Kyle Jacobsen

July 7th – 25th Market Update

Macro & Micro Drivers:

 Q2 earnings potential to validate high P/E ratios

 S&P 500 is trading at about 18.7X earnings
 7/25-7/26 FOMC Meeting
 7/19 ECB Meeting
 7/12 Yellen Speech
 Canada hikes interest rates for the first time in seven years
 Chinese GDP and Credit Implications
 Non-farm payrolls
 Oil Price levels, OPEC Meeting in St. Petersburg, and EIA data
 July PMI Report
 Banks Earnings/Trading Revenues/CCAR “Stress Test”
 Isolated Earnings Names

Q2 U.S. Earnings:
- With high expectations and even greater consequences, Q2 earnings season has required
companies to beat EPS and revenue projections or risk shedding a fair amount of value

- As of July 21st, 84% of the estimated S&P companies that have reported have either met or beat
EPS expectations (73% beat) ( 11% met). The larger drivers for actual earnings winners has been
revenue, guidance, and overseas sales if applicable. Many companies are operating due to
favorable factors and the weaker U.S. dollar therefore, drawing buyers and organically increasing
share price is getting more difficult

- The S&P 500 is trading at about 18.7X earnings which is way above the 15.4 EPS average for the
past 5 years. Overvaluation is nothing new to this market, but achieving proper sector weighting
is now crucial. Utilities, Information Tech, Consumer Discretionary, and Telecom remain top
performers over the past few weeks. Expect Q2 earnings to continue to crush underperformers,
prioritize revenue figures, and reward only the truly lean and best-performing companies with
small intraday gap-ups.

July Jobs Report (For month of June released 7/7):

-Nonfarm payrolls jumped 222,000 in June, against expectations of 179,000
-Unemployment rate is reported at 4.4%
-However, average hourly wage growth remained stagnant at 2.5% annualized
Kyle Jacobsen

Overall, the report was a decent catalyst for an otherwise quiet market. Allowing for broad equity gains, a
small increase in the U.S. dollar, and a decline in gold. In my opinion, the non-farm payroll data is a
macro indicator that the cautious optimism that is engulfing the majority of the U.S. market (Energy
excluded) will maintain its tailwind in the short-term.

Chinese GDP

 China's gross domestic product rose 6.9 percent (y-o-y) in the second quarter from a year earlier,
the same rate as the first quarter. That was higher than analysts' expectations of a 6.8 percent
expansion.
 Driven by industrial production, fixed-asset investment, and retail sales China has some growth
momentum that could continue in the next two quarters this year
 Chinese inflation (CPI) is expected to hover around 1.8% next quarter and employment is
expected to remain at 4%
 However, the main concern is credit growth and interest rates: China uses a MLF (Mid-Term
Lending Facility) to absorb credit and has turned to hiking it’s repo (repossession) rate to 2.45
from 2.2 previously in winter
 1-year SHIBOR @ 4.40% and 1-year lending rate at 4.35% with 2 and 10 yr treasury yields at
3.10% and 3.56% respectively
HSI Index 5-YR Chart:
Kyle Jacobsen

Overall, credit problems and geopolitical problems will continue in China. However, the positive
GDP data allows for short term positivity in a domain with a HSI (Hang Seng Index) that is up
22% YTD. China has high equity valuations and credit problems so long-term there are
many valid bearish scenarios. Short-Term I am neutral and expect monetary policy
tightening to continue.

