Summary

Salvatore divided his presentation in to 2 parts. First, he focused on the overarching macro themes and secondly using these themes to highlight MRB’s recommendations in terms of sector views and positioning within the US Equity market. Looking at the main macro highlights, the Delta variant is likely to derail strong economic growth; however, momentum will inevitably moderate. Future equity returns will be challenging but rising earnings should provide underlying support. Bond Yields have undershot to the downside and will rise with economic recovery. Commodities are overbought and Salvatore suggests there wil be a cooling off period. The recent bounce in the US Dollar was a countertrend move and will lead to renewed softness as the economic recovery solidifies. With regards to Sector Positioning, Salvatore recommends a moderately pro-growth stance, favouring reflation beneficiaries such as Financials and Energy stocks, as well as Healthcare stocks which have appealing valuations.

Inventory levels are low, which will lead to a restocking cycle and economic growth, heled by positive consumer sentiment in the labour markets Looking at Inflation, Salvatore suggests it will be more structural than temporary. Consumer inflation expectations are increasing, which will be highly influential for the Fed’s actions. With job openings at all time highs, there is expected to be upward pressure on wages and salaries. Homeowner’s equivalent rent, making up a large portion of CPI, is expected to continue to rise, and the home price index leads CPI by 18 months. Bonds have been oversold and with yields moving closer to 0 this should indicate the end of the down move. Nominal yields have room to move significantly higher if economic expansion persists. The Dollar has been helped by the spread of the Delta Variant and the Fed’s talk at the June FOMC meeting but will come under renewed downside pressure with the reopening of the global economy. Underlying earnings in the equity market has been very positive, enjoying a significant rebound from economic growth and weak earnings from levels last year. Earnings growth will moderate but will continue to grow and support reflation in the market. Looking at specific sectors, Salvatore highlighted Industrials trading at 18x 2023 earnings, and Consumer Discretionary which is trading at 23x. Exposure to quality in the portfolio is important, with the market pulling forward a lot of returns and choppier trading is to be expected for the remainder of the year. Technology and Communication Service stocks likley to have limited upside. Banks and Consumer Finance stocks have had improved relative earnings, acting as a bridge before better banking fundamentals in loan growth and demand kick in later this year. Energy stocks are overweight, having been hit by the outbreak of the Delta variant, and still have room to run on the upside. They have lagged the rally in oil prices and have 20-25% upside from here. Longer term, the Energy sector has structural issues and is not a buy and hold. Healthcare stocks have seen relative earnings deteriorate as expected; however, share prices have already discounted further weakness and are a Buy with good dividend premiums. Technology, where MRB has a Neutral rating, was a huge beneficiary of the pandemic and relative earnings did well in the first half of 2020 and have been softening since, unable to compete with earnings growth in cyclical sectors that have more leverage to the economic cycle. Industrials relative earnings have been weak, even prior to the pandemic they haven’t strengthened leading to caution. Consumer Discretionary will have less leverage to the economic cycle, so investors should look for the pandemic winners and losers. Real Estate has seen overall weakening cash flows and Salvatore expects the sector to remain under pressure which. Distressed properties hitting the market will put downward pressure on the asset values. Chemicals are at the upper end of their historical range and there is caution based on the experience of the last decade and what improvements will be seen.

Lastly, looking at the risks that could impact these recommended sector positionings, the Delta variant and further hospitalisations / fatalities is one. Higher corporate taxes in Biden’s proposals could lead to a slowdown in earnings, particularly for big Technology stocks. There is also risk in inflation expectations becoming unmoored, where the Fed would have to reduce monetary commendation sooner which would raise concerns around economic growth outlook.

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