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INTERNS’ FIELD GUIDE TO MACRO & MARKETS

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A REFRESHER TO INVESTING WITH A TOP-DOWN APPROACH U24

Congratulations on your summer internship, your new job, or your interest in refreshing
some of the basics of investing with a macro-focused mindset! This Field Guide will
introduce you to an assortment of investment topics, ranging from the basics of economic U24

data to more advanced topics like portfolio construction and factor positioning around the
business cycle. After reading this publication, you will likely have more questions than U24

answers. Our goal for this report is to demonstrate macro’s influence on investing and to
open the door to future discussions on the subject matter. Enjoy and good luck!
Cornerstonemacro.com/FieldGuide
U24
Chapter 1 Chapter 2 Chapter 3 Chapter 4 Chapter 5

The Flavors Of Leading Understanding Sectors & Country/Index

Economic Data Indicators Size & Style Industries Allocation

Pages 3-4 Video Pages 5-6 Video Pages 7-8 Video Page 9 Video Page 10 Video

Chapter 6 Chapter 7 Chapter 8 Chapter 9 Chapter 10

Factor Dividend Portfolio Macro Aware
U24 Valuation
Themes Investing Construction Tool Suite

Pages 11-12 Video Page 13 Video Pages 14-16 Video Page 17 Video Page 18 Video

MichaelKantrowitz,CFA StephenGregory EmilyNeedell,CFA JustinBrant JoeRamirez,CFA

(212) 257-4971 (212) 257-4972 (212) 257-4974 (212) 257-4973 (212) 257-4975
mkantrowitz@cormacteam.com sgregory@cormacteam.com eneedell@cormacteam.com jbrant@cormacteam.com jramirez@cormacteam.com
Copyright 2020 Cornerstone Macro. All rights reserved. This report is prepared exclusively for the use of Cornerstone Macro clients and may not be
redistributed, retransmitted or disclosed, in whole or part, or in any form or manner, without the express written consent of Cornerstone Macro.

June 16, 2020 CornerstoneMacro.com 1

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 2020 FIELD GUIDE
INTRO: MACRO MATTERS PORTFOLIO STRATEGY

THE IMPORTANCE OF MACRO

Macro forces play an enormous role in financial markets. Our analysis suggests that roughly 70%
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of a stock’s movement can be explained by the “big-picture” story, while company-specific

U24 idiosyncrasies only explain about 30%. Meanwhile, most investors on Wall Street are trained with
a bottom-up mindset which can lead to a lot of confusion when macro forces take over markets.
Macro Plays A Huge Role In Explaining Market Moves
Stock Price Explained By Macro CFA Level 1 Topics
U24

100% U24
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90%
Economics
80% 10% U24

70%

60%
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50%

40% Macro Forces Explain The

30% Bulk Of Market All Other Material
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20% Movements 90%

10%

0% CFA Material Hardly Scratches

1995 1998 2001 2004
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2007 2010 2013 2016 2019 The Macro Surface …
Average % Of Stock Price Change Explained By Market, Sector & Industry
(S&P 500 Equal Weighted)

You may have heard that a great company is not always a great investment. This discrepancy can
often be explained by the macro backdrop. For example, investors are often attracted to different
investments during economic recoveries vs economic contractions. That’s why some of the best
companies do not outperform every year, despite consistently strong fundamentals.
Outperformance Is Never Guaranteed, No Matter What You Think You Know
Even The “Winningest” Stocks What If You Could
Don’t Always Outperform Know Future Growth
(i.e. Crystal Ball)
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019

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MSFT
20142013
20152014
20162015
20172016
20182017
20192018
2019

AAPL
AMZN
GOOG
FB
56.6%
% Of Stocks That
Outperform If You
Underperforms
If You Could See The Future And Buy Only The Knew Future Growth
Top 10% Of Future Growers, Only 56.6% Of
Outperforms
Those Companies Would Outperform.
Study From ‘90 - Present
Annual Sales Growth

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2020 FIELD GUIDE
CHAPTER 1: ECO DATA U24
PORTFOLIO STRATEGY

THE 3 FLAVORS OF ECONOMIC DATA

If you’ve studied financial statement analysis, you know that there is a lot of data! There is even U24

more macro data and understanding which data is most influential for markets is paramount to
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success. On balance, leading economic indicators are more important for markets given investors’
forward-looking behavior and are also the most difficult to forecast. Coincident and lagging
indicators serve more as confirmation than market-moving information.

