Currencies

Highlights An analysis on Colombia is available below. If EM share prices hold at current levels, a major rally will likely unfold. If they are unable to hold, a substantial breakdown will likely ensue. The direction of EM US dollar and local currency bond yields will be the key to whether EM share prices break down or not. We expect continuous EM currency depreciation that will likely trigger foreign capital outflows from both EM credit markets and domestic bonds. This leads us to reiterate our short position in EM stocks. We are booking profits on the long implied EM equity volatility and the short Colombian peso/long Russian ruble positions. Feature The Federal Reserve’s intra-meeting rate cut this week might temporarily boost EM risk assets and currencies. However, it is also possible that investors might begin questioning the ability of policymakers in general and the Fed in particular to continuously boost risk assets. In recent years, investors have been operating under the implicit assumption that policymakers in the US, China and Europe have complete control over financial markets and global growth, and will not allow things to get out of hand. Investors have been ignoring contracting global ex-US profits as well as exceedingly high US equity multiples and extremely low corporate spreads worldwide. In the past 12 months, investors have been ignoring contracting global ex-US profits (Chart I-1) as well as exceedingly high US equity multiples. This has been occurring because of the infamous ‘policymakers put’ on risk assets. As doubts about policymakers’ ability to defend global growth and financial markets from COVID-19 heighten, investors will likely throw in the towel and trim risk exposure. A sudden stop in capital flows into EM is a distinct possibility. The Last Line Of Defense EM share prices are at a critical juncture (Chart I-2). If they hold at current levels, a major rally will likely unfold. If they are unable to hold at current levels, a substantial breakdown will likely ensue. Chart I-1Profitless Rally In 2019 Makes Stocks Vulnerable Chart I-2EM Share Prices Are At A Critical Juncture   What should investors be looking at to determine whether EM share prices will find a bottom close to current levels, or whether another major down-leg is in the cards? In our opinion, the direction of EM sovereign and corporate US dollar bond yields as well as EM local currency government bond yields will be the key to whether EM share prices break down or not. Chart I-3 illustrates that EM equity prices move in tandem with EM corporate US dollar bond yields as well as EM local currency bond yields (bond yields are shown inverted on both panels). Falling EM fixed income yields have helped EM share prices tremendously in the past year. Chart I-3EM Equities Drop When EM US Dollar & Domestic Bond Yields Are Rising EM corporate US dollar bond yields can rise under the following circumstances: (1) when US Treasury yields are ascending more than corporate credit spreads are tightening; (2) when EM credit spreads are widening more than Treasury yields are falling; or (3) when both US government bond yields and EM credit spreads are increasing simultaneously. Provided the backdrop of weaker growth is bullish for US government bonds, presently EM corporate US dollar bond yields can only rise if their credit spreads widen by more than the drop in Treasury yields. In short, the destiny of EM equities currently rests with EM corporate spreads. EM corporate and sovereign credit spreads are breaking above a major technical resistance (Chart I-4). The direction of these credit spreads is contingent on EM exchange rates and commodities prices as demonstrated in Chart I-5. Credit spreads are shown inverted in both panels of this chart. Chart I-4A Breakout In EM Sovereign And Corporate Credit Spreads? Chart I-5Falling EM Currencies And Commodities Herald Wider EM Credit Spreads   EM exchange rates are also crucial for foreign investors’ in EM domestic bonds. The top panel of Chart I-6 demonstrates that even though the total return on the JP Morgan EM GBI domestic bond index has been surging in local currency terms, the same measure in US dollar terms is still below its 2012 level. The gap is due to EM exchange rates. EM local currency bond yields are at all-time lows (Chart I-6, bottom panel), reflecting very subdued nominal income growth and low inflation in many developing economies (Chart I-7). Chart I-6EM Currencies Are Key To EM Domestic Bonds Total Returns Chart I-7Inflation Is Undershooting In EM Ex-China   Hence, low EM domestic bond yields are justified by their fundamentals. Yet foreign investors are very large players in EM local bonds, and their willingness to hold these instruments is contingent on EM exchange rates’ outlook. The sensitivity of international capital flows into EM US dollar and local currency bonds to EM exchange rates has diminished in recent years because of global investors’ unrelenting search for yield. As QE policies by DM central banks have removed some $9 trillion in high-quality securities from circulation, the volume of fixed-income securities available in the markets has shrunk. This has led to unrelenting capital inflows into EM fixed-income markets, despite lingering weakness in their exchange rates. Nonetheless, sensitivity of fund flows into EM fixed-income markets to EM exchange rates has diminished but has not yet outright vanished. If EM currencies depreciate further, odds are that there will be a sudden stop in capital flows into EM fixed-income markets. Outside of some basket cases, we do not expect the majority of EM governments or corporations to default on their debt. Yet, we foresee further meaningful EM currency depreciation which will simply raise the cost of servicing foreign currency debt. It would be natural for sovereign and corporate credit spreads to widen as they begin pricing in diminished creditworthiness among EM debtors in foreign currency terms.     Bottom Line: Unlike EM equities, EM fixed-income markets are a crowded trade and are overbought. Hence, any selloff in these markets could trigger an exodus of capital pushing up their yields. Rising yields will in turn push EM equities over the cliff. EM Currencies: More Downside We expect EM currencies to continue depreciating. EM ex-China currencies’ total return index (including carry) versus the US dollar is breaking down (Chart I-8, top panel). This is occurring despite the plunge in US interest rates. Notably, as illustrated in the bottom panel of Chart I-8, EM ex-China currencies have not been correlated with US bond yields. The breakdown in correlation between EM exchange rates and US interest rates is not new. This means that the Fed's easing will not prevent EM currency depreciation. EM currencies correlate with commodities prices generally and industrial metals prices in particular (Chart I-9, top panel). The latter has formed a head-and-shoulders pattern and has broken down (Chart I-9, bottom panel). The path of least resistance for industrial metal prices is down. Chart I-8More downside In EM Ex-China Currencies Chart I-9A Breakdown In Commodities Points To A Relapse In EM Currencies Chart I-10Chinese Imports Are Key To EM Currencies EM currencies’ cyclical fluctuations occur in-sync with global trade and Chinese imports (Chart I-10). Both will stay very weak for now. Finally, China is stimulating, and we believe the pace of stimulus will accelerate. However, the measures announced by the authorities so far are insufficient to project a rapid and lasting growth recovery. In particular, the most prominent measure announced in China is the PBoC’s special re-lending quota of RMB 300 billion to enterprises fighting the coronavirus outbreak. However, this amount should be put into perspective. In 2019, private and public net credit flows were RMB 23.8 trillion, and net new broad money (M2) creation was RMB 16 trillion. Thus, this re-lending quota will boost aggregate public and private credit flow by only 1.2% and broad money flow by mere 2%. This is simply not sufficient to meaningfully boost growth in China. Notably, daily, commodities prices in China do not yet confirm any growth recovery (Chart I-11). Barring an irrigation-type of credit and fiscal stimulus, the mainland economy will disappoint. Bottom Line: The selloff in EM exchange rates will persist. As discussed above, this will likely lead to outflows from both EM credit markets and domestic bonds. Reading Markets’ Tea Leaves It is impossible to forecast the pace and scope of the spread of COVID-19 as well as the precautionary actions taken by consumers and businesses around the world. In brief, it is unfeasible to assess the COVID-19’s impact on the global economy. The direction of EM sovereign and corporate US dollar bond yields as well as EM local currency government bond yields will be the key to whether EM share prices break down or not. Rather than throwing darts with our eyes closed, we examine profiles of various financial markets with the goal of detecting subtle messages that financial markets often send: Aggregate EM small-cap and Chinese investable small-cap stocks seem to be breaking down (Chart I-12). Chart I-11Daily Commodities Prices In China: No Sign Of Revival Chart I-12Investable Small Cap Stocks Seem To Be Breaking Down   The technical profiles of various EM currencies versus the US dollar on a total return basis (including the carry) are consistent with a genuine bear market (Chart I-13). Hence, their weakness has further to go. Global industrial stocks’ relative performance against the global equity benchmark has broken below its previous technical support (Chart I-14). This is a bad omen for global growth. Chart I-13EM Currencies Are In A Genuine Bear Market Chart I-14A Breakdown In Global Industrials Relative Performance   Finally, Korean tech stocks as well as the Nikkei index seem to have formed a major top (Chart I-15). This technical configuration suggests that their relapse will very likely last longer and go further. Chart I-15A Major Top in Korean And Japanese Stocks? All these signposts relay a downbeat message on global growth and, consequently, EM risk assets and currencies. A pertinent question to ask is whether the currently extremely high level of the VIX is a contrarian signal to buy stocks? Investors often buy the VIX to hedge their underlying equity portfolios from short-term downside. However, when and as they begin to view the equity selloff as enduring, they close their long VIX positions and simultaneously sell stocks. In brief, the VIX’s current elevated levels are likely to be a sign that many investors are still long stocks. When investors trim their equity holdings, they will likely also liquidate their long VIX positions. Thereby, share prices could drop alongside a falling VIX. Therefore, we are using the recent surge in equity volatility to close our long position in implied EM equity volatility. Even though risks to EM share prices are still skewed to the downside, their selloff may not be accompanied by substantially higher EM equity volatility. However, we continue to recommend betting on higher implied volatility in EM currencies. The latter still remains very low. Investment Conclusions We reinstated our short position on the EM equity index on January 30, and this trade remains intact. For global equity portfolios, we continue to recommend underweighting EM versus DM. Within the EM equity universe, our overweights are Korea, Thailand, Russia, central Europe, Mexico, Vietnam, Pakistan and the UAE. Our underweights are Indonesia, the Philippines, South Africa, Turkey and Colombia. We are contemplating downgrading Brazilian equities from neutral to underweight. The change is primarily driven by our downbeat view on banks (Chart I-16). This is in addition to our existing bearish view on commodities. We will publish a Special Report on Brazilian banks in the coming weeks. Barring an irrigation-type of credit and fiscal stimulus, the mainland economy will disappoint. Among the EM equity sectors, we continue to recommend a long EM consumer staples/short banks trade (Chart I-17, top panel) as well as a short both EM and Chinese banks versus their US peers positions (Chart I-17, middle and bottom panels). Chart I-16Brazilian Bank Stocks Are Breaking Down? Chart I-17Our Favored EM Equity Sector Bets   We continue to recommend a short position in a basket of the following currencies versus the US dollar: BRL, CLP, ZAR, PHP, IDR and KRW. We are also structurally bearish on the RMB. Today we are booking profits on the short Colombian peso / long Russian ruble trade (please refer to section on Colombia on pages 13-17). With respect to EM local currency bonds and EM sovereign credit, our overweights are Mexico, Russia, Colombia, Thailand, Malaysia and Korea. Our underweights are South Africa, Turkey, Indonesia, and the Philippines. The remaining markets warrant a neutral allocation. As always, the list of recommendations is available at end of each week’s report and on our web page. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Colombia: Upgrade Domestic Bonds; Take Profits On Short Peso Trade Chart II-1Oil Makes A Huge Difference To Colombia's Current Account Today we recommend upgrading local currency bonds and booking profits on the short Colombian peso / long Russian ruble trade. The reason is tight fiscal and monetary policies are positive for bonds and the currency. Although we are structurally bullish on Colombia’s economy, we remain underweight this bourse relative the EM equity benchmark. The primary reason is the high sensitivity of Colombia’s balance of payments to oil prices. In particular, oil accounts for a large share (40%) of Colombia’s exports. As of Q4 2019, the current account deficit was $14 billion or 4% of GDP with oil, and $25 billion or 7.5% of GDP excluding oil (Chart II-1). In short, each dollar drop in oil prices substantially widens the nation’s current account deficit and weighs on the exchange rate. Besides, the current hawkish monetary stance and overly tight fiscal policy will produce a growth downtrend. The Colombian economy has reached a top in its business cycle: The flattening yield curve is foreshadowing a major economic slowdown (Chart II-2, top panel). Our proxy for the marginal propensity to spend for businesses and households leads the business cycle by about six months and is presently indicating that growth will roll over soon (Chart II-2, bottom panel). Moreover, the corporate loan impulse has already relapsed, weighing on companies’ capital expenditures (Chart II-3).  Chart II-2The Business Cycle Has Peaked Chart II-3Investment Expenditures Heading South   The government considerably tightened fiscal policy in the past year and will continue to do so in 2020. The primary fiscal balance has surged to above 1% of GDP as primary fiscal expenditures have stagnated in nominal terms and shrunk in real terms last year (Chart II-4). In regards to monetary policy, the prime lending rate is 12% in nominal and 8.5-9% in real (inflation-adjusted) terms. Such high borrowing costs are restrictive as evidenced by several business cycle indicators that are in a full-fledged downtrend: manufacturing production, imports of consumer and capital goods, vehicle sales and housing starts (Chart II-5). Chart II-4Hawkish Fiscal Policy Chart II-5The Economy Is In The Doldrums Chart II-6Consumer Spending Has Been Supported By Borrowing Overall, economic growth has been held up solely by very robust household spending, which accounts for 65% of GDP. Critically, consumer borrowing has financed such buoyant consumer expenditures (Chart II-6). However, the pace of household borrowing is unsustainable with consumer lending rates at 18%. Moreover, nominal and real (deflated by core CPI) wage growth are decelerating markedly and hiring will slow down in line with reduced capital spending.  