Equities

Highlights Analysis on Turkey is published below. The key reason why we believe the ongoing EM rally will falter is that EM corporate earnings have begun to contract. When EPS growth turns negative, low interest rates typically do not prevent share prices from selling off. The recent pick-up in China’s credit and fiscal spending impulse suggests the bottom in EM corporate profit growth will only occur toward the end of 2019. There are several key differences between the economic backdrops and financial markets signposts between now and 2016. The current profiles of both EM and DM share prices are a close match to those in 2011-2012 when the strong rally in the first quarter was followed by a major selloff in the second quarter. Feature The common narrative in the market is that the current policy backdrop – a pause by the Fed and policy stimulus from China – is a repeat of early 2016. As such, market participants expect moves in global risk assets to be analogous to those during that period. We too could easily adopt this simple narrative, and recommend investors to chase EM higher. Instead, we have chosen to take on the very difficult task of expounding why 2019 is not a repeat of 2016 in EM and China-related financial markets. Based on this, our view remains that investors should not be chasing the current EM rally. The essential pillar of our negative thesis on EM is that their corporate profits will contract this year. This will be bad news not only for EM share prices but also for EM credit markets and currencies. Chart I-1 illustrates that during the past 10 years, EM stock prices plunged every time profit contraction commenced. Having rallied meaningfully in the past three months, EM financial markets will sell off as EM corporate earnings begin to shrink. Chart I-1EM EPS Is Beginning To Contract The basis for EM profit contraction is the continued slowdown in China. Chart I-2 illustrates that China’s credit and fiscal spending impulse leads EM EPS growth by about 12 months. Hence, the recent pick-up in the former entails the bottom in the latter only toward the end of 2019. Chart I-2EM EPS Growth Will Bottom Only Toward The End Of 2019 In brief, even assuming China’s credit and fiscal spending impulse has bottomed and will improve going forward, EM EPS contraction will deepen for now. EM share prices are unlikely to embark on a cyclical bull market until EM EPS growth bottoms. Earnings Versus Interest Rates Lower interest rates are typically bullish for both equity and credit markets so long as corporate profits do not contract. However, when EPS growth turns negative, low interest rates usually do not prevent share prices from selling off. In general, when discussing the effect of interest rates on equities, one should differentiate between economic and financial linkages. Given the cornerstone narrative of this EM rally has been declining U.S. interest rate expectations, we examine the nexus between EM risk assets and U.S. interest rates. The economic link refers to the impact of borrowing costs on aggregate spending, and hence corporate profits. The pertinent question is as follows: Was the Fed tightening responsible for the growth deceleration in EM/China in 2018? The short answer is not really. Chart I-3 illustrates that as of the end of February, while Korean, Taiwanese, Japanese and Singaporean exports to the U.S. expanded by 10% from a year ago, their shipments to China contracted by 10%. Chart I-3Global Trade Slowed Due To China Not The U.S Hence, the slowdown in EM corporate profits has not been caused by Fed policy. U.S. domestic demand in general and imports in particular have so far been expanding at a healthy pace and they have not been instrumental to EM corporate earnings cycles (Chart I-4). This signifies that lower U.S. interest rates should not have a material impact on EM growth, and thereby corporate profits. Chart I-4EM EPS Growth Has Not Been Driven By Sales To U.S. Notably, one can argue that the economic and financial market dynamics that prevailed in 2018 worked in the opposite direction: It was China’s slowdown that ultimately imperiled U.S. manufacturing growth, causing U.S. equity and credit markets to sell off, thereby forcing a reversal in the Fed’s stance. The financial link refers to a declining discount rate for EM risk assets as U.S. interest rates drop. A drop in the discount rate lifts the present value of future cash flows and boosts risk asset prices. However, EM equity multiples have not been historically negatively correlated with U.S. bond yields, as shown on the top panel of Chart I-5. Besides, EM credit spreads do not always positively correlate with U.S. borrowing costs, as widely expected (Chart I-5, middle panel). Chart I-5U.S. Bond Yields And EM: No Stable Relationship Further, EM currencies have not been negatively correlated with either U.S. bond yields or with the interest rate differential between the U.S. and EM (Chart I-5, bottom panel). As to EM local bond yields, especially in high-yielding markets, it is EM exchange rates that drive EM domestic bond yields and their differential over U.S. Treasurys. When EPS growth turns negative, low interest rates usually do not prevent share prices from selling off. Finally, Chart I-6 illustrates the relationship between the returns on EM assets on one hand and U.S. bond yields on the other. This chart corroborates the evidence from Chart I-5 – that the relationship between U.S. interest rates and EM asset markets is not stable. Chart I-6U.S. Bond Yields And EM Risk Assets: No Stable Relationship Even though in the short term financial markets in developing countries seem to react to changes in U.S. interest rates, in the medium and long run there is no stable relationship between EM risk assets and U.S. Treasury yields. In short, lower U.S. interest rate expectations is not a sufficient condition to be positive on EM risk assets. How do we explain the absence of a strong relationship between these financial and economic variables? Our take is as follows: When EPS growth turns negative, low interest rates typically do not prevent share prices and credit markets from selling off. That is why there is no clear and strong relationship between EM risk assets and U.S. interest rates. Was the Fed tightening responsible for the growth deceleration in EM/China in 2018? The short answer is not really. Corporate earnings are the key to sustaining this EM rally. What is needed for EM corporate profits to recover is a revival in Chinese demand. The latter is not yet imminent, implying that EM assets will likely hit an air pocket before a more durable bottom occurs. Are lower interest rates in China a justification for the latest EM equity rebound? Chart I-7 demonstrates that both EM and Chinese investable stock indexes positively correlate with interest rates in China. The reason is because all of them are driven by Chinese growth: When growth accelerates, these share prices and Chinese local bond yields rise, and vice versa. Chart I-7Chinese Interest Rates And EM / China Share Prices: Positive Correlation Bottom Line: Lower interest rates in the U.S. or in China in and of themselves do not constitute sufficient conditions for a cyclical rally in EM share prices. The primary driver of EM share prices in the past 10 years has been Chinese growth, because the latter has a considerable bearing on EM corporate profits. For now, there have been no substantive signs of a growth revival in China. How 2019 Is Different From 2016 We elaborated in detail on how the current round of policy stimulus in China differs from the one in 2015-‘16 in our report titled, Dissecting China’s Stimulus, and will not discuss it here. Instead, we offer several economic and financial signposts illustrating how the EM/China outlook and financial market dynamics in 2019 will differ from those of 2016: Presently, there is no meaningful policy stimulus for the real estate market in China, and property sales will continue to shrink (Chart I-8). This is the opposite of what occurred in 2015-‘16 when the Chinese central bank literally monetized excessive housing inventories by financing residential real estate via its Pledged Supplementary Lending (PSL) facility. The ensuing surge in property demand substantially contributed to the business cycle recovery on the mainland in 2016-‘17. Chart I-8A Downbeat Outlook For Chinese Housing EM share prices have been underperforming the DM equity index since late December. In contrast, EM began outperforming DM in January 2016 (Chart I-9). Chart I-9EM Equities Have Been Underperforming DM Ones Since Late December In early 2016, the pace of EM profit contraction stabilized after 18 months of deepening shrinkage (Chart I-1 on page 1). What’s more, investor sentiment on EM was very downbeat in early 2016. Presently, the EM profit contraction is just commencing, and its rate of change will bottom only in late 2019, as per Chart I-2 on page 2. In the meantime, investors are ill prepared for bad news, as their sentiment on EM is extremely buoyant. Finally, the broad trade-weighted U.S. dollar began selling off in early 2016, corroborating the EM rally. This year the broad measure of the trade-weighted dollar has not sold off. Hence, the dollar has not yet confirmed the EM rebound (Chart I-10). Chart I-10The U.S. Dollar And EM Share Prices Is 2019 Akin To 2012? In terms of share-price patterns, the current profiles of both EM and DM are a close match to those in 2011-2012 (Chart I-11). Following a major plunge in the second half of 2011, share prices bottomed in December 2011 and rallied sharply in the following three months. Not only is the duration similar to what transpired with share prices in 2011-’12, but also the magnitude (Chart I-11). Chart I-11Is 2018-19 Akin To 2011-12? As to the economic backdrop in 2011-‘12, the euro area was in the midst of a credit crisis and China/EM growth was slowing due to the preceding Chinese policy tightening. After the strong rally in January-March 2012, both EM and DM bourses sold off sharply in the second quarter of 2012, re-testing their late 2011 lows. Critically, like the present and unlike early 2016, EM stocks were underperforming DM ones during the early 2012 rally. Lower U.S. interest rate expectations is not a sufficient condition to be positive on EM risk assets. On the surface, it appears that the magic words of the European Central Bank President Mario Draghi that “…the ECB is ready to do whatever it takes to preserve the euro” that halted the global selloff. Yet, in reality, Draghi’s speech was the trigger for – not the cause of – the markets’ reversal. In retrospect, the primary reason for a major bottom in global risk assets in June 2012 was the bottom in the global business cycle in the second half of 2012 (Chart I-12, top panel). Chart I-12Global Growth Has Not Yet Bottomed As can be seen on this panel, global equity prices are often coincident with “soft” economic data like global manufacturing PMI. Global stocks typically lead “hard” economic data and corporate profits but do not always lead “soft” data. Presently, the bottom in global manufacturing and trade is not yet in sight. The bottom panel of Chart I-12 shows that Taiwanese exports of electronics products parts are still nose-diving, and they typically lead global manufacturing PMI by a few months. These electronics parts are inputs into final goods; when producers of these goods plan to increase production they first order these parts. As a result, trade in these electronics parts lead the broader trade/manufacturing cycle. Taiwanese exports of electronics products parts are still nose-diving, and they typically lead global manufacturing PMI by a few months. On the whole, odds are that China’s business cycle as well as global trade and manufacturing have not yet hit a durable bottom and are not about to recover. Countries/industries leveraged to China will experience a meaningful profit contraction. Hence, there is a significant probability that EM stocks re-test their recent lows akin to what transpired in 2012. Investment Considerations There is no meaningful evidence indicating that China’s business cycle and global trade and manufacturing have bottomed. Global cyclical equity sectors have rebounded but have not yet decisively broken above their 200-day moving averages (Chart I-13). Crucially, their relative performance to the overall global index has been rather sluggish (Chart I-14). This corroborates the lack of global growth tailwinds behind this global equity rally. Chart I-13Global Cyclical Equity Sectors: Absolute Performance Chart I-14Global Cyclical Equity Sectors: Relative Performance Asset allocators should continue to underweight EM stocks and credit markets within their global equity and credit portfolios, respectively. Without