Copper

Highlights Prices of global major commodities such as copper and iron ore have rallied significantly this year. It seems that strong Chinese imports once again became the major driving force for both commodities. Is the rally in commodity prices sustainable in 2021? This is the first of three reports focusing on copper, iron ore, and energy. In this week’s report, our views on copper are highlighted below: Chinese imports of copper have substantially outpaced Chinese underlying copper consumption this year, resulting in considerable inventory accumulation. Destocking and underlying demand weakness in 2021 suggest that China’s copper imports are likely to decline next year.  In the meantime, the global refined copper supply will grow at 1.5-2.5% in 2021 from 2020. Copper prices are vulnerable to the downside next year. Short December 2021 LME copper futures.  Feature China’s total demand and imports have surged by 23% and 62% year on year, respectively, in the last six months (Charts 1A and 1B). Both growth rates were the fastest they have been since 2010 (Chart 2). Chart 1AWill Chinese Total Copper Demand Surge Into 2021? Will Chinese Total Copper Demand Surge Into 2021? Will Chinese Total Copper Demand Surge Into 2021? Chart 1BWill Chinese Copper Imports Surge Into 2021? Will Chinese Copper Imports Surge Into 2021? Will Chinese Copper Imports Surge Into 2021? Please note throughout of this report, total demand is defined as the formula below: Total demand = underlying consumption1 + change in inventories Solely due to the surging total demand from China, global copper demand rose by 5% year on year so far this year (Chart 3). China’s total copper demand accounted for 58.4% of global copper demand for the first nine months of this year, increasing from a 53.6% share last year. Chart 2Unusual Strong Growth In Chinese Total Copper Demand And Imports Unusual Strong Growth In Chinese Total Copper Demand And Imports Unusual Strong Growth In Chinese Total Copper Demand And Imports Chart 3China Alone Has Pushed Up Global Copper Demand This Year China Alone Has Pushed Up Global Copper Demand This Year China Alone Has Pushed Up Global Copper Demand This Year In the meantime, global copper ore and refined copper outputs were curbed by the pandemic. As a result, the global copper market balance2 swung from a small surplus in March to a record high deficit in September (Chart 4). However, based on our estimates, China’s total demand for copper this year has meaningfully outpaced its underlying consumption, implying there has been substantial inventory buildup in the country. As a result, China’s strong copper imports will not continue into 2021. Moreover, global copper output is set to increase in 2021, adding further downward pressure on copper prices next year. Chart 4Global Copper Market Balance Has Swung From A Small Surplus To A High Deficit Global Copper Market Balance Has Swung From A Small Surplus To A High Deficit Global Copper Market Balance Has Swung From A Small Surplus To A High Deficit Chart 5China's Total Copper Demand: A Big Deviation From Its Long-Term Underlying Consumption Growth China's Total Copper Demand: A Big Deviation From Its Long-Term Underlying Consumption Growth China's Total Copper Demand: A Big Deviation From Its Long-Term Underlying Consumption Growth Understanding Strong Chinese Copper Demand In 2020 For the past five years, the annual increase in China’s total copper demand grew at a compound annual growth rate (CAGR) of only 2.5%, reflecting the country’s long-term underlying copper usage growth (Chart 5). However, China’s total copper demand (consumption plus change in inventories) has increased by 18.4% year on year for the first nine months of this year. This surge in total demand has significantly outpaced its long-term underlying consumption growth. Our research shows that slightly more than half of China’s total copper demand growth so far this year can be attributable to a solid underlying consumption rebound boosted by the stimulus. The government’s strategic purchases and commercial restocking may have contributed to the other half of the country’s total copper demand growth. Copper Consumption By Real Economy Chart 6The Structure Of China’s Underlying Copper Consumption In 2019 Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper The structure of China’s underlying copper consumption in 2019 stemmed from the following industries and sectors: power (about 49% of Chinese copper usage); refrigeration and air conditioning (15%); transportation (10%); electronic communication (9%); buildings and construction (8%); and others (Chart 6). Table 1 shows our rough estimations of the copper consumption growth in each sector in 2020, respectively. Based on this, we concluded that China’s underlying copper consumption might grow by approximately 10% this year. Table 1Chinese Underlying Copper Consumption Year-On-Year Growth Estimates For 2020 Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper Chart 7Copper Consumption In The Power Industry Has Been Strong Copper Consumption In The Power Industry Has Been Strong Copper Consumption In The Power Industry Has Been Strong The power sector is the largest copper user as copper is among the best conductors of electricity and heat. The metal is used in high, medium and low voltage power networks. Following the pandemic, China significantly boosted investment in the power sector by 17% (year to date, January - October) from the same period last year (Chart 7). The power generation equipment output has surged by 28.7% year on year during the same period, while the electrical cable output increased only slightly. All together, we estimated that the copper consumption from the power sector grew by approximately 16% from last year. While air conditioner output declined moderately from 2019, freezer and refrigerator production has gone up significantly this year (Chart 8). The global “stay-at-home” economy due to the pandemic boosted Chinese exports of freezers and refrigerators.  Considering air conditioner copper usage per unit is generally higher than that in freezers/refrigerators, we assumed this year’s copper consumption in the home appliance sector to be up by 6% from the previous year. Despite a recent sharp rebound in transportation investment and automobile output, in the first ten months of this year the transportation investment grew by only 2% year on year while automobile output still contracted by 4% from the previous year (Chart 9). Hence, we assumed a 2% year-on-year contraction of copper usage in this sector this year.3 Chart 8Moderate Growth In Copper Usage In The Home Appliance Sector Moderate Growth In Copper Usage In The Home Appliance Sector Moderate Growth In Copper Usage In The Home Appliance Sector Chart 9Contracted Automobile Output May Have Reduced Copper Consumption In The Transportation Sector Contracted Automobile Output May Have Reduced Copper Consumption In The Transportation Sector Contracted Automobile Output May Have Reduced Copper Consumption In The Transportation Sector Copper or copper-base alloys are used in printed circuit boards, in electronic connectors, as well as in many semiconductor products. This year, China had set a strategic goal to develop the tech-related new infrastructure, which includes information transmission, software and information technology services, such as 5G networks, industrial internet, and data centers. The tech-related new infrastructure investment has increased by 20% year on year during January - October (Chart 10). We expect the year-on-year copper usage growth in this sector to be 20% this year as well.   The buildings and construction sector accounts for 8% of China’s copper usage. During the first nine months of this year, our broad measure of China’s building construction activity—specifically building area starts and completions—have contracted 3.2% and 9.6% year on year, respectively (Chart 11). Assuming half of this sector’s usage is in building area starts and the other half in completions, we expect the copper consumption in this sector to contract by 6% year on year this year. Chart 10Copper Usage Rising Due To Strong Tech-Related New Infrastructure Investment Copper Usage Rising Due To Strong Tech-Related New Infrastructure Investment Copper Usage Rising Due To Strong Tech-Related New Infrastructure Investment Chart 11Weak Property Market May Have Also Cut Copper Consumption In The Construction Sector Weak Property Market May Have Also Cut Copper Consumption In The Construction Sector Weak Property Market May Have Also Cut Copper Consumption In The Construction Sector Altogether, our calculation shows that the Chinese underlying copper consumption growth for the full 2020 year is likely to be up 10% from last year. Copper Restocking Although the most tracked official data does not show a significant pileup in copper inventories in China, our research indicates that the Chinese government’s strategic and enterprises’ speculative restocking might have accounted for nearly half of China’s total copper demand growth this year. Chinese total copper demand (consumption plus change in inventories) was approximately 9,120 thousand metric tons (kt) during last January - September.4 A 10% growth from this number will equal an increase of 912 kt, still 770 kt (or 46%) short of the total increased amount of 1,678 kt year on year in Chinese total copper demand. First, of the 770-kt gap between China’s total demand and our estimated underlying consumption, we believe that about 200-400 kt of copper—about 4%-8% of Chinese copper imports in the first nine months of this year—were purchased by the Chinese government.5 Many market analysts have been suspecting that China’s State Reserve Board (SRB) has been buying copper this year, as there was no way Chinese underlying consumption could grow as strong as what its total demand and imports suggested. Historically, the SRB bought copper whenever prices declined significantly, and stopped or reduced its purchases when prices had a significant rally. For example, many believe that the SRB bought 200-400 kt in 2008,6 200-500 kt in 2014,7 and 200 kt in 2015,8 when prices dropped considerably. Copper prices have been trading well below US$3 per pound for most of the year, and the Chinese currency has been strengthening. Thus, it is reasonable to assume that the SRB purchased at least a similar amount as in previous cycles to strategically stock up on cheap commodities. Second, Chinese enterprises may have bought 370-570 kt of copper this year.9 Easy money and abundant credit with lower borrowing costs have probably allowed some Chinese enterprises to accumulate copper inventories, representing financial speculative demand (with a motive of selling at higher prices) and/or inventories to be used in future. Chart 12The SHFE Copper Warehouse: No Inventory Accumulation Based On This Measure The SHFE Copper Warehouse: No Inventory Accumulation Based On This Measure The SHFE Copper Warehouse: No Inventory Accumulation Based On This Measure The most often tracked China copper inventory data by market analysts is the copper inventory at Shanghai Futures Exchange (SHFE), which has been highly volatile this year. Its current level is near its level at the end of last year (Chart 12). This means no inventory accumulation in the SHFE copper warehouse. This also implies that Chinese companies may have restocked their copper inventories in their own warehouses, for which no official data can be tracked.  Bottom Line: Chinese underlying consumption accounts for slightly more than half of the increase in the country’s total copper demand this year, whereas the government’s strategic purchases and commercial restocking have most likely contributed to the other half. China’s Copper Demand Boom Is Unsustainable This year’s surging total demand for copper in China was due to the stimulus as a result of the pandemic, as well as government and commercial copper restocking. Looking forward in 2021, these driving forces will either diminish or disappear. First, China’s copper restocking will be followed by destocking. With copper prices having risen by 57% from their trough in March, and now well above US$3 per pound, odds are that the SRB and commercial buyers that have been accumulating copper inventories will considerably reduce their copper purchases next year. Moreover, as China’s financial regulations have become stricter and the monetary stance more hawkish of late, we expect Chinese enterprises will largely refrain from speculative activities in the commodity market next year.  