at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

Today in the podcast, we recap our thoughts on how we’d play defense in the very near-term, if short-term macro

indicators like ISM are in the process of making a peak – something we think the decline in 10 year yields throughout

most of 2Q may have been signaling.

Our bottom line – we worry a peak in major macro indicators like ISM could spark a pullback in the market or a pause in

the rotation into Value and Cyclicals. We think there’s a case for adding some exposure to Classically Defensive sectors

in the near-term. But longer-term we still like Cyclicals.

Flip to slide 2

If you’d like to hear more, here’s another four minutes. While you’re waiting, a quick reminder that if you vote in the

Institutional Investor All America Research survey and find our work helpful, that we appreciate your support in the

Portfolio Strategy category this year.

Now, the details.

Flip to slide 3

1. Point #1: We worry that the move lower in 10 year yields throughout most of 2Q – before this week’s Fed meeting

– was anticipating a decline in major macro indicators like ISM.

 Since the Financial Crisis, 10 year yields and ISM have essentially been the same cycle.

 Early this week, there was a big miss on Empire Manufacturing and a second consecutive monthly

decline, which adds to our concern that ISM is starting to fall. Those fears were given a boost on

Thursday when the Philly Fed survey came out, with a miss on their general business conditions indicator

and decline for the 2 nd month in a row.

Flip to slide 4

 We care about ISM b/c it tends to explain how sectors within the S&P 500 trade.

 Cyclical sectors like Financials, Industrials, Materials and Energy tend to outperform when ISM is rising

and underperform when it’s falling. Defensive sectors including Consumer Staples, Utilities and Health

Care tend to outperform when ISM is falling and lag when it’s rising.

 If this is really what’s going on, then there could very well be a pause in the Value rotation or possibly a

pullback in the US equity market.

2. Point #2: What do investors do about it – I think it depends on one’s time horizon. For investors who really do care

about the short term and want to make some adjustments to their portfolios, we’d add exposure to what we call

Classic Defensive sectors – we define those as Health Care, Staples, and Utilities.

Flip to slide 5

 We recently divided the major sectors in the S&P 500 into three baskets – Classic Defensives (HC,

Staples, Uts), Cyclicals (Fins, Inds, Mats, En), and Secular Growth (Comm, Tech, CD). This is really a

better way of thinking about how to group sectors than Value-Growth in our opinion.

 They key thing we learned from our analysis, Classic Defensives tend to outperform both Cyclicals and

Secular Growth oriented sectors when ISM is falling.

 Secular Growth, which many investors have treated as a defensive proxy, does tend to outperform

Cyclicals when ISM falls, but the relationship is loose.

Flip to slide 6

 Valuations also favor Classic Defensives. Classic Defensives also look attractively valued relative to both

Cyclicals and Secular Growth.

 Meanwhile, Secular Growth also looks expensive vs. both Classic Defensives and Cyclicals.

Flip to slide 7

 Among the 3 Classic Defensives, Health Care offers the most valuation appeal, and Consumer Staples

provides the most resilience when ISM is falling.

3. My third and final point: we’d treat a shift into Classic Defensives as a short-term move, and are not abandoning

strong, at least for the moment.

Flip to slide 8

full year, now tracking at 6.6%. 2022 forecasts have also recently ticked up to 4.1%.

Flip to slide 9

 Typically, Cyclical sectors outperform both Classic Defensives and Secular Growth oriented sectors when

real GDP is tracking above its long-term average of 2.5%, though the pace of that leadership does tend to

soften as the rate of GDP growth slows.

 Additionally, while Cyclicals no longer look attractively valued relative to Classic Defensives, the level of

that overvaluation is rather mild and seems likely to be solved rather quickly. Cyclicals also remain

attractively valued relative to Secular Growth.

Flip to slide 10

 Earnings revisions trends are also stronger in Cyclicals than both Classic Defensives and Secular

Growth.

 In this context, we are sticking with our overweights to Financials, Energy, and Materials – if we are right

about ISM falling, these trades probably won’t work in the very near-term. But we still like them longer-

term.

 The one Cyclical we’d be paring would be Industrials, which we have been market weight and which lacks

the same kind of valuation appeal that we see in Financials, Energy and Materials – making us far less

inclined to ride out a short term storm in macro indicators there.

That’s all for now. Thanks for listening. And please reach out to your RBC representative with any questions.