an improvement in the global business cycle, the rebound in EM currencies is not durable. As China’s growth disappoints, EM currencies will depreciate versus the dollar, the euro and the yen. Renewed currency depreciation will erode returns on EM local currency bonds for international investors. For dedicated EM local bond portfolios, our recommended overweights are Mexico, Brazil, Chile, Russia, central Europe, Thailand and Korea (Chart I-15). Our underweights are South Africa, Indonesia, India and today we are downgrading Turkish local bonds to underweight (please refer to section on Turkey starting on the next page). Chart I-15Favor These Local Currency Bond Markets Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Turkey: Brewing Policy Reversal? The odds of a policy reversal in Turkey are rising. The government’s patience with tight monetary policy may be running thin. The nation’s GDP contracted by 3% in the final quarter of 2018 from a year ago. Further contraction is in the cards. Chart II-1 signifies that monetary policy is indeed tight: Lira-denominated bank loan growth is at zero, and in real (inflation-adjusted) terms bank lending has shrunk by about 18% from a year ago. The ongoing painful economic retrenchment (Chart II-2) and rising unemployment may lead the authorities to loosen monetary policy/liquidity conditions via “backdoor” liquidity easing – something the Turkish central bank has done often over the current decade. Specifically, the central bank’s liquidity provisions to the banking system will likely begin to rise (Chart II-3). The severe liquidity tightening, underway since October 2018 via reduced lending to banks, has been partially responsible for the stability in the exchange rate. As the central bank augments liquidity provisions to the banking system, the lira will again come under renewed selling pressure. Rising unemployment may lead the authorities to loosen monetary policy/liquidity conditions via “backdoor” liquidity easing. The goal of liquidity provisioning would be to bring down interbank rates and, ultimately, lending rates. Presently, the spread between commercial banks’ lending rates and the interbank rate is negative (Chart II-4, top panel). This is unsustainable. The authorities have forced banks to bring down their lending rates in recent months. As a result, the gap between banks’ lending and deposit rates has also narrowed considerably (Chart II-4, bottom panel). This will weigh on the banks’ profitability. Consequently, we are closing our tactical long Turkish banks / short EM banks trade. The government cannot force banks to reduce their lending rates further without reducing their cost of funding. Hence, the central bank might opt to inject excess reserves into the system to bring down interbank rates. Thereafter, the authorities could “guide” banks to further lower their lending rates. Policy easing might not be in the form of outright policy rate cuts to avoid a negative reaction from financial markets. Instead, the central bank could push down inter-bank rates by way of obscure liquidity injections into the banking system. To be sure, the odds of the currency reacting poorly to such loosening of liquidity are non-trivial. This, along with the ongoing recession, the shrinking bank net interest margins and the slow pace of bank loan restructuring, are leading us to downgrade the Turkish bourse that is heavy in bank stocks. Investment Recommendations Downgrade Turkish stocks and local currency bonds back to underweight. We closed our short/underweight positions in the Turkish currency, bonds and equities on August 15, 2018. For details, please see the report Turkey: Booking Profits On Shorts. This has proved to be a timely move as Turkish markets have rebounded notably and outperformed their EM peers (Chart II-5). In our opinion, it is now time to downgrade it again. ​​​​​​​ We are also closing our tactical long Turkish banks / short EM banks trade. This position has netted a modest 2.3% gain since its initiation on November 29, 2018. Andrija Vesic, Research Analyst andrijav@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights Investors should use the following dynamic for tactical asset allocation: 1. Sum the 10-year yields on the T-bond, German bund, and JGB. 2. When the sum is near 4 percent, it is prudent to de-risk portfolios and sit aside, at least for a while. It is a good level to buy a mixed portfolio of high-quality 10-year government bonds. 3. Just below this level, a sum in the 3-4 percent range defines a kind of ‘no man’s land’ in which equities drift sideways. 4. When the sum is near 3 percent, the seemingly rich valuations of equities versus bonds is fully justified. And it is appropriate to redeploy tactically from bonds to equities (Chart of the Week). 5. Use the 65-day fractal dimension to pinpoint the precise transition points between asset-classes: as for example, successfully achieved for the DAX versus German bunds. Right now, with the sum near 3 percent, it is still appropriate to be overweight equities versus bonds, and our preferred expression is overweight the DAX versus the German long bund. Feature Chart of the WeekThe Rule Of 4 Becomes The Rule Of 3 The global long bond yield recently hit a two-year low (Chart I-2). This is the direct result of central banks’ pivot to dovish – a commitment to keep policy rates at current levels, rather than to hike, for the foreseeable future. Chart I-2The Global Long Bond Yield Recently Hit A Two-Year Low One consequence is that high-quality bonds have become riskier. Consider a German bund or a JGB which is yielding zero percent. The short-term potential for capital appreciation – nominal or real – has almost vanished, while the potential for vicious losses has increased dramatically. The technical term for this negative asymmetry is negative skew. Years of research in a field of behavioural economics called Prospect Theory concludes that negative skew is the metric that best encapsulates investment risk. The Correct Way Of Thinking About Investment Risk A great misunderstanding of finance is to equate risk with volatility. Risky assets, such as equities, are risky not because they are volatile in the conventional sense. After all, who minds when their asset price goes up sharply? Risky assets are risky because they have the propensity to experience much larger short-term losses than short-term gains – captured in the saying: equities climb up the stairs on the way up, but they jump out of the window on the way down. High-quality bonds have become riskier. Another great misunderstanding of finance is the idea that bonds offer a diversification benefit and, therefore, that investors should accept a lower return from them. This argument is also flawed. The bond market is bigger than the equity market, and just as bonds are a diversifier for equity investments, equities are a diversifier for bond investments. Indeed, equities have protected bond investors during vicious sell-offs in the bond market such as after Trump’s shock victory in 2016. So we could equally argue that equities offer a diversification benefit. In fact, the correct way of thinking about investment risk is as follows: An investment’s risk depends on the negative asymmetry of its short-term returns. At very low bond yields, bond returns develop the same negative asymmetry as equity returns (Chart I-3). This means that equities lose their excess riskiness versus bonds, requiring equity valuations to experience a phase transition sharply higher (Chart I-4). But when bond yields normalize, equities regain their excess riskiness versus bonds – and their valuations must suffer a phase transition sharply lower. The phase transition in equity valuations is most pronounced when the global 10-year bond yield goes up or down through 2 percent (Chart I-5). This dynamic proved to be the biggest driver of asset allocation in 2018, and is likely to be a big driver in 2019 too. Essentially, higher bond yields can suddenly and viciously undermine the valuation support of equities, triggering a plunge in the stock market and other risk-assets which threatens a disinflationary impulse. The unsurprising response from central banks is to pivot back to dovish, pulling back bond yields to previous lows. These lower bond yields then push up equity (and other risk-asset) valuations back to previous highs. An investment’s risk depends on the negative asymmetry of its short-term returns. The good news is that record high valuations of risk-assets are fully justified if bond yields remain at current levels or decline further. But the longer-term danger is that these rich valuations are hyper-sensitive to rising bond yields. The Bubble In Everything The current episode of elevated risk-asset valuations is not unprecedented, but there is a crucial difference. Previous episodes of elevated risk-asset valuations tended to be localised, either by geography or sector: 1990 was focussed in Japan; 2000 was focussed in the dot com related sectors; 2008 was focussed in the U.S. mortgage and credit markets. Extraordinary monetary policy has boosted the valuations of all risk-assets across all geographies and all asset-classes. By comparison, the post-2008 global experiment with quantitative easing, and zero and negative interest rate policy has boosted the valuations of all risk-assets across all geographies and all asset-classes – equities (Chart I-6), credit (Chart I-7), and real estate (Chart I-8). This makes it considerably more dangerous, because we estimate that the total value of global risk-assets including real estate is $400 trillion, equal to about five times the size of the global economy.1 Chart I-6Equities Remain Richly Valued Chart I-7Credit Remains Richly Valued Chart I-8The EM Real Estate Boom Happened After 2008 Let’s say you had a risk-asset that was priced to generate 5 percent a year over the next decade. Now imagine that the valuation boost from ultra-accommodative monetary policy capitalises all of those future returns to today. For those future returns to drop to zero, today’s price must surge by 63 percent.2 If you were prudent, you might amortise today’s windfall to generate the original 5 percent a year over the next decade. But if you were imprudent, you might spend a large amount of the windfall today. The total value of global risk-assets equals five times the size of the global economy. Now let’s imagine a valuation derating moves the risk-asset’s returns back to the future. For those that had prudently amortised the original windfall, nothing has really changed and future spending patterns would not be impacted. But not everybody is prudent. For those that had imprudently spent the original windfall, future spending would inevitably suffer a nasty recession. The Rule Of 4 Becomes The Rule Of 3 How can we sense the crucial 2 percent level in the global 10-year bond yield? The answer is that it broadly equates to when the sum of the 10-year yields on the T-bond, German bund and JGB is at a 4 percent level (Chart I-9). This is the genesis of our very successful ‘Rule of 4’. In 2019, just as in 2018, investors should use the following dynamic for tactical asset allocation. The rule of 4 identifies when the global 10-year bond yield is at 2 percent. Chart I-9When The Sum Of 10-Year Yields On The T-Bond, Bund, And JGB Equals 4 Percent, The Global 10-Year Yield Equals 2 Percent  Sum the 10-year yields on the T-bond, German bund, and JGB. When the sum is near 4 percent, it is prudent to de-risk portfolios and sit aside, at least for a while. It is a good level to buy a mixed portfolio of high-quality 10-year government bonds. Just below this level, a sum in the 3-4 percent range defines a kind of ‘no man’s land’ in which equities drift sideways.  When the sum is near 3 percent, the seemingly rich valuations of equities versus bonds is fully justified. And it is appropriate to redeploy tactically from bonds to equities. Use the 65-day fractal dimension to pinpoint the precise transition points between asset-classes: as for example, successfully achieved for the DAX versus German bunds (Chart I-10). Overweight equities versus bonds. With the sum of the three 10-year yields now near 3 percent, the rule of 4 has, in a sense, become the rule of 3. It is still appropriate to be tactically overweight equities versus bonds, and our preferred expression is to overweight the DAX versus the German long bund. Chart I-10Use The 65-Day Fractal Dimension To Pinpoint The Precise Transition Points Between Asset-Classes   Dhaval Joshi, Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 Please see the European Investment Strategy Weekly Report “Trapped: Have Equities Trapped Bonds?”, September 13, 2018 available at eis.bcaresearch.com. 2 5 percent compounded over ten years.