Canadian interest rates:

- Canadian key policy interest rate (overnight rate) rises to 75 bps from 50 bps previously
- CAD/USD which has been drastically underperforming for the past few years, spiked up to 0.79
(CAD/USD Spot)
- The rate hike came as a surprise after very poor inflation data a few weeks ago created a fairly dovish
tone from the Bank of Canada
Kyle Jacobsen

ECB (Led by Mario Draghi) meeting on July 19:

- ECB president Mario Draghi muted a previously hawkish tone when he held European interest
rates at 0 bps
- Draghi outlined that the ECB was ready to step in if poor economic conditions ensue
- While the Euro and the European economy itself has been recovering Underlying inflation rates
need to vastly improve until a rate hike is justifiable
- The largest driver of the future for rates in Europe will be based on when the ECB decides to
begin unwinding their quantitative easing (potential taper reaction) with the upcoming September
meeting
- The ECB is ultimately trying to avoid a similar Taper Tantrum to the U.S. in 2013, however, this
will ultimately be decided in how encouraging the ECB monetary policy outlook appears and the
strength of their credit markets at the time.
- Overall, the tone was expected and a delay is the best choice for a Eurozone that is struggling
with wage growth and has a crucial German federal election on September 24th.
- EUR/USD rebounded from a small dip on the news rising about 50 pips to 1.156 (EUR/USD)

Yellen Speech 7/12-7/13:

-Long-term rate sentiment took a minor shift when Janet Yellen claimed that next year’s rate hikes are
going to be on a gradual basis as economic strength indicates the need for them
- This is important because core CPI data released last week displays inflation still at 1.7%, 30 bps below
the target inflation level
Kyle Jacobsen

-The continuation of marginal core CPI data is a slight concern because the Fed has yet to provide
reasoning for the missed target level, without the continuation of hikes treasury yields could continue to
remain in a mid-term lull
-One additional rate hike to 125-150 bps is expected by year end. After that, I believe 2% inflation will
have to be hit for an overly cautious fed to continue tightening

EIA Data from 7/12 and 7/19:

7/12: Crude oil inventories dropped 7.6 million barrels during the week of July 7th.
Prior: -6.3M Actual: -7.6M
-Crude oil imports have fallen from7.8 million barrels to 7.6 million over the month of June.
-Overall, served as a catalyst to boost WTI Crude above $45

7/19: Crude inventories fell by 4.7 million barrels in this week to 490.6 million. Gas and distillates fell
respectively by, 4.4 million and 2.1 million.
Prior: -7.6M Actual: -4.7M
Overall, the data continues to favor short term oil bulls up into the $47 WTI

OPEC and Non-OPEC Meeting in St. Petersburg:

-The meeting led by Saudi Arabia pushed all members to uphold compliance agreements and pointed
towards the potential for stricter production limits for Nigeria which is currently exempt from any
production regulations
-The meeting also pointed blame towards Iraq and the UAE (United Arab Emirates) who have been
producing above the agreed cap
-OPEC and Non-OPEC officials agreed Nigeria would join the deal by capping or even cutting its output
to meet the 1.8 million bpd threshold

Immediate Term Oil Outlook:

OPEC chatters last week about larger potential cuts by Saudi Arabia faded quickly but allowed for some
attention to be drawn to the future compliance by different members.
Overall, the OPEC talks about capping Nigeria allowed for WTI to slightly gap up intraday. However,
barrel price is nearing a key resistance point at $47.10. Currently, with WTI @ $46.33 (7/24) I think we
will continue into the high $40s into this slightly flexible resistance point ($47-$48.50) and I expect WTI
to fall back into the mid to low $40s within the next two weeks since no macro outlook improvements
have developed.
Kyle Jacobsen

July PMI (Purchasing Manager’s Index) Data:

Composite Data: 54.2 Actual 52.7 to 54 Projected
-After a large uptick in June the July PMI saw a smaller but still noticeable increase in both services and
manufacturing domains
-Overall, the increase in new material orders and the overall gains in manufacturing data should allow the
remainder of the summer to be some of the best performing months for manufacturers worldwide