1st Leading Indicators 2nd Coincident Indicators 3rd Lagging Indicators

U24 •Personal income less transfer •C&I loans

•Stock prices - S&P 500
•Mfg weekly hours
•Initial claims
•Manufacturers' new orders,
consumer goods,
•ISM Index of New Orders
•New orders, nondefense capital
goods ex. air
•Building permits
•Leading Credit Index
•Yield Curve
•Consumer Sentiment
payments •Change in CPI for services
•Manufacturing and trade sales •Average duration of U24
•Industrial production unemployment
•Employee payrolls U24 •Change in labor cost
•GDP •Ratio of consumer installment
credit to personal income
GDP PRIME •Ratio of mfg and trade
RATE inventories to sales
STOCK MARKET •Average prime rate
AND PMIS
Leading Indicators Peak BEFORE
Coincident & Lagging Indicators

CEIS PEAK NEXT LAGGING

U24
U24 INDICATORS PEAK
Leading Indicators Tell LEIS PEAK
FIRST 1st 2nd 3rd LAST
You Where Coincident U24
12-24
6-12 MONTHS
And Lagging Data Is LATER MONTHS
AFTER LEIS
Headed
Source:
The Conference Board Leading
Economic Index® for the United States Leading Coincident Lagging Time
(LEIs) (CEIs) Indicators

While financial markets are thought 70%

to be forward-looking, the reality is 50% 60

that stocks move with leading
indicators. The chart of the S&P 500 30%
55
and the Global Manufacturing PMI 10%
is one way to illustrate how macro 50
explains market returns. If you can -10%

figure out where leading indicators -30%

45

are headed, you’ve answered one

-50% 40
of the most important questions. 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
S&P 500 YoY % Chg (L) Global Manufacturing PMI (R)

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 Continued
2020 FIELD GUIDE
CHAPTER 1: ECO DATA PORTFOLIO STRATEGY

HOW DOES THE ECONOMY RESPOND TO CHANGES IN MONETARY POLICY?

While forecasting the business cycle will always be a challenging task, the way the economy reacts U24

to policy trends is consistent. Economic recoveries begin with the lagged effects of lower interest U24

rates showing up first in the extremely “rate-sensitive” housing sector. This is often followed by a
broader improvement in other sectors, a rebound in company profits, and eventually stronger
employment trends. If the economy becomes VERY strong, sometimes inflation rears its ugly head.
This is often a backdrop best described as an economy that is in the “late” part of the cycle. U24

Stimulus Shows Up In Leading Indicators First, Then Eventually Everywhere Else

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STIMULUS DEMAND PICKS UP PROFITS RECOVER PEOPLE ARE HIRED INFLATION PICKS UP

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U24

-24
Earliest

-23
-24 MONTHS

-22
-21
-20
-19
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-18
-17
-16
-15
-14
-13 U24
-12
-11
-10
-9
-8
-7
-6
H OUSING
-5

O
-4
-3
-2 RDERS
MONTHS

-1
0

P
1
2
3 U24
4 ROFITS
5
6
7
8
9
10
E MPLOYMENT
11
12
13
14
15
16
+24 MONTHS
Latest

17
18
19 . HEAT MAP SHOWS THE RESULTS OF CORRELATION ANALYSIS
20
21
BETWEEN CHANGE IN FED TIGHTENING CYCLE AND PEAKS IN
22 DATA.
23
24
Last Series To Inflect
Earliest
Consumer NO

Manufacturing

Cap Goods
Confidence

Production
Industrial

Core CPI
Personal
Payrolls
ISM NO
Permits

Income

Claims

Indicators
NAHB

Sales

AWH

To Turn

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2020
U24 FIELD GUIDE

CHAPTER 2: PMIS PORTFOLIO STRATEGY

PURCHASING MANAGERS INDICES (PMIS) ARE A TYPE OF LEI

PMIs fall under the umbrella of Leading Economic Indicators and they are our favorite type of LEI
to use due to their high correlation with earnings. There are several PMIs out there (ISM
Manufacturing Index, Markit US PMI, Global PMI, etc. ) with different regions of focus and slightly
different methodologies, but the concept is the same. These Manufacturing PMIs are monthly
surveys of Purchasing Managers. The participants are asked if things are better, the same, or worse
than the prior month and the index is calculated as a diffusion index.
PMIs Are A Proxy Of Earnings
Leading Indicators 65
75%
•Stock prices - S&P 500 60
65%
•Mfg weekly hours
•Initial claims 55 55%
•Manufacturers' new
45%
orders, consumer goods, 50
•ISM Index of New Orders 35%
(PMI) 45
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•New orders, nondefense U24 25%
capital goods ex. air 40
15%
•Building permits
•Leading Credit Index 35 5%
1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
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•Yield Curve
•Consumer Sentiment
ISM Mfg. Index (L) S&P 500 Company Positive EPS Revisions (Up/Total, IBES, R)

Companies are
asked about
What Is The ISM Purchasing Manager Index (PMI)? Weight month-over-
ISM month changes
• New Orders Reflects the levels of new orders from customers. 20% in these
Manufacturing PMI
indicators.
Monthly • Production Measures the rate and direction of change, if any, They can
20%
survey of a in the level of production. respond
U24 with
committee of Reports the rate of increase or decrease in the
• Employment 20%
purchasing level of employment. Higher
and supply
executives
• Supplier Reveals if deliveries from suppliers are faster or
Deliveries slower. 20% Same
across the U24

country. Reflects the increases and/or decreases in Lower

• Inventories 20%
inventory levels.