Second, the country’s underlying copper consumption growth will likely drop considerably to the range of -3% to zero next year (Table 2). Table 2Chinese Underlying Copper Consumption Year-on-Year Growth Estimates For 2021 Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper As government stimulus will likely be scaled back substantially next year, infrastructure investment in the power sector will fall from the current level. In 2019, the year-on-year growth of power investment, power generation equipment, and electrical cable output was -0.2%, -15% and 3.3%, respectively. We expect the level of Chinese investment in the power sector to normalize to its long-term trend next year from this year’s substantial increase. Therefore, we estimate a 5%-8% contraction in this sector’s copper consumption next year. Next year’s government-targeted stimulus in the consumption segment may provide a boost in output of home appliances, albeit a modest one. In addition, global demand for freezers and refrigerators due to the pandemic may diminish, as global supply chains as well as production from pandemic-struck countries will likely recover next year. Hence, we expect the copper usage growth in the “refrigeration and air conditioning” sector will drop to a 0-2% year-on-year growth in 2021 from this year’s 6% growth. For copper usage in the transportation sector, we expect a 3%-5% growth next year as the automobile sector will likely continue to recover, and transportation infrastructure investment may also increase slightly due to the government’s effort to expand its electric car charging infrastructure. We expect the investment in the tech-related new infrastructure to increase by 12%-15%, which will be a drop from this year’s sharp growth of 20%.  The copper usage in the buildings and construction sector is likely to continue until the fall of next year. However, as property developers need to complete their existing projects, copper consumption in this sector may decline by 2%-4%, smaller than this year’s 6% contraction. All together, we conclude that the underlying Chinese copper consumption will likely contract by 0-3% next year from 2020. Bottom Line: China’s underlying copper consumption is likely to contract slightly next year, which will weigh on the country’s copper imports. Additionally, as China had accumulated considerable copper inventories this year, the country’s destocking will also depress its copper imports next year. More Global Copper Supply In 2021 Chart 13Global Copper Ore And Refined Copper Supply Are Set To Increase In 2021 Global Copper Ore And Refined Copper Supply Are Set To Increase In 2021 Global Copper Ore And Refined Copper Supply Are Set To Increase In 2021 Global supply of both copper ore and refined copper outside China will go up next year, by about 3-5% in 2021, a sharp contrast with the declines of 2.2% and 3.2% year on year, respectively, for the first nine months of this year (Chart 13). Table 3 shows the world’s top 10 copper producing companies’ capex this year and in 2021. Most of these companies slashed their capex this year due to the pandemic. However, the capex of all these companies will likely be much higher in 2021, which will facilitate copper output growth. The companies that will increase their capex in 2021 are largely outside China. The aggregate capex for the world’s top 10 copper producing companies will increase by nearly 20% year on year in 2021. Some mining giants such as BHP and Rio Tinto produce many other commodities rather than copper, so only part of their investment will go to copper-related assets/operations. For companies with a significant amount of revenue coming from copper, such as Codelco, Glencore, Southern Copper, KGHM, and Antofagasta, all will have more than 20% growth in their 2021 capex. Table 3The World’s Top 10 Copper Producing Companies’ Capex Investment In 2020 & 2021 Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper Chinese Commodities Demand: An Unsustainable Boom? Part I: Copper As these companies account for about half of the global copper production, we believe the 20% increase in their aggregate capex will likely result in a 3%-5% increase in their copper ore and refined copper outputs. China’s copper production growth rate is expected to accelerate within the next few years, mainly driven by the construction of Tibet's Qulong copper mine, the second phase expansion of Duobaoshan, the second phase of the Jiama copper mine, and the Chifeng Fubo project. China is currently the world’s third-largest copper ore producer, accounting for 9% of the global copper ore supply. The country is also the world’s largest refined copper producer, contributing 43% of global refined copper production. After having managed to add a 430-kt smelting capacity and a 640-kt refining capacity this year, the country plans to increase its new smelting capacity of 525 kt and new refinery capacity of 110 kt in 2021, most of which will need copper ore and concentrates. If the 110-kt new refinery capacity is fully utilized, it will increase global refined copper output by about 0.5% next year. Chart 14China: Rising Imports Of Copper Ore Will Likely Reduce Its Refined Copper Imports China: Rising Imports Of Copper Ore Will Likely Reduce Its Refined Copper Imports China: Rising Imports Of Copper Ore Will Likely Reduce Its Refined Copper Imports This year, due to constrained copper ore supply outside China, Chinese copper ore imports only increased 2% year on year during January - September. This has also prompted Chinese refined copper imports. In 2021, rising imports of copper ore by China will likely boost the country’s domestic production of refined copper and reduce imports (Chart 14). In addition, the significant increase in Chinese refined copper imports this year was partially due to the substitution effect of the shortage in global copper scrap supply. This is likely to change. We expect global secondary copper production—refined copper produced from scrap copper—to rise next year from the current level. Global secondary copper output accounts for 17% of global total refined copper supply. The pandemic-triggered lockdowns disrupted the global scrap copper supply chains, including collection, processing, and transportation. According to the International Copper Study Group (ICSG), global secondary refined copper production is expected to decline by 5.5% year on year this year due to a shortage of scrap metal in many regions. This is likely to reverse next year, as fewer countries will force complete lockdowns. Chart 15China: Rising Imports Of Scrap Copper Will Also Likely Reduce Its Refined Copper Imports China: Rising Imports Of Scrap Copper Will Also Likely Reduce Its Refined Copper Imports China: Rising Imports Of Scrap Copper Will Also Likely Reduce Its Refined Copper Imports Also, in order to reduce domestic pollution, starting from the second half of 2019, China has moved the metal scraps10 from the non-restricted category to the restricted category. As a result, importing copper scrap into China requires approval, and the number of approvals is strictly controlled. This had resulted in a sharp drop in the amount of imported copper scrap (Chart 15). China’s imported volumes of copper scrap plunged 38% year on year in 2019 and will likely fall further this year.  Next year, the newly implemented "Solid Waste Pollution Prevention and Control Law" will allow China to import high-quality copper scrap. This will also reduce the country’s need to import refined copper from overseas. Bottom Line: Both rising global ore output and recovering global secondary copper supply will increase the global refined copper supply next year. China will likely boost its imports of ore and high-quality scrap copper while considerably reducing its imports of refined copper. This will be negative to global refined copper prices. Investment Implications Chart 16Net Speculative Positions Of Copper Are At A Multi-Year High Net Speculative Positions Of Copper Are At A Multi-Year High Net Speculative Positions Of Copper Are At A Multi-Year High Fundamentally, China’s contracting underlying copper consumption and destocking, as well as the rising global refined copper supply, are all set to create a bearish backdrop for copper prices in 2021. Meanwhile, net speculative positions of copper in the US as a share of total open interest have risen to a multi-year high (Chart 16). This is a bearish technical signal for copper prices. In addition, LME warehouse copper inventories rebounded recently, which may also be a sign of easing supply bottlenecks and slower market demand (Chart 17). To conclude, copper prices are vulnerable to the downside next year. Short December 2021 LME copper futures outright (Chart 18). We expect a 10%-15% downside in copper prices next year from the current level. Chart 17Rebounding LME Copper Inventories: A Sign Of Easing Supply Bottlenecks And Slower Demand? Rebounding LME Copper Inventories: A Sign Of Easing Supply Bottlenecks And Slower Demand? Rebounding LME Copper Inventories: A Sign Of Easing Supply Bottlenecks And Slower Demand? Chart 18Short December 2021 LME Copper Futures Outright Short December 2021 LME Copper Futures Outright Short December 2021 LME Copper Futures Outright   Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com   Footnotes 1 Underlying consumption is defined as the usage of copper in the real economy and excludes changes in inventories. 2Market balance measured as refined copper total demand minus refined copper production. The market balance is in deficit if total demand exceeds production and it is in surplus if total demand falls short of production. 3Transportation investment is for the transportation infrastructure sector. Here we assumed the copper usage in the transportation sector is evenly divided between transportation infrastructure and automobile production in China. 4According to WBMS data, China’s total demand during last January - September 2019 was 9,120 kt. Since China’s total demand for copper last year was within the range of its long-term underlying consumption, our estimates for China’s real economy driven consumption in 2020 are based on this number. 5Precise numbers are not available, and these data represent our estimates. 6Please refer https://news.smm.cn/news/66571 7Please refer https://www.reuters.com/article/copper-reserve-source-buy-idCNCNEA3N02F20140424 8Please refer https://news.cnpowder.com.cn/31981.html 9We derived this estimate by deducting SRB’s 200-400 kt from the 770-kt gap. 10In early 2019, China announced plans to restrict imports of eight different scrap categories – including aluminum, steel and copper – starting July 1, 2019. Cyclical Investment Stance Equity Sector Recommendations