Besides, disinflationary dynamics in this country will be amplified due to the massive influx of immigration from Venezuela in the past two years. Currently, the number of immigrants from the neighboring country stands at 1.4 million people, or 5% of Colombia’s labor force. Such an enormous increase in labor supply introduces deflationary pressures in the Colombian economy by depressing wage growth. Therefore, despite the depreciating currency, core measures of inflation will likely drop to the lower end of the central bank’s target range in next 18-24 months. Investment Recommendations The economy is heading into a cyclical slump but monetary and fiscal policies will remain restrictive. Such a backdrop is bullish for the domestic bond market and structurally, albeit not cyclically, positive for the currency. We have been recommending fixed-income investors to bet on a yield curve flattening by receiving 10-year and paying 1-year swap rates. This trade has returned 77 basis points since its initiation on January 17, 2019. Given the central bank will stay behind the curve, this strategy remains intact. Today we recommend upgrading Colombian local currency bonds from neutral to overweight. Further currency depreciation and an exodus by foreign investors remain a risk. However, on a relative basis – versus its EM peers – this market is attractive. The share of foreign ownership of local currency government bonds in Colombia is 25%, smaller than in many other EMs. Additionally, Colombian bond yields are 80 basis points above the J.P. Morgan EM GBI domestic bonds benchmark and its currency is one standard deviation below its fair value (Chart II-7). We are also overweighting Colombian sovereign credit within an EM credit portfolio. Fiscal policy is very tight and government debt is at a manageable 50% of GDP. The government considerably tightened fiscal policy in the past year and will continue to do so in 2020. Continue to underweight Colombian equities relative to the emerging markets benchmark. We will be looking for a final capitulation in the oil market to upgrade this bourse. Finally, we are booking profits on our short COP versus RUB trade, which has returned a 19% gain since May 31, 2018 (Chart II-8). As mentioned earlier, the peso has already cheapened a lot according to the real effective exchange rate based on unit labor costs (Chart II-7). Meanwhile, Colombia’s macro policy mix is positive for the currency. Chart II-7The Colombian Peso Has Depreciated Substantially Chart II-8Taking Profits On Our Short COP / Long RUB Trade   In contrast, Russia is relaxing its fiscal policy – which is marginally negative for the ruble – and the currency has become a crowded trade. Juan Egaña Research Associate juane@bcaresearch.com Footnotes   Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights Financial markets are now fully priced for an economic downturn lasting one quarter… …but they are not fully priced for a recession. To go tactically long equities versus bonds requires a high conviction that the coronavirus induced downturn will last no longer than one quarter. The big risk is that the coronavirus incubation period might be very long, rendering containment strategies ineffective. Hence, a better investment play is to go long positive yielding US T-bonds and/or UK gilts versus negative yielding Swiss bonds and/or German bunds… …or go long negative yielding currencies versus positive yielding currencies. Our favoured expression is long CHF/USD. Fractal trade: overweight Poland versus Portugal. Feature Chart I-1AFinancial Markets Are Priced For A One-Quarter Downturn... Chart I-1B...But Not For A ##br##Recession They say that when China sneezes, the rest of the world catches a cold. But the saying was meant as an economic metaphor, not as a literal medical truth.1 The current coronavirus crisis has two potential happy endings: ‘containment’, in which its worldwide contagion is halted; or ‘normalisation’, in which it becomes accepted as just another type of winter flu. The virus crisis also has a potential unhappy ending in which neither containment nor normalisation can happen. Containing Contagion To determine whether the virus crisis has a happy or unhappy ending, we must answer three crucial questions: 1. Does the virus thrive only in cold weather? If yes, then the onset of spring and summer should naturally contain the contagion (in the northern hemisphere). We are not experts in epidemiology or immunology, but we understand that the Covid-19 virus surface is a lipid (fat) which could become fragile at higher temperatures. Albeit this might just be a temporary containment until temperatures drop again. 2. Does the virus have a short incubation period before symptoms arise? If yes, then quarantining and containment will be effective because infected people are quickly identified. But if, after infection, there is a long asymptomatic period, then containment would be impossible – because for an extended period the virus would be ‘under cover’. In this regard, the dispersion of infections is as important as the number of infections. A thousand cases across a hundred countries is much more worrying than a thousand cases concentrated in two or three countries (Chart I-2). Chart I-2Covid-19 Has Spread To 80 Countries 3. Are most infections going undetected because the symptoms are very mild? If yes, then the true mortality rate of the Covid-19 virus is much lower than we think, and perhaps not that different to the mortality rate of winter flu, at around 1 in a 1000. In which case, the new virus could become ‘normalised’ as a variant of the flu. But if the current mortality rate, at ten times deadlier than the flu, is accurate, then it would be difficult to normalise (Chart I-3). Chart I-3The Covid-19 Mortality Rate Is Ten Times Deadlier Than The Flu. Or Is It? An unhappy ending to the crisis will happen if the answer to all three questions is ‘no’. The main risk is that the asymptomatic incubation period appears to be quite long, rendering containment strategies ineffective. Still, even if the happy ending happens, there are two further questions. How much disruption will the economy suffer before the happy ending? And what have the financial markets priced? The Economic Disruption The disruption to the economy comes from both the supply side and the demand side: the supply side because containment strategies such as quarantining entire towns, shuttering factories, and cancelling major sports and social events hurt output; the demand side because a fearful public’s reluctance to use public transport, visit crowded places such as shopping malls, or travel abroad hurt spending. In this way, both production and consumption will suffer a large hit in the first quarter, at the very least. However, when normal activity eventually resumes, production and consumption will bounce back to pre-crisis levels, and in some cases overshoot pre-crisis levels. For example, if the crisis lasts for a quarter, movie-goers will return to the cinemas as usual in the second quarter, albeit they will not compensate for the visit they missed in the first quarter; but for manufacturers, the backlog of components that were not made during the first quarter will mean that twice as many will be made in the second quarter. For the financial markets, it is not the depth of the V that is important so much as its length. Therefore, economic output will experience a ‘V’ (Chart I-4): a lurch down followed by a symmetrical, or potentially even larger, snapback. However, for the financial markets, it is not the depth of the V that is important so much as its length. Chart I-4Economic Output Will Experience A 'V' The Financial Market Disruption Anticipating the economy to experience a V, investors respond to the crisis according to the expected length of the V versus the different lengths of their investment horizons. By length of investment horizon, we mean the minimum timeframe over which the investor cares about a price move, or ‘marks to market’. Say the market expects the downturn to last three months, followed by a full recovery. A three-month investor, caring about the price in three months, will capitulate. He will sell all his equities and buy bonds. Whereas a six-month investor, caring about the price only in six months, will not capitulate because he will factor in both the down-leg and subsequent up-leg of the V. Meanwhile, a twelve-month investor will be completely unfazed by the short-lived downturn. Therefore, if the downturn lasts one quarter only, the market will bottom when all the three-month investors have capitulated, which is to say become indistinguishable in their behaviour from a 1-day trader. In technical terms, the tell-tale sign for this capitulation is that three-month (65-day) fractal structure of the market totally collapses. Last Friday, the financial markets reached this point, meaning that financial markets are now fully priced for an economic downturn lasting one quarter (Chart I-5). Chart I-5When 3-Month Investors Capitulate It Usually Signals A Trend-Reversal... However, six-month and longer horizon investors are still a long way from capitulation. Meaning that the markets are not yet priced for a recession – defined as a contraction in activity lasting two or more straight quarters. It follows that if the down-leg of the V lasts significantly longer than a quarter then equities and other risk-assets have further downside versus high-quality bonds (Chart of the Week). During the global financial crisis, three-month investors had fully capitulated by September 3 2008 when equities had underperformed bonds by a seemingly huge 20 percent. However, equities went on to underperform bonds by a further 50 percent and only found a bottom when eighteen-month investors had fully capitulated in early 2009 (Chart I-6). This makes perfect sense, because profits contracted for a full eighteen months (Chart I-7). Chart I-6...But In The Global Financial Crisis The Market Turned Only When 18-Month Investors Had Capitulated... Chart I-7...Because In The Global Financial Crisis, Profits Contracted For 18 Months All of which brings us to a very powerful investment identity: Financial markets have fully priced a downturn when the time horizon of investors that have fully capitulated = the length of the downturn. The message right today is to go tactically long equities versus bonds if you have high conviction that the coronavirus induced downturn will last no longer than one quarter. Given that the coronavirus incubation period appears to be quite long, rendering containment strategies ineffective, we do not have such a high conviction on this tactical trade. Central banks that are already at the limits of monetary policy easing cannot ease much more. Instead, we have much higher conviction that those central banks that are already at the limits of monetary policy easing cannot ease much relative to those that have the scope to ease. The conclusion is: go long positive yielding US T-bonds and/or UK gilts versus negative yielding Swiss bonds and/or German bunds. Conversely, go long negative yielding currencies versus positive yielding currencies. Our favoured expression is long CHF/USD (Chart I-8). Chart I-8Overweight Positive-Yielding Bonds, And Overweight Negative-Yielding Currencies Fractal Trading System* This week’s recommended trade is to overweight Poland versus Portugal. Set the profit target at 3.5 percent with a symmetrical stop-loss. In other trades, long EUR/GBP achieved its 2 percent profit target at which it was closed. And short palladium has quickly gone into profit, given that the palladium price is down 10 percent in the last week. The rolling 1-year win ratio now stands at 62 percent. Chart I-9Poland Vs. Portugal When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated  December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com   Footnotes 1 The original version of the metaphor is attributed to the nineteenth century Austrian diplomat Klemens Metternich who said: “When France sneezes all of Europe catches a cold”. Subsequently, the Metternich metaphor has been adapted for any economy with outsized influence on the rest of the world. Fractal Trading Model Cyclical Recommendations Structural Recommendations Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

Highlights The near-term path for the DXY remains up. Uncertainty about the trajectory of global growth is a potent tailwind. Central bank ammunition will eventually put a floor under global growth, but it remains a powerless weapon until animal spirits are revived. The signal on when to sell the DXY will originate from the internal dynamics of financial markets. We elaborate on a few key indicators in this report. Long-yen bets remain cheap insurance against a rise in FX volatility. Remain short USD/JPY and CHF/JPY. Until recently, the CAD had proved resilient amid the recent market turmoil. With close ties to the US, the safe-haven umbrella had sheltered the CAD from the vicious downdraft in other commodity currencies. The forces of mean reversion will pressure the CAD at the crosses. We were stopped out of our long AUD/USD trade with a loss of 2.9%. The important lesson is to stand aside when markets start to deviate from fundamentals. Feature Chart I-1Mixed Messages From Bond And Currency Markets Various market participants will look at the recent market action through different lenses. Long equity investors could easily consider this to be a healthy correction necessary to sustain the bull market in stocks. After all, the S&P 500 remains 29% above its 2018 lows, making the 10% peak-to-trough decline essential to flush out stale longs. Bond investors could see the decline in yields through two lenses: 1) a goldilocks scenario where growth eventually rebounds but central banks remain accommodative or 2) a malignant scenario where the cascading resurgence of the virus outside of Wuhan, China tethers the global economy to recession. The inversion of the yield curve in the US certainly supports  scenario 2. As for currency markets, it is becoming more and more evident that pro-cyclical pairs are pricing in an Armageddon scenario (Chart I-1). It is implausible to accurately discern the collective data being discounted in financial markets, especially when the turnover of information is as fluid and rapid as today. That said, there have been a few key market signals that have been sending a consistent message that one can pay heed to. The collective assessment is to stand aside on the dollar (and risk assets) for now. The Message From Financial Markets As a countercyclical currency, the message from high frequency growth/liquidity indicators is that the path of least resistance for the DXY remains up over the next few weeks. Chart I-2Mixed Messages From Stocks And Currencies Chart I-2 shows that the rise in global stocks was already discounting an improvement in global manufacturing in an order of magnitude similar to the 2012 and 2016 episodes. However, currency markets had been discounting a much more subdued recovery (bottom panel). What has become evident in recent days in that the stock market got the story wrong, at least in terms of timing. Currently, stocks are still pricing a continued cyclical bounce in global manufacturing activity (albeit less impressive), while currency markets are pricing in outright deterioration. So directionally, both markets are sending the same message, but they disagree in terms of magnitude.  