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North America
United States
 Strategy Update
29 July 2010
 
US Equity Strategy
Equities and the MacroData Slowdown
Binky Chadha
Chief Strategist(+1) 212 250-4776bankim.chadha@db.com
Keith Parker
Strategist(+1) 212 250-7448keith.parker@db.com
Parag Thatte
Strategist(+1) 212 250-6605parag.thatte@db.com
 Ju Wang
Strategist(+1) 212 250-7911ju.wang@db.com
Deutsche Bank Securities Inc.All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from localexchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies. DeutscheBank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firmmay have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a singlefactor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1.MICA(P) 007/05/2010
Equities strongly correlated to the MAPI
Correl (since Jun 07): 0.71Last 1m: 0.83
-0.50-0.40-0.30-0.20-0.100.000.100.200.30
     D    e    c  -     0     9     J    a    n  -     1     0     F    e     b  -     1     0     M    a    r  -     1     0     A    p    r  -     1     0     M    a    y  -     1     0     J    u    n  -     1     0     J    u     l  -     1     0
-15-12-9-6-3036912
MAPI (lhs)S&P 500 (3m change, %, rhs)
MAPI lowerbound
 
LEI points to equity upside
4.584.604.624.644.664.684.704.72
     M    a    r  -     0     9     M    a    y  -     0     9     J    u     l  -     0     9     S    e    p  -     0     9     N    o    v  -     0     9     J    a    n  -     1     0     M    a    r  -     1     0     M    a    y  -     1     0     J    u     l  -     1     0
6.606.706.806.907.007.107.20
Log of LEI (lhs)Log of S&P 500 (rhs)
 
Bridge to year-end S&P 500 target
11051375
80090010001100120013001400
S&P 500CurrentEarningsRoll2HEarningsbeatP/EExpansionDB Target
80090010001100120013001400
12525120
 
   C  o  m  p  a  n  y
   G   l  o   b  a   l   M  a  r   k  e   t  s   R  e  s  e  a  r  c   h
 
Disappointing macro data in June saw equities sell off sharply. To whatextent did this reflect simply the disappointment of rising expectations?How much importance should equities ascribe to the data slowdown?
Equities have been strongly correlated (83%) with our macro data surprise index(MAPI) as activity data slowed and came in persistently below expectations. In ourview: (i) the MAPI will continue to rebound from the bottom of its historical bandswhich it had reached last week; (ii) the LEI (a proxy for the composite of macrodata) points to up- rather than down-side for equities; and (iii) key hard data remainwithin their recovery channels; some sentiment and confidence indicators havefallen below but these are most impacted by financial market developments.
Data surprise index to continue to rebound
MAPI tends to fluctuate within 2sd bands historically. When data are surprisingpositively, forecasts get upgraded until they are eventually disappointed. With alag, forecasts tend to then be downgraded until the data begins to surprisepositively again. In the present context, the necessary condition for the MAPI torebound fell into place relatively quickly as near term macro forecasts were cutsharply, while our baseline remains that the economic recovery will continue, thusdelivering data that should not disappoint (Figures 1-3).
LEI points to up- rather than down-side for equities. The second derivative,which investors have focused on, is weakly correlated with equities
The LEI remains on an uptrend and the first derivative (growth) positive, while thesecond derivative (acceleration) has turned down. Historically, the strongestcorrelations of equities with the LEI have been between levels (97%), deviationsfrom trend (61%) and the first derivative (43%); and the weakest (26%) with thesecond derivative. This argues for equity up- rather than downside (Figures 4- 9).
Key hard data remain in recovery channels
We see key high frequency “hard” data (consumption—retail sales; capex--durablegoods; industrial production) as remaining within their recovery channels. Housingand consumer confidence remain at low levels. The labor market recovery is yet todeliver sizable jobs growth but still on trend. The PMIs have moved most clearly tothe bottom or below their recovery channels, but as sentiment indicators they aremost impacted by lagged financial market developments (Figures 10-19).
Strategy: The upside to our year-end S&P 500 target of 1375 reflects a bigearnings “roll” (125 points), a small H2 earnings beat (25 points) and somemultiple expansion (120 points) as the MAPI rebounds. The latter is mostpositive for the domestic cyclicals (Financials, Industrials, ConsumerDiscretionary, Tech), which have accounted for most (82%) of the beat in Q2.
 
