down with the increase in money supply in the economy. Once the recoverypicks up, so will money velocity





+1 (646) 491 2601

-2%

0%

2%

4%

6%

8%

10%

12%

14%

16%

Jan

-60

Feb

-61

Mar

-62

Ap

r-6

3

May

-64

Jun

-65

Jul-

66

Au

g-6

7

Sep

-68

Oct

-69

No

v-7

0

Dec

-71

Jan

-73

Feb

-74

Mar

-75

Ap

r-7

6

May

-77

Jun

-78

Jul-

79

Au

g-8

0

Sep

-81

Oct

-82

No

v-8

3

Dec

-84

Jan

-86

Feb

-87

Mar

-88

Ap

r-8

9

May

-90

Jun

-91

Jul-

92

Au

g-9

3

Sep

-94

Oct

-95

No

v-9

6

Dec

-97

Jan

-99

Feb

-00

Mar

-01

Ap

r-0

2

May

-03

Jun

-04

Jul-

05

Au

g-0

6

Sep

-07

Oct

-08

No

v-0

9

Dec

-10

Jan

-12

Feb

-13

Mar

-14

Ap

r-1

5

May

-16

Jun

-17

Jul-

18

Inflation Measures - YoY Change

CPI Core CPI

PCE Core PCE

1.4

1.5

1.6

1.7

1.8

1.9

2.0

2.1

2.2

Jan

-60

Feb

-61

Mar

-62

Ap

r-6

3

May

-64

Jun

-65

Jul-

66

Au

g-6

7

Sep

-68

Oct

-69

No

v-7

0

Dec

-71

Jan

-73

Feb

-74

Mar

-75

Ap

r-7

6

May

-77

Jun

-78

Jul-

79

Au

g-8

0

Sep

-81

Oct

-82

No

v-8

3

Dec

-84

Jan

-86

Feb

-87

Mar

-88

Ap

r-8

9

May

-90

Jun

-91

Jul-

92

Au

g-9

3

Sep

-94

Oct

-95

No

v-9

6

Dec

-97

Jan

-99

Feb

-00

Mar

-01

Ap

r-0

2

May

-03

Jun

-04

Jul-

05

Au

g-0

6

Sep

-07

Oct

-08

No

v-0

9

Dec

-10

Jan

-12

Feb

-13

Mar

-14

Ap

r-1

5

May

-16

Jun

-17

Jul-

18

M2 Velocity and Recessions

Source: The Federal Reserve System, Valens Research Analysis Data Coverage: Quarterly from Q1 2003 to Q3 2018

Historical Inflation and M2 Velocity

Absent inflation or output growth, a decrease in money velocity is symptomatic of an increase in themoney supply, currently brought about by the QE program.

• The increases in the Consumer Price Index have been relatively stable since 1983. The U.S. has not hada bout of severe inflation commonplace in the late ‘40s and the late ‘70s

• The U.S. Federal Reserve’s quantitative easing program increased the money supply in the U.S.economy, reducing the money velocity and keeping inflation at its lowest levels





+1 (646) 491 2601

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%Fe

b-0

9

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Oct

-13

Feb

-14

Jun

-14

Oct

-14

Feb

-15

Jun

-15

Oct

-15

Feb

-16

Jun

-16

Oct

-16

Feb

-17

Jun

-17

Oct

-17

Feb

-18

Jun

-18

Oct

-18

Feb

-19

10-Year Treasury Yield 2-Year Treasury Yield

Source: U.S. Federal Reserve Data Coverage: Daily from Feb-2009 to Feb-2019

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

Feb

-09

Jun

-09

Oct

-09

Feb

-10

Jun

-10

Oct

-10

Feb

-11

Jun

-11

Oct

-11

Feb

-12

Jun

-12

Oct

-12

Feb

-13

Jun

-13

Oct

-13

Feb

-14

Jun

-14

Oct

-14

Feb

-15

Jun

-15

Oct

-15

Feb

-16

Jun

-16

Oct

-16

Feb

-17

Jun

-17

Oct

-17

Feb

-18

Jun

-18

Oct

-18

Feb

-19

10-Year Treasury Yield 3-Month Treasury Yield

Source: U.S. Federal Reserve Data Coverage: Daily from Feb-2009 to Feb-2019Treasury spreads continue to decline, but remain materially positive, signaling limited risk for arecession, and continued positive economic growth. The recent rise in short-term rates is a sign ofexpectations for improvement in near-term economic conditions.

• Treasury yields refer to the total return on investment on the government debt obligations. An increasein yield means a decline in the value of the treasury note, bill, or bond, and vice versa

• The spread between the 2-year and 10-year yields moved wider in late 2016 and early 2017 afterhaving contracted to its narrowest since 2007. Since the rate hike in December 2015, the short-termyields showed more sensitivity to changes in the Fed-funds rate. However, longer-term yields havebeen declining since the November election rally, even while shorter-term rates have risen, signalingexpectations for higher inflation and growth in the near-term

• As of February 4, 2019, the 10-Year Treasury Yield is at 2.7% while the 2-Year Treasury Yield is at 2.5%

3-Month, 2-Year, and 10-Year Treasury Yields: Ten Years Through January 2019

Money Velocity: Treasury Yields





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