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Vermilion Macro Vision: U.S. Equity Strategy

STRATEGY: Looking Forward
Investors continue to help the market plot along in an upward and to-the-right fashion despite many unknowns that still need to be worked out, ranging from Fed comments/interest rates, health care reform, fiscal policy changes and European elections. All one has to do is look at the equity markets to discern just how many votes are being cast in a manner that reflects the collective confidence of investors. Arguably the technicals of the market remain favorable overall; however cracks are appearing in some areas, which we outline below. In summary, we view the U.S. market as characterized by:

• Healthy internals: Breadth remains favorable; however, the Energy Sector is breaking down along with many of the deep cyclicals such as iron ore, copper, precious metals. (See page 2)

• Cyclicals are becoming more mixed: Cyclicals are becoming more mixed, but areas such as Manufacturing, Tech, select Transports, even select areas of the Consumer Discretionary Sector are showing healthy improvement. Restaurants, Hotels and Motels and Casinos are some of the bright spots.

• Defense is improving, but marginally: Utilities and Staples are perking up. We continue to believe interest rates are still likely to move higher, which may provide a headwind at some point.

• Health Care is becoming increasingly healthy: Health Care appears to be improving, and we increased this Sector to a market weight on April 4th.

• Small vs. large caps: Small caps continue to lead the march higher which historically indicates a healthy growth driven market.

• Technicals remain healthy overseas: Foreign markets continue to chip away at the U.S.' leadership status. Shown on the next page, the Europe/U.S. ratio is breaking out from an 11-month bottom. One concern we have is how the rising interest rate environment will affect the fund flows to emerging markets.

• Interest rates: Interest rates appear confined to a trading range between 2.17% and 2.61%. We believe rates will continue to consolidate between these two levels for some time. Our concern continues to be the rate of change or velocity; i.e., any sudden surges or declines of a tightly wound market will likely impact the equity markets. Also, rising rates coupled with a declining dollar would likely impact foreign holders of U.S. bonds and increase selling pressure.

• US dollar: At the present level, the Greenback is residing at a major support level near its 200-day moving average. The Euro is staging a reversal against the dollar and is breaking to a 6-month high. We continue to find Europe a more favorable region than the U.S.

In the remainder of our May Strategy (See attached pdf) we highlight the following Sectors:

• Tech Sector: Overweight. Tech continues to demonstrate its long-term leadership status. Major bases on the long-term charts reflects years of consolidations and enormous upside potential long term.

• Manufacturing Sector: Overweight. Manufacturing remains leadership and, after having hit an all-time high in relative strength, is consolidating its gains. The automobile manufacturers (which are in our Consumer Discretionary Sector) are near new lows, but we have yet to see widespread weakness on the component suppliers. Aerospace/defense continues to climb in altitude and remains an era of leadership.

• Financial Sector: Overweight. The recent pullback in the banks has created a terrific opportunity to increase exposure. After pulling back to their respective 200-day moving averages, we are seeing many names inflect positively to the upside.

• Transportation: Overweight. Strength in this Sector is dependent on the Airlines and the large-cap rails. While there is some strength in a few of the other Groups, they are generally much more mixed.

• Materials: Overweight. On review for downgrade to Market Weight. While the Sector's absolute pattern remains constructive, there are a number of Groups that are breaking down; iron ore, Copper and the precious metals are truly not shining.

Open the attachment to find our complete U.S. equity strategy document, as well as links to our respective sector commentaries.

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