Special Report

Highlights So What? A major antitrust suit could happen within the next couple of years, paradoxically ushering in a rewarding investment opportunity.  Why? The current environment of corporate overreach, protectionism and popular discontent has often preceded large antitrust suits. An outcome other than a breakup would likely be benign for the stock price, while the announcement of a breakup would be negative. However, the completion of the breakup could present a great buying opportunity. Feature “No wonder that Wall Street’s prayer now is ‘Oh Merciful Providence, give us another dissolution’” - Former U.S. President Theodore Roosevelt, 1912   The investment community has been increasingly worried about the possibility of regulatory action against America’s biggest technology companies (the so-called “FAANG” stocks). We addressed the mounting probability of such action in a mid-2018 report. In this report, we focus on the market reaction post-dissolution, by examining some of the biggest antitrust cases in the history of the U.S. Specifically, this report complements our work on the U.S. antitrust framework (please see Appendix A) by looking for potential signs indicating that a monopolization suit could be likely. Moreover, we analyze the stock prices of the companies alleged to have committed antitrust violations to understand the implications for investors’ portfolios. To build our sample of U.S. monopolization cases, we set the following criteria: 1.  Non-merger cases: Antitrust cases blocking mergers between two or more companies are common, and most investors are familiar with them. However, we choose to examine the much rarer cases involving a single firm. 2.  Large-cap companies: A large number of anti-monopoly suits are directed towards small or private companies. We select only companies that had a large market capitalization at the time of the suit, in order to closely match the profile of FAANG stocks. 3.  The Department of Justice sought dissolution: We decided against considering monetary fines, as they are generally not big enough to meaningfully affect the stock price of large companies.1 By focusing on cases where dissolution was sought, we narrow our scope to the most severe cases in antitrust history. Table 1 shows the seven companies that we selected, as well as the final verdict, the timeline of the process, and other details. While our sample may seem small, it is important to remember that since the passing of the Sherman Act in 1890, non-merger anti-monopoly cases against large public companies have been incredibly rare in the U.S., even in the periods with the strictest regulatory enforcement.2  The increasing economic and political power of corporations acted as a catalyst for antitrust enforcement. Our sample includes a variety of outcomes: from cases where the accused won the suit or where the suit was dropped (U.S. Steel and IBM), to cases where there was ultimately no dissolution but a different remedy was imposed (Alcoa and Microsoft), to cases where the accused was broken up (Standard Oil, American Tobacco and AT&T). Power, Protectionism, And Discontent: The Causes Of Anti-Monopoly Suits The economic and political context surrounding the cases in our sample share some common features. 1.  Corporate overreach The issue of power was central to the original intent of the Sherman Act,3 with the U.S. Congress understanding that the concentration of economic power will ultimately result in concentration of political power, “breeding antidemocratic political pressures.”4 The data confirms that the increasing economic and political power of corporations acted as a catalyst for enforcement. With the exception of AT&T, every single one of our examined cases occurred following a period where the earnings of the biggest corporations in the U.S. were increasing at a rate faster than worker compensation (Chart 1, top panel). This dynamic likely increased the feeling of distrust towards big business, as corporations were perceived to be getting a disproportionate amount of the national wealth. The prices in the industries of the accused companies were generally decreasing relative to inflation in the period prior to the beginning of their case. Concern regarding corporate power also arose for different reasons. In 1965, Ralph Nader published the book “Unsafe at Any Speed,” accusing the large American automakers of hiding their safety record. Nader’s work coincided with the origin of the modern anti-tobacco movement. The two would mark the beginning of the consumer movement and would increase scrutiny on the power that companies yielded (Chart 1, bottom panel), providing the political impetus behind the antitrust movement.5  Chart 1Antitrust Action Seeks To Curb Corporate Power 2.  Domestic protectionism Traditional economic theory would suggest that monopoly firms can charge “monopoly prices,” i.e. prices much higher than what would exist in a competitive market. However, the data tells a different story, as the prices in the industries of the accused companies were generally decreasing relative to inflation in the period prior to the beginning of their case (Chart 2). Chart 2AAccused Monopolies Were Cutting Prices (I) Chart 2BAccused Monopolies Were Cutting Prices (II) How to explain this? In contrast to the stereotypical monopoly, most of the accused companies were ruthlessly efficient and competitive, having the ability to substantially lower costs relative to their competitors. Some did this through genuine innovation. The Standard Oil corporation, for example, invented the oil tanker, dramatically reducing loading time and associated risk. As a result, it was able to secure lower transportation costs from the railway companies.6 Others did it through economies of scale. An example is Alcoa, which vertically integrated all four stages of aluminum production.7 Moreover, while being responsible for 90% of the supply of U.S. primary aluminum, it produced it all in a single plant, minimizing overhead costs.8  Due to their ability to charge drastically lower prices, the corporations in our sample were accused of using predatory prices in six out of the seven cases.9 This was despite the fact that these claims often fell flat in court, largely because distinguishing between predatory pricing and price competition is extremely difficult in practice.10 But if these companies were lowering prices through innovation and economies of scale, why were they charged in the first place? At its core, regulation of monopolies has broader policy objectives.11 This ranges from protectionism against foreign competition to protectionism against large domestic corporations. This protectionist streak dates all the way back to John Sherman himself, an advocate of tariffs during his entire political career.12 Thus, the efficiency of major companies accused of forming trusts was often their downfall, as struggling domestic rivals applied political pressure to bring the suit forward.13 The timing of antitrust suits suggests that the government was looking to deflect the blame of the bust phase. 3.  Late cycle, recessions, inflation Finally, with the exception of the Microsoft case in 1998, the government filed the antitrust complaints against the companies in our sample in recessionary or late-cycle periods (within a year of a recession). Additionally, rising and relatively high inflation tended to precede these periods (Chart 3). Although we have no outright evidence, the timing suggests that the government was looking to deflect the blame of the bust phase or general economic mismanagement. Chart 3Are Antitrust Suits A Distraction From Economic Mismanagement? Antitrust Cases And Stock Prices  The length of the cases in our sample range from roughly three years in the Microsoft case to more than 13 years in the Alcoa case. Moreover, the number and type of judicial decisions varied widely between cases. To make for a better comparison we look at only three events in each case: 1.  The Accusation: the date when the suit was first filed by the Department of Justice. 2.  The Decision: the date of the effective end of the case; when the case was either dropped or settled, or when the “last resort” court arrived at a final remedy. 3.  The Breakup: for the cases ending in dissolution, the date when shares of the new companies were distributed to investors; when the breakup was consummated. For all the charts in this section, we denote month “t” as the relevant event month. For information on the stock price movement following other important judicial events, please see Appendix B. The filing of a suit was generally negative for the stock price of the accused company. The Accusation The filing of a suit was generally negative for the stock price of the accused company (Chart 4). The stock price of every one of the companies suffered relative to the appropriate benchmark in the month of the accusation. The effect seems to have been more dramatic for the cases before the 1920’s with an average underperformance of 13% in the month of the event, although they were able to recover from the initial hit within six months. The impact on the more recent cases was more muted, with an average underperformance of 3.7%. The Decision When analyzing the last judicial event of the suit, we separate our cases into three different outcomes: cases where the suit was dropped or won (U.S. Steel and IBM), cases where there was a remedy other than dissolution (Alcoa and Microsoft), and cases concluding in dissolution (Standard Oil, American Tobacco, and AT&T). Both U.S. Steel and IBM outperformed the market in the year following the positive announcement (Chart 5), though the effect seems to have been more muted for U.S. Steel. On the other hand, the effect was much more pronounced for IBM, which found some relief from regulators after famously spending a fortune defending itself. Alcoa, on the other hand, suffered a 4.3% underperformance once its stock disposal remedy was announced, although it managed to recover the losses within seven months (Chart 6). Meanwhile, Microsoft finished the year following the announcement outperforming the market by 12%. For the cases in which dissolution was the result, we look at the performance of the stock from the decision of the breakup until the month before the new shares were distributed. The month of the announcement was negative for both Standard Oil and particularly American Tobacco (Chart 7). AT&T, on the other hand, managed to rally slightly following the settlement. However, the months leading to the breakup involved a significant amount of volatility for all companies, most likely as investors slowly got to know the terms that were being agreed upon for the dissolution. In the AT&T case, the two-year period in which the dissolution was arranged proved to be particularly negative, with the stock underperforming the market by more than 20%. Every single one of the companies outperformed the market on the date of the breakup. The Breakup To analyze the performance following the breakup we look at