Dow Jones 17.2% 27.5% Indices Year to Date 12 Months ...

[Pages:12]Portfolio Strategy

Published by Raymond James & Associates

Michael Gibbs, Director of Equity Portfolio & Technical Strategy, (901) 579-4346, Michael.Gibbs@ David Hydrick, (901) 579-4812, David.Hydrick@ Joey Madere, (901) 529-5331, Joey.Madere@

October 19, 2017

Portfolio Strategy: Weekly Market Guide _______________________________________________________________________________________________________________

Short-term Summary: The S&P 500 continued its steady advance higher over the past week, as 3Q earnings season kicked off and tax policy remains at the forefront of the Congressional agenda. The Senate is expected to vote on the budget today, which will let the House begin the budget reconciliation process (and start the discussion on tax changes).

Equity Market Indices S&P 500 Dow Jones

Price Return

Year to Date 12 Months

14.4%

19.7%

17.2%

27.5%

On the earnings front, 15% of the S&P 500 have reported 3Q earnings thus far. As is common, S&P 500 earnings estimates were revised lower into the quarter (-3% over the past two months), only for actual earnings to come in better than expected. For example, reported earnings growth so far has been 8.44% vs expectations of 2.2% growth. Reported sales growth for the companies that have reported so far has

NASDAQ Composite Russell 2000 MSCI The World MSCI Developed Markets

23.1% 10.9% 15.9% 18.8%

26.3% 23.6% 19.4% 19.5%

been 6.51%, bringing up aggregate expected S&P 500 sales growth for the quarter to 4.85%.

MSCI Emerging Markets 30.7%

24.0%

Technical: Over the past two weeks, the S&P 500 has traded within a very narrow 25 point range. Large Cap Growth is the only S&P style that has gained relative performance during this period. We believe that

NYSE Alerian MLP MSCI U.S. REIT

-13.3% 2.1%

-12.5% 1.6%

this was due to positioning ahead of 3Q earnings reports, as Technology (largest weighting within Growth)

was the only sector with positive estimate revisions heading into the quarter. Also, small cap relative

performance has consolidated following its sharp performance previously. If tax cuts come to fruition,

small caps will have an outsized benefit (relative to large caps) due to their greater leverage to the

domestic economy, higher percentage of U.S. sales, and higher effective tax rates on average. As such, the

recent consolidation could be an attractive buying opportunity.

The S&P 500 is pausing near various technical price targets in the mid-2560s, and we would not be surprised to see the market pull back in the near term. With plenty of support levels nearby, we believe downside is likely limited. Initial levels of support include 2540, 2508, and 2495.

In sum: Investors remain focused on earnings and the potential for fiscal stimulus (i.e., tax cuts). Both their paths will continue to have a significant influence on equity markets moving forward. As long as the pillars of this market remain in place (a healthy global economy, earnings growth, low interest rates, and fairly loose monetary policy around the world), pullbacks should be normal in nature; and we would use them as buying opportunities.

Source: FactSet, Raymond James Equity Portfolio & Technical Strategy

Please read domestic and foreign disclosure/risk information beginning on page 8 and Analyst Certification on page 9.

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.

International Headquarters: The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

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Portfolio Strategy

Macro

Core inflation grew less than expected, remaining at 1.7% y/y, in September. The odds of another Fed rate hike in 2017 ticked slightly lower on the report but have since rebounded to ~80% currently. Wage pressures have risen recently, and there will be many more inflationary readings by the December 13th FOMC meeting. Also, September retail sales bounced back from August's hurricane-affected data, with headline sales growing 1.7% m/m and control sales growing 0.5% m/m. Furthermore, housing data continues to soften (housing starts and building permits down over 4% in September- probably some hurricane effects), and survey data remains strong (empire manufacturing and U of Michigan sentiment both sharply higher). Overseas, China released 3Q GDP in line with estimates at 6.8% y/y, but slightly below the 6.9% growth in the second quarter. China's retail sales and industrial production both rose above expectations, up 10.3% and 6.6% (from 10.1% and 6.0%) respectively. PBOC Governor Zhou Xiaochuan spooked markets a little when he commented on China's high corporate debt levels and growing household debt. This has been a concern for years, and will continue to be monitored by investors. Overall, domestic and global economic activity remain supportive of equity markets.