What Does The PMI Tell Us About Growth?

“A PMI® index over 50 represents growth or expansion within the Fundamental analysts consider
manufacturing sector of the economy compared with the prior the same exact information when
month. A reading under 50 represents contraction, and a reading at carrying out channel checks!
50 indicates an equal balance between manufacturers reporting
advances and declines in their business.”
Source: Institute for Supply Management - PMI Frequently Asked Questions

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 Continued
2020
U24 FIELD GUIDE

CHAPTER 2: PMIS PORTFOLIO STRATEGY

How Do We Forecast Leading Indicators?

Forecasting the ebb and flow of the business cycle (i.e. PMIs and earnings) involves
understanding how and why there are cyclical trends. Our take is that the cycle is largely a
reflection of the amount of “stimulus” or “tightening” in the system. We refer to stimulus and
tightening in a broad sense; for example, stimulus refers to a decline in the cost of money (i.e.
lower rates) or the cost of goods (i.e. falling commodity prices, wages, etc. )
Which Macro Measures Help To Forecast The Business Cycle?

Cost Of Money Cost Of Goods

Fed Funds / Short Rates Prices Paid Indices
Oil Prices Wages
Money Supply Yield Curve

Prime Rate U24 Long-Term Import Prices

U24 Industrial
Rates (Currencies) Commodities
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Two important lessons we’ve learned from studying history are 1) it is the change and not the
level of the cost of money/goods that is useful for forecasting the business cycle and 2) it takes
many quarters for this stimulus/tightening to have an impact on PMIs/Earnings. Below we show
two of our favorite charts. The chart on the left shows the change in 10-yr interest rates,
inverted and advanced 18 months. By inverting and advancing the bond yield series, we are
showing that a decline in rates takes 18 months to provide a boost to PMIs and vice versa when
rates rise.
Changes In the Cost Of Money & The Cost Of Goods Can Be Used To Forecast PMIs U24

75 Cost Of Money -4 70 20
Cost Of Goods
70 -3 30
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65
65 40
-2
60 60
-1 50
55
0 55 60
50
1 70
45 50
2 80
40
Covid 45
35 3 Covid 90

30 4 40 100
1997 2000 2003 2006 2009 2012 2015 2018 2021 2010 2012 2014 2016 2018 2020 2022
ISM Manufacturing New Orders Index (L) ISM New Orders (L) ISM Prices Paid (Inverted, Advanced 15m, R)
10-Year Yield (Inverted, 2-Year Chg, Adv 18m, R)

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 U24

2020 FIELD GUIDE

CHAPTER 3: SIZE & STYLE PORTFOLIO STRATEGY

THERE IS A SPECTRUM OF CYCLICALITY ACROSS SIZE & STYLE BOXES

When it comes to size and style boxes, Large Cap Growth (LCG) is the most defensive of them all
whereas Small-Cap Value is the most cyclical. This is can be shown with factor characteristics – For
U24

example, LCG has the lowest beta, highest ROE and lowest debt/equity ratio whereas Small Cap U24

Value is at the opposite extreme. U24

The Smaller And More Value-Oriented …. The More Cyclical!

CYCLICALITY SPECTRUM BETA U24
Value Core Growth Value Core U24
Growth

Large More Cyclical LEAST Large

CYCLICAL 1.02 1.00 0.98

Mid
1.27 1.19 1.12
More Cyclical
Mid

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Small MOST
CYCLICAL
Small 1.29 1.22 1.17

Another way to think about the cyclicality of size and style boxes is to look at the % of each
universe with negative earnings. The smaller and more value-oriented you are, the larger the % of
nonprofitable stocks. Stocks with weaker fundamentals (i.e. smaller and value) are more sensitive
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to swings in the business cycle.

Size – Small Caps Most At Risk Style – Value Most At Risk
40% 30%
% Of Stocks With Negative Earnings % Of Stocks With Negative Earnings
35%
25%
30%
Small 20%
25%

20% 15%
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15% Mid Value
10%
10%
5%
5%
Large Growth
0% 0%
1995 1998 2001 2004 2007 2010 2013 2016 2019 2022 1995 1998 2001 2004 2007 2010 2013 2016 2019 2022

500 400 600 500 Value 500 Growth

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 Continued
2020
U24
FIELD GUIDE
U24
CHAPTER 3: SIZE & STYLE PORTFOLIO STRATEGY

