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Global Equity Strategy

U.S. Sector Watch


Equity Research / North America

Movement Beneath the Surface November 22, 2010


Sam Stovall, Chief Investment Strategist

For the week ended November 19, the S&P 500 posted a 0.0% price change. The S&P 1500
Composite Index wasn’t much more active, as its weekly change was a gain of 0.1%. Indeed, only the
S&P MidCap 400 and SmallCap 600 Indices showed any signs of life, as they gained 0.8% and 0.2%,
respectively. What’s more, the movements were slight even on the sector level as all 10 sectors within
the S&P 1500 moved from as little as a decline of 0.8% for Financials to a gain of 1.0% for
Industrials. But well beneath the surface – at the sub-industry level – there was ample movement,
particularly as it relates to longer-term momentum trends.

Relative Strength Rankings


Of the 145 sub-industries in the S&P 1500 Composite Index (consisting of the S&P 500, MidCap 400
and SmallCap 600 Indices), 63, or 43%, saw movement in their relative strength ranking. Each week,
the S&P 1500 Sector Scorecard, found on MarketScope@ Advisor, shows price performances and
average STARS rankings for all sectors and sub-industries, as well as their relative strength ranking
(RSR). An “RSR” represents the index’s rolling 52-week price performance versus other sectors or
sub-industries, where an RSR of 5=Top 10%, 4=Next 20%, 3=Middle 40%, 2=Next 20%, 1=Bottom
10%. Over the long term, it has been shown that the groups with high RSRs have outperformed those
with low RSRs. Of course, past performance is no guarantee of future results.
Sam Stovall S&P 1500 Sub-Industries With Rising and Falling Relative Strength Rankings
Chief
Investment Strategist

212-438-9549 Sectors w ith High STARS and RSR Sectors w ith Low STARS and RSR
Rising Relative Strength Current Prior STARS Falling Relative Strength Current Prior STARS
sam_stovall@sandp.com Auto Parts & Equipment 5 4 4.6 Security & Alarm Services 2 3 2.0
Apparel, Acc., & Luxury Goods 5 4 4.5 Restaurants 4 5 2.9
Oil & Gas Equipment & Services 4 3 4.2 Diversified REITs 3 5 2.9
Construction & Engineering 3 2 4.1 Personal Products 3 4 3.0
Diversified Banks 2 1 4.0 Specialized REITs 3 4 3.1
General Merchandise Stores 4 3 4.0 Agricultural Products 2 3 3.3
Footw ear 5 4 4.0 Systems Softw are 2 3 3.3
Oil & Gas Exploration & Prod. 3 2 3.8 Household Appliances 3 4 3.3
Asset Mgmt & Custody Banks 3 2 3.8 Property & Casualty Insurance 2 3 3.4
Department Stores 3 2 3.5 Specialty Chemicals 3 4 3.4
Source: MarketScope Advisor

A Constructive Chart
Looking at the rolling 12-month relative price performance charts for the sub-industries listed above,
one that appears to be “constructive” is Construction & Engineering. Below is a rolling 12-month
relative strength chart of this S&P 1500 sub-industry versus the S&P Composite 1500 Index. The
jagged blue line represents the sub-industry index’s rolling 52-week price return as compared with the
52-week performance for the S&P 1500. Any point above 100 indicates market outperformance over
the prior year, while points below 100 indicate market underperformance. The red line is a rolling 39-
week moving average, while the blue and green bands indicate one and two standard deviations,
respectively, above and below the long-term mean.

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This report is for information purposes and should not be considered a solicitation to buy or sell any security. Neither Standard & Poor’s
nor any other party guarantees its accuracy or makes warranties regarding results from its usage. Redistribution is prohibited without
written permission. Copyright © 2010 by Standard & Poor’s Financial Services LLC. All rights reserved. “S&P”, “S&P 500”, and
“Standard & Poor’s” are registered trademarks of The McGraw-Hill Companies, Inc. “S&P MidCap 400” and “S&P SmallCap 600” are
trademarks of The McGraw-Hill Companies, Inc. All required disclosures and analyst certification appear on the last page of this report.
Equity Research /
North America

S&P 1500 Construction & Engineering Index versus the S&P 1500 as of 11/19/10
180
Above 100 = Sector out-performance vs. the broader market
160
+2 Std. Devs.