What U.S. earnings I was/am watching and why in the next few days:
7/10 – 7/18 Earnings Watch:
HOG- Harley Davidson has gotten smashed this year with a $15 million dollar EPA tariff, slowing
demand in China, and expectations of shrinking revenue. Could be trading at a huge discount. Speculative
position could see pop with good earnings but a riskier play given headwinds with retail revenue.
NFLX- High valuation but consistent EPS growth and thematic summer play. In short, people (especially
younger people) have more free time in the summer and are more likely to watch more Netflix and utilize
entertainment. I think this brings in new subscription revenue. Speculative position pre earnings could see
a pop of 5 – 7% with good earnings release.
AKS- AK Steel is a thematic play based off of Trump tariff chatter with China. At its core, steel has
improved but still has upside possibilities. AKS is a best of breed domestically over (X, U.S. Steel) due to
consistent EPS growth, less share dilution (ROE improvement) in the short term. Reports on Jul 25.
Kyle Jacobsen

PEP- Pepsi earnings should provide insight into non-cyclicals/consumer good performance. Important
earnings release to see if overtraded defensive plays in the sector can maintain valuations.

Banks and CCAR:

Banks- Big banks get a minor boost from improved quarterly net interest income margins (due to rate
hike to 100-125 bps) but overall, that has already been priced in. Other big factors will be trading
revenue, and wealth management revenue. Overall, good EPS beats but for most revenue was the
sustaining factor of whether share price appreciated.

CCAR (Comprehensive Capital and Analysis Review) – The bank “stress test”:
What it is: CCAR evaluates the capital planning processes and capital status of the largest U.S. based
banks.
It includes the firms future forecasted capital actions like dividend payments and share buybacks. This is
done in order to ensure banks have strong capital levels to absorb losses and have the ability to lend to
households/businesses in poor economic conditions.

Banks take losses in FICC trading, hints towards investor’s outlook for FICC:
BAC- Got to watch this earning call live, “responsible/sustainable growth” was the name of the game,
with wealth management and retail lines of business growing revenue. BAC had a 14% year-over-year
decline in revenue
JPM- similar EPS to the other bulge bracket firms with a FICC revenue of $3.2 billion that was down
19% year-over-year
Citi- $3.4 Billion in FICC trading revenue with a 6% year-over-year decline
MS- Morgan Stanley was one of the few to actually see a gap up in share price following earnings due to
revenue increases in IB and Wealth Management divisions. Down 8% year-over-year in regards to FICC
trading revenue.
Kyle Jacobsen

Forward-Looking Statements:

FOMC Meeting 7/25/17-7/26/17:

This FOMC meeting is crucial for all markets and will allow for investors to forecast:
1. What month the Fed will begin to unwind the balance sheet
2. If a December rate hike is still probable
3. If Yellen believes any long-term tightening is still necessary or if our current situation is suitable
into 2018

Hawkish Case:
The Fed starts unraveling the balance sheet at this meeting. Initially, causing a spike in treasuries and
gains in bank stocks but a drop in the broader outperforming market sectors (defensive and tech stocks).
Neutral Case:
The Fed stays on target to begin unraveling in September, with no overly biased comments towards rate
hikes. Causing a continuation in the “cautiously optimistic” elongation of our current bull market.
Dovish Case:
The Fed removes their previous hint towards balance sheet reduction in September and pushes all
thoughts of another hike into 2018. This would cause treasuries to drop and the yield curves to continue
flattening. Meanwhile, most equity sectors would continue small, gradual gains.

Overall, Yellen has mastered being very unrevealing when presenting, I believe she will continue that
very sensitive and calm approach. The last thing Yellen wants or anyone in this market needs is a shock.
However, volatility made fresh lows last week and I wouldn’t be surprised for something on the
geopolitical forefront to bring some action back into this lazy summer market.
Next biggest political driver domestically will be the healthcare bill from Washington that is unlikely to
pass.

Tickers I’m Watching: VXX, AKS, MELI, FANG, SHLD, XLI, TOL, FLC (Preferred CEF), ITM (Muni
bond ETF), THC, UNH.
Thanks for reading!!