AFTER DECADES OF VALUE LEADERSHIP, STRUCTURAL TRENDS NOW FAVOR GROWTH

Most of today’s textbooks were written for a world that no longer exists. The ”Value Bubble” was
U24
a decades-long period where rising debt, globalization, and China’s investment boom led to strong
growth and persistent value leadership. This Value Bubble peaked in the late 2000s when global
leveraging peaked and growth rates slowed. Since the great financial crisis (2008), the rate of
growth around the world has been slowing and there are fewer and fewer stocks with strong
revenue growth. Since then, investors have been paying up for growth where they can find it. This
has led to a sustained period of growth-stock leadership. In this new world, the time for value to
shine is during periods of strong economic recoveries. These periods have been few and far
between.
We’ve Gone From A World Of FUEL FOR VALUE BUBBLE
Buy & Hold Value To Buy & Hold Growth BETWEEN 1982 - 2007 U24
5,100 110%

4,600 Lower Rates

Consumers’ Appetite For Debt 100%
4,100 Created An Earnings Bubble
90%
(i.e. Value Tailwind) … U24

3,600 Lower Inflation

80%
3,100
70%
2,600 Consumer
60% Debt Boom
2,100
50%
1,600
… Since 2009 Less 40% Globalization
1,100
Consumer Leverage Has
600 Made Growth More Valuable 30%
China Investment
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100 20% Boom

1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 2006 2011 2016 2021

Value Relative To Growth (FamaFrench Data, L) U.S. Consumer Debt To GDP (%, R)

Value vs. Growth Boils Down To Supply And Demand

# Of Stocks With Topline Growth >!5%

1.25 275
Investors paying
Growth P/E Relative To Mkt

up for growth.
1.15 225
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1.05 175
U24

0.95 125

0.85 75
Growth becoming
increasingly scarce.
0.75 25
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Growth NTM P/E Relative To S&P 500 (L)
# Of S&P 500 Stocks With Topline Growth Greater Than 15% (5Yr,R)

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 2020
U24
FIELD GUIDE
CHAPTER 4: SECTORS PORTFOLIO STRATEGY

A GUIDE TO SECTOR ROTATION AROUND THE BUSINESS CYCLE

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Sector selection on its own can be daunting – which sectors should you overweight/underweight
and when? However, when placing sector selection in the context of the macro business cycle, the
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picture gets clearer. As shown below, more “cyclical” or “risk-on” sectors tend to outperform when
the business cycle is picking up, whereas more “defensive” or “risk-off” sectors are preferred in
downturns.
Sector Rotation Around The Business Cycle
Growth
Media Internet Retail
HLC Tech
Chemicals Pharma Consumer Services
Leisure Biotech
Hardware
Transportation Discretionary Software
U24
Energy Equip Insurance
Metals Tech Comm Svcs Commercial Services
Div Financials
Industrials REITS
Semis Health Care
Durables Household
U24 Products
Capital Goods Materials Staples
Banks Staples Retail
Oil & Gas E&P Financials Electric Utils
Real Estate
Oil & Gas Drilling Gas Utils
Autos
Energy -- Cyclical Sectors Utilities
Housing
-- Growth Sectors
-- Stability & Defense

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How can we quantitatively measure how cyclical or defensive a sector is? One way is to look at the
beta of the stocks within each sector. Beta measures how sensitive a stock is to the overall market.
As shown below, the risk-on sectors have higher median betas and a larger range of betas than the
risk-off sectors.
There Is A Spectrum Of Cyclicality Amongst Sectors
Energy
Most Cyclical
ENE
(i.e. High Beta)
Materials MAT
Industrials U24
IND
Financials FIN
U24 Technology TECH
Comm Srvcs CS
Discretionary DIS
Health Care HC
Staples STA
Real Estate RE
Most Defensive Utilities UT -σ
1
Median
Median
+σσ
1
σ
(i.e.0.2
Low Beta) 0.4 0.0 0.2
0.6 0.4 0.8 0.6 1.0 0.8 1.0
1.2 1.2 1.4 1.4 1.61.6

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2020 FIELD GUIDE
CHAPTER 5: COUNTRY SELECTION PORTFOLIO STRATEGY

INDEX COMPOSITION IS A MAJOR DRIVER OF COUNTRY INDEX PERFORMANCE U24

Composition plays a key role in index performance and is an important element to consider when
selecting countries to invest in. Below we show how the composition of the S&P 500 has gotten
less cyclical over time and that it is now at an all-time low. It is important to remember that the
composition of an index can change its factor attribution. At the bottom of the page, we sort the
developed and emerging markets (iShares ETFs) by their cyclical weights.
What's Behind An Index Changes Over Time And Varies Drastically Across Countries
80% 80%

70% 70%

60% 60%
The S&P 500 Today
U24
50% 50% Looks Nothing Like It

Did 5, 10 Or 20 Years Ago U24

40% 40%

30% 30%

20% U24 20%

1925 1935 1945 1955 1965 1975 1985 1995 2005 2015 2025
Growth, Stability and Defense (Tech, Comm. Health Care, Staples, Discretionary, Utilities, REITs)
Cyclicals (Financials, Industrials, Materials and Energy)