the portfolios that were given to investors in exchange for their pre-dissolution shares. The AT&T case resulted in the simplest portfolio: for every 10 shares of old AT&T, the investor received 10 shares of new AT&T, plus one share of each of the other seven companies. The Standard Oil portfolio involved varying amounts of shares of 34 companies. The American Tobacco portfolio was slightly more complex, as the stock for two of the post-breakup companies was not given away for free but instead offered at a discount. Given that shareholders might not have had the funds available for this purchase we show the portfolio without the investment (LOWER BOUND) and fully invested up to the amount permitted (UPPER BOUND). Every single one of the companies outperformed the market on the date of the breakup (Chart 8). Furthermore, they all managed to outperform by large amounts over the following year, with AT&T outperforming by 14%, American Tobacco outperforming by 47% (10% for the lower bound), and Standard Oil outperforming by a gargantuan 66%.14 While this sample size is small, the large positive market effect from the breakup of companies from such disparate industries has drawn the interest of academics.15 Overall, it seems that the fear that competition might bring about earnings erosion is misguided. Rather, earnings growth outperformed the market following the dissolution (Chart 9). Investment Implications The previous analysis provides us with some answers to the following questions: When will one or more of the FAANGs be accused of monopolization? The current political environment is ripe for significant antitrust enforcement, particularly for the high-flying FAANG stocks. Whether it is election meddling, data privacy issues, perceived ideological bias, or large accumulation of wealth, Americans across the political spectrum are wary of the power of tech companies (Chart 10). Moreover, BCA expects the next recession by 2021 with inflation trending to the upside. Thus, we expect that antitrust action against a large tech company is likely to occur in the next couple of years. Which of the FAANGs is the most likely target? Among all FAANG stocks, no company has crushed its rivals more than Amazon (Chart 11). This makes it particularly vulnerable to antitrust enforcement, and it is thus not surprising that President Trump most often singles it out, entirely aside from any personal issues with CEO Jeff Bezos.16 Chart 11Amazon Is Devastating Small Retailers How will the stock of an accused company react? A monopoly suit will likely be negative for the stock. If recent history is any guide, the underperformance on the event could be relatively mild (2% to 5%), although the stock could underperform by up to 15%, if similar to older cases. However, investors must remember that monopoly cases have historically developed across multi-years periods. Thus, while individual court decisions will influence the stock through the process, other factors will determine the overall trend of these stocks throughout the duration of the case. The date when the breakup is complete could prove to be a fantastic buying opportunity, as competition is unlikely to erode earnings. How will the stock price react when the case is decided? Outcomes in which the accused wins the suit, or there is a remedy other than dissolution will ultimately be benign for the stock within a one-year period. Thus, investors should fade any selloff in this situation. In the case of a breakup, investors should try to sell the stock of the accused on or before the announcement, as the agreement of the terms of the dissolution will likely bring a substantial amount of volatility and negative performance to the share price. However, the date when the breakup is complete could prove to be a fantastic buying opportunity, as competition is unlikely to erode earnings.   Juan Manuel Correa Ossa, Senior Analyst juanc@bcaresearch.com     APPENDIX A A Brief History Of Monopoly Regulation Interest in monopolies started in the late nineteenth century with the emergence of the business trust. It increased markedly in the earlier years of the twentieth century (Appendix A Chart 1, top panel). Soon breaking up powerful companies became a popular bipartisan goal for many voters. Appendix A Chart 1Monopoly Regulation Throughout The Years Politicians reacted accordingly. In 1890, Congress passed the Sherman Act, the first federal legislation regulating competition. This piece of legislation served as the basis for prosecuting the first few cases  in our sample: Standard Oil in 1906, American Tobacco in 1907, and U.S. Steel in 1911. After a brief respite in the roaring 1920’s, monopoly regulation rose throughout the New Deal, with the 1937 Alcoa case being the landmark case of this era. Regulation continued to tighten and peak in the 1950’s – the era with the strictest enforcement of monopoly laws in the history of the Unites States (Appendix A Chart 1, middle panel). No cases from our sample fall in this period, probably because intense antitrust regulation made it difficult for large monopolies to exist in the first place. Nevertheless, as the 1960’s passed, interest started to dwindle. While regulation of monopolies was a staple talking point of the State of the Union address for Republicans and Democrats alike throughout the first half of the twentieth century, no president would again feature it after 1962.17  Amid this decline in enforcement, the IBM and AT&T cases were the last monopoly cases for many years, as the “Chicago School”, and its free market paradigm, rose in popularity in the 1970’s and 1980’s (Appendix A Chart 1, bottom panel). Monopoly enforcement would continue to decline throughout the 1990’s and into the present, with the Microsoft case being the only one from our sample that developed during the past three decades. Appendix B   Footnotes 1      The largest monetary fine ever imposed by the Department of Justice on an antitrust case was the $925 million fine against Citicorp. This amounts to roughly 0.6% of the market cap of Netflix, the smallest of the FAANGs. Even larger fines imposed in the EU, like the €4.34 billion fine imposed against Google had little effect on the stock price. 2      Please see Spencer Weber Waller, ”The Past, Present, and Future of Monopolization Remedies,” Antitrust Law Journal, 76:11 (2008), pp. 14-15, available at lawecommons.luc.edu 3      Please see Lina M. Khan, "Amazon's Antitrust Paradox," The Yale Law Journal 126:710 (2017), pp. 739. 4      Khan 740. 5      Please see Steve Coll, The Deal of The Century: The Break Up of AT&T (New York, NY: Open Road Media, 2017). 6      Please see Werner Troesken, “The Letters of John Sherman and the Origins of Antitrust”, The Review of Austrian Economics 15:4 (2002), pp. 279, available at www.gmu.edu 7      Please see Don E. Waldman and Elizabeth J. Jense, Industrial Organization: Theory and Practice: Fourth Edition (Routledge, 2016). 8      Please see Robert W. Crandall, ”The Failure of Structural Remedies in Sherman Act Monopolization Cases”, AEI-Brookings Joint Center For Regulatory Studies, Working Paper No. 01-05 (March 2001). 9      Ironically, U.S. Steel, the only case won in court and without a predatory pricing allegation, was the only company that fit the definition of a stereotypical monopoly. Its need to coordinate with more efficient competitors to set prices was ultimately used as key evidence to prove that U.S. Steel did not have monopoly power. Please see William H. Page, “Standard Oil and U.S. Steel: Predation and Collusion in the Law of Monopolization and Mergers”, Southern California Law Review 85:3 (2012), pp. 112, available at scholarship.law.ufl.edu 10     Please see Federal Trade Commission, “Predatory or Below-Cost Pricing”, available at www.ftc.gov 11     Please see Christopher Grandy, “Original Intent and The Sherman Antitrust Act: A Re-examination of the Consumer-Welfare Hypotheses,” The Journal of Economic History 53:2 (1993), pp. 360, available at www.jstor.org 12     Please see William Kolasky, “Trustbusters: Senator Sherman And The Origin of Antitrust”, Antitrust Magazine of the ABA Section of Antitrust Law 24:1 (2009), pp. 86. 13     Some examples include the Ohio Oil lobby in the Standard Oil case, MCI in the AT&T case, and Netscape in the Microsoft case. 14     The explosive performance of the trusts after their breakup would anger Theodore Roosevelt, who would bitterly joke that people in Wall Street prayed: ‘Oh Merciful Providence, give us another dissolution’”. Please see Steve Weinberg, Taking on the Trust: The Epic Battle of Ida Tarbell and John D. Rockefeller (Norton & Company, 2009). 15     Please see Malcolm R. Burns, “The Competitive Effects of Trust-Busting: A Portfolio Analysis,” Journal of Political Economy 85:4 (1977), pp. 719, available at www.jstor.org 16     Please see AXIOS, “Trump Hates Amazon, not Facebook,” dated March 28, 2018, available at www.axios.com. 17     Please see The Atlantic, “The Rise And Fall of the Word ‘Monopoly’ In American Life,” dated June 20, 2017, available at www.theatlantic.com

Highlights Portfolio Strategy As growth becomes scarce, investors flock to sectors that are slated to outgrow the broad market and shy away from the ones that are forecast to trail the SPX’s growth rate. This week we rank sectors and subsectors by EPS growth in our universe of coverage, and identify sweet and trouble spots. Fired up crack spreads, firming refining industry operating metrics, reaccelerating exports along with washed out technicals and compelling valuations, all signal that the time is ripe to buy into refining weakness. The cable industry’s demand headwinds are reflected in depressed relative valuations at a time when industry pricing power is trying to stage a comeback and a drifting lower greenback may also provide positive profit offsets. Stick with a benchmark allocation. Recent Changes Boost the S&P Oil & Gas Refining & Marketing index to overweight all the way from underweight today, locking in relative profits of 21%. Table 1 Feature Equities broke out last week and surpassed the upper band of their recent trading range, despite economic data releases that continued to surprise to the downside. Two weeks ago, we cautioned investors not to put cash to work as a tactical indigestion period loomed, with the SPX facing stiff resistance near the 2,800 level. In addition, we posited that most of the good news related to the U.S./China trade spat front was reflected in the S&P 500’s V-shaped recovery (top panel, Chart 1). In relative terms, the bottom panel of Chart 1 confirms that the easy money has already been made on the assumption of a positive resolution to the U.S./China trade dispute. Chart 1Trade Deal Priced In Going forward, the earnings juggernaut will have to remain in place in order for stocks to vault to fresh all-time highs, likely in the back half of the year. The Trump administration’s massive fiscal stimulus artificially fueled profit growth last year both by lowering the corporate tax rate and by encouraging overseas