U.S. EQUITY RESEARCH Sector Watch PULLBACK PROBABILITIES

U.S. EQUITY RESEARCH Sector Watch January 17, 2017 Sam Stovall Chief Investment Strategist CFRA Author of The Seven Rules of Wall Street One New York Plaza th 34 Floor New York, NY 10004 (646) 517-2993 [email protected]

PULLBACK PROBABILITIES During Up Years Since WWII, YTD Declines Averaged More Than 4% The U.S. equity market started the year favorably. The S&P 1500 Index rose 1.6%, through January 13, along with seven of its 11 sectors and 74% of its sub-industries. Yet many strategists have begun waving the yellow flag, cautioning investors of an impending stock market decline. Is this a bold call? Not really, for three reasons: During bull markets since 1945, the S&P 500 experienced a pullback (a decline of 5.0%-9.9%) once a year, on average, a correction (a 10% to 19.9% decline) every 2.8 years, and a bear market (-20%+) every 4.7 years. Second, the S&P 500 suffered a YTD price decline in more than 80% of all years in which the S&P 500 recorded a positive annual performance since WWII. Finally, the DJIA broke through the 19,000 mark and threatened the 20,000 level without experiencing a 5%+ price decline along the way. Typically, the DJIA rose another 4.0% in 68 calendar days after eclipsing a millennium level before slipping into a pullback or correction. The Dow only twice eclipsed two 1,000-point marks without digesting gains along the way: 1999 and 2007. One comforting fact is that the Dow hit a new alltime high following all post-millennial declines before ultimately succumbing to bear markets. YTD Decline? So What Else is New? Since 1945, the S&P 500 fell into a meaningful decline about every 7 ½ months. So the advent of a pullback, correction or bear market should come little surprise to investors. In addition, during 83% of all years in which the S&P 500 posted a positive return, the market recorded a YTD decline at some point along the way. Even though the YTD decline averaged close to a pullback at 4.4%, the “500” recovered from YTD declines of 10%-20% four times (1947, 1948, 1984, and The S&P 500 Recorded YTD Price Declines in 83% of all Up Years Since 1945 5%

5%

0%

0%

-5%

-10%

| Average: -4.4%

-5%

-10%

-15%

-15%

-20%

-20%

-25%

-25%

Source: CFRA, S&P DJ Indices. Past performance is no guarantee of future results. Data: 12/31/1944-12/31/2016.

This report is for information purposes and should not be considered a solicitation to buy or sell any security. Neither CFRA nor any other party guarantees its accuracy or makes warranties regarding results from its usage. CFRA, the CFRA inverted pyramid logo, and STARS are registered trademarks of CFRA. S&P GLOBAL™ is used under license. The owner of this trademarks is S&P Global Inc. or its affiliate, which are not affiliated with CFRA Research or the author of this content. Copyright © 2017 CFRA. Redistribution, reproduction and/or photocopying in whole or in part is prohibited without written permission. All rights reserved.