What is remarkable is that over the past few days, currency markets that were already poised for a malignant growth outcome are still selling off indiscriminately, with our favorite greed/fear barometers making fresh lows. If we had a strong certainty that global growth was on a path toward a V-shaped recovery, then currency performance could be interpreted as a sign of capitulation. But given the uncertainty now tainted around the nascent recovery we witnessed early this year it also warns against bottom-fishing at current levels. For example, peak-to-trough, the AUD/JPY, a key barometer of greed versus fear in currency markets, is down 28% and on the verge of breaking below the key 70-72 support zone. The performances of even more high-octane currency pairs such as the RUB/JPY, the ZAR/JPY or even the BRL/JPY have been dismal. As these pairs break through key support zones, it could trigger a flurry of sell orders that would reinforce the downtrend. Europe, Asia and emerging markets have a much higher concentration of cyclical stocks in their bourses compared to the US. Thus, whenever cyclical sectors are underperforming defensives at the same time that non-US markets are underperforming US ones, it is a clear sign that the marginal dollar is rotating towards the US. In a nutshell, the performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. This applies to both emerging and developed market currencies (Chart I-3). So far, this has not been the case. The backdrop could be extremely attractive valuations, but the catalyst will have to be capitulation from current sellers of cyclical stocks. The performance of more cyclical currencies will require confirmation of a breakout in their relative equity market performance. Chart I-3ACapital Keeps Flowing Out Of Cyclical Markets Chart I-3BCapital Keeps Flowing Out Of Cyclical Markets The 2015-2016 roadmap was instructive on when such a capitulation might occur. Even as the market was selling off, certain cyclical sectors such as industrials started to outperform defensives ones (Chart I-4). This was a clear sign that selling pressure in cyclical sectors had been exhausted. The overall market bottomed eight months later, along with a peak in the dollar. The signal from bond yields is that non-US currencies should be outperforming. This is reflected by the fact that the drop in bond yields has been much more pronounced in the US across the curve spectrum. Currencies tend to rise with relative yields for the simple reason that markets need to make an investor indifferent between buying the currency today or in the future. If yields are higher today, the forward rate will be lower, discounting expected depreciation in the higher-yielding currency. Since the financial crisis, it has been rare that this correlation breaks down (Chart I-5). The only way one can square falling US rates with a rising dollar today is that Federal Reserve rate cuts will be most potent on the US domestic sector, helping the US consumer charge the eventual rebound in global growth. My colleague Mathieu Savary argues that this could indeed be the backdrop for the dollar over the next two-to-three years. Chart I-4Pay Heed To Subtle Divergences Chart I-5Interest Rates And The Dollar As for the near term, what is clear is that US growth continues to outperform, which is supportive of the dollar. The sharp drop in the economic surprise index for the G10 relative to the US supports this view (Chart 6). In commodity markets, the copper-to-gold and oil-to-gold ratios are breaking down along with government bond yields. This clearly signifies that the liquidity-to-growth transmission mechanism is impaired (Chart I-7). “Force majeures” are rare, so the fact that China has already issued more than 1,600 certificates covering copper, liquefied natural gas, and coal imports reveals an inherent belief that the slowdown will be genuine and meaningful. Chart I-6The US Still Has Positive Growth ##br##Surprises Chart I-7Commodity Markets Are Sending A Distress Signal Earnings revisions are heading lower across a swathe of geographies. Bottom-up analysts are usually less certain about the level of earnings but spot on about the direction (Chart I-8). Not surprisingly, the downgrades have been driven by emerging markets, meaning that return on capital will be best sought in less-cyclical bourses such as the US. Momentum-wise, being long the US dollar is becoming a captivating trade. 75% of currencies are currently falling versus the dollar. The history of this indicator is that it has usually required a move into overbought conditions before a bet on a playable reversal can be justified (Chart I-9). Chart I-8Earnings Revisions In EM Have Fallen Off A Cliff Chart I-9A Growing Consensus Of Short Dollar ##br##Trades On a cyclical horizon (over the next year), we remain dollar bears given our inherent belief that the shock from the virus will soon dissipate, and green shoots from global growth will reemerge. However, for more tactical investors, momentum currently favors the greenback. In addition to the indicators above, we are also monitoring global growth economic barometers on when to time a shift away from the DXY. On Volatility And Safe Havens The dollar is expensive across most measures of purchasing power, but less so when other fundamental factors such as interest-rate differentials and productivity trends are taken into consideration. The risk is that, as a reserve currency, the dollar rally continues unimpeded by valuation and sentiment concerns for the time being (Chart I-10). This is not our base case, but the probability of such a scenario is not zero. More importantly, currency volatility remains near record lows as the latest dollar rally simply supercharges a trend in place over the past decade (Chart I-11). Every seasoned investor does and should pay attention to low volatility. Over the last three episodes where volatility dropped to these levels, the dollar soared and pro-cyclical currencies suffered severe losses. Everyone remembers 1997-1998, 2007-2008, and 2014-2015. So far, the risk is that this time will be the same. Chart I-10The Dollar Is Expensive, But Not Excessively So Chart I-11Currency Volatility Remains ##br##Depressed Most clients acknowledge that recent US dollar purchases have been on an unhedged basis. This means as long as nominal US yields remain above those in the rest of the world, this trend can continue. That said, the prospect for real capital losses should the consensus long-dollar trade be wrong is non-negligible. The dollar has been in a bull market since 2011, but the shift in valuations has simply unwound the undervaluation gap. The dollar tends to run in long cycles, and a decisive move into much overvalued territory is possible (though again, not our base case). US Treasurys have started to outperform gold, suggesting the US dollar is becoming, at the margin, the currency of preference for safety (Chart I-12).   The gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. The yen provides valuable portfolio insurance at this economic crossroads. One of the most potent moves in rate markets has been the +135-basis-point move in favor of Japanese yields (Chart I-13). More importantly, the gap between the USD/JPY and real rates has opened up a rare arbitrage opportunity. Should a selloff in global risk assets materialize, the yen will strengthen. On the other hand, if global growth does eventually accelerate, the yen will surely weaken on its crosses but could still strengthen vis-à-vis the dollar. Chart I-12The Signal From Bonds Versus Gold Chart I-13JGBs Are Becoming Attractive This win-win situation for the yen hinges on three key pivotal developments: For most of the past five years, the Bank of Japan was one of the most aggressive central banks in terms of asset purchases. This was a huge catalyst for a downturn in the trade-weighted yen (Chart I-14). With renewed expansion of the Fed’s balance sheet, monetary policy is tightening on a relative basis in Japan. Movements in the yen are as influenced by external conditions as what is happening domestically, given Japan’s huge export sector. For example, the yen reacts very potently to moves in the VIX (Chart I-15). The yen is a very cheap currency, and the latest selloff has all but assured further depreciation into undervalued territory. As we will illustrate in an upcoming report, it pays to be contrarian when it comes to currency valuations, albeit over the longer term (Chart I-16). Chart I-14The BoJ And QE: No More Bullets Chart I-15The Yen Is Still A Risk Off Currency Chart I-16A Win-Win Dynamic For Long Yen Positions In a situation where global growth does improve, the yen will tend to weaken, given that it is usually used to fund carry trades. That said, our contention is that the yen will surely weaken at the crosses but could still strengthen versus the dollar. This is because the USD/JPY and the DXY tend to have a positive correlation, since the dollar drives the yen most of the time. More conservative investors can remain short CHF/JPY. The authorities at the Swiss National Bank must be pacing up and down over the impact of a strong currency in a deflationary world. Given that Swiss interest rates are the lowest in the G10, the CHF becomes the only tool of adjustment to inflate domestic prices. Selling the franc and loading up on US and international stocks as they correct is a foolproof way cushion the business cycle in Switzerland. Meanwhile, inflation differentials with the US have been lower in Japan compared to Switzerland, but the franc has been stronger. This suggests that, as a safe haven, the franc is incrementally more expensive than the yen. Bottom Line: The yen is the most attractive safe-haven currency at the moment. Remain short USD/JPY and CHF/JPY. We are widening our stops on both trades to account for the rise in market volatility.    Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Currencies US Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been mostly positive: The Markit preliminary manufacturing PMI decreased to 50.8 from 51.9 in February. New home sales jumped by 7.9% month-on-month in January.  Consumer confidence increased slightly to 130.7 from 130.4 in February. Durable goods orders slipped 0.2% month-on-month while nondefense capital goods orders excluding aircraft grew 1.1% month-on-month in January. The DXY index depreciated by 1.2% this week. Markets sold off dramatically on the back of renewed fears about Covid-19. While markets are pricing in 71 basis points of easing over the next 12 months, Fed Vice Chair Clarida emphasized a wait-and-see approach. Fed inaction places a near-term bid on the dollar, though longer term, we remain bearish. Avoid outright dollar bets for now.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020   The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been positive: The Markit manufacturing PMI improved to 49.1 from 47.9 while the services PMI increased to 52.8 from 52.5 in January. This nudged the composite PMI further into expansion territory at 51.6. Core CPI came in at 1.4% year-on-year in January. Sentiment improved in the euro area this week. In February, the economic sentiment indicator increased to 103.5 from 102.6, the business climate indicator improved to -0.04 from -0.19, and the industrial confidence moved up to -6.1 from -7.    In Germany, the closely watched IFO survey bounced to 96.1, driven by the expectations component. So far, the V-shaped recovery in European manufacturing expectations appears un-derailed. The euro appreciated by 1.4% against the US dollar this week. Following the powerful upward momentum that we saw in the DXY index over the last few days, some specter of mean reversion is not a surprise. This week, President Lagarde reiterated the need for fiscal measures to combat climate change, which will also be euro-bullish beyond Covid-19.    Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been mostly negative: The national CPI grew by 0.7% in January, decreasing slightly from 0.8% the previous month. More instructive will be the Tokyo CPI print released as we go to press. The Jibun Bank manufacturing PMI declined to 47.6 from 48.8 in February. The coincident index decreased to 94.1 while the leading economic index increased to 91.6 in December. The Japanese yen appreciated by 2% against the US dollar this week. As we go to press, Japan is temporarily closing all schools to temper the spread of the coronavirus. Domestically, data were weak already with the PMI weighed down by new orders and output prices. Tourism, a key source of domestic demand, has also been hit hard. As a safe-haven currency, a risk-off scenario will only trigger repatriation flows benefitting the yen.   Report Links: Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2   Recent data in the UK have been positive: The Markit manufacturing PMI increased to 51.9 from 50 while the services PMI decreased to 53.3 from 53.9 in February. That still underpinned a solid composite PMI at 53.3. The BRC shop price index declined by 0.6% year-on-year in January.   The British pound was flat against the US dollar this week. BoE deputy governor Cunliffe took a somewhat hawkish tone, stating that “there is not much monetary policy can do” in the case of a supply shock from Covid-19. Uncertainty over monetary policy, Brexit and Covid-19 are now compounding influences on pound volatility.  Our bias is a trading range for GBP-USD between 1.28-1.32 until a clear catalyst emerges.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: The value of construction work done in Q4 2019 contracted by 3% quarter-on-quarter, improving from a contraction of 7.4% the previous quarter. Private capital expenditure contracted by 2.8% quarter-on-quarter in Q4 2019, worsening from a contraction of 0.4% the previous quarter. The Australian dollar depreciated by 0.6% against the US dollar this week. Australia is more exposed to negative developments regarding Covid-19, given strong ties to China. Weak data on investment and consumption have also suppressed the Australian dollar recently. Notwithstanding, AUD/USD, now at post-crisis lows, looks deeply oversold. We were stopped out of our long AUD/USD trade for a loss of 2.9%. For risk management purposes, we are standing aside.   Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019   New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mixed: Exports decreased to NZD 4.7 billion from NZD 5.5 billion while imports were flat at NZD 5.1billion in January. The monthly trade balance was in a deficit of NZD 340 million in January.   The ANZ business confidence indicator worsened to -19.4 from -13.2 in January. Retail sales grew by 0.7% quarter-on-quarter in Q4 2019, declining from a 1.7% expansion in Q3 2019. The New Zealand dollar depreciated by 0.1% against the US dollar this week. Like its antipodean partner, New Zealand is highly exposed to the slowdown in the Chinese economy. In the short-term, tourism will be hit hard, as will other service industries. This environment will not be favorable for long NZD trades.      Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019   Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been mixed: Retail sales growth remained flat month-on-month at 0.5% in December, slowing significantly from growth of 1.1% the previous month. Wholesale sales grew by 0.9% month-on-month in December, improving from a contraction of 1.1% the previous month. The current account deficit narrowed to CAD 8.76 billion from CAD 10.86 billion in Q4 2019. We get GDP data this Friday morning, and we anticipate a nascent recovery put at risk from Covid-19.  The Canadian dollar depreciated by 0.7% against the US dollar this week. In addition to global risk-off flows, the Canadian dollar was hurt by the sharp decline in oil prices, which are now close to 2019 lows. Uncertainty has led markets to price in 52 basis points of further easing from the BoC. This will support our long EUR/CAD trade going forward.   Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies- November 8, 2019   Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 There is scant data out of Switzerland this week: The expectations component of the ZEW survey declined to 7.7 from 8.3 while the current situation component declined to 15.4 from 29.2 in February. The Swiss franc appreciated by 1.5% against the US dollar this week. This must be sending shock waves along SNB corridors. Domestic data remain weak but, as with the Japanese yen, the franc was propped up by safe-haven flows. In the near-term, expect the franc to trade more on global sentiment rather than economic fundamentals. EUR/CHF strengthened slightly over the past few days but remains close to historic lows. The SNB will be watching carefully for signs of sustained strength in the franc and will act as needed to prevent rampant appreciation.   Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020   Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been positive: The unemployment rate decreased to 3.9% from 4% in December.  Retail sales grew by 0.5% month-on-month in January, improving from a contraction of 2% in the previous month. The Norwegian krone depreciated by 0.7% against the US dollar this week. The petrocurrency was hurt by falling oil prices which triggered a 9.7% decline in the Oslo Bors All-Share Index this week. At 1.5%, the Norway’s policy rate is among the highest in developed markets. If the economy remains weak and there is another global easing cycle, the Norges Bank will feel the pressure. We remain short USD/NOK but acknowledge that this trade could continue to underperform in the next few days.    Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019   Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: Consumer confidence improved to 98.5 from 92.6 in February. The producer price index contracted by 0.4% year-on-year in January. The trade balance moved into a surplus of SEK 9.9 billion from a deficit of 2.3 billion. Retail sales grew by 2.7% year-on-year in January, slowing slightly from 2.8% the previous month. Capacity utilization decreased to -2.1% in Q4 2019 from 0.5% the previous quarter. The Swedish krona appreciated by 1.3% against the US dollar this week. Usually, when a currency is cheap, the undervaluation starts to show up in external balances as was the case with Sweden trade data. The key concern for the Riksbank at the moment will be the impact of the negative oil price shock on its inflation forecast as well as the impact of Covid-19 on external demand.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019   Footnotes Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Highlights Global growth will quickly recover if the Covid-19 outbreak is soon controlled. If the virus's spread doesn't slow, a worldwide recession will take hold in 2020. BCA remains cyclically bullish, but tactical caution is warranted as long as uncertainty around Covid-19 remains high. A strong dollar is generally good for the US, except for exporters. The dollar possesses greater cyclical upside, a trend that will affect global asset allocation. The dollar will correct in 2020, which could allow cyclical stocks and value stocks to outperform growth equities in the short term. Foreign equities will also temporarily outperform US stocks this year. Feature 10-year Treasury yields hit an all-time low of 1.26% this morning, and the S&P 500 finally buckled under the pressure. Meanwhile, the US dollar seems unstoppable and commodity prices are still hobbling near recent lows. The economic and financial outlook for 2020 is unusually divided. On the positive front, economic momentum slowly turned the corner after a soft 2019. Liquidity aggregates have been improving, economic sentiment is bottoming and inventories are melting away. However, if Covid-19 morphs into a global pandemic, then these nascent positives will disappear. Faced with mounting uncertainty, the S&P 500 could still face additional tactical downward pressure. However, if Covid-19 does not turn into a global pandemic, then equities should recover in the second quarter. Additionally, the dollar’s strength remains a great concern, and for 2020, it too will depend on Covid-19's continued spread. While the next 12 months are likely to be painful for the dollar, its cyclical highs still lie ahead. The dollar’s trend will affect relative sector and regional performance. Covid-19 Under Control? The Covid-19 outbreak is key to the 2020 outlook. If Covid-19 is contained, then global growth can recover after a dismal first quarter. However, if the recent uptick in cases outside of China continues to increase beyond the coming two to three weeks, 2020 will witness a quick but painful recession as governments will impose quarantines and consumer confidence will collapse. If Covid-19 is contained, then global growth can recover after a dismal first quarter. Our colleagues from BCA Research’s Global Investment Strategy service estimate that Covid-19 could easily curtail global growth by more than 1% this quarter. China’s economy is experiencing a severe contraction, which should result in negative seasonally adjusted quarterly growth in Q1.1 Live indicators, such as the number of traffic jams in Shanghai streets or daily coal consumption are very weak, standing 20% and 32% below last year’s levels. Moreover, China accounts for 19.3% of global GDP, and its imports account for 12.5% of the rest of the world’s exports. China’s weak domestic activity has a ripple effect around the world. Making matters worse, the recent factory closings are scuttling global supply chains, which further lowers non-Chinese output. Finally, Chinese tourism accounts for 4.7% of global service exports, which will be deeply negatively impacted by the current immobility of Chinese citizens. As severe as the impact of Covid-19 will be in Q1, it will be fleeting. Epidemics and natural disasters may stop economic activity for a finite time, but they create pent-up demand that boosts economic growth in the following quarters. In the case of SARS, the lost output was recovered over the subsequent two quarters. Excess money is expanding at a brisk pace, which confirms that both the quantity and price of global output can rebound quickly (Chart I-1). The same is true of various liquidity measures, such as BCA Research’s US Financial Liquidity Index, which has an excellent record of forecasting the Global Leading Economic Indicator, the US ISM, and EM export prices. Most importantly, deleveraging is a tertiary concern for Chinese policymakers for the next two years. PMIs show that inventory levels are rapidly falling around the world. A purge in inventory allows pent-up demand to boost economic activity. Nowhere is this trend more powerful than in Sweden. Manufactured goods, especially intermediate and capital goods, represent a large percentage of Sweden’s output and exports. Thus, Sweden sits early in the global supply chains. Today, the decline in Swedish inventories is so deep that the country’s new orders-to-inventories ratio is surging, which historically indicates increases in our Global Industrial Activity Nowcast as well as US and global capital expenditures (Chart I-2). Chart I-1Ample Liquidity Will Cushion The Blow Chart I-2Positive Signal From Inventories   Improving liquidity and purged inventory bode very well for global economic activity. Our Global Growth Indicator, a variable mainly based on commodity prices and the bond yields of cyclical economies, has already predicted an improvement in global industrial production (Chart I-3). Our models showed that even Germany’s economy, which is largely driven by global economic gyrations, will experience a turnaround despite abysmal industrial production readings (Chart I-4). Chart I-3The Global Growth Indicator Continues To Rebound Chart I-4There's Hope Even For Germany The Federal Reserve is prepared to nurture the recovery. Falling job ads in the US, along with the New York Fed Underlying Inflation Gauge and BCA Research’s Pipeline Inflation Indicator point to a slowdown in core CPI (Chart I-5). Additionally, the FOMC wants to see inflation expectations recover toward the 2.3% to 2.5% zone reached when economic agents believe in the Fed’s capacity to sustain core PCE near 2%. BCA Research’s US Bond Strategy service’s adaptive expectations models show that based on current realized inflation trends, it would take a substantially long time for inflation expectations to move back into that zone. Chart I-5Disinflationary Pressures In The US The current health crisis is unleashing a wave of global stimulus. EM central banks, particularly in the Philippines and Indonesia, are cutting rates, thanks to low global and domestic inflation. Fiscal stimulus is expanding. Singapore has announced an SGD 800 million package aimed at fighting the impact of Covid-19; South Korea, Malaysia and Indonesia are also boosting spending. Even Germany is considering fiscal stimulus to support its economy. In China, the PBoC has injected RMB 2.3 trillion so far this year and cut rates. Most importantly, deleveraging is a tertiary concern for Chinese policymakers for the next two years. Factions opposed to President Xi will use his handling of the virus crisis to capitalize on discontent and gain more seats on the Politburo and Central Committee at the 2022 Communist Party Congress. To combat this opposition, President Xi is abandoning the deleveraging campaign and is generously stimulating the economy to generate greater income gains. The news is not all positive however, as the risk of a global pandemic remains elevated. There is no consensus in the medical community as to whether or not the pandemic is in remission. Chinese factories are re-opening and people are on the move, which is giving the virus an opportunity to spread again. Worryingly, new clusters of cases have popped up in South Korea, Iran, and Italy. In the US too, an individual without any links to previously known cases has fallen ill. These developments must be monitored closely. As BCA Research’s Global Investment Strategy service recently showed, the 2009/10 H1N1 outbreak (known as swine flu) affected between 700 million and 1 billion people worldwide.2 According to the Lancet, it resulted in 151,700 to 575,400 deaths or a fatality rate of 0.01% to 0.08%, well below current estimates of 2.3% for Covid-19. Thus, if Covid-19 spreads as much as H1N1, it could kill between 16 and 23 million people worldwide in a short amount of time. If such an outcome comes to pass, then we are looking at a global recession. Factory closures will grow in length and prevalence, which will paralyze global supply chains. International tourism will collapse and consumers around the world will shun crowded public places, which will hurt consumption substantially. Prudence forces us to not be cavalier and protect ourselves against what would be an extremely adverse outcome if Covid-19 were to spread much further. The uncertainty around such binary outcomes is hard to price for markets. As we argued last month, investors must input large risk premia in asset prices to compensate for this lack of visibility. When we last wrote, we saw no such margin of safety in the S&P 500, but its 11.5% collapse since February 19 has gone a long way in adjusting this mispricing. In fact, some bargains in the industrial, energy or transport sectors have emerged. Bottom Line: Investors should continue to hedge their exposure to risk assets until the situation becomes clearer. For now, our central scenario remains that new cases will soon peak and economic activity will recover. In this case, stocks and bond yields now have very limited downside, and they will recover later this year. Equities will ultimately reach new highs. However, prudence forces us to not be cavalier and protect ourselves against what would be an extremely adverse outcome if Covid-19 were to spread much further. The US Benefits From A Strong Dollar Looking beyond Covid-19, BCA Research expects the US dollar to correct in 2020. However, we increasingly view this downdraft as a temporary phenomenon. The dollar’s cyclical highs remain ahead in the next two to three years. Ultimately, the US is a consumer-driven economy and households benefit from a firm currency. A higher dollar also acts as a tax cut for consumers. Surprisingly, the dollar does not have a negative impact on employment. The unemployment rate and the dollar are negatively correlated (Chart I-6). The 27% dollar rally since 2011 is not antithetical with a US unemployment rate at a 51-year low of 3.6%. Less than 10% of US jobs are in the manufacturing sector, compared with 14.4% and 15.8% in Europe and Japan respectively (Chart I-7). Moreover, 93.6% of jobs created since the labor market troughed in 2010 have been in the service sector. Given that the service sector is domestically driven and is immune to the deflationary impact of a stronger dollar, the low share of manufacturing in the US’s GDP means that the labor market is resistant to a firm USD. Chart I-6The Labor Market Does Not Abhor A Strong Dollar... Chart I-7...Because The US Is Manufacturing Light   A higher dollar also acts as a tax cut for consumers. A dollar rally leads to a rapid decline in the share of disposable income spent on food and energy (Chart I-8). As a result, households have more discretionary disposable income to spend on services that generate domestic jobs. A strong dollar makes job creation less inflationary and permits the Fed to keep monetary policy easier for longer. A strengthening dollar redistributes income to the middle class, which supports consumption. When the dollar rallies, the share of salaries in national