140

+1 Std. Dev.
120

39-Week Moving
100 52-Week Relative Average
Strength

80
-1 Std. Dev.
60

Below 100 = Sector under-performance vs. the broader market -2 Std. Devs.
40
Jun-06

Jun-07

Jun-08

Jun-09

Jun-10
Aug-06

Aug-07

Aug-08

Aug-09

Aug-10
Dec-05
Feb-06
Apr-06

Oct-06
Dec-06
Feb-07
Apr-07

Oct-07
Dec-07
Feb-08
Apr-08

Oct-08
Dec-08
Feb-09
Apr-09

Oct-09
Dec-09
Feb-10
Apr-10

Oct-10
Dec-10
Source: Standard & Poor’s Equity Research

S&P equity analysts follow five of the eight stocks in the Construction & Engineering sub-industry,
with four of the five having positive investment outlooks: Fluor Corp (FLR 58****), Jacobs
Engineering (JEC 40*****), Quanta Services (PWR 18****), and URS Corp (URS 41****). Chicago
Bridge & Iron Company (CBI 29****), a non-index component, is also viewed favorably. The
following is equity analyst Stewart Scharf’s most current sub-industry outlook.

“Our fundamental outlook for the construction & engineering sub-industry group remains positive, as
we expect bidding for new awards to gradually pick up during 2011, while pent-up demand for
delayed or postponed projects drives backlog growth. Crude oil prices have been rebounding ($85 a
barrel as of mid-November), remaining well above the $65 to $70 a barrel critical level for budgeted
projects. We see most major oil companies increasing their capital spending plans, especially for
upstream drilling and exploration projects in the Canadian oil sands, while a moratorium on deep-sea
drilling in the aftermath of the Gulf oil spill was recently lifted. Additionally, we think acquisition
activity should pick up due to lower borrowing rates and more attractive multiples.

“We believe several major C&E companies should benefit from power generation projects, including
coal-fired plants, oil & gas, and nuclear power plants. Meanwhile, in September 2010, President
Obama proposed a $50 billion infrastructure plan to rebuild roads, railways and airport runways,
while in July, Congress approved $45 billion of highway construction funds for FY 11 (Sep.), a 10%
rise from FY 10. Additionally, Congress is considering a new $450 billion transportation bill, while
the recent elections should have a positive effect on public as well as private infrastructure spending,
in our view. We expect transportation infrastructure spending to be aided in part by state and local
government bond issues. However, budget shortfalls are likely to continue due to lower tax revenues
resulting from high unemployment levels and the weak housing market. We believe new awards will
strengthen for clean fuels program-related projects as new emissions regulations go into effect in
2015. In our view, investments will strengthen in Latin America, Asia, Eastern Europe and the Middle
East, as most global C&E companies focus on developing regions.

“We still expect private-customer cautiousness to impact the timing for new awards. However, with
Standard and Poor’s valuations well below historical levels and long-term prospects seen as robust, we think this group
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Equity Research /
North America

will outperform the market over the next 12 months, led by those companies that are more geographic
and customer diverse. The group recently traded at 14X our 2011 EPS estimate, a modest premium to
the multiple for the S&P 1500. We project 15% EPS growth for 2011, while our 12-month relative
strength ranking remains below average.”

So there you have it. S&P believes there’s always an opportunity someplace. The Sector Scorecard
can help investors quickly identify potential opportunities based on underlying fundamentals (S&P
STARS) or changes in momentum. A few have been highlighted here, with one in particular –
Construction & Engineering – that appears to us to have favorable long term price performance
potential.

