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Vermilion Macro Vision: Sector Synopsis

Borrowing from Oval Office vernacular, big picture technicals are phenomenal. Perhaps that's too strong of a word, but long-term trends, coupled with our Sector and international observations, supports a bullish outlook. The short-term term outlook is, admittedly, murky: plenty of events could set-in motion a pullback, ranging from Fed comments/dot plot to health care policy to delayed tax reform. But the weight of the evidence does not indicate a cyclical top is on the doorstep. To believe otherwise, you have to overlook a long list of technical improvements, including:

• Healthy internals: Advance-decline lines are confirming the market's advance. No divergences are present.

• Cyclical leadership: Cyclicals, for the most part, continue to lead. Transports, Tech, and Manufacturing top our rankings. Consumer Discretionary and, more recently, Energy are the two caveats. The former is a long-term laggard, but contains pockets of strength like Casinos (LVS, WYNN) and Homebuilders (PHM, KBH); the latter, a former leader, is shedding relative strength despite mostly intact price trends.

• Defense remains on the defensive: Short-term rebounds aside, defensive and dividend-payers continue to lag. The 10-year Treasury yield's chart is beginning to break out from a multi-month base--providing no relief for these Sector. Staples and Utilities' relative strength trends are hovering around 12-month lows. Underweight.

• Small vs. large caps: Small caps have underperformed since December, but the Russell 2000/S&P 500 ratio's 12-month uptrend remains intact. We will give small caps the benefit of the doubt until this trend is broken (see next page).

• Improving technicals overseas: Technicals abroad are improving. Europe and Japan are accelerating out from their 2016 base patterns; emerging markets (VWO), despite underperforming this year, are breaking out.

That is the positive argument. What about technicals that are, or could detract from our bullish outlook? Right now, two things concern us: (1) continued weakness in the Consumer Discretionary Sector and (2) the future rate of change in interest rates. Retail and restaurants remain very selective, and Group-wide strength is nowhere to be seen. On the interest rate front, with a March hike all but certain, the long-end of the curve is beginning to break out. The 10-year Treasury yield is emerging from a 4-month consolidation. The key level to watch remains 3.0%.

In the remainder of our March Strategy we highlight the following Sectors:

• Tech Sector: Overweight. Tech is extending its long-term leadership status, with strength broadening out beyond semiconductors. The Sector boasts a larger inventory of base patterns.

• Manufacturing Sector: Overweight. Our Manufacturing just reached a milestone beyond reach of every other Sector: all-time relative strength highs. Breadth is great here. Stay overweight.

• Financial Sector: Overweight. Financials are extending their leadership--impressive considering the drag provided by REITs.

• Materials Sector: Overweight. Short-term weakness in Materials, especially base metals Groups, represents a buying opportunity. Chemicals continue to outperform.

• Energy Sector: Market Weight (downgrade). Energy's lack of participation this year is costing it dearly in terms of relative strength. Price patterns remain attractive, holding above support, but the same no longer applies to relative strength. For this reason we are downgrading Energy to market weight.

Open the attachment to continue reading our latest U.S. equity strategy document, as well as links to our respective sector commentaries.

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