Your feedback is important to us. Please take our client survey today. Highlights Mounting populism has created a structural tailwind behind inflation. The risk that inflation accelerates quickly is greater than the market appreciates. Monetary dynamics strongly influence consumer prices when inflation is stationary. The Federal Reserve’s back-door monetization of debt is inflationary. Financial assets do not embed a sufficiently large risk premium against higher inflation. The long-term, real returns of equities are likely to be poor. Small cap stocks and commodities offer cheap protection against higher inflation. Feature The equity market is extremely vulnerable to positive inflation surprises. The expectation of an extended period of low interest rates and extraordinarily easy monetary policy is the crucial justification for the S&P 500’s exceptionally elevated multiples. Anything that could threaten this policy set up would create a danger for stocks. Whether the mean of inflation in a given period is stationary will determine the influence that money has on inflation. The problem for the S&P 500 is that investors assign a much-too-small probability to the inflation risk, especially as structural and political forces point to an elevated chance that inflation will reach 3% to 5% within the next 10 years. There is also a non-trivial probability that inflation begins rising significantly faster than the market anticipates, even if it is not BCA Research’s base case. The dichotomy between the low odds of a quick turnaround in inflation embedded in financial asset prices and the inflationary threat created by monetary and fiscal choices is too large. It will force market participants to assign a greater inflation risk premium in bonds and stocks to protect against this eventuality. This process could precipitate painful corrections in both bond and equity prices. The good news is that inflation protection remains cheap. Three Stages Of Inflation The staggering recent increase in money supply and the extraordinary fiscal stimulus rolled out this year raise two questions: Are we exiting the recent period of low and stable inflation that has prevailed? Is inflation becoming a threat to financial asset prices? Major turning points in inflation provide context to assess the risk of an impending threat of increased inflation. From a statistical perspective, three phases in inflation dynamics have defined the past 100 years (Chart I-1): Chart I-1Three Stages Of Inflation Three Stages Of Inflation Three Stages Of Inflation 1922 to 1965: Inflation gyrated violently from as low as -12.1% to as high as 11.9% in response to various shocks such as the Great Depression or World War II. Nonetheless, inflation’s mean was stationary or trendless. 1965 to 1998: A period of great upheaval when inflation trended strongly, moving up until 1980 and then down until 1998. 1998 to present: Inflation has been stable, flatlining between 0.6% and 2.9%. Chart I-2More Often Than Not, Money Matters More Often Than Not, Money Matters More Often Than Not, Money Matters Empirically speaking, whether the mean of inflation in a given period is stationary will determine the influence that money has on inflation. The era of stationary inflation from 1922 to 1965 saw M2 closely correlated with changes in US consumer prices, but the link was severed from 1965 to 1998 when inflation trended strongly (Chart I-2, top and bottom panel). When inflation stabilized again from 1998 to 2020, M2 growth again explained gyrations in consumer prices (Chart I-2, bottom panel). Why did inflation behave differently from 1965 to 1998 compared with other episodes in the past 100 years? The defining factor of the pre-1965 era was an adherence to the gold standard. The gold standard created a hard anchor on prices because its rigidity made monetary policy credible, which produced stable inflation expectations. The velocity of money was also steady. Consequently, using the Fisher formulation of the equation of exchange (Price*Output = Money*Velocity or PY=MV), inflation became a direct derivative of the money supply. Various shocks such as a war or a depression would impact the rate of expansion of money, leading to a nearly linear effect on prices. When we examine unstable inflation from 1965 to 1998, it helps if we split the period into two subsamples: 1965 to 1977 and 1977 to 1998. The first interval generated accelerating inflation due to a multitude of factors. In the mid-1960s, slack in the US economy disappeared while demand became excessive as a result of the federal government’s increased spending from The Great Society programs and the Vietnam War. Additionally, by 1965, the gold standard was under attack. The US current account disappeared between 1965 and 1969. Worried by the deteriorating US balance of payment dynamics, French President De Gaulle sent his navy to repatriate France’s gold at the New York Fed. Other countries followed suit. The continued pressure on the US balance of payments, along with the need for easier monetary policy following the 1970 recession, lead to the 1971 Smithsonian Agreement whereby President Nixon unpegged the dollar from gold, effectively killing the gold standard. Any semblance of monetary rectitude disappeared and inflation expectations began to drift up. The oil shock of 1973 fueled the inflationary dynamics and pushed inflation higher through the rest of the decade. The developments outside of monetary policy reinforced downward pressure on inflation expectations created by the Fed’s orthodoxy. The second interval began in 1977, three years before inflation peaked. This date marks the implementation of the Federal Reserve Reform Act, which modified the Fed’s mandate from only targeting full employment to full employment and stable inflation. At first, the Act had little practical impact until Paul Volker became Fed chair in 1979 and began to combat inflation. Prior to 1977, the unemployment rate was below NAIRU (the unemployment rate consistent with full employment) most of the time, the economy overheated and ultimately, inflation trended up (Chart I-3). However, since 1977, the unemployment rate has mostly been above NAIRU and the labor market has predominantly experienced excess slack. Consequently, inflation expectations re-anchored to the downside and realized inflation collapsed. Chart I-3The Effect Of The Federal Reserve Reform Act Of 1977 The Effect Of The Federal Reserve Reform Act Of 1977 The Effect Of The Federal Reserve Reform Act Of 1977 Chart I-4The Monetarist Fed: 1977 to 1998 The Monetarist Fed: 1977 to 1998 The Monetarist Fed: 1977 to 1998 The relationship between short rates and money supply provides another way to appreciate the change in monetary policy after 1977. The Fed opted for a monetarist approach (officially and unofficially) when it had to combat high realized and expected inflation. During most of the past 100 years, money supply changes and short rates were either negatively correlated or not linked at all (Chart I-4, top and second panel); however, they began to move together from 1979 to 1998 (Chart I-4, bottom panel). The Fed boosted rates to preempt the inflationary impact of faster money supply expansion, which curtailed the link between prices and M2. Between 1977 and 1998, major structural forces also pushed down inflation and severed the bond between money supply and CPI. Starting with President Reagan, a period of aggressive deregulation and union-busting increased competition and removed some pricing power from labor.1 Most importantly, the rapid widening in globalization resulted in international trade representing an ever-climbing portion of global GDP. By adding more people to the global network of supply chains, globalization further entrenched the loss of workers’ pricing power, which caused wages to lag productivity and decline as a share of national income (Chart I-5). The developments outside of monetary policy reinforced downward pressure on inflation expectations created by the Fed’s orthodoxy. In the final phase from 1998 to 2020, the stabilization of inflation reunited prices and money supply. Inflation flattened due to several factors. By 1998, 70% of the global population lived in a capitalist system (compared to market shares only 28% in 1977). Thus, most of the expansion of the global labor supply was completed. China entered the WTO only in 2001, but it had been exerting its deflationary influence for many years by stealing market share away from newly industrialized Asian economies. Additionally, following the Asian Crisis of 1997, many Asian economies (including China and Japan) elected to build large dollar FX reserves to contain their currencies versus the USD, and subsidize economic activity. This process created some stability in global goods prices and slowed the USD’s depreciation started in 2002. In response to these influences, inflation expectations stabilized in the late 1990s, creating an anchor for realized inflation (Chart I-6). Thanks to this steadiness in inflation expectations, the Phillips curve (the inverse link between wages and the unemployment rate) flattened. The economy entered a feedback loop where consistent inflation rates begat stable wages, which in turn created more stability in aggregate prices. Fluctuations in the rate of inflation became directly linked to changes in the output gap and thus, variations in demand. Importantly, the flat Phillips curve and the well-anchored inflation expectations freed the Fed to maintain easier policy during expansions and allow money supply to expand in line with money demand. Chart I-5Expanding Globalization Robbed Labor Of Its Bargaining Power Expanding Globalization Robbed Labor Of Its Bargaining Power Expanding Globalization Robbed Labor Of Its Bargaining Power Chart I-6The Anchoring Of Inflation Expectations The Anchoring Of Inflation Expectations The Anchoring Of Inflation Expectations   Bottom Line: The correlation between inflation and M2 growth since 1998 is as relevant as it was from 1922 to 1965. What The Future Holds Structurally, inflation will likely trend higher. The Median Voter Theory (MVT), developed by Anthony Downs and upheld by our Geopolitical Strategy service as the key constraint on global and US policymakers, is at the heart of our position. Over the past 40 years, income and wealth inequalities have soared worldwide, especially in the US and the UK, which have both embraced ‘laissez-faire’ capitalism enthusiastically. Moreover, these countries also suffer from pronounced levels of intergenerational social immobility.2 The effect of these aforementioned trends has become so pervasive that life expectancy for a large swath of the US population is decreasing (Chart I-7). The shift by median voters to the left on economic matters will force greater fiscal profligacy and regulatory rigidity. This policy mix will add a secular drift to inflation. In response to widening inequalities, voter preferences have shifted to the left on economic matters and toward populism. Brexit and the election of President Trump both fit this pattern because they represent the repudiation of the prevalent neoliberal discourse that pushed toward more globalization, more immigration and more deregulation. Moreover, voters in the UK and the US increasingly doubt the benefits of free trade (Chart I-8). Chart I-7Inequalities Are Physically Hurting Many US Voters November 2020 November 2020 Chart I-8Free Trade Is Out… November 2020 November 2020   Attitudes toward the government’s role in the economy have also changed. Voters in the US are much more open than they were 10 or 20 years ago to a greater involvement of the public sector in the economy. Additionally, support toward socialism has become more widespread among various demographic groups (Chart I-9). The MVT posits that politicians who want to access or remain in power must cater to voter preferences. Hence, when compared with the Great Financial Crisis, the swift fiscal policy easing that accompanied the COVID-19 recession illustrates the understanding by politicians that spending is popular, especially in times of crisis (Chart I-10). Chart I-9…But State Intervention Is In November 2020 November 2020 Chart I-10Politicians Deliver What Voters Want November 2020 November 2020   Greater government spending and larger fiscal deficits are used to achieve faster nominal growth. When the output gap is negative, public spending helps the economy and may even increase national savings. However, if profligacy continues after the economy has reached full employment, it generates excess demand relative to aggregate supply and puts downward pressure on the national savings rate. This is inflationary. To redistribute income toward the middle class, populists aim to diminish competition in the economy. They reregulate the economy, which indirectly protects workers. They also limit global trade flows as much as possible. Free trade is good for the economy, but it puts downward pressure on the price of goods relative to services. Therefore, to remain competitive domestic goods producers must compress their labor costs, which either hurts wages for middle-class workers or destroys the number of manufacturing jobs with high wages. Undoing this process raises labor costs and undermines a major deflationary influence on the economy. Tax policy is another tool to force a redistribution of income and wealth toward the middle class. We should expect increased taxes on higher-income households. This process puts more money in the pockets of a middle class whose marginal propensity to consume is around 95% to 99% compared with 50% to 60% for households at the top of