cash repatriation. The latter boosted share buybacks to an all-time record. Despite 24% EPS growth and $1tn in equity retirement, the SPX ended 2018 6% lower. Why? It became clear that EPS growth was headed lower. In order to gauge trend EPS growth we opt to use EBITDA, a cash flow proxy measure that strips out the direct impact of last year’s fiscal easing. Chart 2 clearly shows that trend growth took a step down following the positive base effects of the GFC-induced collapse and averaged close to 5%/annum from 2012 to 2014. Subsequently, the late-2015/early-2016 manufacturing recession sunk EBITDA into contraction, but the euphoria surrounding the newly elected President pushed trend EBITDA growth to near 10%/annum for two full years in 2017 and 2018. Chart 2Return To 5% Growth? Since the late-2018 peak, 12-month forward EBITDA growth continues to drift lower and is now hovering just shy of 3%. Our sense is that 5% organic profit growth is consistent with nominal GDP printing 4%-4.5% at this stage of the business cycle, signaling that a return to the 2012-2014 growth backdrop is likely later in the year. As a reminder, positive profit growth in calendar 2019 remains one of the three pillars underpinning stocks that we have highlighted since the beginning of this year. Stocks have come full circle recovering all of last December’s losses, but in order to make fresh all-time highs, profits will have to deliver. We deem that an earnings validation phase is transpiring and there are early signs that profit growth will trough sometime in the first half of the year. Not only has EBITDA breadth put in a bottom (Chart 2), but also economically hypersensitive indicators suggest that forward EBITDA growth will soon tick higher. Namely, the ISM manufacturing new orders component has perked up on a year-over-year basis. The trough in lumber futures momentum corroborates this message, as does the tick higher in the U.S. boom/bust indicator (Chart 3). Chart 3Growth Green-shoots Given the current macro backdrop and awaiting the profit validation, when growth becomes scarce investors flock to sectors that are outgrowing the broad market and shy away from ones that trail the SPX’s growth rate. Typically, in recessionary times that would equate to investors bidding up defensive sectors that command stable cash flow businesses and avoiding highly cyclical industries. But, BCA does not expect a recession in the coming year. Thus, in order to identify high growth sectors that should outperform during the current soft patch and growth laggards that should underperform, we compiled a table with the GICS1 sectors and all the subsectors we cover. First, we rank the GICS1 sectors and then within each sector we rank the subsectors, both times by absolute 12-month forward EPS growth using I/B/E/S/ data (see second columns, Table 2). We aim to reproduce this table once a quarter. Table 2Identifying S&P 500 Sector EPS Growth Leaders And Laggards The third columns in Table 2 show the sector growth rate relative to the SPX. The final columns in Table 2 highlight the trend in relative growth. In more detail, they compare the current relative growth rate to that of three months ago: a positive sign indicates an upgrade in analysts’ relative estimates and a negative sign a downgrade in analysts’ relative estimates. Industrials and financials (we are overweight both) are leading the pack outpacing the broad market by 410bps and 350bps, respectively, and enjoy a rising profit trend. On the flip side, energy (overweight) and real estate (underweight) trail the broad market by 490bps and 1480bps, respectively, and showcase a deteriorating EPS trend. With regard to energy, we first identified that analysts are really punishing this sector in the January 22 Weekly Report and the sector’s 2019 EPS contribution was and remains negative.1 Our overweight call will be offside if oil prices suffer a new setback, but our Commodity & Energy strategy service remains bullish on oil, implying relative EPS outperformance in 2019. Year-to-date, energy has bested the SPX by 170bps. This week, we make an energy sector subsurface tweak, and also update a communication services subgroup. Light My Fire Last summer we took refiners down to a below benchmark allocation as all of the good news was perfectly reflected in soaring relative share prices (top panel, Chart 4), at a time when cracks were forming. Now we are compelled to book gains of 21% and boost exposure all the way to overweight. Chart 4Crack Spreads Are On Fire Today, refiners paint a near exact opposite picture compared with last July. Relative share prices are no longer rising by 50%/annum. Instead, momentum has collapsed and is now contracting (middle panel, Chart 4). Sell-side analyst exuberance has turned into outright pessimism: refiners’ profits are expected to trail the broad market in the coming year. By comparison, last summer they were penciled in to beat the market by 30 percentage points (bottom panel, Chart 4). Granted M&A activity had also added fuel to the fire, but now all the hot air has come out of the refining industry, and then some. Refiners’ riches move in tandem with crack spreads. When refining margins widen, profits excel and vice versa. Now that refining margins are in a slingshot recovery, refining ills will turn into fortunes (bottom panel, Chart 4). Importantly, wide Brent-WTI spreads underpin crack spreads. Moreover, the crude oil versus refined product inventory backdrop currently reinforces a widening in refining margins. In absolute terms, gasoline stockpiles are being worked off (gasoline inventories shown inverted, bottom panel, Chart 5) and grinding higher demand for refined petroleum products (top panel, Chart 5) will further tighten the industry’s inventory outlook. Chart 5Healthy Supply/Demand Backdrop One way domestic refiners are taking advantage of the still wide Brent-WTI differential is via the export markets. Net refined products exports are running at over 3mn barrels/day (bottom panel, Chart 6), and the softening greenback since November will further boost profits with a slight lag as U.S. refining exports will grab an even larger slice of the global pie (U.S. dollar shown inverted and advanced, middle panel, Chart 6). Chart 6U.S. Dollar Softness Is A Boon To Refining Profits On the valuation front, both the relative forward P/E and P/S have undershot their respective historical means and EPS breadth is as bad as it gets, offering investors an excellent entry point in the pure-play oil & gas refining industry (Chart 7). Chart 7Extreme Analyst Pessimism Reigns In sum, fired up crack spreads, firming refining industry operating metrics, reaccelerating exports along with washed out technicals and compelling valuations, all signal that the time is ripe to buy into refining weakness. Bottom Line: Lift the S&P oil & gas refining & marketing index to overweight all the way from a below benchmark allocation, crystalizing 21% in relative profits since last summer’s inception. The ticker symbols for the stocks in this index are: BLBG: S5OILR – PSX, MPC, VLO, HFC. Cable’s Down But Not Out Cable & satellite stocks had been in an uninterrupted run from the depths of the Great Recession until the peak in relative share prices in August 2017. Since then, cord cutting news and the proliferation of on demand streaming services have wreaked havoc on the industry and cable stocks have trailed the market by over 33% from peak to the most recent trough (top panel, Chart 8). Chart 8Cable Signals Are… This deteriorating demand backdrop more than offset the industry’s reaction function, which has been intra and inter-industry M&A. Now that the M&A dust has settled, what is next in store for the industry? We reckon that leading profit indicators are a mixed bag and we continue to recommend a benchmark allocation in this niche communications services subgroup. The top panel of Chart 8 shows that relative outlays on cable are on a slippery slope, and will continue to weigh heavily on relative share prices for the coming quarters. Nevertheless, the ISM services survey ticked higher recently and is on the cusp of making fresh recovery highs, unlike its sibling the ISM manufacturing survey. This is encouraging news for cable executives and suggests that demand for cable services may not be as moribund as the PCE release is projecting (second panel, Chart 9). Chart 9..A Mixed… While the cable demand backdrop is unclear, industry pricing power has managed to exit deflation. Cable selling prices have been positive for the better part of the past decade, but starting in late-2017 they collapsed by roughly 600bps relative to overall inflation. True, this deflationary impulse dented profit margins, but currently the industry’s selling prices – and to a much lesser extent profit margins – are in a V-shaped recovery mostly courtesy of base effects (middle & bottom panels, Chart 8). Absent a sustained hook up in cable demand, selling price inflation will prove fleeting and the recent margin expansion phase will also lose steam. Meanwhile, cable stocks and the U.S. dollar enjoy a positive correlation as most of the constituents’ earnings are derived domestically (Chart 10). The recent U.S. dollar softness will, at the margin, weigh on relative profits and thus relative share prices, especially if the Fed stays pat and refrains from raising rates for the rest of the year as the bond market currently expects. Chart 10…Bag Finally, earnings breadth continues to fall, but relative valuations are still well below the historical mean (third & bottom panels, Chart 9). Netting it all out, cable’s demand headwinds are well reflected in depressed relative valuations at a time when industry pricing power is trying to stage a comeback and a drifting lower greenback may both provide positive profit offsets. Bottom Line: Remain on the sidelines in the S&P cable & satellite index. The ticker symbols for the stocks in this index are: BLBG: S5CBST – CMCSA, CHTR, DISH.   Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com   Footnotes 1      Please see BCA U.S. Equity Strategy Weekly Report, “Dissecting 2019 Earnings” dated January 22, 2019, available at uses.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor value over growth Favor large over small caps