29 July 2010 US Equity StrategyPage 2 Deutsche Bank Securities Inc.
MAPI reversion worth 8% in the S&P 500.
The key concern in financial markets has beenthe slowdown in the US data and whether it presages a double-dip recession. The S&P 500has been closely correlated with macro data surprises. With sharp cuts in forecasts, webelieve that, in line with historical behavior, the MAPI should continue to rebound from here.An average traversal to neutral in the MAPI from current levels is worth an estimated 8%upside in the S&P 500 based on our analysis.
The upside to our year-end target of 1375 for the S&P 500 reflects a big earnings “roll”(125 points), a small earnings beat (25 points) and some multiple expansion (120points).
Relative to our YE target for the S&P 500, which remains 1375, the upside fromyesterday’s close of around 1105, we expect:(i)
A big earnings roll.
We expect 125 points of upside to come simply from the earnings“roll”. LTM earnings are currently $75.5. The 2010 bottom-up consensus has moved up to$83.2. This implies an LTM earnings “roll” by year end of $7.7 simply as lower earningsquarters fall out of the last 12 months and more recent higher earnings quarters raise thetotal. At fair value multiples this is worth 125 points ($7.7 x 16.4 = 125 points) on the S&P500;(ii)
A small earnings beat.
We expect a relatively small 25 points of upside from 2H earningsbeats relative to consensus. We are at $84.6 for 2010 vs bottom-up consensus of $83.2. Thisimplies a 3.4% average earnings beat during H2 2010, which compares with an average beatover the last 6 quarters of over 10%. The difference of $1.4 x 16.4 = 25 points on the S&P500; and(iii)
Some multiple expansion as MAPI turns up.
We estimate 120 points or 11% of upsidefrom current levels to come from an expansion of the multiple. The current multiple on LTMearnings at yesterday’s close was 14.7 relative to what we consider to be historical fair valueof 16.4. So $75.5 x (16.4 - 14.7) = 120. The close correlation of the S&P 500 with the MAPIdiscussed above suggests that much of the recent contraction in the multiple can beattributed to the disappointment in macro data, and should reverse as the MAPI rebounds(Figures 20-21).
MAPI reversion is most positive for the domestic cyclicals (Financials, Industrials,Consumer Discretionary, Tech).
An equity rally driven by US macro data surprises wouldobviously be most positive for the domestic cyclicals. In a baseline of economic recovery,with US macro data continuing its upward trend, we remain overweight the domesticcyclicals (Financials, Industrials, Consumer Discretionary and Tech). We remain underweightthe global cyclicals (Energy & Materials) as well as Utilities and Telecom. In Q2, in a quarterof likely slower GDP growth, the cyclicals still managed to beat Q2 earnings estimates by themost and generate the highest earnings growth. The domestic cyclicals have togetheraccounted for most (82%) of the earnings beat thus far in Q2. We continue to see thegreatest earnings upside and momentum for the domestic cyclicals (Figures 22-23).
 
29 July 2010 US Equity StrategyDeutsche Bank Securities Inc. Page 3
Figure 1: Equities have been strongly correlated (85%) with our macro data surpriseindex (MAPI) on heightened growth concerns as activity data slowed and came inpersistently below expectations
Correlation
Since 1997: 0.39Since Jun 2007: 0.71Since Mar 09: 0.58Last 1m: 0.83-0.50-0.40-0.30-0.20-0.100.000.100.200.30
     3     0  -     D    e    c  -     0     9     1     3  -     J    a    n  -     1     0     2     7  -     J    a    n  -     1     0     1     0  -     F    e     b  -     1     0     2     4  -     F    e     b  -     1     0     1     0  -     M    a    r  -     1     0     2     4  -     M    a    r  -     1     0     0     7  -     A    p    r  -     1     0     2     1  -     A    p    r  -     1     0     0     5  -     M    a    y  -     1     0     1     9  -     M    a    y  -     1     0     0     2  -     J    u    n  -     1     0     1     6  -     J    u    n  -     1     0     3     0  -     J    u    n  -     1     0     1     4  -     J    u     l  -     1     0     2     8  -     J    u     l  -     1     0
-15-12-9-6-3036912MAPI (lhs)MAPI Upper and Lower bounds (+/-2 s.d.)S&P 500 (3m change, %, rhs)
Source: Bloomberg Finance LP, Deutsche Bank 
Figure 2: The MAPI has bounced from the bottom of its historical bands which it hadreached last week
-0.9-0.7-0.5-0.3-0.10.10.30.50.7
   J  u   l  -   9   7   J  a  n  -   9   8   J  u   l  -   9   8   J  a  n  -   9   9   J  u   l  -   9   9   J  a  n  -   0   0   J  u   l  -   0   0   J  a  n  -   0   1   J  u   l  -   0   1   J  a  n  -   0   2   J  u   l  -   0   2   J  a  n  -   0   3   J  u   l  -   0   3   J  a  n  -   0   4   J  u   l  -   0   4   J  a  n  -   0   5   J  u   l  -   0   5   J  a  n  -   0   6   J  u   l  -   0   6   J  a  n  -   0   7   J  u   l  -   0   7   J  a  n  -   0   8   J  u   l  -   0   8   J  a  n  -   0   9   J  u   l  -   0   9   J  a  n  -   1   0   J  u   l  -   1   0
-0.9-0.7-0.5-0.3-0.10.10.30.50.7Recession Macro Activity Pulse Index MAPI Upper and Lower bounds (+/- 2 s.d.)
Source: Bloomberg Finance LP, Deutsche Bank 
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