the income distribution. Re-shuffling the composition of national income toward the middle class will boost demand and puts upward pressure on consumer prices. Central banks are not immune to the preference of the median voter. As we showed earlier, the Fed Reform Act of 1977 had a meaningful impact on inflation, but only after Volcker took the helm of the FOMC. Given the damages wrought by high inflation in the 1970s, the median voter wanted to see less inflation, which enabled Volcker’s hawkish shift. As Marko Papic argued in a recent BCA Research webcast,3 a minority of voters (and policymakers) remember the pain created by inflation, but everyone is aware of the difficulties created by low nominal growth. Moreover, the Fed is still a creature of Congress and the median voter’s preferences greatly affect the legislative body’s decisions. Consequently, the Fed’s policy stance will likely become structurally looser in response to indirect voter pressure. Inflation accelerates when the Fed expands money supply faster than the federal government sucks in liquidity via its deficit. The Fed’s recent adoption of an average inflation mandate fits within this paradigm. According to its new strategy, the Fed will start tightening policy after the unemployment gap has closed and inflation is above 2%. This is reminiscent of the model prior to 1977 (when full employment conditions were paramount), which generated a significant inflation upside. Bottom Line: The shift by median voters to the left on economic matters will force greater fiscal profligacy and regulatory rigidity. It will also contribute to a more dovish bias by central banks. This policy mix will add a secular drift to inflation. What About Now? Markets may be failing to recognize the risk that inflation will rise sooner rather than later. Low yields, subpar inflation expectations, dovish central bank pricing and the valuation premium of growth relative to value stocks already reflect the strong deflationary force created by a deeply negative output gap. Thus, a quicker-than-expected recovery in inflation threatens the financial markets. Our structural inflation view is not the source of this danger. The hidden, near-term inflationary risk arises because we are still in an environment where broad money matters because inflation remains stationary. M2 is expanding at 23.7%, its fastest rate on record. If relationships of the past 20-plus years hold, then this is a warning sign for inflation. The catalyst to crystalize the structural inflationary pressures created by economic populism may be the loose monetary and fiscal conditions caused by the COVID-19 recession. Chart I-11The Real Near-term Inflation Risk The Real Near-term Inflation Risk The Real Near-term Inflation Risk This view may seem simplistic in light of the current large output gap, but when fiscal policy is included in the assessment, the picture becomes clearer. Since 1998, the gap between the expansion of M2 and the issuance of debt to the public by the federal government has explained inflation better than broad money alone (Chart I-11). Inflation accelerates when the Fed expands money supply faster than the federal government sucks in liquidity via its deficit. However, inflation decelerates when the Fed expands the money supply slower than the public sector pulls in private funds. In other words, if the Fed eases monetary conditions enough to finance the deficit, then debt monetization occurs, the private sector is not crowded out and demand gets a massive boost. This point is crucial and feeds the stronger economic recovery compared with the one post-GFC. In 2009 and 2010, the private sector was deleveraging and commercial banks were retrenching their lending. Neither the demand for nor the supply of credit was ample. Therefore, the Fed’s rapid balance sheet expansion had a limited impact on broad money. Instead, it skewed the composition of M2 toward commercial bank excess reserves at the Fed and away from private-sector deposits. Broad money was not rising quickly enough to fully finance the government and real interest rates did not fall as far as they should have. The economy suffered. A virtuous cycle has emerged, one which creates more inflation risks than are priced in. Nowadays, broad money responds much better to the Fed’s intervention because the balance sheets of the nonfinancial private sector are much healthier than in 2008 and deleveraging is absent. This mitigates the tightening credit standards of commercial banks. As Chart I-12 illustrates, household net worth is more robust than it was 12 years ago, debt-servicing costs account for a much narrower slice of disposable income and the government’s aggressive actions have bolstered household finances. Moreover, the majority of job losses have been concentrated in low-income jobs, thus, above-average earners have kept their incomes. Under these conditions, households have taken advantage of record low mortgage rates to purchase real estate, which is contributing to growth in the residential sector (Chart I-13, top two panels). Meanwhile, the rapid rebound in businesses’ capex intentions (which even small firms exhibit) and in core capital goods orders indicates that animal spirits are much more vigorous than anyone expected this past spring (Chart I-13, bottom two panels). At that time, the dominant narrative posited that firms were tapping their credit lines to set aside cash. Chart I-12Robust Household Balance Sheets = No Liquidity Trap Robust Household Balance Sheets = No Liquidity Trap Robust Household Balance Sheets = No Liquidity Trap Chart I-13Housing And Capex Are In The Driver's Seat Housing And Capex Are In The Driver's Seat Housing And Capex Are In The Driver's Seat   Chart I-14Unlike In 2008/09, Real Rates Have Collapsed Unlike In 2008/09, Real Rates Have Collapsed Unlike In 2008/09, Real Rates Have Collapsed Thanks to these more favorable balance sheet dynamics, the Fed’s injection of liquidity is boosting M2 enough to finance the Treasury’s issuance. Hence, real interest rates are much lower than in 2009/10 even if the economy is recovering much more quickly (Chart I-14). Policymakers are not crowding out the private sector. A virtuous cycle has emerged, one which creates more inflation risks than are priced in. A counterargument is that technology is too deflationary for the above dynamics to matter. The reality is that technology is always a deflationary force. The expansion of the capital stock has always been about providing each worker with access to newer and better technology to boost productivity. The current low level of productivity gains suggests that the dominant discourse exaggerates the economic advances from new technologies. Thus, inflation stationarity and the interplay between monetary and fiscal policy still matters to CPI. Investors should monitor factors that would indicate if the upside risk to near-term inflation described above is morphing into reality. Doing so would seriously damage financial asset prices made vulnerable to higher inflation by prohibitive valuations. We propose tracking the following variables: The household savings rate. If savings normalize faster because consumer confidence firms, then spending will accelerate, profits will rise more quickly and money will expand further, all of which will bring back inflation sooner. A Blue Sweep in the US presidential election. If the Democrats take control of both the executive and legislative branches, then they will expand stimulating policies that will bolster demand. This, too, would boost profits and broad money supply, which would be inflationary. The velocity of money. An increase in money velocity, which remains depressed, would accentuate the impact of rapid money growth. It would also suggest that animal spirits are strengthening, which will further encourage economic transactions. A weak dollar. The dollar is set to weaken because of savings dynamics and the global recovery. A runaway decline in the USD would indicate that the interplay between monetary and fiscal policy is debasing money, unleashing an inflationary spiral.  Bottom Line: The probability that inflation returns quickly is much more meaningful than financial markets appreciate because of the interplay between money growth, fiscal deficits and robust private-sector balance sheets. This dissonance will create a substantial risk for asset prices next year. Investment Implications The most important implication of the analysis above is that investors should consider inflation protection in all asset classes. However, this protection is cheap to acquire because investors are focusing on deflation, not inflation. Chart I-15Inflation Protection Remains Cheap Inflation Protection Remains Cheap Inflation Protection Remains Cheap Bonds Our bond strategists recently moved to a below-benchmark duration in fixed-income portfolios in light of the economic recovery and the increasing probability of a Blue Wave on November 3, an argument highlighted in the Section II Special Report written by our colleagues Rob Robis and Ryan Swift. The Fed’s new average-inflation target, coupled with the global economic recovery, should put upward pressure on inflation breakeven rates, which are still well below 2.3%-2.5% normally associated with stable inflation near 2% (Chart I-15). The underestimated upward risk to inflation further favors climbing yields. Beyond lifting inflation breakeven rates, this risk would also raise inflation uncertainty, which warrants a greater term premium and a steeper yield curve (Chart I-16). Additionally, higher inflation would occur lockstep with declining savings. The recent surge in excess savings was a primary driver of the collapse in yields; its reversal would push up long-term interest rates (Chart I-17). Chart I-16Rising Inflation Uncertainty Will Steepen The Yield Curve Rising Inflation Uncertainty Will Steepen The Yield Curve Rising Inflation Uncertainty Will Steepen The Yield Curve Chart I-17Excess Savings Will Fall And Yields Will Rise Excess Savings Will Fall And Yields Will Rise Excess Savings Will Fall And Yields Will Rise   The Dollar The US dollar is the major currency most exposed to growing populism because of the extraordinary income inequalities observed in the US. Moreover, a generous combined monetary and fiscal policy setting in the US has eroded the dollar’s appeal as the country’s trade deficit widens (it normally narrows during a recession) in response to pronounced national dissaving (Chart I-18, left panel). Furthermore, US broad money growth stands far above that of other major economies (Chart I-18, right panel). Compared with other major central banks, the Fed is more guilty of financing the public-sector’s debt binge. Debt monetization creates a real risk to a stable USD. Chart I-18AFalling Savings And The Fed's Generosity Will Tank The Greenback November 2020 November 2020 Chart I-18BFalling Savings And The Fed’s Generosity Will Tank The Greenback November 2020 November 2020   The expanding global recovery creates an additional problem for the countercyclical dollar. China’s role is particularly important in this regard as the nation’s domestic economic activity will improve further in response to the lagged impact of a rapid climb in total social financing (Chart I-19, top panel). Sturdy Chinese demand results in climbing global industrial production, which will hurt the greenback. Likewise, China’s healthy recovery has lifted interest rate differentials in favor of the yuan (Chart I-19, bottom panel). A strong CNY flatters China’s purchasing power abroad and diminishes deflationary pressures around the world. This combination should stimulate the global manufacturing sector, which benefits foreign economies more than it does the US.  