Highlights Global equities will remain rangebound for the next month or so, but should move decisively higher as economic green shoots emerge in the spring. A revival in global growth will cause the recent rally in the U.S. dollar to stall out and reverse direction, setting the stage for a period of dollar weakness that could last until the second half of next year. Rising inflation will force the Fed to turn considerably more hawkish in late-2020 or early-2021. This will cause the dollar to surge once more. The combination of a stronger dollar and higher interest rates will trigger a recession in the U.S. in 2021, which will spread to the rest of the world. Investors should maintain a bullish stance towards global equities for the next 12 months, but look to reduce exposure at some point next year. Feature Stocks Temporarily Stuck In The Choppy Trading Range We argued at the end of February that global equities and other risk assets would likely enter a choppy trading range in March as investors nervously awaited the economic data to improve.1 Recent market action has been consistent with this thesis, with the MSCI All-Country World Index falling nearly 3% at the start of the month, only to recoup its losses over the past few days. We expect stocks to remain in a holding pattern over the coming weeks, as investors look for more evidence that global growth is bottoming out. The U.S. dollar is a countercyclical currency, meaning that it moves in the opposite direction of global growth (Chart 1). This countercyclicality stems from the fact that the U.S. economy is more geared towards services than manufacturing compared with the rest of the world. This makes the U.S. a low-beta play on global growth (Chart 2). As such, when global growth accelerates, capital tends to flow from the U.S. to the rest of the world, translating into more demand for foreign currency and less demand for dollars. Chart 1The Dollar Is A Countercyclical Currency Chart 2The U.S. Is A Low-Beta Play On Global Growth Given the dollar’s countercyclical nature, it is not surprising that the slowdown in global growth over the past 12 months has given the greenback a lift. The broad trade-weighted dollar has strengthened by almost 8% since February 2018, putting it near the top of its post 2015-range (Chart 3). Chart 3The Dollar Has Gotten A Lift From Global Growth Disappointments Stocks Will Rally And The Dollar Will Weaken Starting In The Spring We expect the U.S. dollar to strengthen over the coming weeks as global economic data continues to underwhelm. However, an improvement in leading economic indicators in the spring will set the stage for a reacceleration in global growth and a decline in the dollar in the second half of this year. The combination of stronger growth and a weaker dollar later this year should be highly supportive of global equities. Equity investors with a 12-month horizon should overlook any near-term weakness and maintain a bullish bias towards stocks. We do not have a strong view on U.S. versus international equities at the moment, but expect to upgrade the latter once we see more confirmatory evidence that global growth is bottoming out. Equity investors with a 12-month horizon should overlook any near-term weakness and maintain a bullish bias towards stocks.   A Stronger China Will Lead To A Weaker Dollar Our expectation that the dollar will weaken in the second half of this year hinges on what happens to China. The deceleration in global growth in 2018 was largely the consequence of China’s deleveraging campaign. China’s slowdown led to a falloff in capital spending throughout the world. Weaker Chinese growth also put downward pressure on the yuan, pulling other EM currencies lower with it (Chart 4). All this occurred alongside an escalation in trade tensions, further dampening business sentiment. Chart 4EM Currencies Are Off Their Early 2018 Highs While it is too early to signal the all-clear on the trade front, the news of late has been encouraging. A recent Bloomberg story described how Trump watched approvingly as Asian stocks rose and U.S. futures rallied following his decision to delay the scheduled increase in tariffs on Chinese goods.2 As a self-professed master negotiator, Trump needs to secure a deal with China before next year‘s presidential election, while also convincing American voters that the deal was concluded on favorable terms for the United States. Reaching a deal with China early on in his term would have been risky if the agreement had failed to bring down the bilateral trade deficit — an entirely likely outcome given how pro-cyclical U.S. fiscal policy currently is.  At this point, however, Trump can crow about making a great deal with China while reassuring voters that the product of his brilliance will be realized after he has been re-elected. This means that we are entering a window over the next 12 months where Trump will want to strike a deal. For their part, the Chinese want as much negotiating leverage with the Trump administration as they can muster. This means being able to convincingly demonstrate that their economy is strong enough to handle the repercussions from turning down a trade deal that fails to serve their interests. Since the credit cycle is the dominant driver of Chinese growth, this requires putting the deleveraging campaign on the backburner. Admittedly, credit growth surprised on the downside in February. However, this followed January’s strong showing. Averaging out the two months, credit growth appears to be stabilizing on a year-over-year basis. Conceptually, it is the change in credit growth that correlates with GDP growth.3 Thus, merely going from last year’s pattern of falling credit growth to stable credit growth would still imply a positive credit impulse and hence, an uptick in GDP growth. In practice, we suspect that the Chinese authorities will prefer that credit growth not only stabilize but increase modestly. In the past, this outcome has transpired whenever credit growth has fallen towards nominal GDP growth (Chart 5). The prospect of a rebound in credit growth in March was hinted at by the PBOC, which spun the weak February data as being caused by “seasonal factors.” Chart 5Historically, China Has Scaled Back On Deleveraging When Credit Growth Has Fallen Close To Nominal GDP Growth Europe: Down But Not Out Stronger growth in China will help European exporters. Euro area domestic demand will also benefit from a rebound in German automobile production, the winding down of the “yellow vest” protests in France, and incrementally easier fiscal policy. In addition, the ECB’s new TLTRO facility should support credit formation, particularly in Italy where the banks remain heavily reliant on ECB funding. Our expectation that the dollar will weaken in the second half of this year hinges on what happens to China. Euro area financial conditions have eased significantly over the past three months, which bodes well for growth in the remainder of the year. It is encouraging that the composite euro area PMI has rebounded to a three-month high. The expectations component of the euro area confidence index has also moved up relative to the current situation component, which suggests further upside for the PMI in the coming months (Chart 6). Chart 6Easing Financial Conditions Bode Well For Euro Area Growth The selloff in EUR/USD since last March has been largely driven by a decline in euro area interest rate expectations (Chart 7). If euro area growth accelerates in the back half of the year, the market will probably price back in a few rate hikes in 2020 and beyond. Chart 7EUR/USD Sell-Off Has Been Driven By Falling European Rate Expectations What Will The Fed Do? Of course, the degree to which a steeper Eonia curve benefits EUR/USD will depend on what the Fed does. The 24-month discounter has fallen from over +100 bps in March 2018 to -25 bps today, implying that investors now believe that U.S. short rates will fall over the next two years (Chart 8). Chart 8The Fed's Dovish Messaging Has Worked... Almost Too Well We expect the Fed to raise rates more than what is currently priced into the curve, thus justifying a short duration position in fixed-income portfolios. However, the Fed’s newfound “baby step” philosophy will probably translate into only two hikes over the next 12 months. Such a gradual pace of Fed rate hikes is unlikely to prevent the euro from appreciating against the dollar starting in the middle of this year, especially in the context of a resurgent global economy. We do not expect any major inflationary pressures to emerge in the near term. In contrast to the euro, the yen should depreciate against the dollar in the back half of this year. The yen is a “risk-off” currency and thus tends to weaken whenever global risk assets rally (Chart 9). The government is also about to raise the sales tax again in October, a completely unnecessary step that will only hurt domestic demand and force the Bank of Japan to prolong its yield curve control regime. We would go long EUR/JPY on any break below 123. Chart 9The Yen Is A Risk-Off Currency A Blow-Off Rally In The Dollar Starting In Late-2020 What could really light a fire under the dollar is if the Fed began raising rates aggressively while the global economy was slowing down. In what twisted parallel universe could that happen? The answer is this one, provided that inflation rose to a level that evoked panic at the Fed. We do not expect any major inflationary pressures to emerge in the near term. The growth in unit labor costs leads core inflation by about 12 months (Chart 10). Thanks to a cyclical pickup in productivity growth, unit labor cost inflation has been trending lower since mid-2018. However, as we enter late-2020, if the labor market has tightened further by then, wage growth will likely pull well ahead of productivity growth, causing inflation to accelerate. Chart 10Decelerating Unit Labor Costs Will Dampen Inflationary Pressures For The Time Being All things equal, higher inflation is bearish for a currency because it implies a loss in purchasing power relative to other monies. However, if higher inflation spurs a central bank to hike policy rates by more than inflation has risen – thus implying an increase in real rates – the currency will tend to strengthen. Chart 11 shows the “rational expectations” response of a currency to a scenario where inflation suddenly and unexpectedly rises by one percent relative to partner countries and stays at this higher level for five years while nominal rates rise by two percent. The currency initially appreciates by 5%, but then falls by 2% every year, eventually finishing down 5% from where it started.4 The yen should depreciate against the dollar in the back half of this year. The real world is much messier of course, but we suspect that the dollar will stage a final blow-off rally late next year or in early-2021 (Chart 12). Since the Fed will be hiking rates in a stagflationary environment at that time, global growth will weaken, further boosting the dollar. The resulting tightening in both U.S. and global financial conditions will likely trigger a global recession and a bear market in stocks. Investors should maintain a bullish stance towards global equities for the next 12 months, but look to reduce exposure at some point next year.   Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com Footnotes 1      Please see Global Investment Strategy Weekly Report, “Gretzky’s Doctrine,” dated March 1, 2019. 2      Jennifer Jacobs and Saleha Mohsin, “Trump Pushes China Trade Deal to Boost Markets as 2020 Heats Up,” Bloomberg, March 6, 2019. 3      Recall that GDP is a flow variable (how much production takes place every period), whereas credit is a stock variable (how much debt there is outstanding). By definition, a flow is a change in a stock. Thus, credit growth affects GDP and the change in credit growth affects GDP growth. 4      The 2% annual decline in the currency is necessary for the real interest parity condition to be satisfied. Strategy & Market Trends MacroQuant Model And Current Subjective Scores Tactical Trades Strategic Recommendations Closed Trades