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2016), and drops of 20% or more twice (1970 & 2009). Periods of Decline Granted, getting these slumps out of the way early in the year helps to give the market time to get back on its feet. Not surprisingly, we see that 70% of all YTD declines were recorded in the first quarter of the year (with approximately 1/3rd of all YTD declines coming in January alone). The remaining quarters witnessed YTD declines 16%, 9%, and 5% of the time, respectively. So should the S&P 500 experience a post-inauguration slump, it would actually be following a fairly familiar pattern. “Done In” by the Dow The financial media has been focused on “Dow 20K” for weeks. Indeed, on January 6, the DJIA came within ½ of a point of crossing 20,000. Now, the press, admittedly, is getting tired of reporting on the eventuality of the DJIA eclipsing that millennial mark. The greater story, however, is that the DJIA has traversed nearly 2,000 points without experiencing a “resetting of the dials” by slumping 5% or more as it usually did following the overtaking of prior millennial marks. After the 10,000 level was first breached, the DJIA typically rose an additional 4% in 68 calendar days (about 2 ¼ months) after closing above a 1,000-point level. It then stumbled into a pullback or correction before DJIA Returns After Hitting Millennial Levels recovering and Months then breaking Millennial Level Hit Topped Out Until Next 5%+ Drop Til Next above the next Threshold Date Price Date Price % Chg. # Days Millennial millennial level 10K 3/29/99 10,006.78 5/13/99 11,107.90 11.0 45 1.2 11K 5/3/99 11,014.69 5/13/99 11,107.90 0.8 10 89.6 two years later. 12K 10/19/06 12,011.73 2/20/07 12,786.64 6.5 124 6.2 Only twice did 13K 4/25/07 13,089.89 7/19/07 14,000.41 7.0 85 2.8 the DJIA capture 14K 7/19/07 14,000.41 7/19/07 14,000.41 0.0 0 69.7 two 1,000-point 15K 5/7/13 15,056.20 8/2/13 15,658.36 4.0 87 6.5 marks without an 16K 11/21/13 16,009.99 12/31/13 16,576.66 3.5 40 7.4 intervening 5%+ 17K 7/3/14 17,068.26 9/19/14 17,279.74 1.2 78 5.7 decline: 1999 18K 12/23/14 18,024.17 5/19/15 18,312.39 1.6 147 23.0 19K 11/22/16 19,023.87 ? ? ? ? ? and 2007. Even 20K ? 20,000.00 ? ? ? ? ? though the DJIA Mean 4.0 68 24 remains below the 20K level, it Source: CFRA, Yahoo.com. Past performance is no guarantee of future results. has still avoided a “resetting of the dials” after overtaking the 19K level. But like the frustrating wait for a child who continues to resist a nap, a post-millennial decline is just a matter of time. Conclusion So there you have it. Investors remain vigilant to the eventuality of a Trump Slump, as YTD declines are common and a post-millennial Dow decline is already overdue. What’s more, many also believe that the impending sell-off will represent only a respite in the market’s continued climb. They vow to “buy the dip.” Yet market action typically doesn’t adhere to the timetable nor the magnitude expected by the masses. So while a dip is certainly due, investors may not be prepared for a drop that arrives later, lasts longer and digs deeper. SECTOR WATCH

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Glossary

Required Disclosures

★★★★★ 5-STARS (Strong Buy): Total return is expected to outperform the total return of a relevant benchmark, by a wide margin over the coming 12 months, with shares rising in price on an absolute basis. ★★★★☆ 4-STARS (Buy): Total return is expected to outperform the total return of a relevant benchmark over the coming 12 months, with shares rising in price on an absolute basis. ★★★☆☆ 3-STARS (Hold): Total return is expected to closely approximate the total return of a relevant benchmark over the coming 12 months, with shares generally rising in price on an absolute basis. ★★☆☆☆ 2-STARS (Sell): Total return is expected to underperform the total return of a relevant benchmark over the coming 12 months, and the share price not anticipated to show a gain. ★☆☆☆☆ 1-STAR (Strong Sell): Total return is expected to underperform the total return of a relevant benchmark by a wide margin over the coming 12 months, with shares falling in price on an absolute basis. CFRA Ranking Definitions: Overweight rankings are assigned to approximately the top quartile of the asset class. Marketweight rankings are assigned to approximately the second and third quartiles of the asset class. Underweight rankings are assigned to approximately the bottom quartile of the asset class. S&P Capital IQ Quality Ranking Growth and stability of earnings and dividends are deemed key elements in establishing S&P Capital IQ earnings and dividend rankings for common stocks, which are designed to capsulize the nature of this record in a single symbol. It should be noted, however, that the process also takes into consideration certain adjustments and modifications deemed desirable in establishing such rankings. The final score for each stock is measured against a scoring matrix determined by analysis of the scores of a large and representative sample of stocks. The range of scores in the array of this sample has been aligned with the following ladder of ranking. A+ Highest A High A- Above Average B+ Average

B Below Average B- Lower C Lowest D In Reorganization

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