Developed Emerging
Markets Growth, Markets Growth,
Symbol Cyclicals Stab. & Def. U24 Symbol Cyclicals Stab. & Def.
US Nasdaq QQQ 6 94 Philippines EPHE 30 70
New Zealand ENZL 18 84 Least China MCHI 30 69
US S&P 500 SPY U24 29 71 Cyclical South Korea EWY 34 67
Netherlands EWN 28 71 Taiwan EWT 34 66
Japan EWJ 34 66 Mexico EWW 34 66
Switzerland EWL 34 66 Thailand THD 47 53 U24

Israel EIS 33 67 South Africa EZA 50 49

Germany EWG 41 59 Chile ECH 45 55
France EWQ 44 56 Malaysia EWM 49 50
Hong Kong EWH 46 53 India INDA 50 48
Spain EWP 50 46 Indonesia EIDO 57 42
UK EWU 49 51 Poland EPOL 56 44
Italy EWI 56 44 Turkey TUR 62 39
Norway ENOR 57 43 UAE UAE 62 38
Ireland EIRL 62 35 Brazil EWZ 65 35
Australia EWA 66 34 Qatar QAT 77 21
Peru EPU 81 21
Sweden EWD 69 30 Most
Canada EWC 71 30 Colombia ICOL 81 19
Cyclical Russia ERUS 88 13
Austria EWO 76 24

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2020 FIELD GUIDE
CHAPTER 6: FACTORS PORTFOLIO STRATEGY

FACTOR LEADERSHIP CHANGES WITH THE MACRO BACKDROP

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Similar to sector selection,

factor selection can be aided by
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Risk-On Risk-Off
putting it in the context of the Phases Phases
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business cycle. But first, what
are factors? A factor is a
characteristic common to a
group of stocks. To invest in a
factor means to choose stocks Investors’
that all have relatively similar Preferences
measurements for that Change Around
characteristic. For example, The Market Cycle
investing in high Earnings Yield
means to target a basket of U24

stocks that all have relatively

high earnings yields compared
to their peers. On this page, we
Recovery U24
Expansion
show how factor leadership Period of strong market
Period of strongest
tends to change around the returns and narrowing
returns led by strong
business cycle. Generally, riskier P/E expansion leadership.
factors like “high beta” tend to
outperform during the recovery Factor Leaders: Factor Leaders:
portion of the cycle while more Low P/E NTM High Book Yield
defensive factors like strong U24
High Beta Low P/E NTM
profitability or interest coverage High Dispersion High Momentum
do relatively better later in the
cycle.

Quality Growth Trough

Average returns are Returns are typically still Returns are typically
positive but low led by positive, but EPS growth negative with BOTH EPS
EPS growth. begins to slow materially. and P/E falling.

Factor Leaders: Factor Leaders: Factor Leaders:

High FCF Yield High P/Book Low Debt to Equity
High Div Yield High Momentum High Momentum
Low EPS Variance High ROIC High Interest Coverage

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 Continued
2020 FIELD GUIDE
CHAPTER 6: FACTORS PORTFOLIO STRATEGY

FACTOR LEADERSHIP IS NOT BOUND BY SIZE, STYLE OR SECTOR

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It is important to note that factor leadership around the business cycle generally holds no matter
what universe of stocks you look at. A small-cap investor should expect higher beta names within
the S&P 600 to outperform lower beta names in the same benchmark during a cycle recovery, just
U24

as a large-cap investor would expect the same relative performance within the S&P 500. The same
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can be said for value vs. growth investors or sector-specific investors. Below we show how a
handful of factors have performed similarly over time in the growth and value universes.

Factor Leadership Is If A Theme Isn’t

Not Bound By Size,
Style Or Sector Labels
& Working Everywhere It
Isn’t Actually Working!

Book Yield In Growth & Value Momentum In Growth & Value

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105.96 127.9 Value
102.2 Growth 137.45
100.96 122.9
92.2 127.45
95.96 117.9 U24

82.2 90.96 112.9 117.45

Value 85.96 107.9

107.45
72.2
80.96 102.9
62.2 97.45
75.96 97.9 Growth
52.2 70.96 92.9 87.45
Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20

Book Yield High Relative To Low (S&P 500 Value) U24

Momentum High Relative To Low (S&P 500 Growth)
Book Yield High Relative To Low (S&P 500 Growth) Momentum High Relative To Low (S&P 500 Value)

LT Growth In Growth & Value Profitability In Growth & Value 125

119.25 148.2
155.2 120
Value
114.25 138.2 115
145.2
110
135.2 109.25 128.2 Growth
105

125.2 Growth 104.25 118.2 100

95
115.2 99.25 108.2
90
105.2 94.25 98.2 Value
85

95.2 89.25 88.2 80

Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20

Long-Term Growth High Relative To Low (S&P 500 Growth) ROA High Relative To Low (S&P 500 Value)
Long-Term Growth High Relative To Low (S&P 500 Value) ROA High Relative To Low (S&P 500 Growth)