Investors should consider inflation protection in all asset classes. Equities BCA Research still prefers global equities to bonds on a cyclical basis. The early innings of a pickup in inflation would solidify this bias. Our Adjusted Equity Risk Premium, which accounts for the expected growth rate of earnings and the non-stationarity of the traditional ERP, shows a solid valuation cushion in favor of stocks (Chart I-20). Moreover, forward earnings for the S&P 500 have upside, judging by the gap between the Backlog of Orders and the Customer Inventories components of the ISM Manufacturing survey (Chart I-21). Chart I-19China's Robust Growth Hurts The Dollar China's Robust Growth Hurts The Dollar China's Robust Growth Hurts The Dollar Chart I-20The Adjusted ERP Still Favors Stocks The Adjusted ERP Still Favors Stocks The Adjusted ERP Still Favors Stocks   We also continue to overweight cyclical sectors over defensive ones. The existence of greater inflation risk than the market believes confirms this view. Cyclicals would outperform if investors priced in quicker inflation because they would also bid down the dollar and push up inflation breakeven rates (Chart I-22). These relationships exist because industrials and materials enjoy greater pricing power in an inflationary environment and financials would benefit from a steeper yield curve. An outperformance of deep cyclicals relative to defensive equities should result in an underperformance of US shares relative to the rest of the world. Chart I-21Earnings Revisions Have Upside Earnings Revisions Have Upside Earnings Revisions Have Upside Chart I-22Deep Cyclicals Will Like The Brand New World Deep Cyclicals Will Like The Brand New World Deep Cyclicals Will Like The Brand New World   The long-term outlook for real stock returns is poor, despite a positive six- to nine-month view. Higher inflation will force a greater upside in yields. However, the current extraordinary market multiples can only be justified if one believes that yields will stay depressed for many more years. Thus, inflation would likely prompt a de-rating of equities. Furthermore, our structural inflation view rests on the imposition of populist economic policies. A move backward in globalization and redistributionist policies would lift the share of wages in national income, which would compress extraordinarily wide profit margins (Chart I-23). Therefore, real long-term profits will probably suffer. Paradoxically, nominal stock prices may still eke out positive nominal gains, but that will be a consequence of the money illusion created by higher inflation. Chart I-23Populism Threatens Profit Margins Populism Threatens Profit Margins Populism Threatens Profit Margins BCA Research still prefers global equities to bonds on a cyclical basis. Investors should continue to overweight equities versus bonds, despite pronounced hurdles to long-term, real returns in stocks. Historically, periods of transition from low inflation to higher inflation have allowed stocks to outperform bonds, even if equities generate negative real returns (Table I-1). The exceptionally low real yields and thin inflation protection offered by government bonds increases the likelihood that history will be repeated. Table I-1Rising Inflation: Equities Beat Bonds November 2020 November 2020 A size bias may offer some protection against higher inflation both in the near and long term. We have been positive on small cap equities since September and our US Equity Strategy service upgraded the Russell 2000 to overweight this week.4 A bump in railroad freight volumes augurs well for the domestic economy to which small caps are very sensitive. Additionally, stronger railroad freight volumes also indicate net rating upgrades for junk bonds, which decreases the riskiness of a highly levered small cap sector (Chart I-24). Moreover, small cap stocks are positively linked to major trends produced by higher inflation, such as a weaker dollar and higher commodity prices (Chart I-25). Small firms also enjoy rising consumer confidence, a variable targeted by populist politicians (Chart I-26). Therefore, the potential for a re-rating of the Russell 2000 relative to the S&P 500 is elevated, especially if investors reassess the likelihood of higher inflation.  Chart I-24Small-Cap Stocks Are Set To Shine Small-Cap Stocks Are Set To Shine Small-Cap Stocks Are Set To Shine Chart I-25Small-Cap Will Enjoy Higher Inflation... Small-Cap Will Enjoy Higher Inflation... Small-Cap Will Enjoy Higher Inflation... Chart I-26...And Populists ...And Populists ...And Populists Commodities BCA Research remains positive on the prices of natural resources on a cyclical basis even if there is more risk of a near-term correction for this asset class. Commodities are highly sensitive to a global industrial cycle that offers significant upside and to China in particular. Moreover, commodities are high-beta plays on a weaker dollar and higher inflation expectations (Chart I-27). Natural resources will benefit from economic populism because it lifts demand for cyclical spending. Moreover, commodities are natural hedges against the risk of higher inflation. In this context, it makes sense to allocate more funds to resource stocks to protect an equity portfolio against inflation. Investors worried about the near-term outlook for commodities should rotate out of copper into crude. Copper has withstood the COVID-19 shock much better than Brent despite the strong cyclicality of both natural resources. Following this move, net speculative positions and sentiment measures for copper are toward the top of their ranges of the past 15 years. Meanwhile, the opposite is true for oil. Since 2005, increases in the Brent-to-copper ratio have followed declines to the current levels in the relative Composite Sentiment Indicator (Chart I-28), which includes sentiment and positioning measures for both commodities. Chart I-27Commodities Remain Efficient Inflation Hedges Commodities Remain Efficient Inflation Hedges Commodities Remain Efficient Inflation Hedges Chart I-28A Contrarian Tactical Trade: Buy Brent / Sell Copper A Contrarian Tactical Trade: Buy Brent / Sell Copper A Contrarian Tactical Trade: Buy Brent / Sell Copper   Fundamentals also point in that direction. After collapsing in recent months, global inventories of copper are beginning to climb relative to Brent. Moreover, oil production has dropped significantly relative to copper. Oil demand fell even more dramatically than that of copper, but the gap between production and demand growth is moving in favor of crude. Real long-term profits will probably suffer. This trade is agnostic to the direction of the business cycle. Copper prices embed a much more optimistic take toward global economic activity than Brent. Therefore, copper is more vulnerable to a negative economic upset than oil and less likely to benefit from a positive economic surprise. Mathieu Savary Vice President The Bank Credit Analyst October 29, 2020 Next Report: November 30, 2020   II. Beware The Bond-Bearish Blue Sweep US Election & Duration: We estimate that there is an 72% probability of a US election result that will give a lift to US Treasury yields via increased fiscal stimulus. Those are strong enough odds to justify a move to a below-benchmark cyclical US duration stance on a 6-12 month horizon. US Treasuries: We anticipate a moderate bear market in US Treasuries to unfold during the next 6-12 months. In addition to below-benchmark portfolio duration, investors should overweight TIPS versus nominal Treasuries, hold nominal and real yield curve steepeners, and hold inflation curve flatteners. Non-US Country Allocation: Within global government bond portfolios, downgrade the US to underweight. Favor countries that have lower sensitivity to rising US Treasury yields with central banks that are likely to be more dovish than the Fed in the next few years. That means increasing allocations to core Europe and Japan, while reducing exposure to Canada and Australia. Stay neutral on the UK given the near-term uncertainties over the final Brexit outcome. With the US presidential election just two weeks away, public opinion polls continue to show that Joe Biden is the favorite to win the White House. However, the odds of a “Blue Sweep” - combining a Biden victory with the Democratic Party winning control of both the US Senate and House of Representatives - have increased since the end of September according to online prediction markets. US Treasury yields have also moved higher over that same period (Chart II-1), which we interpret as the bond market becoming more sensitive to the likelihood of a major increase in US government spending under single-party Democratic control. Chart II-1A Blue Sweep Is Bond Bearish A Blue Sweep Is Bond Bearish A Blue Sweep Is Bond Bearish Table II-1A Comparison Of The Candidates' Budget Proposals November 2020 November 2020 According to a recent analysis done by the Committee for a Responsible Federal Budget, President Trump’s formal policy proposals would increase US federal debt by $4.95 trillion between 2021 and 2030, while Biden’s plan would increase the debt by $5.60 trillion (Table II-1).5 While those are both massive fiscal stimulus plans, there is a stark difference in the policy mix of their proposals that matters for the future path of US bond yields. Under Biden, spending is projected to increase by a cumulative $11.1 trillion, partially offset by $5.8 trillion in revenue increases and savings with the former vice-president calling for tax hikes on corporations and high-income earners. On the other hand, Trump’s plan includes $5.45 trillion of spending increases and tax cuts over the next decade, offset by $0.75 trillion in savings. Conclusion: Biden would increase spending by over twice that of a re-elected Trump, with much of that spending expected to be front-loaded in the early part of his first term. Outright spending is more reflationary than tax cuts because it puts more money in the pockets of consumers (spenders) relative to producers (savers). The Biden plan would be more stimulating for overall activity even if the increase in debt is about the same. Chart II-2The Biden Platform Is Highly Stimulative The Biden Platform Is Highly Stimulative The Biden Platform Is Highly Stimulative Another analysis of the Biden and Trump platforms was conducted by Moody’s in September, based on estimates of how much of each candidate’s promises could be successfully implemented under different combinations of White House and Congressional control.6 The stimulus figures were run through the Moody’s US economic model, which is similar to the budget scoring model of the US Congressional Budget Office, to produce a year-by-year path for the US economy over the next decade (Chart II-2). Moody’s concluded that the US economy would return to full employment in the second half of 2022 under a President Biden – especially if the Democrats win the Senate - compared to the first half of 2024 under a re-elected President Trump. Such a rapid closing of the deep US output gap that opened up because of the COVID-19 recession would likely trigger a reassessment of the Fed’s current highly dovish policy stance. At the moment, the US overnight index swap (OIS) curve discounts one full 25bp Fed hike by late 2023/early 2024, and two full hikes by late 2024/early 2025 (Chart II-3). This pricing of the future path of interest rates has occurred even with the Fed promising to keep the funds rate anchored near 0% until at least the end of 2023. The likelihood of some form of increased fiscal spending after the election will cause the bond market to challenge the Fed’s current forward guidance even more, putting upward pressure on Treasury yields. Chart II-3US Fiscal Stimulus Will Pull Forward Fed Liftoff US Fiscal Stimulus Will Pull Forward Fed Liftoff US Fiscal Stimulus Will Pull Forward Fed Liftoff Our colleagues at BCA Geopolitical Strategy see a Blue Sweep as the most likely outcome of the US election, although their forecasting models suggest that the race for control of the Senate will be much closer than the Biden vs Trump battle (there is little chance that control of the House of Representatives would switch back to the Republicans).7 Their scenarios for each of the White House/Senate combinations, along with their own estimated probability for each, are the following: Biden wins in a Democratic sweep: BCA probability = 27%. The US economy will benefit from higher odds of unfettered fiscal stimulus in 2021, although financial markets will simultaneously have to adjust for the negative shock to US corporate earnings from higher taxes and regulation. Government bond yields should rise on the generally reflationary agenda. Trump wins with a Republican Senate: BCA probability = 23%. In this status quo scenario, a re-elected President Trump would still face opposition from House Democrats on most