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NOT to sell in May

NOT to sell in May

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Published by nom1237
2013-05-02
2013-05-02

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Published by: nom1237 on May 04, 2013
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www.jpmorganmarkets.com
North America Equity Research
02 May 2013
US Equity Strategy FLASH
New cycle lows in HY spreads another reason NOT tosell in May; Contrarian to stay Cyclical in 2Q; 17 ideas
Portfolio StrategyThomas J Lee, CFA
 AC
(1-212) 622-6505thomas.lee@jpmorgan.com
Katherine C Khor 
(1-212) 622-0934katherine.khor@jpmorgan.comJ.P. Morgan Securities LLC
See page 21 for analyst certification and important disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that thefirm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor inmaking their investment decision.
There are really two storylines supporting a constructive thesis on equity markets: (i)falling equity risk premia(ERP)driving a re-rate and/or (ii) reflation/cyclical liftdriving earnings. On the former, investors are primarily leveraging this by seekingspread compressionequities, or“bond-like” equities, and re-rating those higher— hence, dividend stocks (although ironically, in past regimes of falling ERP, Cyclicalsusually have led). And naturally, in a reflationary world, capital spending rises(incentives created), driving top-line/EPS accelerationand,thus, Cyclicalslead. Neither is mutually exclusive, but the falling ERP remains the more credible base casein investors’ consensus.
Balance of 2Q: what storyline leads?Referring to some axioms relied upon asformer sector analyst.
In 2013, the cadence of the economic data, alternating between cyclical lift and softness, has tilted towards soft-side readingsrecently— resulting in falling inflation expectations (TIPS, commodities, etc.) and,thus, providing more support for an ERP thesis than cyclical lift/reflation. In any case, thekey question for the investor is what storyline gains credibility over the balance of the 2Q (8 weeks). To answer this, we refer to axioms relied on during 15years(1993-2007) as former equitysector analystcovering Wireless Services (prior totaking the mantle as Equity Strategist at J.P.Morgan).
Foremost, we learned in the early 1990s (and heard repeated many times from HYcounterparts), high-yield markets lead equities. This was particularly true coveringthe capital-consuming wireless sector which relied on access to debt markets for viability. What is it telling us at the moment? Take a look at Figure 3;HY spreads recently fell to new tights (lows) for this cycle, at 484bp STW (below previous tightsof 503bp on 3/13).
 As we have noted many times in the past 4 years, new HY tights pointto new highs in equity levels, providing a supportive backdrop for stocks tocontinue to build upon recent highs. The flip-side of this is the positive backdrop for HY is negated if spreads widen by25bp, or rise above 514bp STW.
In “The Wisdom of Crowds,” James Surowiecki argued that the judgmentof the crowd is usually rightunless judgmentsare not derived independently (contrasting “how many gumballs ina jar” vs.“stock markets”). We found this particularly pertinent when consensus isgrounded on intuitive arguments. Take the current consensus of “sell in May”— many guideposts argue for this: (i) treasury yields and commodities have plunged;(ii) downside reads in economic data;and (iii) this has held up in 2010, 2011 and2012, so why should 2013 be any different.
Source: J.P. Morgan, FactSet,Bloomberg.
 
Performance:
S&P500(LHS)5/2/131,598
Cyclicals(RHS),5/2/13, 109
Defensives(RHS)5/2/131171001021041061081101121141161181201,4001,4501,5001,5501,6001,65012/122/134/136/138/1310/1312/13
    1    0    0   =   s    t   a   r    t   o    f   y   e   a   r
S&P500 (LHS)Cyclicals (RHS)Defensives (RHS)
2Q12 3Q12 4Q12 1Q13 QTD YTDS&P500
(3%)6%-1%10%2%12%
Cycl
(Mat, IT, Disc, Ind)(5%)5%0%8%1%9%
Near- Cycl
(Ener, Fin)(7%)8%1%10%1%11%
Def 
(Stpl, HC, Tel, Util)5%3%-3%12%4%17%
Valuation:2013E 2014E
S&P500 Level1598EPS$110$117P/E (current)14.5x13.7xDiv Yield2.2%2.4%
S&P500 Year-End Targets:
Price1580P/E13.2x13.5x
Sector Ratings:
Overweight Neutra
MaterialsTelecomIndustrialsDiscretionary
Underweight 
TechnologyStaplesFinancialsUtilitiesEnergyHealthCare
 