Highlights Every diversified currency portfolio should hold the yen as insurance against rising market volatility. However, for tactical investors, the latest dovish shift by global central banks almost guarantees the Bank of Japan will err on the side of stronger stimulus (explicitly or indirectly). Our bias is that USD/JPY could trade sideways in the next three to six months, but EUR/JPY could test 132 by year-end. Carefully monitor any shift in yen behavior in the coming months, in particular its role as a counter-cyclical currency. Investors who need to hedge out sterling volatility should favor GBP calls. Hold onto the USD/SEK shorts established last week, currently 1.6% in the money. USD/NOK shorts are looking increasingly attractive, as will be discussed in next week’s report. Feature The yen has proven an extremely tough currency to forecast in the last few years. Carry-trade investors who used widening interest rate differentials between the U.S. and Japan in 2018 to forecast yen weakness got decimated in the February and March 2018 equity drawdowns. More agile investors who timed the global equity market bottom in early 2016 have been shifted to the wayside on yen shorts, as the currency has strengthened since then. For value-based investors, the yen that was 14% cheap on a fundamental basis in 2015 is 19% cheaper vis-à-vis fair value today. Seasoned investors recognize the need to pay heed to correlation shifts, as they can make or break forecasts. In the currency world, the most recent have been dollar weakness after the Federal Reserve first tightened policy in December 2016, dollar weakness in 2017 despite four Fed rate hikes and more recently, yen resilience despite the equity market rally since 2016. In this report, we revisit traditional yen relationships to identify which have been broken down, and which still stand the test of time. Trading Rules A rule of thumb still holds true for yen investors: buy the currency on any equity market turbulence (Chart I-1). In of itself, this advice is not sufficient. If one could perfectly time equity market corrections, being long the yen will be low on a long list of alpha-generating ideas. Chart I-1The Yen Is A Risk-Off Currency The power of the signal comes when macroeconomic conditions, valuations and investor sentiment all align in a unifying message. Back in late 2016, global growth was soft, the yen was very cheap and everyone was short the currency on the back of a dovish shift by the Bank of Japan (BoJ). Having recently introduced yield curve control (YCC), the market was grappling with the dovish implications for the currency, arguably the most significant change in monetary policy by any central bank over the last several years. In retrospect, this was the holy grail for any contrarian investor. Given that backdrop, the yen strengthened by circa 10% from December 2016 to mid-2017, even as equity markets remained resilient. When the equity market drawdown finally arrived in early 2018, it carried the final legs for the yen rally. This backdrop underlines the golden rule for trading the yen, primarily as a safe-haven currency. Economically, the net international investment position of Japan is almost 60% of GDP, one of the largest in the world. On a yearly basis, Japan receives almost 4% of GDP as income receipts, which more than offsets the trade deficit it has been running since the middle of last year (Chart I-2). It is therefore easy to see why any volatility in markets could lead to powerful repatriation flows back to Japan. Chart I-2Japan's Income Receipts Are Quite Large One other factor to consider is that during bull markets, countries that have negative interest rates are subject to powerful outflows from carry trades. The impact of these are difficult to measure, but it is fair to assume that periods of low hedging costs (which tend to correspond to periods of lower volatility) can be powerful catalysts. As markets get volatile and these trades get unwound, unhedged trades become victim to short-covering flows (Chart I-3). Chart I-3Hedging Costs Have Risen The global picture today has some echoes from 2016. Growth is slowing everywhere and markets have staged a powerful bounce from the December lows. This has been in anticipation of a better second half of this year. In the occasion that data disappointments persist beyond the first half, especially out of China, stocks will remain in a “dead zone,” which will be potent fuel for the yen. This is not our baseline scenario, as we expect growth to bottom in the second half of this year, but it remains an important alternative to consider at a time when Japanese growth is surprising to the downside. If the BoJ is preemptive and eases monetary policy, the yen will weaken. But the odds are highly in favor of the yen strengthening before. Bottom Line: Every diversified currency portfolio should hold the yen as insurance against rising market volatility. The BoJ’s Next Move By definition, any data dependent central bank will be behind the curve, but the incentive for the BoJ to act preemptively this time around is getting stronger. The starting point is that history suggests the consumption tax hike, scheduled for October this year, will be disastrous for the economy. Since the late 1990s, every time the consumption taxed has been hiked, the economy has slumped by an average of over 1.3% in subsequent quarters. For an economy with a potential growth rate of just 0.5%-1%, this is a highly unpalatable outcome (Chart I-4). More importantly, similar to past episodes, the consumption tax is being hiked at a time when the economy is slowing, with growth in the third quarter of last year clocking in at -2.4%. Chart I-4The Consumption Tax Hike Will Be Negative However, things are not that simple for the Japanese Prime Minister Shinzo Abe’s administration. Despite relatively robust economic conditions since the Fukushima disaster, consumption has remained tepid, even though there has been tremendous improvement in labor market conditions. By the same token, the savings ratio for workers has surged (Chart I-5). If consumers are caught in a Ricardian equivalence negative feedback loop,1 exiting deflation becomes a pipe dream for the central bank. Chart I-5Strong Labor Market, Weak Consumption The good news is that the government realizes this and has been taking steps to remedy the situation. At the margin, this is positive: The Japanese government recently passed a law that will allow the largest inflow of foreign workers into the country. There are about 1.5 million foreign workers in Japan today, who collectively constitute circa 2% of the labor force. The importance of foreign labor cannot be understated. Due to Japan’s demographic cliff, foreign workers were responsible for 30% of all new jobs filled in 2017. Assuming public aversion towards immigration remains benign, as is the case now (these are mostly lower-paying jobs in sectors with severe labor shortages), the government’s target to attract 350,000+ new workers by 2025 will go a long way in alleviating the country’s chronic labor shortage. This will also be marginally beneficial for consumption. Abe’s government hopes to offset the consumption tax hike with increased social security spending, especially on child education. For example, preschool and tertiary education will be made free of charge, financed by the tax hike. Labor reform has gone a long way to increase the participation ratio of women in the labor force (Chart I-6), but the reality is that almost 50% of single mothers in Japan still live below the poverty line, according to the BoJ. This is because many of them remain temporary workers. Temporary workers receive about half the pay of full-time workers’ and are not privy to most social security benefits. This has contributed to the surge in the worker’s savings ratio. Alleviating this source of uncertainty could help solve the consumption problem. Chart I-6Rising Female Participation In The Labor Force Transactions made via cashless payments (for example, via mobile pay) will not be subject to the 2% tax increase for nine months. Cashless payments in Japan account for less than 25% of overall transactions – among the lowest of developed economies. Increasing the share of cashless payments will help lift the velocity of money, which will be a positive development for the BoJ (Chart I-7). Chart I-7Money Velocity Is Still Falling Finally, the Phillip’s curve appears to be finally working in Japan, with wages accelerating at a 1.4% pace. Provided the government continues to indirectly put pressure on big firms to raise wages by at least 2-3% in upcoming Shunto wage negotiations, this trend should continue. An extended period of rising wages will help shift the adaptive mindset of Japanese households away from deflation (Chart I-8). Chart I-8Rising Wages Will Help At The Margin The BoJ pays attention to three main variables when looking at inflation: Core CPI prices, the GDP deflator and the output gap, in addition to other measures. The recent slowdown in the economy has tipped two of those indicators in the wrong direction (Chart I-9). This makes it difficult for the Abe administration to declare victory over deflation – something he plans to do before his term expires by September 2021. Chart I-9Inflation Variables Are Softening The perfect cocktail for the Japanese economy will be expansionary monetary and fiscal policy. But despite government efforts to offset the consumption tax hike with higher spending, the IMF still projects the fiscal drag in Japan to be 0.7% of GDP in 2019. This puts the onus on the BoJ to ease financial conditions. At minimum, this suggests that either the stealth tapering of asset purchases by the BoJ could reverse and/or new stimulus could be announced. Bottom Line: The swap markets are currently pricing some form of policy easing in Japan over the next 12 months. Ditto for Japanese banks (Chart I-10A and Chart 10B). Given the recent dovish shift by global central banks, the probability of a move by the BoJ has risen. Any surprise move will initially strengthen USD/JPY. However, given the probability that the dollar weakens in the second half of this year, our bias will be to fade this move. Portfolio investors can use this as an opportunity to buy insurance, should markets become turbulent in the next few months. Chart I-10AThe Market Is Pricing In A Dovish BoJ (1) Chart I-10BThe Market Is Pricing In A Dovish BoJ (2) Corporate Governance, Profits And The Equity/Yen Correlation Once global growth eventually bottoms, inflows into Japan could accelerate, given cheap equity valuations and improved corporate governance that has been raising the relative return on capital (Chart I-11). Depending on whether