domestic economic issues, forcing him to tilt towards more protectionist foreign and trade policies in his second term. Fiscal stimulus would be easy to agree, though not as large as under a Democratic sweep. US Treasury yields would rise, but would later prove volatile due to the risk to the cyclical recovery from a global trade war, as Trump’s tariffs will not be limited to China and could even affect the European Union. Biden wins with the Senate staying Republican: BCA probability = 28%. This is ultimately the most positive outcome for financial markets - reduced odds of a full-blown trade war with China, combined with no new tax hikes. Bond yields would drift upward over time, but not during the occasional fiscal battles that would ensue between the Democratic president and Republican senators. The first such battle would start right after the election. Treasuries would remain well bid until financial market pressures forced a Senate compromise with the new president sometime in H1 2021. Trump wins with a Democratic Senate: BCA probability = 22%. This is the least likely scenario but one that could produce a big positive fiscal impulse. Trump is a big spender and will veto tax hikes, but will approve populist spending on areas where he agrees. The Democratic Senate would not resist Trump’s tough stance on China, however, thus keeping the risk of US-China trade skirmishes elevated. This is neutral-to-bearish for US Treasuries, depending on the size of any bipartisan stimulus measures and Trump’s trade actions. The key takeaway is that the combined probability of scenarios that will put upward pressure on US Treasury yields is 72%, versus a 28% probability of a more bond-neutral outcome. That is a bond-bearish skew worth positioning for by reducing US duration exposure now, ahead of the November 3 election. Of this 72%, 45 percentage points come from scenarios in which President Trump would remain in power. Hence his trade wars would eventually undercut his reflationary fiscal policy. This would become the key risk to the short duration view after the initial market response. Bottom Line: The most likely scenarios for the US election will give a cyclical lift to US Treasury yields via increased fiscal stimulus. This justifies a move to a below-benchmark US duration stance on a 6-12 month horizon. If Trump is re-elected, the timing of Trump’s likely return to using broad-based tariffs will have to be monitored closely. A Moderate Bear Market While our anticipated Blue Sweep election outcome will lead to a large amount of fiscal spending in 2021 and beyond, we anticipate only a modest increase in bond yields during the next 6-12 months. In terms of strategy, our recommended reduction in portfolio duration reflects the fact that fiscal largesse meaningfully reduces the risk of another significant downleg in bond yields and strengthens our conviction in a moderate bear market scenario for bonds. This does raise the question of how large an increase in US Treasury yields we expect during the next 6-12 months. We turn to this question now. Chart II-4Less Election-Day Upside Than In 2016 Less Election-Day Upside Than In 2016 Less Election-Day Upside Than In 2016 Not Like 2016 First, we do not expect a massive election night bond rout like we saw in 2016 (Chart II-4). For one thing, the Fed was much more eager to tighten policy in 2016 than it is today, and it did deliver a rate hike one month after the Republicans won the House, Senate and White House (Chart II-4, bottom panel). This time around, the Fed has made it clear that it will wait until inflation is running above its 2% target before lifting rates off the zero bound and will not respond directly to expectations for greater fiscal stimulus. Second, 2016’s election result was mostly unanticipated. This led to a dramatic adjustment in market prices once the results came in. The PredictIt betting market odds of a “Red Sweep” by the Republicans in 2016 were only 16% the night before the election. As of today, the betting markets are priced for a 58% chance of a Blue Sweep in 2020. Unlike in 2016, bonds are presumably already partially priced for the most bond-bearish election outcome. A Slow Return To Equilibrium To more directly answer the question of how high bond yields can rise, survey estimates of the long-run (or equilibrium) federal funds rate provide a useful starting point. In a world where the economy is growing at an above-trend pace and inflation is expected to move towards the Fed’s target, it is logical for long-maturity Treasury yields to settle near estimates of the long-run fed funds rate. Indeed, this theory is borne out empirically. During the last two periods of robust global economic growth (2017/18 & 2013/14), the 5-year/5-year forward Treasury yield peaked around levels consistent with long-run fed funds rate estimates (Chart II-5). As of today, the median estimates of the long-run fed funds rate from the New York Fed’s Survey of Market Participants and Survey of Primary Dealers are 2% and 2.25%, respectively. In other words, a complete re-convergence to these equilibrium levels would impart 80 – 100 bps of upward pressure to the 5-year/5-year forward Treasury yield. We expect this re-convergence to play out eventually, but probably not within the next 6-12 months. In both prior periods when the 5-year/5-year forward Treasury yield reached these equilibrium levels, the Fed’s reaction function was much more hawkish. The Fed was hiking rates throughout 2017 & 2018 (Chart II-5, panel 4), and the market moved quickly to price in rate hikes in 2013 (Chart II-5, bottom panel). The Fed’s new dovish messaging will ensure that the market reacts less quickly this time around. Also, continued curve steepening will mean that the 5-year/5-year forward yield’s 80 – 100 bps of upside will translate into significantly less upside for the benchmark 10-year yield. The 10-year yield and 5-year/5-year forward yield peaked at similar levels in 2017/18 when the Fed was lifting rates and the yield curve was flat (Chart II-6). But, the 10-year peaked far below the 5-year/5-year yield in 2013/14 when the Fed stayed on hold and the curve steepened. Chart II-5How High For Treasury Yields? How High For Treasury Yields? How High For Treasury Yields? Chart II-6Less Upside In 10yr Than In 5y5y Less Upside In 10yr Than In 5y5y Less Upside In 10yr Than In 5y5y   The next bear move in bonds will look much more like 2013/14. The Fed will keep a firm grip over the front-end of the curve, leading to curve steepening and less upside in the 10-year Treasury yield than in the 5-year/5-year forward. In addition to shifting to a below-benchmark duration stance, investors should maintain exposure to nominal yield curve steepeners. Specifically, we recommend buying the 5-year note versus a duration-matched barbell consisting of the 2-year and 10-year notes (Chart II-6, bottom panel).8 TIPS Versus Nominals We have seen that a full re-convergence to “equilibrium” implies 80 – 100 bps of upside in the 5-year/5-year forward nominal Treasury yield. Bringing TIPS into the equation, we have also observed that long-maturity (5-year/5-year forward and 10-year) TIPS breakeven inflation rates tend to settle into a range of 2.3 – 2.5 percent when inflation is well-anchored and close to the Fed’s target (Chart II-7). The additional fiscal stimulus that will follow a Blue Sweep election makes it much more likely that the economic recovery will stay on course, leading to an eventual return of inflation to target and of long-maturity TIPS breakeven inflation rates to a 2.3 – 2.5 percent range. However, as with nominal yields, this re-convergence will be a long process whose pace will be dictated by the actual inflation data. To underscore that point, consider that our Adaptive Expectations Model of the 10-year TIPS breakeven inflation rate – a model that is driven by trends in the actual inflation data – has the 10-year breakeven rate as close to fair value (Chart II-8).9 This fair value will rise only slowly over time, alongside increases in actual inflation. Chart II-7Overweight TIPS Versus Nominals Overweight TIPS Versus Nominals Overweight TIPS Versus Nominals Chart II-8Real Yields Have Likely Bottomed Real Yields Have Likely Bottomed Real Yields Have Likely Bottomed   All in all, we continue to recommend an overweight allocation to TIPS versus nominal Treasuries. TIPS breakeven inflation rates will move higher during the next 6-12 months, but are unlikely to reach our 2.3 – 2.5 percent target range within that timeframe. TIPS In Absolute Terms As stated above, we expect nominal yields to increase more than real yields during the next 6-12 months, but what about the absolute direction of real (aka TIPS) yields? Here, our sense is that real yields have also bottomed. If we consider the extreme scenario where the 5-year/5-year forward nominal yield returns to its equilibrium level and where long-maturity TIPS breakeven inflation rates return to our target range, it implies about 80 bps of upside in the nominal yield and 40 bps of upside in the breakeven. This means that the 5-year/5-year real yield has about 40 bps of upside in a complete “return to equilibrium” scenario. While we don’t expect this “return to equilibrium” to be completed within the next 6-12 months, the process is probably underway. The only way for real yields to keep falling in this reflationary world is for the Fed to become increasingly dovish, even as growth improves and inflation rises. After its recent shift to an average inflation target, our best guess is that Fed rate guidance won’t get any more dovish from here. Real yields fell sharply this year as the market priced in this change in the Fed’s reaction function, but the late-August announcement of the Fed’s new framework will probably mark the bottom in real yields (Chart II-8, bottom panel).10 Chart II-9Own Inflation Curve Flatteners And Real Curve Steepeners Own Inflation Curve Flatteners And Real Curve Steepeners Own Inflation Curve Flatteners And Real Curve Steepeners Two More Curve Trades In addition to moving to below-benchmark duration, maintaining nominal yield curve steepeners and staying overweight TIPS versus nominal Treasuries, there are two additional trades that investors should consider in order to profit from the reflationary economic environment. The first is inflation curve flatteners. The cost of short-maturity inflation protection is below the cost of long-maturity inflation protection, meaning that it has further to run as inflation returns to the Fed’s target (Chart II-9). In addition, if the Fed eventually succeeds in achieving a temporary overshoot of its inflation target, then we should expect the inflation curve to invert. Real yield curve steepeners are in some ways the mirror image of inflation curve flatteners. Assuming no change in nominal yields, the real yield curve will steepen as the inflation curve flattens. But what makes real yield curve steepeners look even more attractive is that increases in nominal yields during the next 6-12 months will be concentrated in long-maturities. This will impart even more steepening pressure to the real yield curve. Investors should continue to hold inflation curve flatteners and real yield curve steepeners. Bottom Line: We anticipate a moderate bear market in US Treasuries to unfold during the next 6-12 months. In addition to below-benchmark portfolio duration, investors should overweight TIPS versus nominal Treasuries, hold nominal and real yield curve steepeners, and hold inflation curve flatteners. Non-US Government Bonds: Reduce Exposure To US Treasuries The mildly bearish case for US Treasuries that we have laid out above not only matters for our recommended duration stance, but also for our suggested country allocation within global government bond portfolios. Simply put, the risk of rising bond yields is much higher in the US than elsewhere, both for the immediate post-election period but also over the medium-term. Thus, the immediate obvious portfolio decision is to downgrade US Treasuries to underweight. The move higher in US Treasury yields that we expect is strictly related to spillovers from likely US fiscal stimulus. While other countries in the developed world are contemplating the need for additional fiscal measures, particularly in Europe where there is a