Factor Performance Is All Shown Sector Neutral

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2020 FIELD GUIDE
CHAPTER 7: DIVIDEND INVESTING
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PORTFOLIO STRATEGY

HIGH DIVIDEND YIELD IS A CYCLICAL FACTOR

Dividend/income strategies have been around for a very long time but have become increasingly
popular in the low interest rate environment of today. While dividend stocks provide income, that
does not make them defensive overall. In aggregate, high dividend paying stocks are highly cyclical.
U24
U24
High Dividend Yield Is A CYCLICAL Factor
305 585
295 Risk-Off Risk-On
565
285 Factors Factors
545
275
525
265
505
255
485
245 U24

U24 465
235
225
Overall, High-Dividend 445

215
Stocks Are Very Cyclical 425

205 405
Jan-10 Jan-12 Jan-14 Jan-16 Jan-18 Jan-20 Jan-22
60m Correlation
Dividend Yield High Relative To Low (S&P 500, L)
Factor Performance
Earnings Yield High Relative To Low (S&P 500, R) S&P 500, 2010-2020

Dividend ETFs Typically Have Huge Sector Biases

UT iShares Select 26.1% UT SPDR S&P Dividend 9.2%
SECTOR BIASES RELATIVE TO

Dividend

SECTOR BIASES RELATIVE TO

MAT 5.0% STA 9.0%
DIS DVY 1.4% MAT
SDY 9.8%
ENE 2.3% FIN 6.6%
Overweight
S&P 500

S&P 500
FIN 0.7% DIS 0.8%
Big UT U24 Staples & UT
STA 1.5% ENE 4.1%
COMM
Overweight
-3.2% COMM -2.7%
RE -3.0% RE 1.2%
IND -2.5% IND -7.1%
HC -13.2% Beware Of Sector Biases U24
HC -8.2%
TECH -15.3%
In Dividend ETFs TECH -22.9% U24
-20% -15% -10% -5% 0% 5% 10% 15% 20% 25% 30% -25% -20% -15% -10% -5% 0% 5% 10% 15%
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IND Vanguard Dividend 12.3% STA Vanguard High 8.4%

Appreciation
SECTOR BIASES RELATIVE TO

Dividend Yield
SECTOR BIASES RELATIVE TO

STA 10.1% FIN 4.4%

UT VIG 2.9% UT VYM 6.4%
MAT 2.0% ENE 2.9%
S&P 500
S&P 500

DIS -0.3% Overweight MAT 1.2%

HC -2.0% HC
Industrial Overweight 1.7%
RE -3.0% IND -0.8%
Staples & UT
ENE -2.9% COMM -2.9%
FIN -4.1% RE -3.0%
TECH -7.8% DIS -5.2%
COMM -7.2% TECH -13.1%

-10% -5% 0% 5% 10% 15% -15% -10% -5% 0% 5% 10%

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 U24

2020 FIELD GUIDE

CHAPTER 8: VALUATION PORTFOLIO STRATEGY

VALUATION IS A POOR MARKET-TIMING TOOL U24

You’ve probably heard it many times on CNBC… market commentators opining on the valuation of
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the equity market as a reason to be more bullish or bearish! Funny thing is that valuation,
measured in nearly every way possible (i.e., P/E, Fed Model, CAPE, Rule of 20, etc.), is a horrible
timing tool and shows little to zero evidence of forecasting returns over a 12-month period.
Below, we show two examples using Shiller’s popular CAPE as well as the so-called “Fed Model.”
As you can see, there is basically no correlation between the level of these respective valuation
measures and future returns. This makes us question whether valuation should be a reason to be
bullish or bearish at all – the math suggests not. Valuation, in our view, is always a condition and
not a catalyst. In other words, stocks don’t fall because they are expensive, nor do they rise
because they are cheap. Macro catalysts, such as a slowdown in earnings or a strong recovery in
leading indicators better explain the direction of stocks, regardless of valuation levels. Lastly,
expensive markets aren’t always overvalued and cheap markets aren’t necessarily a “good deal.”
Shiller CAPE vs.
CAPE Model – Stocks Are “Expensive” 12m S&P 500 Forward Returns
50 50x
45 45x
40
Expensive ??? 40x
35 U24 Not An 35x
30 Effective 30x
25 Forecasting 25x
20 Tool For 20x
15 Market 15x
10 Returns 10x
5
5x No Correl
0
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 2020
0x With Future
-60% -40% -20% 0% 20% 40% 60%
Cycically Adjusted CAPE Ratio (Shiller) Returns
Fed Model vs.
12m S&P 500 Forward Returns
Fed Model – Stocks Are “Cheap”
4%
4%