income increases because the dollar creates a headwind for profit margins (Chart I-9). Rich households garner more than 50% of their income from profits and rents. Therefore, if a stronger dollar increases the share GDP accounted for by wages, then a rising greenback redistributes income to middle-class households away from the rich. This redistribution is positive for consumption because middle-class households have a marginal propensity to consume of 90%, compared with 60% for households in the top decile of the income distribution. Furthermore, the more consumption can grow as a share of GDP, the more the economy can withstand a rallying currency. Chart I-8A Firm Dollar Cut "Taxes" Chart I-9The Dollar Is A Redistributor   Chart I-10A Strong Dollar Boosts Real Incomes A strong dollar also weighs on inflation, which has positive ramifications for consumers and the economy. By mid-2015, the dollar had rallied by an impressive 13.8%. While nominal wages grew at 2.2%, well below today’s rate of 3.8%, real wages were expanding at their highest rate in this cycle, courtesy of low inflation. Real consumption was also enjoying its largest gain in this cycle, expanding at 4.6% per annum (Chart I-10). A firm dollar also dampens inflation expectations (Chart I-11), allowing a flattening of the Phillips Curve, which links inflation to the unemployment rate. In other words, a strong dollar makes job creation less inflationary and permits the Fed to keep monetary policy easier for longer, delaying the inevitable date when the Fed kills the business cycle. Moreover, the disinflationary impact of a rising dollar puts downward pressure on interest rates (Chart I-12). In turn, lower rates keep financial conditions easier than would have otherwise been the case, which supports growth. Chart I-11A Hard Currency Dampens Inflation Expectations Chart I-12A Strong Dollar Depresses Interest Rates   A counterargument to the view that a strong US dollar is good for the business cycle is that it will hurt capex. While true, it is easy to overestimate this impact on growth. Not only does capex represent a much lower share of GDP than consumption, it most often contributes less to changes in GDP than consumer spending (Chart I-13). Moreover, lower interest rates triggered by a firm dollar support residential activity, which in turn mitigates some of the drag created by lower corporate capex. Finally, as Chart I-14 illustrates, 74.7% of the US’s capex emanates from sectors that are minimally affected by the dollar, creating greater resilience to a stronger currency than many realize. Chart I-13Consumption Dominates Capex Chart I-14Even Within Capex, The Dollar Is Not As Dominant As Believed   Chart I-15Symptoms Of US Resilience The US economy is indeed robust in the face of the strong dollar. If the dollar was hurting the US, then Germany should benefit from a falling euro. However, German net exports are weakening. Moreover, US profits are not lagging European ones as US firms continue to benefit from stronger global pricing power than their European counterparts. Finally, capex intentions in the US are surprisingly resilient (Chart I-15). Three forces increase the US’s economic capacity to withstand a strong dollar this cycle. First, the structural improvement in the US’s energy trade balance allows the US current account to remain stable at -2.5% of GDP despite a widening non-oil trade deficit. Secondly, the Trump Administration’s profligate spending boosts demand and insulates the economy from a rising dollar. BCA Research’s Geopolitical Strategy service expects President Trump to win the election, albeit with a conservative probability of 55%, but also believes a Democratic victory would lead to larger spending increases than tax hikes. The current expansive fiscal policy set up will thus remain in place going forward. Finally, the Sino-US Phase One deal will provide a welcome relief valve for US manufacturers, who are victims of the stronger dollar. While economic reality probably will not allow the deal to boost China’s purchases of US goods by $200 billion vis-à-vis the higher water mark of $186 billion of 2017 (Chart I-16), nonetheless it will force China to substitute goods purchases away from Europe and Japan in favor of the US. A hard dollar can feed on itself by widening the gap between US and foreign growth, a trend currently underway. Our favorite structural valuation measure also does not suggest that the dollar is currently a major hurdle for the US economy. BCA Research's Foreign Exchange Strategy service’s Long-Term Fair Value models, which account for differences in the productivity and neutral rate of interest of the US and its trading partners, show that the dollar is still roughly fairly valued and that its equilibrium is trending up (Chart I-17). Chart I-16The Phase One Deal Is Ambitious Chart I-17The Dollar Is Not Expensive Enough To Cause Pain   In this context, the US dollar has further cyclical upside. A strong dollar may not be as negative to the US economy as investors believe, but it hurts emerging economies. According to the Bank for International Settlements, there is more than US$12 trillion of USD-denominated foreign currency debt in the world. Therefore, a firm dollar tightens financial conditions outside the US. A hard dollar can feed on itself by widening the gap between US and foreign growth, a trend currently underway. Investment Implications For The Remainder Of The Cycle… Chart I-18The S&P 500 Likes A Firm Dollar The dollar’s additional cyclical upside is good news for US capital markets over the next few years. The S&P 500 performs better when the dollar is firm (Chart I-18). US stocks generated average annual returns of 12% during the 53% dollar rally of 1978 to 1985, 12% during the 33% dollar rally of 1995 to 2002, and 11% as the USD appreciated 27% during the past nine years. This compares well to an annualized return of 4% when the dollar suffers cyclical bear markets. The following observations explain why the US stock market performs better when the dollar appreciates: A strong dollar allows interest rates to remain lower than would have been the case otherwise, which also allows stock multiples to remain elevated. A strong dollar elongates the US business cycle by delaying the Fed’s tightening of monetary conditions. A longer business cycle dampens volatility and invites investors to bid down the equity risk premium. A strong dollar supports the US corporate bond market. A robust dollar may negatively impact bonds issued by energy or natural resources companies, but it also keeps the Fed at bay, which prevents a generalized increase in volatility and spreads. Lower rates allow for easy financial conditions and plentiful buybacks, a helpful combination for equities. Chart I-19The Dollar Holds The Key To Growth Vs Value A hard dollar is fundamental to the outperformance of US equities relative to global stocks. Global investors usually not do not hedge the currency component of equity returns. A firm USD automatically creates a powerful advantage for US stocks that invites greater inflows. In addition, a climbing dollar hurts value stocks (Chart I-19). Value stocks overweight cyclical sectors such as financials, industrials, materials and energy, sectors which depend on higher inflation, expanding EM economies and higher yields to outperform, three variables that suffer from an appreciating USD. An underperformance of value stocks also causes a poor outcome for foreign markets, which heavily overweight value over growth (Table I-1).   Table I-1Key Overweights By Market Chart I-20A Strong Dollar Fuels Tech Multiples The tech sector also benefits from a firm dollar. Tech stocks generate long-term earnings growth and they are generally not as sensitive to the global business cycle as traditional cyclical equities are. When the global business cycle weakens, yields decline and the dollar appreciates, then earnings growth becomes scarce. In this environment, investors willingly bid up assets that can generate a structural earning expansion. Tech multiples become the prime beneficiary of that phenomenon (Chart I-20), which allows US stocks to meaningfully outperform the rest of the world when the dollar hardens. Bottom Line: A firm dollar will allow the business cycle to expand for longer, which suggests that the dollar will make greater highs over the coming two to three years. Within this time frame, US stocks will likely continue to outperform their global counterparts, despite their valuations disadvantage. … And For 2020 In 2020, the dominant driver for the US dollar will be global growth. The pickup in BCA’s Global Growth Indicator and the elevated chance of a rising Chinese combined credit and fiscal impulse will lift global activity and thus, force down the USD (Chart I-21). Additionally, existing trends in global money supply growth reinforce the near-term downside risk to the dollar, assuming Covid-19 does not become a global pandemic (Chart I-22). Chart I-21China Stimulus Will Lift Growth Chart I-22Bearish Monetary Dynamics For The Dollar In 2020   Chart I-23The Euro Is Not The Best Anti-Dollar Bet For 2020 The euro is unlikely to be the main beneficiary from a dollar correction. EUR/USD does not yet trade at a discount to our fair value estimates consistent with an intermediate-term bottom (Chart I-23). Moreover, the euro lags pro-cyclical currencies such as the AUD, CAD, NZD, or SEK, when global growth starts to recover but inflation remains weak. Finally, the Phase One Sino-US trade deal will create a drag on the positive impact of a Chinese recovery on European exports for machinery.3 Bottom Line: A dollar correction in 2020 is congruent with a period of underperformance for tech stocks relative to industrials, financials, materials and energy stocks. The correction also supports value relative to growth equities this year, as well as foreign bourses relative to the S&P 500. Investors who elect to bet against the dollar in 2020 should only do so with great caution as they will be betting against the broader cyclical trend. A correction in the dollar, by definition, is transitory. Thus, the aforementioned equity implications will also likely be temporary. Ultimately, the US economy remains the global growth leader in the post-2008 environment. Mathieu Savary Vice President The Bank Credit Analyst February 27, 2020 Next Report: March 26, 2020 II. Labor Strikes Back The balance of power in US labor negotiations has shifted infrequently in the industrial age. Successful strikes beget strikes. Key factors that have bolstered management for decades are poised to reverse. Public opinion has a significant impact on labor-management outcomes. Elections have consequences. Organized labor isn’t dead. Where will inflation come from, and when will it arrive? An investor who answers these questions will have advance notice of the end of the expansion and the bull markets in equities and credit. Per our base-case scenario, the expansion won’t end until monetary policy settings become restrictive, and the Fed won’t pursue restrictive policy unless inflation pressures force its hand. The fur flies when each party thinks the other should make the bulk of the concessions: labor negotiations over the next couple of years could be interesting. Inured by a decade of specious warnings that “money printing” would let the inflation genie out of the bottle, investors are skeptical that inflation will ever re-emerge. The inflation backdrop has become much more supportive in the last few years, however, upon the closing of the output gap, and the stimulus-driven jolt in aggregate demand. Output gaps in other major economies will have to narrow further (Chart II-1) for global goods inflation to gain traction, and mild inflation elsewhere in the G7 (Chart II-2) suggests that goods prices are not about to surge. Chart II-1There's Still Enough Spare Capacity ... Chart II-2... To Restrain Global Goods Inflation Services are not so easily imported, though, and services inflation is a more fully domestic phenomenon. Rising wages could be the spur for services inflation, and the labor market is tight on several counts: the unemployment rate is at a 50-year low; the broader definition of unemployment, also encompassing discouraged workers and the underemployed, reached a new all-time (25-year) low in December; the JOLTS job openings and quits rates at or near their all-time (19-year) highs; and the NFIB survey and a profusion of anecdotal reports suggest that employers are having a hard time finding quality candidates. With labor demand exceeding supply, wages for nonsupervisory workers have duly risen (Chart II-3). Gains in other compensation series have been muted, however, and investors have come to yawn and roll their eyes at any mention of the Phillips Curve. Chart II-3Wage Growth Is Solid, But It's Lost A Good Bit Of Momentum Perhaps it’s not the Phillips Curve that’s broken, but workers’ spirits. A supine organized labor movement could explain why the Phillips Curve itself is so flat. As the old saying goes, if you don’t ask, you know what you’re going to get, and beleaguered unions and their memberships, cowed by two decades of woe coinciding with China’s entry into the WTO (Chart II-4), have been afraid to ask. Strikes are the most potent weapon in labor’s arsenal; if it can’t credibly wield them, it is sure to be steamrolled. Chart II-4Globalization Has Been Unkind To Labor Two years of high-profile strike victories by public- and private-sector employees may suggest that the sands have begun to shift, however, and inspired our examination of labor’s muscle. An Investor’s Guide To US Labor History Let's begin our exercise with a review of US labor relations. The Colosseum Era (1800-1933) We view US industrial labor history as having three distinct phases. We label the first, which lasted until the New Dealers took over Washington, the Colosseum era (Figure II-1), because labor and management were about as evenly matched as the Christians and the lions in ancient Rome. Uprisings in textile mills, steel factories, and mines were swiftly squelched, often violently. Management was able to draw on public resources like the police and state National Guard units to put down strikes, or was able to unleash its own security or ad hoc militia forces on strikers or union organizers without state interference. The public, staunchly opposed to anarchists and Communists, generally sided with employers. Figure II-1Significant Events In The Colosseum Era Unions won some small-bore victories during the period, but they nearly all proved fleeting as companies regularly took back concessions and public officials and courts failed to enforce the loose patchwork of laws aimed at ameliorating industrial workers’ plight. Labor inevitably suffered the brunt of the casualties when conflicts turned violent. Workers were hardly choir boys, and seem to have initiated violence as often as employers’ proxies, but they were inevitably outgunned, especially when police, guardsmen or soldiers were marshaled against them. Societal norms have changed dramatically since the Colosseum era, but the lore of past “battles” encourages an us-versus-them union mentality that occasionally colors negotiations. Employees and employers