2
North America Equity Research
02 May 2013Thomas J Lee, CFA(1-212) 622-6505thomas.lee@jpmorgan.com
We want to take the other side of this trade for multiple reasons, but the three mostnotable: (i) client positioning is diametrically opposite of that in the last 3 years—HF beta, for instance, rather than registering the highs of the year in April (as was the casein 2010, 2011 and 2012) today is at the lowest levels since 8/12 (see Figure 6); (ii) we  believe the early downturn in gasoline (and other commodities) will act as stimulus incoming weeks by as much as 50bp lift to GDP (q/q)—in past 3 years, gasoline surged in2Q and thus was a headwind; (iii) the message from continued improvement in joblessclaims (new cycle lows this week at 324k) and the rally in HY market in the faceof mixed economic data argues the seasonal weaknessin the economy is not likely to playout in 2Q as in past years.
Being non-consensus also means feeling “off-sides” away from the“safety of the crowd.” Thus, it is tempting to consider cuttinglosses and movingtoconsensus. In our view, the continued outperformance of Defensives into 2Q isconsensus—after all, if one were to positionfor a “sell in May,” whylook to buy aCyclical? And as noted above, the HF beta at new lows argues for investors expectinga sell-off. We continue to support OW Cyclicals through 2Q, albeit, high-FCF yielding.History supports this as we have noted in recent notes: (i) 1Q laggards have led in 2Q in11 of 13 years (exceptions 2002 and 2008, “US Equity Strategy FLASH: 1Q Laggardsto Outperform 2Q…”dated 4/4/13); (ii) the recent material underperformance of Cyclicals by 821bp is the 8th worst since 1973,and in the 10 worst Cyclicalunderperformance periods they outperformed in the following quarter 9 of 10 times (see“US Equity Strategy FLASH: Europe Feedback Part II…”dated 4/26/13);and (iii)while valuations are not necessarily the reason to create turning points, Cyclicals tradeat the largest discount to Defensives (30%) since 1990 (see Figure 7).
Obviously, improvements in economic data or policy backdrop will be key. Visibilityin the US housing recovery remains impressive and this is still a multi-year story.There is also room for policy surprise in Europe whether from the ECB or potentiallyfrom an easing of austerity measures. And we continue to see the continuedimprovement in US jobless claims as pointing to an economy sustaining momentumdespite concerns about seasonal weakness and sequester cuts.
What could go wrong?Consensus continues to be right in avoiding Cyclicals.
Therisk to this view is that the consensus is right, moreso on the favoring of Defensives.Therefore, we would see the following as undermining our views: (i) evidence emergesthe price weakness in commodities is DUE TO DEMAND, thus, no 2Q lift; (ii) USsequester is more severe than anticipated leading to further miss—we will have somesense looking at the April payrolls report; and (iii) the divergences last longer thanexpected and Cyclicals extend their underperformance another quarter.
Our base case for the next two months, therefore, seesequities higher through end of 2Q and Cyclicals outperformingduring that period. But asnoted in past reports, we would rather buy high-FCF yield equities (over dividends),inclusive of Cyclicals and other areas of the market. We have identified 17stocks usingthe following criteria:i) High FCF Yield (in the highest quartile of FCF yield,translatingto FCF Yield ≥ 5.5%); ii) OW rated by J.P. Morgan analysts; iii) High Dividend Yield(above 2%); and iv) Positive upside to J.P. Morgan price targets. The tickers are:
UFS,TEVA, CA, AAPL, CMTL, STJ, CG, PRU, BBY, WFC, TWC, BA, SPLS, KEY,CBL, CTL
and
GD
(seeFigure 8).
 