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2% Cheap ??? 2%
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Not An 0%
0%
Effective
-2% Forecasting -2%
Tool For
-4% Market -4%
Returns
-6% -6%
No Correl
-8% -8% With Future
1985 1990 1995 2000 2005 2010 2015 2020 2025 -60% -40% -20% 0% 20% 40% 60%
Fed Model (10yr Treasury Yield - S&P 500 Earnings Yield)
Returns

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 26x
Continued
2020 FIELD GUIDE
CHAPTER 8: VALUATION
1990s 22x
PORTFOLIO STRATEGY

1980s
VALUATION REQUIRES A DYNAMIC APPROACH 18x

PE
Throughout history, there has been a wide variation14xin the level of the market’s P/E. We’ve also
seen how some relationships with P/Es have changed. One example is looking at the level of
10x
interest rates and P/Es. While it’s often taught that lower interest rates lead to higher P/Es, history
suggests that is not always the case. When rates are6xhigh and falling, P/E usually rises. However,
lower rates is usually a bad thing when it’s a result of a growth
1970s slowdown or deflation risks. The
2x
point here is that drivers of valuation change over time!4% 6% 8% 10% 12% 14% 16%
Sometimes
26x PEs & Rates Sometimes PEs & Rates Have
10-Year Treasury Bond Yie ld vs. S&P 500 NTM P/E
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Have A22x Negative Correlation

1990s A Positive Correlation
26x U24 26x

18x 1980s
1990s 22x

PE
22x IN HIGH –RATE REGIMES,
14x U24
2000s
1980s HIGHER RATES ARE A RISK SO
18x 18x

PE
10x P/ES TYPICALLY DECLINE

PE
14x
IN HIGH –RATE REGIMES,
WHEN RATES RISE.
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14x 6x
From: “You Didn't Learn1970s
About This In Your HIGHER RATES ARE A RISK SO
10x 2x
Valuation Textbook” Report Link
4% 6% 8% 10% 12% 14% 16%
10x BOND YIELD P/ES TYPICALLY DECLINE
WHEN RATES RISE.
6x 10-Year Treasury Bond Yie ld vs. S&P 500 NTM P/E 6x 1960s
1970s 26x 1950s
2x
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2x
1%
B2%
OND YIELD
3% 4% 5% 6% 7% 8%
4% 6% 8%
22x 10% 12% 14% 16%
2000s
10-Year Treasury Bond Yie ld vs. S&P 500 NTM P/E 10-Year Treasury Bond Yield vs. S&P 500 NTM P/E
18x
PE
PE

26x
IN HIGH –RATE REGIMES, IN LOW –RATE REGIMES,
14x
HIGHER RATES ARE A RISK SO
LOWER RATES ARE A RISK SO
22x 10x U24
P/ES TYPICALLY
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DECLINE
P/ES TYPICALLY DECLINE
2000s WHEN RATES RISE.
18x
6x 1960s WHEN RATES FALL.
PE

2x 1950s
% 16% 14x
BOND YIELD
1% 2% 3% 4% 5% 6% 7% 8%
BOND YIELD
IN LOW –RATE REGIMES,
10-Year Treasury Bond Yield vs. S&P 500 NTM P/E LOWER RATES ARE A RISK SO
With An Ever-Changing Macro Backdrop The Average P/E Depends On
10x
P/EYour Starting
S TYPICALLY Point
DECLINE
20.0
6x 1960s WHEN RATES FALL.
30 19.5

2x 1950s 19.0 Average S&P

BOND 500
YIELD
PE

25 1% 2% 3% 4% 5% 6% 7% 8% P/Es, starting from …

18.5
IN LOW –RATE REGIMES,
10-Year Treasury Bond Yield vs. S&P 500 NTM P/E 18.0 U24
20 LOWER RATES ARE A RISK SO
17.5
P/ES TYPICALLY DECLINE
15 17.0
WHEN RATES FALL.
16.5
10 BOND YIELD 16.0
7% 8%
15.5
P/E
5
15.0
1955 1965 1975 1985 1995 2005 2015 2025
Full History 1960 1970 1980 1990 2000 2010
S&P 500 Trailing P/E (1960 -
2020) S&P 500 Trailing P/E

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 Continued
2020 FIELD GUIDE
CHAPTER 8: VALUATION
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PORTFOLIO STRATEGY

THE RIGHT WAY TO USE VALUATION

Valuation is often a reason for investors to purchase individual stocks too. We’ve found that
evaluating a stock’s valuation relative to its peers, rather than to its own long-term average, is a
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far more profitable way to use valuation. Just like we showed for the overall equity market on
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page 15, time series valuation isn’t a useful tool for generating profits. The bar charts below
illustrate the results of backtests using valuation in three different ways. As you can see, the only
one that demonstrates monotonic performance is when using valuation cross-sectionally.
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Questions To Answer When Comparing
A Stocks Current Multiple To … Comparing Multiple
… Peak Multiple
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… Average To Current Peers