need each other, and their tether can only be stretched so far before it starts pulling them back together. The UAW Era (1933-1981) Established presumptions about the employer-employee relationship were upended when FDR entered the White House. Viewing labor organization as a way to ease national suffering, New Dealers passed the Wagner Act to grant private-sector workers unionization and collective bargaining rights, and created the National Labor Relations Board to ensure that employers respected them. The Wagner Act greatly aided labor organization, enabling unions to build up the heft to engage with employers on an equal footing. Unionized workers still fought an uphill battle in the wake of the Depression, but tactics like the sit-down strike (Box II-1) produced some early labor victories that paved the way for more. BOX II-1 David Topples Goliath: The Flint Sit-Down Strike   The broad mass of factory workers had not been organized to any meaningful degree before the New Deal, and the United Auto Workers (UAW) was not formed until 1935. Despite federal protections, the fledgling UAW had to conduct its operations covertly, lest its members face employer reprisals. At the end of 1936, when it took on GM, only one in seven GM employees was a dues-paying member. The strike began the night of December 30th when workers in two of GM’s Flint auto body plants sat down at their posts, ignoring orders to return to work. The sit-down action was more effective than a conventional strike because it prevented GM from simply replacing the workers with strikebreakers. It also made GM think twice about attempting to remove them by force, lest valuable equipment be damaged. GM was unsure how to dislodge the workers after a court injunction it obtained on January 2nd went nowhere once the UAW publicized that the presiding judge held today’s equivalent of $4 million in GM shares. It turned off the heat in one of the plants on January 11th, before police armed with tear gas and riot guns stormed it. The police were rebuffed by strikers who threw bottles, rocks, and car parts from the plant’s upper windows while spraying torrents of water from its fire hoses. No one died in the melee, but the strike was already front-page news across the country, and the attack helped the strikers win public sympathy. Michigan’s governor responded by calling out the National Guard to prevent a rematch, shielding the strikers from any further violence. The strike was finally settled on February 11th when GM accepted the UAW as the workers’ exclusive bargaining agent and agreed not to hinder its attempts to organize its work force. The UAW signed a similar accord with Chrysler immediately after the Flint sit-down strike, and the CIO (the UAW’s parent union) swiftly reached an agreement with US Steel that significantly improved steelworkers’ pay and hours. Labor unions’ path wasn’t always smooth – Ford fiercely resisted unionization until 1941, and ten protesters were killed, and dozens injured, by Chicago police at a peaceful Memorial Day demonstration in support of strikers against the regional steelmakers that did not follow US Steel’s conciliatory lead – but it generally trended upward after the New Deal (Figure II-2). From the 1950 signing of the Treaty of Detroit, a remarkably generous five-year agreement between the UAW and the Big Three automakers, the UAW ran roughshod over the US auto industry for three-plus decades. The New Deal’s encouragement of unionization had given labor a fighting chance, and was the foundation on which all of its subsequent gains were built. Figure II-2Significant Events In The UAW Era The Reagan-Thatcher Era (1981 - ??) The disastrous strike by the air traffic controllers’ union (PATCO) is the watershed event that heralded the end of unions’ golden age. Strikes by federal employees were illegal, so PATCO broke the law when it went on strike in April 1981, spurning the generous contract terms its leaders had negotiated with the Reagan administration. PATCO had periodically held the flow of air traffic hostage throughout the seventies to extract concessions from its employer, earning the lasting enmity of airlines, government officials and the public. Other unions were aghast at PATCO’s openly contemptuous attitude, and declined to support it with sympathy strikes, while conservatives blasted the new administration behind closed doors for the profligacy of its initial PATCO offer. President Reagan therefore had an unfettered opportunity to make an example out of the controllers, and he seized it, firing those who failed to return to work within 48 hours and banning them from ever returning to government employment. A fed-up public supported the president’s hard line, and employers and unions got the message that a new sheriff was in town. His deputies were not inclined to enforce labor-friendly statues, or investigate labor grievances, with much vigor, and they would not necessarily look the other way when public sector unions illegally struck. Management has been in the driver's seat, but the factors that have kept it there have a high risk of reversing. Unions also found themselves on the wrong side of the growing disaffection with bureaucracy that was bound up with the push for deregulation. The globalization wave further eroded labor’s power. Unskilled workers in the developed world would be hammered by the flat world that allowed people, capital and information to hopscotch around the globe. Eight years of a Democratic presidency brought no relief, as the “Third Way” Clinton administration embraced the free-market tide (Chart II-5), and the unionized share of employees has receded all the way back to mid-thirties levels (Chart II-6). Chart II-5Inequality Took Off ... Chart II-6... As Unions Lost Their Way A Fourth Phase? A handful of data points do not make a trend, especially in a series that stands out for its persistence, but the bargaining power pendulum could be shifting. Public school teachers won improbable statewide victories with illegal strikes in three highly conservative states in the first half of 2018 (Table II-1); a canny hotel workers union steered its members to big gains in their contract negotiations with Marriott in the second half of 2018; and the UAW bested General Motors and the rest of the Big Three automakers last fall. Unions may have more bargaining power than markets and employers realize, and they could be on the cusp of becoming more aggressive in flexing it. Table II-1Teachers' Unions Conquer The Red States Takeaways (I) There are two key takeaways from our historical review: 1. US industrial history makes it clear that employees are unlikely to gain ground if government sides with employers. Employees no longer have to fear that the state will look the other way while strikers are beaten, or fail to prosecute those responsible for loss of life, but they face especially long odds when the government is inclined to favor employers. Its thumb weighs heavily on the scale when it drags its feet on enforcement; cuts funding to agencies policing workplace standards; and appoints agency or department heads that are conditioned to see things solely from employers’ perspective, shaped by long careers in management. 2. Successful strikes beget strikes, and the converse is also true. Withholding their labor is employees’ most powerful weapon, and when employers can’t replace them cheaply and easily, strikes often succeed. Striking is frightening for an individual, however, because it cuts off his or her income (or sharply reduces it, if the striker’s union has a strike fund) until the strike is over. If the strike fails, the employee may find him/herself blacklisted, impairing his/her long-term income prospects on top of his/her short-term losses. Prudent workers should therefore strike sparingly, with the due consideration that a prudent poker player exercises before going all-in. Companies will do whatever they perceive to be socially acceptable in conflicts with employees, but no more. When other unions facing comparable conditions pull off successful strikes, it makes it much easier for another union to take the leap, in addition to making success more likely, provided conditions truly are comparable. “Before they occur, successful strikes appear impossible. Afterward, they seem almost inevitable .”4 The retrospective inevitability stiffens the spine of potential strikers who observe successful outcomes, and raises the bar for action among potential strikers who observe failures. “Just as defeats in struggle lead to demoralization and resignation, victories tend to beget more victories .”5 Public opinion matters just as surely as momentum, and it proved decisive in the Flint sit-down strike and in the air traffic controllers’ showdown with President Reagan. According to Gallup’s annual poll, Americans now regard unions as favorably as they did before Thatcher and Reagan came to power (Chart II-7). Chart II-7Could Unions Make A Comeback? Where Strikes Come From And Who Wins Them Since strikes are such an important determinant of the support for labor, what drives successful labor actions? The Origin Of Strikes Strikes (and lockouts) occur when labor and management cannot reach a mutually acceptable settlement, often because at least one side overestimates its bargaining power. It is easy to agree when labor and management hold similar views about each side’s relative power, as when both perceive that one of them is considerably stronger. In that case, a settlement favoring the stronger side can be reached fairly quickly, especially if the stronger side exercises some restraint and does not seek to impose terms that the weaker side can scarcely abide. Restraint is rational in repeated games like employer-employee bargaining, and when both parties recognize that relative bargaining positions are fluid, they are likely to exercise it. It's no surprise that unions have started to look pretty good to workers after a decade of sluggish growth and widening inequality. History shows that the pendulum between labor and management swings, albeit slowly, as societal views evolve6 and the business cycle fluctuates. As a general rule, management will have the upper hand during recessions, when the supply of workers exceeds demand, and labor will have the advantage when expansions are well advanced, and capacity tightens. A high unemployment rate broadly favors employers, and a low unemployment rate favors employees. Neither the number of work stoppages (Chart II-8, top panel), nor the number of workers involved (Chart II-8, middle panel) correlates very well with the unemployment gap (Chart II-8, bottom panel), in the Reagan-Thatcher era, however, as work stoppages have dwindled almost to zero. Chart II-8Swamped By The Legal And Regulatory Tide Game theory is better equipped than simple regression models to offer insight into the origin of strikes. We posit a simple framework in which each side can hold any of five perceptions of its own bargaining power, resulting in a total of 25 possible joint perceptions. Management (M) can believe it is way stronger than Labor (L), M >> L; stronger than Labor, M > L; roughly equal, M ≈ L; weaker than Labor, L > M; or way weaker than Labor, L >> M. Labor also holds one of these five perceptions, and the interaction of the two sides’ perceptions establishes the path negotiations will follow. Limiting our focus to today’s prevailing conditions, Figure II-3 displays only the outcomes consistent with management’s belief that it has the upper hand. For completeness, the exhibit lists all of labor’s potential perceptions, but we deem the two in which labor is feeling its oats (circled) to be most likely, given the success of recent high-profile strikes.7 Management’s confidence follows logically from four decades of victories, but may prove to be unfounded if its power has already peaked. Figure II-3The Eye Of The Beholder Strike outcomes turn on which side has overestimated its leverage. The broad factors we use to assess leverage are overall labor market slack; economic concentration; regulatory and legal trends; and the sustainability of either side’s accumulated advantage, which we describe as the labor-management rubber band. Other factors that matter on a case-by-case basis, but are beyond the scope of our analysis, include industry-level slack, a labor input’s susceptibility to automation, and the degree of labor specialization/skill involved in that input. For these micro-level factors, a given group of workers’ leverage is inversely related to the availability of substitutes for their input. Labor Market Slack              Despite muted wage growth, the labor market is demonstrably tight. The unemployment rate is at a 50-year low, the broader definition of unemployment is at the lowest level in its 26-year history, and the prime-age employment-to-population ratio is back to its 2001 levels, having surpassed the previous cycle’s peak (Chart II-9). The job openings rate is high, indicating that demand for workers is robust, and so is the quits rate, indicating that employers are competing vigorously to meet it. The NFIB survey’s job openings and hiring plans series (Chart II-10) echo the JOLTS findings. Chart II-9Prime-Age Employment Is At An 18-Year High ... Chart II-10... But There Are Still Lots Of Help Wanted Signs The lack of labor market slack decisively favors workers’ negotiating position. It is a sellers’ market when demand outstrips supply, and labor victories tend to be self-reinforcing. Successful strikes beget strikes, and management volunteers concessions as labor peace becomes a competitive advantage during strike waves. Given that the crisis-driven damage to the labor force participation rate has healed as the gap between the actual part rate (Chart II-11, solid line) and its demographically-determined structural proxy has closed (Chart II-11, dashed line), the burden of proof rests squarely with those who argue that there is an ample supply of workers waiting to come off the sidelines. Chart II-11The Labor Force Participation Gap Has Closed Economic Concentration The trend toward economic concentration (Chart II-12) has endowed the largest companies with greater market power, as evidenced by surging corporate profit margins. The greater the concentration of employment opportunities in local labor markets, the more closely they resemble monopsonies.8 Unfortunately for labor, monopsonies restrain prices just as monopolies inflate them. As we have shown,9 there is a robust inverse relationship between employment concentration and real wages (Chart II-13). Chart II-12Less Competition = More Power Chart II-13One Huge Buyer + Plus Multiple Small Sellers = Low Prices Economic concentration has been a major driver of management’s Reagan-Thatcher era dominance. Sleepy to indifferent antitrust enforcement has helped businesses capture market power, and it will continue to prevail through 2024 unless the Democrats take the White House in November. The silver lining for workers is that concentration could have the effect of promoting labor organization in services, where unions have heretofore made limited progress. The only way for employees to combat employers’ monopsony power is to organize their way to becoming a monopoly supplier of