Standard and Poor’s


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Glossary

S&P STARS - Since January 1, 1987, Standard & Poor’s Equity Research Standard & Poor’s Equity Research Services – Standard & Poor’s Equity
Services has ranked a universe of common stocks based on a given stock’s Research Services U.S. includes Standard & Poor’s Investment Advisory
potential for future performance. Under proprietary STARS (STock Services LLC; Standard & Poor’s Equity Research Services Europe
Appreciation Ranking System), S&P equity analysts rank stocks according includes Standard & Poor’s LLC- London; Standard & Poor’s Equity
to their individual forecast of a stock’s future total return potential versus Research Services Asia includes Standard & Poor’s Investment Advisory
the expected total return of a relevant benchmark (e.g., a regional index Services (HK) Limited, and Standard & Poor’s LLC in Singapore, Standard
(S&P Asia 50 Index, S&P Europe 350 Index or S&P 500 Index)), based on & Poor’s Malaysia Sdn Bhd, and Standard & Poor’s Information Services
a 12-month time horizon. STARS was designed to meet the needs of (Australia) Pty Ltd.
investors looking to put their investment decisions in perspective.

S&P Quality Rankings (also known as S&P Earnings & Dividend Abbreviations Used in S&P Equity Research Reports
Rankings)- Growth and stability of earnings and dividends are deemed key CAGR- Compound Annual Growth Rate
elements in establishing S&P’s earnings and dividend rankings for common CAPEX- Capital Expenditures
stocks, which are designed to capsulize the nature of this record in a single CY- Calendar Year
symbol. It should be noted, however, that the process also takes into DCF- Discounted Cash Flow
consideration certain adjustments and modifications deemed desirable in EBIT- Earnings Before Interest and Taxes
establishing such rankings. The final score for each stock is measured EBITDA- Earnings Before Interest, Taxes, Depreciation and Amortization
against a scoring matrix determined by analysis of the scores of a large and EPS- Earnings Per Share
representative sample of stocks. The range of scores in the array of this EV- Enterprise Value
sample has been aligned with the following ladder of rankings: FCF- Free Cash Flow
A+ Highest B- Lower FFO- Funds From Operations
A High C Lowest FY- Fiscal Year
A- Above Average D In Reorganization P/E- Price/Earnings
B+ Average NR Not Ranked PEG Ratio- P/E-to-Growth Ratio
B Below Average PV- Present Value
R&D- Research & Development
S&P Issuer Credit Rating - A Standard & Poor’s Issuer Credit Rating is a ROE- Return on Equity
current opinion of an obligor’s overall financial capacity (its ROI- Return on Investment
creditworthiness) to pay its financial obligations. This opinion focuses on ROIC- Return on Invested Capital
the obligor’s capacity and willingness to meet its financial commitments as ROA- Return on Assets
they come due. It does not apply to any specific financial obligation, as it SG&A- Selling, General & Administrative Expenses
does not take into account the nature of and provisions of the obligation, its WACC- Weighted Average Cost of Capital
standing in bankruptcy or liquidation, statutory preferences, or the legality
and enforceability of the obligation. In addition, it does not take into Dividends on American Depository Receipts (ADRs) and American
account the creditworthiness of the guarantors, insurers, or other forms of Depository Shares (ADSs) are net of taxes (paid in the country of origin).
credit enhancement on the obligation. The Issuer Credit Rating is not a
recommendation to purchase, sell, or hold a financial obligation issued by Standard & Poor’s
an obligor, as it does not comment on market price or suitability for a 55 Water Street
particular investor. Issuer Credit Ratings are based on current information New York, NY 10041
furnished by obligors or obtained by Standard & Poor’s from other sources (212) 438-2000
it considers reliable. Standard & Poor’s does not perform an audit in
connection with any Issuer Credit Rating and may, on occasion, rely on
unaudited financial information. Issuer Credit Ratings may be changed,
suspended, or withdrawn as a result of changes in, or unavailability of, such
information, or based on other circumstances.