Is The Company The Same 2.0 100%
And Has The Competitive Multiple 1.5 90%
Landscape Changed? What Is The 80%
1.0
… Trough Multiple Outlook For The 62% 60%
70%
Industry; Has
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It 0.5
56% 60%
Was The Economic
Changed Or 0.0
46%
50%
Backdrop The Same?
Will It? 35% 40%
-0.5
Effective
30%

✓
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-1.0
20%
-1.5 10%
Average -2.0 0%
1 2 3U24 4 5
S&P
12 Month Excess Performance (L) Basket Hit Rate (R)
1500

Comparing Multiple Comparing Multiple To

To Cycle Average U24
Long-Term Average
2.0 100% 1.5 100%

1.5 90% 90%

1.0
80% 80%
1.0 67% 68%
64% 70% 0.5 70%
63%
0.5 54% 60% 52% 60%
0.0
0.0 50% 44% 50%
41% 41% 39%
-0.5
-0.5 40% 40%
Not Effective Not Effective

 
30% -1.0 30%
-1.0
20% 20%
-1.5 -1.5
10% 10%
-2.0 0% -2.0 0%
1 2 3 4 5 1 2 3 4 5
S&P S&P
12 Month Excess Performance (L) Basket Hit Rate (R) 12 Month Excess Performance (L) Basket Hit Rate (R)
1500 1500

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 2020 FIELD GUIDE
CHAPTER 9: PORTFOLIO MGMT U24
PORTFOLIO STRATEGY
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BEWARE OF SECTOR BIASES & THE IMPORTANCE OF PORTFOLIO SIZE

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Portfolio management is very much about how you construct a portfolio. Outperforming
portfolios can quickly become underperforming ones if risk is not effectively managed and more
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importantly, understood. If an investor does not have a firm grasp of their portfolio's exposures
(sector, geographic, size etc.) they may not understand why their portfolio is outperforming or
underperforming. In the end, it is hard to fix something if you don’t know what is wrong with it.
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Sectors Have Very Different Fundamentals And Very Different Weights In Indices
22 Sector Fundamentals 28%

20
Are Not Comparable 26%
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24% Tech Makes Up The
18
22%
Lion’s Share Of Large
16
Caps But Not Small Caps
20%

14 18%
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16% U24
12
14%
10 Financials consistently has a 12%
lower P/E than Utilities,
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8 10%
2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 S&P 500 S&P 400 S&P 600
Tech Wgt Tech Wgt Tech Wgt
Utilities Sector PE NTM Financials Sector PE NTM

Often investors and consultants misrepresent when you should have a concentrated portfolio
and when you should increase diversification. When correlations are high you want to have
more stocks in your portfolio in order to be diversified and when correlations are low you want
to have a more concentrated portfolio.
High Correlations Mean More Stocks Should Be In Your Portfolio, Not Less
0.85

When Correlations  189.1

0.75
More Stocks Are Needed To
169.1 0.65
Maintain Diversification
0.55
149.1

0.45
When Correlations  129.1
0.35
Less Stocks Are Needed To
109.1
Maintain Diversification 0.25

89.1 0.15
1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020

150 Stock Portfolio Relative To 50 Stock (Lowest PE, L) S&P 500 Avg Stock Correlation (R)

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 U24

2020 FIELD GUIDE

CHAPTER 10: MACRO AWARE TOOLS P ORTFOLIO STRATEGY

MACRO AWARE: WHICH STOCKS, ETFS, INDUSTRIES ARE MOST CORRELATED WITH MACRO?
To see how macro affects your portfolio, use our Macro-Aware tool suite to see the correlations of U24

Industries, Stocks, And ETFs with various macro variables (i.e. PMIs, Inflation, Employment,
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Housing, Etc.) This is a useful tool for any investor, portfolio manager, or research analyst who
wants to see the impact of macro forces on their positions.
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Click Here For Video Introduction

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In the example below, we show our Macro Aware Stock Screener, which allows you to paste in
your tickers and see the impact of various economic variables on your positions. The tool also
allows you to see factor traits of each security as well as how they performed in past market
recoveries.

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Paste In Your See The Correlation To See The Factor Profile See Recent & Historical
Tickers Economic Variables (Choose From >15 Factors) Performance Stats
(Choose From >50 Variables)

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2020 FIELD GUIDE PORTFOLIO STRATEGY

Visit The Interns’ Field Guide To Macro & Markets Website:

Cornerstonemacro.com/FieldGuide U24

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For More From The Portfolio Strategy Team, Visit Our

Resource Portal cornerstonemacro.com/strategy-portal

MichaelKantrowitz,CFA StephenGregory EmilyNeedell,CFA JustinBrant JoeRamirez,CFA

(212) 257-4971 (212) 257-4972 (212) 257-4974 (212) 257-4973 (212) 257-4975
mkantrowitz@cormacteam.com sgregory@cormacteam.com eneedell@cormacteam.com jbrant@cormacteam.com jramirez@cormacteam.com

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