renewed surge in coronavirus infections and growing economic restrictions, no country is facing as sharp a policy choice as the US with its upcoming election. We can say with a fair degree of certainty that the US will have a relatively more stimulative fiscal policy stance than other developed economies over at least the next couple of years. This implies a higher relative growth trajectory for the US that hurts Treasuries more on the margin than non-US government debt. In addition, the likely path of relative monetary policy responses are more bearish for US Treasuries. As described above, the scope of the US stimulus will cause bond investors to further question the Fed’s commitment to keeping the funds rate unchanged for the next few years. That also applies to the Fed’s other policy tools, like asset purchases. The Fed is far less likely to continue buying US Treasuries at the same aggressive pace it has for the past eight months if there is less need for monetary stimulus because of more fiscal stimulus. Chart II-10The Fed Will Gladly Trade Less QE For More Fiscal Stimulus November 2020 November 2020 According to the IMF, the Fed has purchased 57% of all US Treasuries issued since late February of this year, in sharp contrast to the ECB and Bank of Japan that have purchased over 70% of euro area government bonds and JGBs issued (Chart II-10). If US Treasury yields are rising because of improving US growth expectations, fueled by fiscal stimulus, the Fed will likely tolerate such a move and buy an even lower share of Treasuries issued – particularly if the higher bond yields do not cause a selloff in US equity markets that can tighten financial conditions and threaten the growth outlook. The fact that US equities have ignored the rise in Treasury yields seen since the end of September may be a sign that both bond and stock investors are starting to focus on a faster trajectory for US growth. In terms of country allocation, beyond downgrading US Treasuries to underweight, we recommend upgrading exposure to countries that are less sensitive to changes in US Treasury yields (i.e. countries with a lower yield beta to changes in US yields). In Chart II-11, we show the rolling beta of changes in 10-year government bond yields outside the US to changes in 10-year US Treasury yields. This is a variation of the “global yield beta” concept that we have discussed in the BCA Research bond publications in recent years. Here, we modify the idea to look at which countries are more or less correlated to US yields, specifically. A few points stand out from the chart: Chart II-11Reduce Exposure To Bond Markets More Correlated To UST Yields Reduce Exposure To Bond Markets More Correlated To UST Yields Reduce Exposure To Bond Markets More Correlated To UST Yields All countries have a “US yield beta” of less than 1, suggesting that Treasuries are a consistent outperformer when US yields fall and vice versa. This suggests moving to underweight the US when US yields are rising is typically a winning strategy in a portfolio context. The list of higher beta countries includes Canada, Australia, New Zealand, the UK and Germany; although Canada stands out as having the highest yield beta in this group. The list of lower beta countries includes France, Italy, Spain, and Japan. In Chart II-12, we show what we call the “upside yield beta” that is estimated only using data for periods when Treasury yields are rising. This gives a sense of which countries are more likely to outperform or underperform during a period of rising Treasury yields, as we expect to unfold after the election. From this perspective, the “safer” lower US upside yield beta group includes the UK, France, Germany and Japan. The riskier higher US upside yield beta group includes Canada, Australia, New Zealand, Italy and Spain. Chart II-12Favor Bond Markets Less Correlated to RISING UST Yields Favor Bond Markets Less Correlated to RISING UST Yields Favor Bond Markets Less Correlated to RISING UST Yields Spain and Italy are less likely to behave like typical high-beta countries as US yields rise, however, because the ECB is likely to remain an aggressive buyer of their government bonds as part of their asset purchase programs over the next 6-12 months. We also do not recommend trading UK Gilts off their yield beta to US Treasuries in the immediate future, given the uncertainties over the negotiations over a final Brexit deal. Both sets of US yield betas suggest higher-beta Canada, Australia and New Zealand are more at risk of relative underperformance versus lower-beta France, Germany and Japan. In terms of government bond country allocation, we recommend reducing exposure to the former group and increasing allocations to the latter group. Bottom Line: Within global government bond portfolios, downgrade the US to underweight. Favor countries that have lower sensitivity to rising US Treasury yields, especially those with central banks that are likely to be more dovish than the Fed in the next few years. That means increasing allocations to core Europe and Japan, while reducing exposure to “higher-beta” Canada and Australia.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Ryan Swift US Bond Strategist rswift@bcaresearch.com III. Indicators And Reference Charts The S&P 500 is experiencing its second correction in the past two months. The market looks even more fragile than it did in September. COVID-19 is heating up fast enough that lockdowns are re-emerging globally, the odds of an imminent fiscal deal have cratered to a near-zero chance, and investors are paying more attention to the growing risk of gridlock in Washington where a Biden Presidency and a Republican Senate majority would result in temporary fiscal paralysis. In this context, the decline in the momentum of the BCA Monetary Indicator, the elevated reading of our Speculation Indicator and the overvaluation of the stock market create the perfect cocktail for a dangerous few weeks. The longer we live in uncertainty regarding the elections’ result, the worse the market will fare. Short-term indicators confirm that equities are likely to remain under downward pressure in the coming weeks. Both the proportion of NYSE stocks above their 30-week and 10-week moving averages are still deteriorating after forming negative divergences with the S&P 500. They are also nowhere near levels consistent with a solid floor under the market. Moreover, our Intermediate Equity Indicator and the S&P 500 as a deviation from its 200-day moving average have rolled-over after reaching extremely overbought levels. Finally, both the poor performance of EM stocks as well as the underperformance of the Baltic Dry index and global chemical stocks relative to bond prices and the VIX indicate that cyclical assets could suffer from a wave of growth disappointment. Despite these short-term headwinds, the main pillar supporting the rally remains intact: global monetary conditions are highly accommodative. Moreover, the economic and financial risks created by the tepidity of fiscal support in recent months is self-limiting. As the economy progressively teeters toward a second leg of the recession, the pressure will rise for policymakers to spend generously once again to support their nations. Our cyclical indicators confirm the positive backdrop for stocks. Our Monetary Indicator remains at the top of its pre-COVID-19 distribution, which will put a natural floor under stocks, even if its recent deterioration is consistent with a market correction. Moreover, our Revealed Preference Indicator continues to flash a buy signal for stocks. Additionally, the BCA Composite Sentiment Indicator stands toward the middle of its historical distribution and the VIX has not hit the extremely compressed levels that normally precede major cyclical tops in the S&P 500. When weighing the short-term negative forces against the cyclical positives, we expect the S&P 500 to find a floor between 3000 and 3100. At this level, the froth highlighted by our Speculation Indicator will have dissipated.  The bond market’s dynamics are interesting. Despite the violent sell-off in equities, Treasury yields are not declining much. Bonds are too expensive and with short-term rates near their lower bound, Treasurys are losing their ability to hedge equity risk in portfolios. Moreover, the bond market seems to understand that any recession will encourage additional fiscal profligacy, which puts a floor under yields. These dynamics suggest that once equities stabilize, yields could start rising meaningfully. Finally, the dollar continues its sideways correction. However, as risk aversion rises and global growth deteriorates, the dollar is likely to catch further upside in the near term, especially as it has not fully worked out this summer’s oversold conditions. Moreover, the dollar is a momentum currency. Thus, once its start to turn around, its rally is likely to be more powerful than most expect, which will put additional downward pressures on commodity prices. Consequently, it is too early to start selling the USD again or to bottom fish natural resources. EQUITIES: Chart III-1US Equity Indicators US Equity Indicators US Equity Indicators Chart III-2Willingness To Pay For Risk Willingness To Pay For Risk Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators US Equity Sentiment Indicators US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Revealed Preference Indicator Revealed Preference Indicator Chart III-5US Stock Market Valuation US Stock Market Valuation US Stock Market Valuation Chart III-6US Earnings US Earnings US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations US Treasurys And Valuations US Treasurys And Valuations Chart III-10Yield Curve Slopes Yield Curve Slopes Yield Curve Slopes Chart III-11Selected US Bond Yields Selected US Bond Yields Selected US Bond Yields Chart III-1210-Year Treasury Yield Components 10-Year Treasury Yield Components 10-Year Treasury Yield Components Chart III-13US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Global Bonds: Developed Markets Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets Global Bonds: Emerging Markets Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP US Dollar And PPP US Dollar And PPP Chart III-17US Dollar And Indicator US Dollar And Indicator US Dollar And Indicator Chart III-18US Dollar Fundamentals US Dollar Fundamentals US Dollar Fundamentals Chart III-19Japanese Yen Technicals Japanese Yen Technicals Japanese Yen Technicals Chart III-20Euro Technicals Euro Technicals Euro Technicals Chart III-21Euro/Yen Technicals Euro/Yen Technicals Euro/Yen Technicals Chart III-22Euro/Pound Technicals Euro/Pound Technicals Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Broad Commodity Indicators Broad Commodity Indicators Chart III-24Commodity Prices Commodity Prices Commodity Prices Chart III-25Commodity Prices Commodity Prices Commodity Prices Chart III-26Commodity Sentiment Commodity Sentiment Commodity Sentiment Chart III-27Speculative Positioning Speculative Positioning Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop US And Global Macro Backdrop US And Global Macro Backdrop Chart III-29US Macro Snapshot US Macro Snapshot US Macro Snapshot Chart III-30US Growth Outlook US Growth Outlook US Growth Outlook Chart III-31US Cyclical Spending US Cyclical Spending US Cyclical Spending Chart III-32US Labor Market US Labor Market US Labor Market Chart III-33US Consumption US Consumption US Consumption Chart III-34US Housing US Housing US Housing Chart III-35US Debt And Deleveraging US Debt And Deleveraging US Debt And Deleveraging   Chart III-36US Financial Conditions US Financial Conditions US Financial Conditions Chart III-37Global Economic Snapshot: Europe Global Economic Snapshot: Europe Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China Global Economic Snapshot: China Global Economic Snapshot: China   Mathieu Savary Vice President The Bank Credit Analyst   Footnotes 1 Please see The Bank Credit Analyst Special Report "Labor Strikes Back," dated February 27, 2020, available at bca.bcaresearch.com 2 High odds of staying in the income decile of your parents. 3 Please see Geopolitical Strategy Webcast "Geopolitical Alpha In 2020-21," dated October 21, 2020. Marko also recently published a book "Geopolitical Alpha." 4 Please see US Equity Strategy Weekly Report "Vigilantes Gone Missing?" dated October 26, 2020, available at uses.bcaresearch.com 5 http://www.crfb.org/papers/cost-trump-and-biden-campaign-plans 6 https://www.moodysanalytics.com/-/media/article/2020/the-macroeconomic-consequences-trump-vs-biden.pdf 7 Please see BCA Research Geopolitical Strategy Special Report, “Introducing Our Quantitative US Senate Election Model”, dated October 16, 2020, available at gps.bcaresearch.com 8 For more details on this recommended steepener trade please see US Bond Strategy Weekly Report, “Positioning For Reflation And Avoiding Deflation”, dated August 11, 2020, available at usbs.bcaresearch.com 9 For more details on our Adaptive Expectations Model please see US Bond Strategy Weekly Report, “How Are Inflation Expectations Adapting?”, dated February 11, 2020, available at usbs.bcaresearch.com 10 For a detailed look at the implications of the Fed’s policy shift please see US Bond Strategy / Global Fixed Income Strategy Special Report, “A New Dawn For US Monetary Policy”, dated September 1, 2020, available at usbs.bcaresearch.com

