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Compass: Maintain overweights in energy, materials, and manufacturing

​Highlighted Themes:

Market Overview... see pages 1-4

Sector Commentary: Maintain overweights in late-stage cyclical sectors; financials and tech depict bottom-up improvements -- selectively increase exposure; consumer discretionary is still plagued by retail stocks... see pages 5-7

• Actionable Groups & Constituents: Bottom-up ideas with an emphasis on tech (A, ATVI, EA, CRM, TXN, etc.) and late-stage cyclicals (DVN, FMC, NBL, SLCA, etc.)... see pages 8-15

Market Observations:

The S&P 500’s 5-week retreat is pulling it back to break even for the year. Retail stocks – ex-AMZN, of course – are the primary culprit, and they still pose as the red flag that won’t go away. Troublesome? Yes, but positive technical observations continue to outweigh the negatives, which we list below. For these reasons, we are maintaining our cautiously optimistic outlook.

Late-stage cyclical sectors – energy, materials, and manufacturing – continue to lead, and the recent pullback has not altered their attractive technical set-ups. We view the recent bout of weakness as a buying opportunity in names depicting bottom patterns such as HAL and NUE. Stay overweight. (See our May Macro Vision book for additional ideas.)

Financials continue to recover. Banks, insurers, and investment managers are stepping, filling the void left by REITs’ short-term weakness. This is resulting in the Sector’s relative strength trend inflecting higher. It’s too early to label the Sector as leadership, but these price improvements are encouraging, as we need to see financials participate from an absolute perspective to remain bullish on the broad market.

Tech depicts incremental improvements. 2016 has not been kind to Tech, but from a big-picture perspective, the Sector’s leadership status remains intact; the YTD pullback in relative strength is holding above the 3-year uptrend. Further, semis are beginning to exhibit strength following the SOX’s successful pullback to the 200-day MA. Also, AAPL is working through what appears to be a failed breakdown (bullish).

Strength is filtering down into small and mid caps. The Russell 2000, though still well below its 2015 high, has outperformed the S&P 500 since the February low. Mid caps, however, are near-term leadership. The S&P 400 Index has outperformed both the S&P 500 and Russell 2000 YTD, posting a 3.4% return. We would like to see this trend continue to maintain our bullish outlook.

Value continues to outperform growth. While a “neutral” sign in terms of its effect on our market outlook, the value/growth relationship continues to tilt in favor of value. The Russell 3000 Value/Growth ratio is breaking out from a 10-month bottom, supporting our overweight recommendation of the late-stage cyclicals (and the improvements we’re seeing in financials).