labor. Regulatory And Legal Trends Over the last four decades, unions have endured a near-constant drubbing from state capitols, federal agencies and the courts, as union and labor protections have been under siege from all sides. Since the air traffic controllers’ disastrous strike, labor’s regulatory and legal fortunes have most closely resembled the competitive fortunes of the Harlem Globetrotters’ beleaguered opposition. But the regulatory and legal tide has been such a huge benefit for management since the beginning of the Reagan administration that it cannot continue to maintain its pace. If the electorate has had enough of Reagan-Thatcher policies, elected officials will stop implementing them. Investors seem to assume that it will, however, to the extent that they think about it at all. It stands to reason that employers may be similarly complacent. We will look more closely at the presidential election and its potential consequences in Part 3, but labor concerns and inequality are capturing more attention, even among Republicans. With Republicans’ inclination to side with business only able to go in one direction, the chances are good that it has peaked. The Labor-Management Rubber Band For all of the romantic allure of labor’s battles with management in the Colosseum era, employees and employers have a deeply symbiotic relationship. One can’t exist without the other, and pursuing total victory in negotiations is folly. Even too many incremental wins can prove ruinous, as the UAW discovered to its chagrin in 2008. A half-century of generous compensation and stultifying work rules saddled Detroit automakers with a burden that would have put them out of business had the federal government not intervened. Table II-2Average Salaries Of Public School Teachers By State We think of labor and management as being linked by a tether with a finite range. Since neither side can thrive for long if the other side is suffering, the tether pulls the two sides closer together when the gap between them threatens to become too wide. When labor does too well for too long at management’s expense, profit margins shrink and the company’s viability as a going concern is threatened. When management does too well, deteriorating living standards drive the best employees away, undermining productivity and profitability. Before the low-paying entity’s work force becomes a listless dumping ground for other firms’ castoffs, it may rise up and strike out of desperation. Teachers’ unions might have appeared to be setting themselves up for a fall in 2018 by illegally striking in staunchly conservative West Virginia, Oklahoma and Arizona, but desperate times call for desperate measures. Per the National Education Association’s data for the 2017-18 academic year, average public school teacher pay in West Virginia ranked 50th among the 50 states and the District of Columbia, Oklahoma ranked 49th and Arizona ranked 45th (Table II-2). Adjusting the nominal salaries for cost disparities across states, West Virginia placed 41st, Oklahoma 44th and Arizona 48th. Given that real teacher salaries had declined by 8% and 9% since 2009-10 in West Virginia and Arizona, respectively, the labor-management rubber band had stretched nearly to the breaking point. Consolidating The Macro Message Parties to negotiations derive leverage from the availability of substitutes. When alternative employment opportunities are prevalent, workers have a lot of leverage, because they can credibly threaten to avail themselves of them. Teaching is a skill that transfers easily, and every state has a public school system, so teachers in low-salary states have a wealth of ready alternatives. The converse is true for low-salary states; despite much warmer temperatures, it is unlikely that teachers from top-quintile states will be willing to take a 25-33% cost-of-living-adjusted pay cut to decamp to Arizona (Table II-3). Table II-3Cost Of Living-Adjusted Public School Teacher Salaries By State It is easy to see from Figure II-4 why management has had the upper hand. Economic concentration and the legal and regulatory climate have increasingly favored it for decades. The immediate future seems poised to favor labor, however, as the legal and regulatory climate cannot get materially better for employers, and the labor-management rubber band has become so stretched that some sort of mean reversion is inevitable. We have high conviction that labor’s one current advantage, a tight labor market, will remain in its column over the next year or two. On a forward-looking basis, the macro factors as a whole are poised to support labor. Figure II-4Macro Drivers Of Negotiating Leverage Takeaways (II) We think it is more likely than not that the labor movement in the United States will remain weak relative to its 1950s to 1970s heyday. We do think, however, that the probability that unions could rise up to exert the leverage that accrues to workers in a tight labor market is considerably larger than the great majority of investors perceive. Alpha – market-beating return – arises from surprises. An investor captures excess returns when s/he successfully anticipates something that the consensus does not. If the disparity involves a trivial outcome, then any excess return is likely to be trivial, but if the outcome is significant, the investor who zigged when the rest of the market zagged stands to separate him/herself from the pack. We think the outcome of a shift in leverage from employers to employees would be very large indeed. We would expect that aggregate wage gains of 4% or higher would quickly drive the Fed to impose restrictive monetary policy settings, eventually inducing the next recession and the end of the bull markets in equities, credit and property. A union revival may be a low-probability event, but it would have considerable impact on markets and the economy. Given our conviction that the probability, albeit low, is much greater than investors expect, we think the subject is well worth sustained attention. The Public-Approval Contest The last question to approach is how does labor or management win in the court of public opinion? Capturing Hearts And Minds Public opinion has shaped the outcomes of labor-management contests throughout US labor relations history. Labor was continually outgunned before the New Deal, coming up against private security forces, local police and/or the National Guard when they struck. Employers were able to turn to hired muscle, or request the deployment of public resources on their behalf, because the public had few qualms about using force to break strikes. College athletes were even pressed into service as strikebreakers after the turn of the century for what was viewed at the time as good, clean fun.10 Public opinion is not immutable, however, and by the time of the Flint sit-down strike, it had begun to shift in the direction of labor. The widespread misery of the Depression went a long way to overcoming Americans’ deep-seated suspicion of the labor movement and the fringe elements associated with it. Some employers were slow to pick up on the change in the public mood, however, and Ford’s security force thuggishly beat Walter Reuther and other UAW organizers while they oversaw the distribution of union leaflets outside a massive Ford plant just three months after Flint. Ford won the Battle of the Overpass, but its heavy-handed, retrograde tactics helped cost it the war. Reuther, who later led the UAW in its ‘50s and ‘60s golden age, was a master strategist with a knack for public relations. Writing the playbook later used to great effect by civil rights leaders, Reuther invited clergymen, Senate staffers and the press to accompany the largely female team of leafleteers. When the Ford heavies commenced beating the men, and roughly scattering the women, photographers were on hand to document it all.11 The photos helped unions capture public sympathy, just as televised images of dogs and fire hoses would later help secure passage of landmark civil rights legislation. Unions’ Fall From Grace Figure II-5Unions' 1980s Public Opinion Vortex Labor unions enjoyed their greatest public support in the mid-fifties, and largely maintained it well into the sixties, until rampant corruption and ties to organized crime undermined their public appeal. The shoddy quality of American autos further turned opinion against the UAW, the nation’s most prominent union, and a college football star named Brian Bosworth caused a mid-eighties furor by claiming that he had deliberately sought to prank new car buyers during his summer job on a Chevrolet assembly line. Bosworth later retracted the claim that GM workers had shown him how to insert stray bolts in inaccessible parts of car bodies to create a maddening mystery rattling, but the fact that so many Sports Illustrated readers found it credible eloquently testified to the UAW’s image problem. President Reagan accelerated the trend when he successfully stood up to the striking air traffic controllers, but his administration could not have taken such a hard line if unions hadn’t already been weakened by declining public support. Together, the public’s waning support for unions and the Reagan administration’s antipathy for them were powerfully self-reinforcing, and they fueled a vicious circle that powered four decades of union reversals (Figure II-5). As a prescient November 1981 Fortune report put it, “‘Managers are discovering that strikes can be broken, … and that strike-breaking (assuming it to be legal and nonviolent) doesn’t have to be a dirty word. In the long run, this new perception by business could turn out to be big news.’”12 Emboldened by the federal government’s replacement of the controllers, and the growing public perception that unions had devolved into an insular interest group driving the cost of living higher for everyone else, businesses began turning to permanent replacement workers to counter strikes.13 As an attorney that represented management in labor disputes told The New York Times in 1986, “If the President of the United States can replace [strikers], this must be socially acceptable, politically acceptable, and we can do it, also.”14 Labor’s New Face … Polling data indicate that unions have been recovering in the court of public opinion since the crisis, when the public presumably soured on them over the perception that the UAW was selfishly impeding the auto industry bailout. Their image got a boost in 2018 (Chart II-14), as striking red-state teachers embodied the shift from unions’ factory past to their service-provider present. “The teachers, many of them women, are redefining attitudes about organized labor, replacing negative stereotypes of overpaid and underperforming blue-collar workers with a more sympathetic face: overworked and underappreciated nurturers who say they’re fighting for their students as much as they’re fighting for themselves.”15 Chart II-14Feeling The Bern? Several commentators have heard organized labor’s death knell in US manufacturing’s irreversible decline. Unions gained critical mass on docks, factory floors, steel mills and coal mines, but few of today’s workers make their living there. Those who remain have little recourse other than to accept whatever terms management offers, as their jobs can easily be outsourced to lower-cost jurisdictions. The decline in private-sector union membership has traced the steady diminution of factory workers’ leverage (Chart II-15). Chart II-15Tracking Manufacturing's Slide Service workers represent unions’ future, and they have two important advantages over their manufacturing counterparts: many of their functions cannot be offshored, and a great deal of them are customer-facing. When MGM’s chairman was ousted from his job after clashing with Las Vegas’ potent UNITE-HERE local over the new MGM Grand Hotel’s nonunion policy, his successor explained why he immediately came to terms with the union. “‘The last thing you want is for people who are coming to enjoy themselves to see pickets and unhappy workers blocking driveways. … When you’re in the service business, the first contact our guests have is with the guest-room attendants or the food and beverage servers, and if that person’s [sic] unhappy, that comes across to the guests very quickly.’”16 … Management’s New Leaf … The Business Roundtable’s latest statement on corporate governance principles laid out a new stakeholder vision, displacing the Milton Friedman view that corporations are solely responsible for maximizing shareholder wealth. The statement itself is pretty bland, but the preamble in the press release accompanying it sounds as if it had been developed with labor advocates’ help (Box II-2). It is a stretch to think that the ideals in the Roundtable’s communications will take precedence over investment returns, but they may signal that management fears the labor-management rubber band has been stretched too far.17 The Environmental, Social and Governance (ESG) movement has the potential to improve rank-and-file workers’ wages and working conditions. ESG proponents have steadily groused about outsized executive pay packages, but if asset owners and institutional investors were to begin pushing for higher entry-level pay to narrow the income-inequality gap, unions could gain some powerful allies. BOX II-2 Farewell, Milton Friedman   America’s economic model, which is based on freedom, liberty and other enduring principles of our democracy, has raised standards of living for generations, while promoting competition, consumer choice and innovation. America’s businesses have been a critical engine to its success. Yet we know that many Americans are struggling. Too often hard work is not rewarded, and not enough is being done for workers to adjust to the rapid pace of change in the economy. If companies fail to recognize that the success of our system is dependent on inclusive long-term growth, many will raise legitimate questions about the role of large employers in our society. With these concerns in mind, Business Roundtable is modernizing its principles on the role of a corporation. Since 1978, Business Roundtable has periodically issued Principles of Corporate Governance that include language on the purpose of a corporation. Each version of that document issued since 1997 has stated that corporations exist principally to serve their shareholders. It has become clear that this language on corporate purpose does not accurately describe the ways in which we and our fellow CEOs endeavor every day to create value for all our stakeholders, whose long-term interests are inseparable. We therefore provide the following Statement on the Purpose of a Corporation, which supersedes previous Business Roundtable statements and more accurately reflects our commitment to a free market economy that serves all Americans. This statement represents only one element of Business Roundtable’s work to ensure more inclusive prosperity, and we are continuing to challenge ourselves to do more. Just as we are committed to doing our part as corporate CEOs, we call on others to do their part as well. In particular, we urge leading investors to support companies that build long-term value by investing in their employees and communities. … And The Public’s Left Turn Chart