investors choose to hedge these inflows or not, this will dictate the yen’s path. At present, the cost of hedging does not justify sterilizing portfolio flows (see Chart I-3). Chart I-11Corporate Governance Could Lift Return On Capital The traditional negative relationship between the yen and the Nikkei still holds (Chart I-12). Weakening global growth is negative for the export-dependent Nikkei, and positive for the yen. This is because weakening global growth dips Japanese inflation expectations, and leads to higher real rates. This tends to lift the cost of capital for Japanese firms. Chart I-12The Yen/Equity Correlation Could Shift That said, another factor has been at play. Over the past few years, an offshoring of industrial production has been eroding the benefit of a weak yen/strong Nikkei. In a nutshell, if company labor costs are no longer incurred in yen, then the translation effect for profits is minimized on currency weakness. Investors will need to monitor the equity market/yen correlation over the next few years. It remains deeply negative, but could easily shift, dampening the yen’s counter-cyclical nature. Back in the 80s and 90s, the yen did shift into a pro-cyclical currency. Bottom Line: A dovish shift is increasingly likely by the BoJ. Meanwhile, our bias remains that if markets rebound in the second half of this year, this will be marginally negative for JPY. This could also put EUR/JPY near 132 by year end. A Few Notes On The Pound Recent market developments have become incrementally bullish for sterling. After Tuesday’s second defeat for Prime Minister Theresa May's Brexit deal, and again Wednesday’s rejection of a no-deal Brexit by 312 votes to 308, the probability is rising that the U.K. will either forge a deal for a more orderly separation with the EU or hold a new referendum altogether. Tuesday’s loss was expected because the EU had not offered a viable compromise to the Irish backstop - a deal that will keep Northern Ireland in the EU customs union beyond the transition date of December 2020. Meanwhile, Wednesday’s vote to leave the union sans arrangement was simply unpalatable for Parliament, given economics 101. Almost 50% of U.K. exports go to the E.U. A no-deal Brexit at a time when global exports are in a soft patch, and with much higher tariffs, was a no go for the majority.2 Complete sovereignty of a nation is and has always been a desirable fundamental right. For the average U.K. voter that has not benefited much from globalization, the risk was that Parliament repeatedly failed to pass a motion asking for an extension to the March 29 deadline. As we go to press, this risk has faded as MPs have voted 412 to 202 for a delay. An extension will likely be granted till the May 23-26 EU elections. The preference for an extension has been echoed by EU Commissioner President Jean-Claude Junker, Chief Negotiator Michel Barnier and Dutch Prime Minister Mark Rutte, all heavyweights in this imbroglio. For sterling investors, what is clear is that developments over the next few weeks will be volatile, but increasingly bullish. Admittedly, GBP has already rallied from its December lows. But long-term GBP calls still remain cheap, despite rising volatility (Chart I-13). Our fundamental models also suggest cable is cheap relative to its long-term fair value and it will be tough to the pound to depreciate if the dollar weakens in the second half of this year (Chart I-14). Chart I-13GBP Calls Are Cheap Chart I-14The Pound Is Cheap Bottom Line: The probability of a no-deal Brexit has fallen. Going forward, risk reversals suggest sterling calls remain relatively cheap to puts. Investors who need to hedge out any sterling volatility should therefore favor GBP calls. Housekeeping Our short AUD/NZD position hit its target of 1.036 this week. We are closing this trade for a 7% profit. As highlighted in last week’s report,3 a lot of bad news is already priced into the Australian dollar, which is down 37% from its 2011 peak. Outright short AUD bets are therefore at risk from either upside surprises in global growth, or simply the forces of mean reversion.   Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Ricardian equivalence suggests in simple terms that public sector dissaving will encourage private sector savings. 2 Please see Geopolitical Strategy Weekly Report, titled “The Witches’ Brew Keeps Bubbling…,” dated March 13, 2019, available at gps.bcaresearch.com 3 Please see Foreign Exchange Strategy Weekly Report, titled “Into A Transition Phase,” dated March 8, 2019, available at fes.bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Data in the U.S. continue to soften: The nonfarm payrolls came in at 20k in February, missing the forecast by 160k. Core consumer prices in February decelerated to a 2.1% year-on-year growth. Nonetheless, February average hourly earnings increased 3.4% year-on-year. Moreover, the unemployment rate in February fell to 3.8%. Lastly, retail sales in January grew at 0.2% month-on-month, outperforming expectations. The DXY index depreciated by 0.7% this week. The U.S. economy keeps growing above trend, but at a slower pace than last year. During the 60 minutes interview with CBS last weekend, Federal Reserve Chair Jerome Powell emphasized that while it is difficult for the economy to keep growing near 4% every year, it remains very healthy and any near-term recession is unlikely. We favor underweighting the dollar as we enter into a transition phase, where non-U.S. growth outperforms. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been promising: German factory orders in January came in at -3.9% year-on-year, improving from the last reading of -4.5%. The euro area industrial production month-on-month growth came in at 1.4% in January, outperforming expectations. In France, the Q4 nonfarm payrolls increased to 0.2% quarter-on-quarter, double the forecast. German consumer prices stayed at 1.7% year-on-year in February. EUR/USD appreciated by 1.2% this week. We favor overweighting the euro as easing financial conditions put a floor under growth. Report Links: Into A Transition Phase - March 8, 2019 A Contrarian Bet On The Euro - March 1, 2019 Balance Of Payments Across The G10 - February 15, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: M2 money supply missed expectations in February, coming in at 2.4%. Besides, machine tool orders fell by -29.3% year-on-year in February. Total machinery orders were also weak in January, coming in at -2.9% on a year-on-year basis. Lastly, foreign investment in Japanese stocks was -1.2 trillion yen, while investment in Japanese bonds fell to 245.7 billion yen. USD/JPY has been flat this week. A dovish move by the BoJ is likely and it could further cheapen the yen. If global growth bottoms in the later half of this year, this will be bad news for the yen, given its counter-cyclical nature. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Yen Fireworks - January 4, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mostly positive: In January, industrial production and manufacturing production both outperformed expectations, with industrial production coming in at -0.9% year-on-year and manufacturing production coming in at -1.1% year-on-year. GDP growth in January came in at 0.5% month-on-month, higher than expectations. GBP/USD appreciated by 1.1% this week. Cable rallied after the parliament vote on Wednesday. The sentiment remains positive since chances of a no-deal Brexit have diminished. We recommend long-term call options on cable to capture any upside potential. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Deadlock In Westminster - January 18, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia continue to deteriorate: Home loan growth in January contracted to -2.6%. The National Australian Bank business confidence index fell to 2 in February, while the business conditions index fell to 4. Consumer confidence in March decreased to -4.8%. AUD/USD moved up by 0.4% this week. The housing market and overall economy continue to weaken in Australia. However, the Australian dollar is at a 10-year low suggesting much of the bad news is priced in. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: Electronic card retail sales came in at 3.4% yoy, slightly lower than the previous reading of 3.5%. Food price index in February fell to 0.4% month-on-month. NZD/USD increased by 0.9% this week. We remain underweight NZD/USD, on overvaluation grounds. We are also closing our short AUD/NZD position for a 7% profit. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Updating Our Intermediate Timing Models - November 2, 2018 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have confirmed robust labor market conditions: The unemployment rate in February came in line at 5.8% while the participation rate increased to 65.8%. New jobs created in February were 55.9k, the strongest since 1981, beating analysts’ forecasts of zero job creation. February average hourly wage growth also increased to 2.25% year-on-year. However, housing starts in February fell to 173.1k, underperforming expectations. USD/CAD fell by 0.6% this week. The Canadian economy, especially the housing sector continues to show signs of weakness, despite a strong labor market. The risk is that overvaluation in the housing market and elevated debt levels impair consumer spending power. While the rising oil price helps, we think the benefits are more marginal than in the past. Report Links: Into A Transition Phase - March 8, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland has been negative: Producer and import price growth in February fell to -0.7% year-on-year. EUR/CHF appreciated by 0.3% this week. Our long EUR/CHF trade is now 0.5% in the money since initiated on December 7, 2018. We continue to favor the euro versus the swiss franc as the later benefits less from a bottoming in global growth. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Waiting For A Real Deal - December 7, 2018 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been mostly positive: Overall consumer price inflation in February fell to 3% year-on-year; however, core inflation increased to 2.6% yoy. Producer prices also increased by 8% year-on-year in February. USD/NOK depreciated by 1.8% this week. Our long NOK/SEK trade is 2.8% in the money over two months. We continue to overweight NOK due to the cheap valuations and rising oil prices. The pickup in inflation also allows the Norges bank to become incrementally hawkish. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been disappointing: In February, consumer price inflation fell to 1.9% yoy. The unemployment rate climbed to 6.6% in February. USD/SEK depreciated by 1.5% this week, mainly due to the recent weakness in the dollar. We remain positive on the SEK versus USD based on an expected pickup in the Swedish economy and cheap valuations. Report Links: Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Global Liquidity Trends Support The Dollar, But... - January 25, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades