Sector Strategy. ꟾ May 2017 ꟾ. S&P 500 Index Trailing 5 Years New All Time High! 10 Year U.S. Treasury Trailing 5 Years

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1 5// 11// 5//13 11//13 5//14 11//14 5//15 11//15 5//1 11//1 5// 5// 11// 5//13 11//13 5//14 11//14 5//15 11//15 5//1 11//1 5// Billings: (40) Conrad: (40) Helena: (40) Missoula: (40) ꟾ May 20 ꟾ Sector Strategy The S&P 500 is the most well-known market index in the world. Its level, trend, and outlook are analyzed from almost every conceivable angle. While looking at the Index is important, we never want to lose sight of what s under the hood. What is actually driving the Index quarter-to-quarter and year-to-year? Have there been significant changes in the make-up of the Index over time? As the name implies, the S&P 500 is comprised of five hundred of the largest publicly traded companies in the U.S. The underlying stocks are not only a part of the Index, but can be categorized into 11 broad sectors, 24 industry groups, industries, and 15 sub-industries. The eleven sectors and their corresponding weights in the Index are shown in the table to the right. By plotting the changes in a sector s weight over time, we can learn a lot about the drivers and fundamental characteristics of the market... S&P 500 SECTORS WEIGHTING (as of 4/30/) Information Technology 22.5% Financials 14.1% Health Care 14.0% Consumer Discretionary.5% Industrials.2% Consumer Staples 9.3% Energy.3% Utilities 3.2% Real Estate 2.9% Materials 2.% Telecommunications 2.3% Eric Vermulm, CFA Chief Investment Officer evermulm@stockmanbank.com 2,400 S&P 500 Index Trailing 5 Years New All Time High! 3.3% Year U.S. Treasury Trailing 5 Years 2,000 1,00 2.% 2.3% 1.% = 2.41% 1, % Market Update ꟾ Page ꟾ May 20

2 Energy The graph below shows the Energy Sector since Oil and gas companies currently make up.3% of the S&P 500, with a 2 year average weight of 9.4%. Standard deviation* bands are also shown. Just a few years ago, as crude oil prices reached $150 per barrel, Energy made up 1% of the S&P 500. Calls for peak oil the theory that we were running out of easily found crude were common. Many thought we were going through a structural shift in the economy and that demand for oil would outpace supply indefinitely. Thanks to new technology and unconventional drilling, this idea turned out to be wrong (for the time being at least). As the Energy sector broke above 14% of the economy in 200 (and similar to 1990), you would have done well by moving to an underweight position. Today, we re at the other end of the spectrum, with the sector one standard deviation below its average. There is widespread pessimism on oil companies fears that new supply sources in the U.S. will keep prices lower for longer. Energy Sector Energy Sector Average +1SD -1SD +2SD -2SD *Standard deviation is a measure of volatility. If a data series is normally distributed (i.e. a bell curve), we would expect ~% of observations to occur between +/- 1 standard deviation, and ~95% of observations to occur between +/- 2 standard deviations. The further a data point is away from the average, the greater the probability (all things equal) for reversion to the mean. Market Update ꟾ Page 2 ꟾ May 20

3 From a purely statistical point of view, this is a buying opportunity in Energy. For this and a number of other reasons, Stockman Wealth Management is positioning portfolios slightly overweight in the sector. However, we would also point out that commodity cycles can often be very long. Investors who purchased Energy stocks in 199 (the last time we saw a value opportunity similar to today) had to wait over six years for the cycle to finally turn up in Health Care From a low of % in 1993 to a high of 1% in 2009, Health Care s weight in the S&P 500 has been generally trending higher. Shifting demographics, namely the silver tsunami of baby boomers requiring more medical care, is spurring demand. This trend shows no sign of fading, with most economists expecting Health Care to become an even larger part of the Index in future years. Countering this point, over the last years, Health Care has three times ( , 2009, and 2015) approached 1% of the Index, and each time it has reversed lower. When the sector approached this level, it would have been a good time to lower Health Care exposure (relative to other sectors). At Stockman Wealth Management, we are continuing to hold an overweight position in the Health Care sector thanks to the defensiveness of many medical stocks as well as their (relatively) attractive valuations. However, we re watching the recent weight decrease very closely for signs of a sustained downturn. Health Care Sector 1 14 Health Care Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page 3 ꟾ May 20

4 Technology The Technology bubble of the late 1990s shows how quickly economic trends can shift. Technology grew from 5% of the S&P 500 in 1993 to over 33% of the market in 2000 a nearly seven fold increase in less than seven years. This rapid exponential growth is the textbook look of a bubble. Although the late 1990s were a time of extreme euphoria, the underlying idea that technology would grow into a bigger and bigger part of our lives was clearly right. Except for the bear market of , Technology as a percentage of the market has steadily grown. Today it makes up 22.5% of the S&P 500. Will it continue to grow? Most forecasters would say yes as the Internet of Things (IoT) brings technology into more and more areas of the economy. At that same time, some industries in the sector are starting to look overvalued and frothy. At Stockman Wealth Management, we are continuing to hold more mature Technology stocks: ones with defensive characteristics, proven business models, and clear competitive advantages. 3 Information Technology Sector Information Technology Sector Average +1SD -1SD +2SD -2SD Recent issues of Market Update can be found online at the Stockman Wealth Management page of To be included on the distribution list (six issues per year, plus special updates as necessary), please contact us at: evermulm@stockmanbank.com - thank you! Market Update ꟾ Page 4 ꟾ May 20

5 Consumer Discretionary The Consumer Discretionary sector which represents a varied group of companies ranging from Walt Disney to General Motors has been the workhorse of this bull market, outpacing every other sector and climbing an average of 24% per year since the recovery began in In hindsight, the sector bottoming at approximately % of the Index in late 200 was a clear buy signal. Today, Discretionary stocks make up.5% of the S&P 500, roughly in-line with the long-term average of.2%. One thing we would point out, however, is that Standard and Poor s moved a number of Discretionary stocks into the Consumer Staples sector in 2003 (see the red circle in the graph below). If we account for this shift and its long-term impact, the Discretionary sector is likely one standard deviation, and possibly approaching two, above average. This, along with the sector s poor performance in past bear markets, is one of the main reasons client portfolios are underweight in Discretionary stocks. Consumer Discretionary Sector S&P Rebalance to Consumer Staples Consumer Discretionary Sector Average +1SD -1SD +2SD -2SD What would you like to learn about in the next edition of Market Update? Please us your feedback and questions to: evermulm@stockmanbank.com Market Update ꟾ Page 5 ꟾ May 20

6 The Bottom Line As the market continues to work its way higher, it s important to understand which sectors and industries are driving outperformance. As we ve highlighted in prior issues, most time tested fundamental and technical indicators are not currently warning of an imminent recession. Yet, with an aging bull market and above average valuations, risks are rising. A tactical sector strategy, where areas with weak growth prospects and higher valuations are underweighted, can help minimize risk when the next bear market arrives. For further detail on the market, the graphs of all * S&P sectors are shown in the attached addendum. *Real Estate, the 11th sector, was carved out of Financials in the summer of 201. Without a significant historical track record, we have excluded Real Estate from this analysis. On June 2, 105, The Corps of Discovery, led by Captains Lewis & Clark, arrived at a fork in the yet unexplored Missouri River. All the crew members of the Corps (including expert waterman Pierre Cruzatte) felt the north fork was the true Missouri and should be followed. The two Captains, however, correctly overruled them, and guided the expedition southwest, saving a costly (in time, and perhaps lives) journey up the Marias River. In an amazing display of discipline and courage, the crew accepted this decision and very cheerfully [said] they were ready to follow us anywhere. Stepping off the map into uncharted territory, in what they thought was the wrong direction, and being happy about it. Undaunted courage indeed. Data sourced from The Journals of Lewis and Clark The views expressed are those of the author at the time of writing and are subject to change. This material has been distributed for educational/informational purposes only, and should not be considered as investment advice or a recommendation for any particular security, strategy, or investment product. The material is based upon information we consider reliable, but its accuracy and completeness cannot be guaranteed. Past performance is not a guarantee of future returns. As with any investment vehicle, there is a potential for profit as well as the possibility of loss. 402 North Broadway PO Box 250, Billings, MT (40) North Sanders Street PO Box 329, Helena, MT 5904 (40) South Main Street PO Box 2, Conrad, MT (40) North Higgins Avenue, Suite 200 PO Box 9, Missoula, MT 590 (40) Stockman Wealth Management is an SEC registered investment advisor (RIA). We specialize in constructing high quality portfolios based on each individual client s risk tolerance and goals. Through detailed analysis, an objective outlook, and unmatched customer service, we work to be your valued investment partner. Please feel free to contact any one of our offices to learn more about Stockman Wealth Management. Not FDIC Insured ꟾ No Bank Guarantee ꟾ May Lose Value Market Update ꟾ Page ꟾ May 20

7 Consumer Discretionary Sector S&P Rebalance to Consumer Staples Consumer Discretionary Sector Average +1SD -1SD +2SD -2SD Consumer Staple Sector S&P Rebalance from Consumer Discretionary 5 Consumer Staple Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page ꟾ May 20

8 Energy Sector Energy Sector Average +1SD -1SD +2SD -2SD 25 Financial Sector S&P creates the Real Estate sector out of Financials Financial Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page ꟾ May 20

9 Health Care Sector 1 14 Health Care Sector Average +1SD -1SD +2SD -2SD 1 Industrial Sector Industrial Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page 9 ꟾ May 20

10 3 Information Technology Sector Information Technology Sector Average +1SD -1SD +2SD -2SD Material Sector Material Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page ꟾ May 20

11 Telecommunication Sector Telecommunication Sector Average +1SD -1SD +2SD -2SD Utility Sector Utility Sector Average +1SD -1SD +2SD -2SD Market Update ꟾ Page 11 ꟾ May 20