II-16Help! As our Geopolitical Strategy colleagues have argued since the 2016 primaries, the median voter in the US has been moving to the left as the financial crisis, the hollowing out of the middle class and the widening wealth gap have dimmed the luster of Reagan-Thatcher free-market policies.18 Globalization has squeezed unskilled labor everywhere in the developed world, and white-collar workers are starting to look over their shoulders at artificial intelligence programs that may render them obsolete as surely as voice mail and word processing decimated secretaries and typists. Banding together hasn’t sounded so good since the Depression, and nearly half of all workers polled in 2017 said they would join a union if they could (Chart II-16). Millennials are poised to become the single biggest voting bloc in the country. They were born between 1981 and 1996, and their lives have spanned two equity market crashes, the September 11th attacks, and the financial crisis, instilling them with a keen awareness of the way that remote events can upend the best-laid plans. Many of them emerged from college with sizable debt and dim earnings prospects. They would welcome more government involvement in the economy, and their enthusiastic embrace of Bernie Sanders and Elizabeth Warren (Chart II-17) indicates they’re on unions’ side. Chart II-17No 'Third Way' For Millennials Elections Have (Considerable Regulatory) Consequences Electoral outcomes influence the division of the economic pie between employers and employees. Labor-friendly presidents, governors and legislatures are more likely to expand employee protections, while more vigilantly enforcing the employment laws and regulations that are already on the books. The White House appoints top leadership at the Labor Department, the National Labor Review Board (NLRB), and the Occupational Safety and Health Administration (OSHA), along with the attorney general, who dictates the effort devoted to anti-trust enforcement. The differences can be stark. Justice Scalia’s son would no more have led the Obama Department of Labor than Scott Pruitt (EPA), Wilbur Ross (Commerce) or Betsy Devos (Education) would have found employment anywhere in the Obama administration. McDonald’s has good reason to be happy with the outcome of the 2016 election; its business before the NLRB wound up being resolved much more favorably in 2019 than it would have been when it began in 2014 (Box II-3). At the state level, Wisconsin public employees suffered a previously unimaginable setback when Scott Walker won the 2010 gubernatorial election, along with sizable legislative majorities (Box II-4). BOX II-3 The Right Referee Makes All The Difference The Fight for $15 movement that began in 2012 aimed to nearly double the median fast-food worker’s wages. A raise of that magnitude would pose an existential threat to fast-food’s business model, and McDonald’s and its franchisees sought to stymie the movement’s momentum. The NLRB opened an investigation in 2014 following allegations that employees were fired for participating in organizing activities. McDonald’s vigorously contested the case in an effort to avoid the joint-employer designation that would open the door for franchise employees to bargain collectively with the parent company. (Absent a joint-employer ruling, a union would have to organize the McDonald’s work force one franchise at a time.) When the case was decided in McDonald’s favor in December, the headline and sub-header on the Bloomberg story reporting the outcome crystallized our elections-matter thesis: McDonald’s Gets Win Under Trump That Proved Elusive With Obama Board led by Trump appointees overrules judge in case that threatened business model BOX II-4 Wisconsin Guts Public-Sector Unions Soon after Wisconsin Governor Scott Walker took office in January 2011, backed by sizable Republican majorities in both houses of the legislature, he sent a bill to legislators that would cripple the state’s public-sector unions. Protestors swarmed Madison and filled the capitol building every day for a month to contest the bill, and Democratic legislators fled the state to forestall a vote, but it eventually passed nonetheless. The bill struck at a rare union success story; nearly one-third of public-sector employees are union members and that ratio has remained fairly steady over the last 40 years (Chart II-18). Wisconsin’s public-sector unions now do little more than advocate for their members in disciplinary and grievance proceedings, and overall union membership in the state has fallen by a whopping 43% since the end of 2009. Judicial appointments make a difference, too. The Supreme Court’s Janus decision in April 2018, banning any requirement that public employees pay dues to the unions that bargain for them on not-so-readily-apparent First Amendment grounds,19 was widely viewed as a body blow to public-sector unions. The 5-4 decision would certainly have gone the other way had President Obama’s nominee to succeed the late Justice Scalia been confirmed by the Senate. Chart II-18Public-Sector Union Membership Has Held Up Well Final Takeaways We do not anticipate that organized labor will regain the position it enjoyed in the fifties and sixties, when global competition was weak and shareholders and consumers were anything but vigilant about corporate operations. Even a more modest flexing of labor muscle that pushes wages higher across the entire economy has a probability of less than one half. Investors seem to think the probability is negligible, though, and therein lies an opportunity. Elected officials deliver what their constituents want, as do the courts, albeit with a longer lag. Society’s view of striking/strikebreaking tactics heavily influences how they’re deployed and whether or not they’ll be successful. We believe that public opinion is beginning to coalesce on employees’ side as labor puts on a more appealing face; as businesses increasingly fret about inequality’s consequences; and as millennials swoon over progressives, undeterred by labels that would have left their Cold War ancestors reaching for weapons. The median voter theory has importance beyond predicting future outcomes; it directly influences them. As the center of the electorate leans to the left, elected officials will have to deliver more liberal outcomes if they want to keep their jobs. If the electorate has given up on Reagan-Thatcher principles, organized labor is bound to get a break from the four-decade onslaught that has left it shrunken and feeble. There is one overriding market takeaway from our view that a labor recovery is more likely than investors realize: long-run inflation expectations are way too low. Although we do not expect wage growth to rise enough this year to give rise to sustainable upward inflation pressures that force the Fed to come off of the sidelines, we do think investors are overly complacent about inflation. We continue to advocate for below-benchmark duration positioning over a cyclical timeframe and for owning TIPS in place of longer-maturity Treasury bonds over all timeframes. Watch the election, as it may reveal that labor’s demise has been greatly exaggerated. Doug Peta, CFA Chief US Investment Strategist Bibliography Aamidor, Abe and Evanoff, Ted. At The Crossroads: Middle America and the Battle to Save the Car Industry. Toronto: ECW Press (2010). Allegretto, S.A.; Doussard, M.; Graham-Squire, D.; Jacobs, K.; Thompson, D.; and Thompson, J. Fast Food, Poverty Wages: The Public Cost of Low-Wage Jobs in the Fast-Food Industry. Berkeley, CA. UC-Berkeley Center for Labor Research and Education, October 2013. Bernstein, Irving. The Lean Years: A History of the American Worker, 1920-1933. Boston: Houghton Mifflin (1960). Blanc, Eric. Red State Revolt: The Teachers’ Strike Wave and Working-Class Politics. Brooklyn, NY: Verso (2019). Emma, Caitlin. “Teachers Are Going on Strike in Trump’s America.” Politico, April 12, 2018, accessed January 20, 2020. Finnegan, William. “Dignity: Fast-Food Workers and a New Form of Labor Activism.” The New Yorker, September 15, 2014 Greenhouse, Steven. Beaten Down, Worked Up: The Past, Present and Future of American Labor. New York: Alfred A. Knopf (2019). Greenhouse, Steven. “The Return of the Strike.” The American Prospect, Winter 2019 Ingrassia, Paul. Crash Course: The American Auto Industry’s Road from Glory to Disaster. New York: Random House (2010). King, Gilbert. “How the Ford Motor Company Won a Battle and Lost Ground.” smithsonianmag.com, April 30, 2013, accessed January 24, 2020. Loomis, Erik. A History of America in Ten Strikes. New York: The New Press (2018). Manchester, William. The Glory and the Dream: A Narrative History of America, 1932-1972. New York: Bantam (1974). Norwood, Stephen H. “The Student As Strikebreaker: College Youth and the Crisis of Masculinity in the Early Twentieth Century. Journal of Social History Winter 1994: pp. 331-49. Sears, Stephen W. “Shut the Goddam Plant!” American Heritage Volume 33, Issue 3 (April/May 1982) Serrin, William. “Industries, in Shift, Aren’t Letting Strikes Stop Them.” The New York Times, September 30, 1986 Wolff, Leon. “Battle at Homestead.” American Heritage Volume 16, Issue 3 (April 1965) *Current newspaper and Bloomberg articles omitted. III. Indicators And Reference Charts Last month, we warned that the S&P 500 rally looked increasingly vulnerable from a tactical perspective and that the spread of Covid-19 was likely to be the catalyst of a pullback that could cause the S&P 500 to retest its October 2019 breakout. Since then, the S&P 500 has corrected significantly. As long as new cases of Covid-19 continue to grow quickly outside of China, the S&P 500 can suffer additional downside. Limited inflationary pressures, accommodative global central banks, and the potential for a large policy easing in China suggest that stocks have significant upside once Covid-19 becomes better contained. Nonetheless, despite the positive signals from our Willingness-To-Pay measure or our Monetary and Composite Technical Indicators, we recommend a cautious tactical stance on equities. Our BCA Composite Valuation index is not depressed enough to warrant closing our eyes when the risk of a recession caused by a global pandemic remains as high as it is today. Either valuations will have to cheapen further or Covid-19 will have to be clearly contained before we buy stocks without strong fears. 10-year Treasurys yields remain extremely expensive. However, our Composite Technical Indicator suggests that in such an uncertain climate, yields can fall a little more. Nonetheless, Treasurys seem like an asset that has nearly fully priced in the full impact of Covid-19, and thus, any downside in yield will be very limited.  The rising risk premia linked to the coronavirus is also helping the dollar right now, but as we have highlighted before, many signs show that global growth was in the process of bottoming before the outbreak took hold. As a result, we anticipate that the dollar could suffer plentiful downside if Covid-19 passes soon. Moreover, the rising probability that Senator Bernie Sanders wins the Democratic nomination could hurt the greenback over the remainder of the year. Finally, commodity prices have corrected meaningfully in response to the stronger dollar and the growth fears created by the spread of Covid-19. However, they have not pullback below the levels where they traded when they broke out in late 2019. Moreover, the advanced/decline line of the Continuous Commodity Index remains at an elevated level, indicating underlying strength in the commodity complex. Natural resources prices will likely become the key beneficiaries of both the eventual pullback in virus-related fears and the weaker dollar. EQUITIES: Chart III-1US Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Chart III-5US Stock Market Valuation Chart III-6US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations Chart III-10Yield Curve Slopes Chart III-11Selected US Bond Yields Chart III-1210-Year Treasury Yield ComponentsChart III-13US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP Chart III-17US Dollar And Indicator Chart III-18US Dollar Fundamentals Chart III-19Japanese Yen Technicals Chart III-20Euro Technicals Chart III-21Euro/Yen Technicals Chart III-22Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Chart III-24Commodity Prices Chart III-25Commodity Prices Chart III-26Commodity Sentiment Chart III-27Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop Chart III-29US Macro Snapshot Chart III-30US Growth Outlook Chart III-31US Cyclical Spending Chart III-32US Labor Market Chart III-33US Consumption Chart III-34US Housing Chart III-35US Debt And Deleveraging   Chart III-36US Financial Conditions Chart III-37Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China   Mathieu Savary Vice President The Bank Credit Analyst Footnotes 1 Non-seasonally adjusted growth is always negative in Q1, due to the impact of the Chinese Lunar New Year Celebration. This is why we emphasize the seasonal adjustment. 2 Please see Global Investment Strategy Weekly Report "Markets Too Complacent About The Coronavirus," dated February 21, 2020, available at gis.bcaresearch.com 3 Please see The Bank Credit Analyst "February 2020," dated January 30, 2020 available at bca.bcaresearch.com 4 Blanc, Eric. Red State Revolt: The Teachers’ Strike Wave and Working-Class Politics, Verso: New York (2019), p. 204. 5 Ibid, p. 209. 6 We will discuss public opinion, and its impact on elected officials and courts, in Part 3. 7 Please see the January 13, 2020 US Investment Strategy Special Report, “Labor Strikes Back, Part 1: An Investor’s Guide To US Labor History,” available at www.bcaresearch.com. 8 A monopsony is a market with a single buyer, akin to a monopoly, which is a market with only one seller. 9 Please see the July 2019 Bank Credit Analyst Special Report, “ The Productivity Puzzle: Competition Is The Missing Ingredient,” available at bcaresearch.com. 10 Students were excused from classes and exams and sometimes even received academic credit for their work. 11 King, Gilbert, “How The Ford Motor Company Won a Battle and Lost Ground,” Smithsonian.com, April 30, 2013. 12 Greenhouse, Steven, Beaten Down, Worked Up, Alfred A. Knopf: New York (2019), pp. 137-8. 13 High unemployment, in addition to declining respect for unions, helped erase the stigma of crossing picket lines. 14 Serrin, William, “Industries, in Shift, Aren’t Letting Strikes Stop Them,” New York Times, September 30, 1986, p. A18. 15 Emma, Caitlin, “Teachers Are Going on Strike in Trump’s America,” Politico, April 12, 2018. 16 Greenhouse, p. 44. 17 Please see the January 20, 2020 US Investment Strategy Special Report, “Labor Strikes Back, Part 2: Where Strikes Come From And Who Wins Them,” available at usis.bcaresearch.com. 18 Please see the June 8, 2016 Geopolitical Strategy Monthly Report, “Introducing The Median Voter Theory,” available at gps.bcaresearch.com. 19 The Court found for the plaintiff in Janus, who bridled at the closed-shop law that forced him to join the union that bargained on his and his colleagues’ behalf, because the union’s espousal of views with which he disagreed constituted a violation of his free-speech rights as guaranteed by the First Amendment.