S&P Core Earnings - Standard & Poor’s Core Earnings is a uniform


methodology for adjusting operating earnings by focusing on a company’s
after-tax earnings generated from its principal businesses. Included in the
Standard & Poor’s definition are employee stock option grant expenses,
pension costs, restructuring charges from ongoing operations, write-downs
of depreciable or amortizable operating assets, purchased research and
development, M&A related expenses and unrealized gains/losses from
hedging activities. Excluded from the definition are pension gains,
impairment of goodwill charges, gains or losses from asset sales, reversal of
prior-year charges and provision from litigation or insurance settlements.

S&P 12 Month Target Price – The S&P equity analyst’s projection of the
market price a given security will command 12 months hence, based on a
combination of intrinsic, relative, and private market valuation metrics.

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Required Disclosures

S&P Global STARS Distribution


In North America The research and analytical services performed by SPIAS, S&P LLC,
As of September 30, 2010, research analysts at Standard & Poor’s Equity S&PM, and SPIS are each conducted separately from any other analytical
Research Services North America recommended 39.2% of issuers with buy activity of Standard & Poor’s.
recommendations, 52.5% with hold recommendations and 8.3% with sell
recommendations. Standard & Poor’s or an affiliate may license certain intellectual property or
provide pricing or other services to, or otherwise have a financial interest in,
In Europe certain issuers of securities, including exchange-traded investments whose
As of September 30, 2010, research analysts at Standard & Poor’s Equity investment objective is to substantially replicate the returns of a proprietary
Research Services Europe recommended 36.6% of issuers with buy Standard & Poor’s index, such as the S&P 500. In cases where Standard &
recommendations, 43.2% with hold recommendations and 20.2% with sell Poor’s or an affiliate is paid fees that are tied to the amount of assets that
recommendations. are invested in the fund or the volume of trading activity in the fund,
investment in the fund will generally result in Standard & Poor’s or an
In Asia affiliate earning compensation in addition to the subscription fees or other
As of September 30, 2010 research analysts at Standard & Poor’s Equity compensation for services rendered by Standard & Poor’s. A reference to a
Research Services Asia recommended 46.8% of issuers with buy particular investment or security by Standard & Poor’s and/or one of its
recommendations, 44.4% with hold recommendations and 8.8% with sell affiliates is not a recommendation to buy, sell, or hold such investment or
recommendations. security, nor is it considered to be investment advice.

Globally Indexes are unmanaged, statistical composites and their returns do not
As of September 30, 2010, research analysts at Standard & Poor’s Equity include payment of any sales charges or fees an investor would pay to
Research Services globally recommended 39.5% of issuers with buy purchase the securities they represent. Such costs would lower performance.
recommendations, 50.2% with hold recommendations and 10.3% with sell It is not possible to invest directly in an index.
recommendations.
Standard & Poor’s and its affiliates provide a wide range of services to, or
5-STARS (Strong Buy): Total return is expected to outperform the total relating to, many organizations, including issuers of securities, investment
return of a relevant benchmark by a wide margin over the coming 12 advisers, broker-dealers, investment banks, other financial institutions and
months, with shares rising in price on an absolute basis. 4-STARS (Buy): financial intermediaries, and accordingly may receive fees or other
Total return is expected to outperform the total return of a relevant economic benefits from those organizations, including organizations whose
benchmark over the coming 12 months, with shares rising in price on an securities or services they may recommend, rate, include in model
absolute basis. 3-STARS (Hold): Total return is expected to closely portfolios, evaluate or otherwise address.
approximate the total return of a relevant benchmark over the coming 12
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(Sell): Total return is expected to underperform the total return of a relevant Poor’s and/or one of its affiliates have had business relationships within the
benchmark over the coming 12 months, and the share price is not past year, please go to:
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expected to underperform the total return of a relevant benchmark by a wide services/articles/en/us/?assetID=1245187982940
margin over the coming 12 months, with shares falling in price on an
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Required Disclosures

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