3
North America Equity Research
02 May 2013Thomas J Lee, CFA(1-212) 622-6505thomas.lee@jpmorgan.com
Figure 1: Summary Statistics –S&P 500
Source: J.P.Morgan, FactSet and Bloomberg.
Figure 2: Potential Catalysts
Source: J.P. Morgan and FactSet.
Related ETFCurrent ETF Current P/E Buzz-o- Delta vs. % change -- Mkt Cap Weight
Equal 
Recommended Weighting DeltaGICS # Index Index Ticker Price (NTM) Meter Wk Ago
1 week1 monthYTD
YTD
- - - Neutra + + +S&P 500 Index 1,583 SPY
$158.2815.1x
236 18 0.2 0.9 11.0
12.5 
Russell 2000 947 IWM
$91.8215.6x
201 12 1.9(0.4)11.6
8.4
Cyclicals
15Materials
245 XLB
$38.8515.0x
184 48
1.0(1.2)
2.9
1.4
- - | 1% -
25Discretionary
430 XLY
$54.3215.5x
249 24
0.62.4
14.5
15.7 
- - | 1% -
20Industrials
355 XLI
$40.9114.5x
226 25
0.6(2.0)
7.9
7.9
- - | 1% -
45Technology
483 XLK
$30.5314.6x
216 9
2.80.0
4.2
10.2 
- - | 1% -Near-Cyclicals
10Energy
569 XLE
$77.0512.9x
229 6
0.8(2.5)
6.8
7.7 
- - 0% - -
40Financials
249 XLF
$18.4912.4x
268 23
0.41.6
12.7
14.9
- - | 2% -Defensives
30Staples
422 XLP
$40.9017.5x
250 31
(1.4)2.7
16.9
19.0 
-3% - | - -
35Health Care
543 XLV
$46.8314.8x
235 30
(2.8)1.8
17.3
14.3
- - 0% - -
50Telecom
166 IYZ
$26.4517.9x
197(5)
(1.7)5.0
13.6
10.5 
- - 0% - -
55Utilities
208 XLU
$41.0217.0x
236 4
0.54.9
17.3
17.6 
-3% - | - -
MondayTuesdayWednesdayThursdayFriday
5/65/75/85/95/10Economics/PolicyEconomics/PolicyEconomics/PolicyEconomics/PolicyEconomics/Policy
2:00pm Senior loan officer survey (2Q, tentative)10:00am JOLTS (Mar)8:30am Initial claims (w/e prior Sat)2:00pm Federal budget (Apr)3:00pm Consumer credit (Mar)10:00am Wholesale trade (Mar)
CorporateCorporateCorporateCorporateCorporateJ.P. Morgan EventsJ.P. Morgan EventsJ.P. Morgan EventsJ.P. Morgan EventsJ.P. Morgan Events
 Asia Rising Dragons Forum (Kuala Lumpur)Asia Rising Dragons Forum (Singapore)Asia Rising Dragons Forum (Singapore)Asia Rising Dragons Forum (Hong Kong)Asia Rising Dragons Forum (Hong Kong)Earnings: APC, AMTG, AVID, BPI, DPM, EOG, FTR, GDP, GWAY,HOLX, ORBK, PAA, PL, PSB, QLYS, RPAI, SMG, STAG, SHO,SYY, TLLP, SSP, TSN, VNO, WLKEarnings: ARAY, AER, ARC, ARB, ARCC, ARIA, CAR, BMC,CHRW, CA, CHTR, CHSP, XEC, CNK, GSJK, DVA, DNDN, DTV,DISCA, DISH, DIS, DEI, DRQ, EMR, ENDP, EXEL, GTY, GSM,LOPE, HCN, HTA, HSIC, HFC, HUSKF, IFF, KGC, LPX, LUFK,MAKO, MRO, MCK, MODN, TAP, MDLZ, MYGN, OAK, OMX,ONXX, PLT, QLTY, RAX, RLOC, REG, RBCN, RHP, SD, BOX,SGEN, SLRC, SYMC, TRNX, TW, TRIP, UUU CN, VVUS, WFM,WMB, WPZ, WYNNEarnings: AMRN, APO, BR, CSTE, CRZO, CTL, CLVS, CTSH,CLR, CUZ, TRAK, DTSI, ETP, FSC, FOSL, GNMK, GEI CT, GLP,GRPN, HL, HII, INFI, LAMR, MWE, MDVN, MBLX, NWSA, NICE,OILT, PVA, PNNT, PRGO, PPO, KWK, RGP, SLH, WEN, TC, THI,TDG, VSI, WPRTEarnings: AGU, AL, AMCX, APEI, APA, BVMF3 BZ, BBD/B, CVC,CFN, CF, CDE, CTB, CPA, CPNO, DF, ESE, EVEP, ET, FXCM,GXP, PODD, LPI, LPR, MNKD, MPEL, MNST, NVDA, OREX,PCLN, PSA, SVNT, SODA, GEVA, TSLA, CG, THS, VRTU, VC,WR, WINEarnings: ARX, FOLD, BTE, BECN, CCXI, DDS, IAG SM, MGA,MCP, NCLH, QRE, RNDY, SGNT, SLW, SIRO
Relevant Sector ETFs
Double
Sectors
SingleDoubleDUGEnergyXLEDIGSMNMaterialsXLBUYMSIJIndustrialsXLIUXISCCDiscretionaryXLYUCCSZKStaplesXLPUGERXDHealth CareXLVRXLSKFFinancialsXLFUYGREWTechnologyXLKROMTelecomIYZSDPUtilitiesXLUUPW
SDSS&P 500SPYSSO
**Single beta ETFs based on SP500, Double Beta & Telecom on DJ Indicies. 
Positive BetaNegative Beta

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