Economic data reported in the past week (actual vs estimate): US CPI m/m (Sep): 0.5% vs 0.6%, 0.4% prior CPI Ex Food and Energy m/m (Sep): 0.1% vs 0.2%, 0.2% prior CPI y/y (Sep): 2.2% vs 2.3%, 1.9% prior CPI Ex Food and Energy y/y (Sep): 1.7% vs 1.8%, 1.7% prior Retail Sales Advance m/m (Sep): 1.6% vs 1.7%, -0.1% prior Retail Sales ex Auto m/m (Sep): 1.0% vs 0.9%, 0.5% prior Retail Sales ex Auto and Gas (Sep): 0.5% vs 0.4%, 0.0% prior U of Michigan Sentiment (Oct P): 101.1 vs 95.0, 95.1 prior Business Inventories (Aug): 0.7% vs 0.7%, 0.3% prior Empire Manufacturing (Oct): 30.2 vs 20.4, 24.4 prior Import Price Index m/m (Sep): 0.7% vs 0.6%, 0.6% prior Industrial Production m/m (Sep): 0.3% vs 0.3%, -0.7% prior NAHB Housing Market Index (Oct): 68 vs 64, 64 prior Housing Starts (Sep): 1127k vs 1175k, 1183k prior Housing Starts m/m (Sep): -4.7% vs -0.4%, -0.2% prior Building Permits (Sep): 1215k vs 1245k, 1272k prior Building Permits m/m (Sep): -4.5% vs -2.1%, 3.4% prior Initial Jobless Claims (Week): 222k vs 240k, 244k prior Philly Fed Business Outlook (Oct): 27.9 vs 22.0, 23.8 prior Leading Index (Sep): -0.2% vs 0.1%, 0.4% prior

China's retail sales and industrial production bounced

back in September.

3Q GDP slightly below 2Q, and slightly above 3Q'16

China GDP y/y (3Q): 6.8% vs 6.8%, 6.9% prior Retail Sales y/y (Sep): 10.3% vs 10.2%, 10.1% prior Industrial Production y/y (Sep): 6.6% vs 6.5%, 6.0% prior

Source: Bloomberg, FactSet, RJ Equity Portfolio & Technical Strategy

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.

International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

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Fundamentals

Earnings: 74 S&P 500 companies have reported 3Q17 earnings so far. As is common, S&P 500 earnings estimates were revised lower into the quarter (-3% over the past two months), only for actual earnings to come in better than expected. For example, reported earnings growth so far has been 8.44% vs expectations of 2.2% growth. Reported sales growth for the companies that have reported so far has been 6.51%, bringing up aggregate expected sales growth for the S&P 500 to 4.85%. Sector sales and earnings growth expectations for the quarter are shown in the table below. As we have noted, Financials earnings are expected to take a hit due to insurance companies' exposure to the recent hurricanes. Ex-Insurance companies, Financials earnings are expected to be strong, contributing 36% of the S&P 500's earnings growth this quarter. Also, Technology is the only sector with positive estimate revisions since the end of 2Q, and the sector is expected to grow earnings by 8.7% on sales growth of 8.2%. Full year S&P 500 earnings estimates remain ~$130.

Consensus earnings estimates: ?2017: $129.59 (top-down strategists); $130.75 (bottom-up analysts). We are using $128 as our base case estimate to formulate fair value S&P 500 levels. ?2018: $142.51 (top-down strategists); $145.75 (bottom-up analysts). We are using $138 as our base case estimate to formulate fair value S&P 500 levels.

2,600 2,500 2,400 2,300 2,200 2,100 2,000

Portfolio Strategy

S&P 500 Price and P/E

Price (left)

P/E (right)

20.0 2017

19.5

19.0

18.5

18.0

17.5

17.0

10/18/2016 11/18/2016 12/18/2016

1/18/2017 2/18/2017 3/18/2017 4/18/2017 5/18/2017 6/18/2017 7/18/2017 8/18/2017 9/18/2017 10/18/2017

Valuation: The S&P 500 P/E has expanded over the past two months (since 2Q earnings season ended) to 19.9x currently (top right chart). Our thesis remains that valuation is generous, although it remains supported by low interest rates and low inflation. Moving forward, equities need earnings growth as opposed to valuation expansion. Using a P/E of 19.5x and a next 12 month earnings estimate of $138 (current consensus is $142.71), results in a potential price level of 2,691 for the S&P 500 over the next year (+5% from current levels before dividends).

