FOCUS: U.S. Equities

Market Outlook:

- While there are numerous conflicting data points, we maintain our view that the correction is not over

- Downtrend remains in place and we’re very close to over-bought levels

- Bear markets are characterized by short, sharp rallies that really hurt portfolios and challenge convictions, which is why an unemotional process is so important

- S&P 500 could see 2000, but it would be a good place to re-evaluate the condition factors we watch

Positives

- Secular bull market that started in 2013 remains alive and well, both fundamentally & technically

- Central bankers around the world unite! …more stimulus to come

- There remains notable asset classes and markets and industry groups to invest in

- Industrials and transports give us some comfort there’s light at the end of the tunnel

Negatives

- Made 20d high on the index level, but it was only 35% on individual stock basis (you want to see 60%)

- Value traded not confirming even as headline volumes “ok”

- Energy and materials names have been beaten up badly, meaningfully reducing values in the space

- When market experiences a “trash trade”, or mean reversion rally, you tend to see higher volumes but lower value traded

- Liquidity continues to be reduced causing increased volatility

- Reduced global liquidity results in tighter credit conditions

- Credit spreads not confirming the rally

- Spread improvement should be sharp and lead the rally, neither true at present

- Some reasonable improvement in HY indices, but mostly driven by energy bounce

- BBB spreads barely moved off highs

- European CDS spreads flagging real caution over there, both in the banks and the sovereigns 

TOP PICKS:

United Health (UNH.N) 

-UNH is the largest Medicare contractor in the US, as well as a top pharmacy benefits manager and Medicaid provider. Supported by secular trends in Medicare and Medicaid, the company has significant demographic tailwinds for years to come.

- Best-in-class management, having booked proactive repositioning charges in the last month, is well-placed to sort through challenges faced by all managed-care operators related to ACA and public health exchanges

- Management has an established track record of beating earnings estimates and raising guidance, while delivering consistent mid-teen EPS growth and returning about 50% of annual cash flow to shareholders as dividends and share buybacks. PEG ratio of ~1x right now is unusually inexpensive for company like this

-At present there is some noise in the name (and managed care industry generally) owing to Affordable Care Act challenges, but the stock hasn’t broken down and we’d give management a little rope here because of their extremely strong track record 

TJX Companies (TJX.N) 

- TJX is the largest global off-price retailer with over 3,400 stores in the US, Canada, UK and Europe. They drive traffic to stores by selling brand name apparel at a 20-60% discount to department stores. Off-price has benefited from market share donation by JCP, Sears, Kohl’s and other department stores.

-TJX was one of the few bright spots in the retail space with 4Q15 (4Q16 for TJX) same-store sales growth of 6% (JWN 1%, M -5.2%, ROST 4%, KSS 0.4%). TJX delivered strong results in a very tough retail environment once again proving the company’s resilient business model. The company will likely take advantage of struggling department store peers to source profitable inventory (pack away) and drive traffic to stores.

- TJX is a high quality operator with a durable business model that works throughout the business cycle. The company can increases prices when consumer spending accelerates and decrease prices when it slows. TJX has had only one year of negative same-store sales growth in 1996 following the acquisition of Marshalls.

- The company’s scale allows it to buy direct from apparel manufacturers rather than the common misconception that TJX buys merchandise that is defective or has fallen off a truck.

- Apparel manufacturers prefer to sell to the off-price channel because off-price retailers have more consistent traffic and do not return merchandise. Department stores sometimes return merchandise to the manufacturer if it does not sell.

-The company continues to grow stores and improve the scale and operations of its European division. This should improve margins of the European division longer-term. Homegoods (Homesense), its home furnishing division, is also a promising segment with solid store growth and margins. We are confident in the company’s ability to grow square footage by 4-6% per year, drive traffic to stores, and expand into new geographies. 

Facebook (FB.O) 

- Facebook had a 1.59B user base that grew 14% YoY in 4Q15. This growth has been on a downward trend, but is still really strong considering the enormous user base. Moreover, user engagement trends continue to be strong.

- Facebook is starting to really monetize several platforms including Instagram, video ads and instant messaging. It’s addressing mobile advertising monetization, which was a major concern following the IPO. Mobile advertising now represents 80% of total advertising revenue and was up 82% YoY in 4Q15.

- Most importantly, it’s all hitting the bottom line. In 4Q15 the company posted 66% YoY FX neutral advertising growth, 60.3% operating margins, 68% free cash flow (FCF) growth. These results came despite the fact that the company is currently in an investment cycle for OPEX and CAPEX which could lead to higher long-term margin potential. They’re sitting on about $18bln in cash, so that’s about 36% of assets in cash and generating more each quarter. 

Past Picks: Nov. 17, 2015

Home Depot (HD.N)

Monster Beverage (MNST.O)

Facebook (FB.O)

Total Return Average : -2.70%