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Cyclical Sector Growth Leads Amid Elevated Valuations

Our attention has turned to S&P 500 second quarter earnings performance as the first quarter is nearly complete. The good news is that a number of the issues plaguing the last several quarters began to ease as the first quarter finished and the second quarter began. For one, oil prices crossed back above $50 per barrel on June 7th. That is certainly a positive for the energy sector which has been dragging down index earnings. The dollar has relinquished its highs, which will remove top line pressure at companies that do business in foreign areas. And even though economic data remains mixed, housing, consumer spending habits and consumer sentiment remain bright spots. The bad news is that growth is expected to remain negative for the fourth quarter in a row.

Encouragingly, the picture turns brighter in the second half of the year, with both the third and fourth quarter expected to post increases in earnings growth. Consumer discretionary will be a large driver in the second half and materials is the only other sector projected have double digit growth in both quarters. Analysts are anticipating a turnaround in the sector after four quarters of declines. Materials and industrials typically are drivers of early cycle improvement in the economy and the market. As such, we will keep an eye on the trajectory of the growth rates for these sectors as clues into the direction of the market and economy.

From a valuation perspective, the S&P 500 reached an elevated forward 12-month price-to- earnings (P/E) multiple of 17.6x on June 8. While a pull back at the end of last week led to a slightly reduced multiple, the last time the index had a 17.6x multiple was on Sept. 29, 2009, according to S&P Global Market Intelligence data.

For reference, the 10-year historical average forward multiple for the index is 16.0x. Over the last year, the index has bounced around between 15.0x and 17.5x with the market retreating each time the multiple reaches the high end of that band. We expect that multiple to return to more normal levels in the near term, which given the unlikeliness of significant increases to earnings per share (EPS) means a pull-back in the index is more likely to drive a reduced market multiple.

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