Q3'17 Expected Growth

Sector

% Reported Earnings Sales

Consumer Discretionary 12%

-3.1%

1.7%

Consumer Staples

21%

1.1%

3.9%

Energy

3%

120.1%

15.0%

Financials

30%

-10.1%

0.9%

Health Care

8%

2.7%

4.8%

Industrials

21%

2.5%

5.0%

Information Technology 14%

8.7%

8.2%

Materials

12%

2.2%

12.8%

Real Estate

9%

5.9%

3.7%

Telecommunications

33%

-1.7%

-0.5%

Utilities

0%

-5.1%

2.5%

S&P 500

15%

2.3%

4.9%

2017 Expected Growth

Earnings Sales

3.5%

3.7%

3.1%

2.5%

251.4%

16.7%

8.0%

4.0%

5.5%

5.2%

4.8%

4.3%

11.2%

9.2%

22.9%

16.4%

5.1%

5.0%

-0.4%

-1.7%

1.8%

5.0%

9.2%

5.7%

P/E Last 12M

21.7 20.6 54.1 16.0 17.8 19.9 20.5 20.6 18.9 12.7 18.6 19.6

P/E to Growth Next 12M 1.15 2.33 1.60 1.36 1.55 1.79 1.36 1.96 1.83 4.95 3.99 1.50

YTD Return 12.0

5.2 -9.4 12.9 20.9 13.7 30.4 16.5 6.5 -13.0 11.5 14.4

Source: FactSet, RJ Equity Portfolio & Technical Strategy

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.

International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

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Technical: Short Term

Source: FactSet, RJ Equity Portfolio & Technical Strategy ? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

Portfolio Strategy

The S&P 500 has continued to print new "all-timehighs"- i.e., most recently in today's trading session. The index has rallied as much as 6.07% from its August 21st intraday low (the low point when the index was last trading under its 50 DMA). However (as stated earlier) while the index has moved higher, it has done so more recently at a glacial pace- trading within a less that than 25 point range over the past two weeks.

This morning, the index sold off rather sharply, gapping down on the open, and trading off a little more than 1/2 a percent. This was likely fueled in part, by concerns of a sharp selloff in Hong Kongwhere the HANG SENG closed down 1.92% after falling as much as 2.15% (with most of the damage late in its session).

However, the S&P 500 recouped all of its early losses, and closed once again at new highs.

It is worth noting that the S&P 500 momentum indicators are in the "overbought" zone, and MACD looks like it could roll over. However, stochastics have held in overbought territory for over a month now- characteristic of a strong market.

All-in-all, we would not be surprised to see the market take a pause or pull back in the near-term. However, as we have stated in previous issues, we believe that upside and downside price action is likely limited.

Initial support levels: 2540, 2508, & 50 DMA currently 2494.27.

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Technical: Small Caps

We have noted previously that the small caps had gained sharp relative performance over the past couple months, as the reflation trade regained steam.

Over the past couple weeks, the small caps have consolidated some of their strength. This has provided an opportunity for investors optimistic on tax reform (or tax cuts) to add exposure.

Due to their greater leverage to the domestic economy, a higher percentage of U.S. sales, and higher effective tax rates in general, small caps will receive an outsized benefit from tax cuts compared to their large cap peers.

Portfolio Strategy

Small caps have consolidated some of their relative strength over the past couple months. This could be providing an attractive entry point

if tax cuts come to fruition.

Source: FactSet, RJ Equity Portfolio & Technical Strategy

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.

International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

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Growth vs. Value

Although the S&P 500 has been fairly stagnant over the past couple of weeks, Large Cap Growth has been the only S&P style to gain relative strength.

We believe that this is due to positioning ahead of 3Q earnings season, as Technology is the largest weighting within Growth and is expected to continue its strong fundamental momentum. As we have noted previously, the Technology sector is the only sector with positive earnings estimate revisions for 3Q since the end of 2Q.

This could create a "buy on the rumor, sell on the fact"for Growth's relative performance on their earnings reports.

S&P Styles

Year to Date (Price Return)

Growth Blend

Large Cap 20.5%

14.4%

Mid Cap 13.2%

9.7%

Small Cap 10.4%

8.8%

Value 7.6% 6.0% 7.0%

Source: FactSet, RJ Equity Portfolio & Technical Strategy

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved. International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

Portfolio Strategy

Past couple of weeks: Growth gained while all others lost. Likely positioning ahead

of EPS

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Portfolio Strategy

Credit Spreads

The spread between the US 10 year Treasury yield and BAA corporate bond yield is a measure we monitor for strength of corporate balance sheets and access to capital. As you can see the credit spread typically has an inverse correlation with equity markets. Over the past week, credit spreads have continued to narrow; and the corporate bond market continues to suggest no signs of stress beneath the surface.

Source: FactSet, RJ Equity Portfolio & Technical Strategy

? 2017 Raymond James & Associates, Inc., member New York Stock Exchange/SIPC. All rights reserved.

International Headquarters:The Raymond James Financial Center | 880 Carillon Parkway | St. Petersburg, Florida 33716 | 800-248-8863

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Portfolio Strategy

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