Highlights China’s surge in refined copper imports allows it to cover a structural short position it has in this critical commodity – mostly in its unrefined state – and ensures the stimulus being deployed to revive its economy ahead of the 100th anniversary of the founding of the Communist Party in July will not falter due to a lack of basic raw materials (Chart of the Week). We expect continued resilience in commodities generally into 2021 – particularly in base metals, iron ore and crude oil – as markets realize China’s Communist Party is intent on showcasing its brand of policy-driven, vertically integrated capitalism as the engine of its robust economic growth. As with oil, we expect copper demand will benefit from a weaker USD and stronger global trade. The odds of a COVID-19 vaccine being available by year-end or early 2021 remain favorable, which also will support a revival in demand.1 We are keeping our COMEX copper forecast at $3.00/lb at end-2020, and expect 2021 to finish at $3.15/lb. We would not be surprised by higher prices, and are, therefore, getting long December 2021 COMEX copper at tonight's close. Feature The surge in refined copper imports hedged Chinese firms against supply disruptions caused by the pandemic and reduced availability of scrap copper on global markets this year. COVID-19 may have derailed the Communist Party’s realization of the “Chinese Dream” this year, wherein the leadership vowed real per-capita GDP would double in the decade ending in 2020, but it is unlikely to diminish the celebration of the Party’s 100th anniversary in July.2 Chart of the WeekVol Falls As Know Unknowns Are Resolved Vol Falls As Know Unknowns Are Resolved Vol Falls As Know Unknowns Are Resolved The global commodity-demand destruction caused by the COVID-19 pandemic depressed the prices of commodities generally, particularly those which China is structurally short – e.g., copper, iron ore, oil and natural gas. As terrible as the pandemic has been in human terms, it has allowed Chinese firms and the State Reserve Bureau to sharply increase imports of refined copper, which rose 34% in the January-to-July period to 2.5mm MT amid such low prices, which bottomed at $2.10/lb in late March and now are trading above $3.00/lb.3 China accounts for more than 50% of global refined copper consumption and ~ 40% of refined production (Chart 2).4 Chart 2China Dominates Metals Consumption China's Copper Buying Spree Heralds Communist Party's Centenary Celebrations China's Copper Buying Spree Heralds Communist Party's Centenary Celebrations The surge in refined copper imports hedged Chinese firms against supply disruptions caused by the pandemic and reduced availability of scrap copper on global markets this year. Global copper ore and concentrate supply fell ~ 3% y/y in 2Q20, led by a 28% decline in Peru’s mine production, according to the World Bureau of Metal Statistics (Chart 3). This was a result of containment policies that limited mining activities to slow the pandemic’s spread in Latin America. In Chile, COVID-19 cases stabilized in recent months at around 100 per million people (Chart 4). In Peru, cases have been declining since August, but from an elevated level. Supply is expected to recover rapidly as these economies reopen, but further mine disruptions remain a risk. Chart 3Peru's Copper Ore Supplies Recovering Peru's Copper Ore Supplies Recovering Peru's Copper Ore Supplies Recovering Chart 4COVID-19 Copper Supply Risks Falling COVID-19 Copper Supply Risks Falling COVID-19 Copper Supply Risks Falling Commodity-Demand Indicators Move Higher we expect the effect of expansionary monetary and fiscal policies globally will continue to show up in our indicators and for the US dollar to resume its downward trajectory. Global central banks and government stimulus unleashed in the wake of the COVID-19 pandemic, combined with a depreciating US dollar, pushed our commodity-demand indicators higher over the last few months (Chart 5). This supported copper prices, which are up 42% since their March 23 low. Moreover, the pickup in economic activity in China’s major trading partners provided further support to copper demand, given that ~ 17% of China’s copper consumption comes from exports of products containing copper (Chart 6).5 Chart 5Commodity Demand Is Reviving Commodity Demand Is Reviving Commodity Demand Is Reviving Chart 6Expect Chinese Employment Gains As Economy Continues To Recover Expect Chinese Employment Gains As Economy Continues To Recover Expect Chinese Employment Gains As Economy Continues To Recover For the balance of 2H20, we expect the effect of expansionary monetary and fiscal policies globally will continue to show up in our indicators and for the US dollar to resume its downward trajectory. These are key factors driving our positive view on metal – especially copper – prices. Communist Party’s 100th Anniversary Will Boost Commodity Prices China’s buying spree for commodities it is structurally short – particularly copper, iron ore and oil – minimizes the risk fiscal and monetary stimulus deployed to revive its economy will be derailed this year or next. This is particularly important next year: We expect stimulus will continue and will be hitting the economy full force in time for the Communist Party’s centennial celebrations in July. For the infrastructure and construction spending that will be spurred by the massive stimulus, this is critical to spurring employment – a key goal of the Party’s domestic harmony focus – domestic manufacturing, services, and exports (Chart 6).6 This will keep demand for copper – and commodities generally – strong into 2021, as markets realize China’s Communist Party is intent on showcasing its brand of policy-driven, vertically integrated capitalism as the engine of its world-beating economic performance. And, because stocks of critical commodities are increasing as stimulus is hitting the domestic economy next year, the risk of massively inflating prices while the county is celebrating the Party’s centennial in July – as happened following the Global Financial Crisis (GFC) – is minimized, but not completely eliminated (Chart 7). Chart 7COMEX Stocks Will Move To China COMEX Stocks Will Move To China COMEX Stocks Will Move To China That said, we still expect copper to move higher next year. In our modeling of prices, we note world PMIs, EM FX rates, the USD, also drive copper prices, in addition to those factors discussed above specific to China. We expect COMEX high-grade copper prices to end 2020 at $3.00/lb, and to average $3.11/lb next year (Chart 8). On the back of this expectation, we are getting long December 2021 COMEX copper at tonight’s close, expecting 2021 to end at $3.15/lb. Chart 8Copper Prices Expected To Increase Copper Prices Expected To Increase Copper Prices Expected To Increase Risks To Our Copper View Geopolitical risks remain the chief threat to our bullish copper view. The US Presidential election campaign rhetoric, in particular, has turned bellicose vis-à-vis China, with President Donald Trump threatening to “decouple” economically from China if he is reelected.7 These sorts of pronouncement threaten to escalate what could now be considered a trade dispute to an all-out trade war, particularly if it includes sanctions against US firms investing in manufacturing and services in China, as Trump promises. At the limit, this would put a long-term bid under the USD, and reverse the nascent recovery in commodity demand resulting from a weaker dollar. Outright military confrontation between the US and China also is a risk, particularly as tensions in the South China Sea and the Asia-Pacific region continue. The most likely confrontation would be an escalation of hostilities resulting from a naval or aerial face-off, the number of which has been steadily increasing. The threat of a second wave of COVID-19 also remains a risk, particularly if it results in another round of lockdowns globally. That said, we believe the odds of this are very low, as the capacity to absorb another shutdown in economic activity in DM and EM economies likely has been exhausted by measures already implemented this year. It is highly unlikely any economy can afford another round of economic shutdown without triggering an economic depression. Bottom Line: China’s surge in refined copper imports allows it to cover its structural short position in the commodity, and, equally importantly, to ensure an expected revival of economic activity into 2021 – when the Communist Party celebrates its 100th anniversary – will not falter because it lacks basic raw materials. We are keeping our COMEX copper forecast at $3.00/lb at end-2020, and expect 2021 prices to average $3.11/lb. On the back of this expectation, we are getting long December 2021 COMEX copper at tonight’s close.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Hugo Bélanger Associate Editor Commodity & Energy Strategy HugoB@bcaresearch.com     Commodities Round-Up Energy: Overweight Brent prices dipped below $40/bbl for the first time since mid-June. Prior to this move, prices had been stable in a narrow range around $43/bbl since mid-June. Pessimism is increasing re the outlook for demand, as Saudi Arabia reduced its official selling prices (OSPs) for crude delivered to Asian buyers by $1.40/bbl. The negative sentiment was exacerbated by the selloff in tech stocks that began last Thursday. WTI net speculative positions are down to 20% of total open interests vs. 22% in July, as hedge funds exit oil markets. Base Metals: Neutral The LMEX index is up 4% over the past four weeks, supported by higher metals’ consumption and imports in China. Moreover, mobility trends in Europe, Japan, and the US have begun to turn up again in recent weeks based on Apple mobility data. The recovery in China’s economic activity remains the main pillar of our base metals outlook. However, Europe, Japan, and the US still represent a non-negligible share of global metal demand (e.g. ~ 24% copper consumption). Hence, the recent uptick in mobility data is constructive for base metal prices.  Precious Metals: Neutral Gold prices are down 2% since last week, pressured by a slight increase in the US dollar and real rates. The divergence in COVID-19 cases between the US and Europe increases the risk of a short-term bounce higher if this leads to the US economy outperforming that of the EU (Chart 9). Still, mounting geopolitical risks ahead of the US election, lower-for-longer interest rates, and a resumption of the downward trend in the USD over the medium term should support gold later this year. Ags/Softs:  Underweight Soybean prices remain steady, near 2-year highs. The USDA crop progress report listed 55% of soybeans in good or excellent condition for the week ending September 6, 2020. This is a substantial deterioration compared to 66% in those categories last week and 73% at the beginning of August. Corn futures were supported by similar weak supply fundamentals. The USDA reported 55% of corn crops in good or excellent condition against 62% the previous week. Going forward, it will be important to monitor the DXY as it has been strengthening since the beginning of September and could be a headwind to these commodity prices if it breaks to the upside (Chart 10). Chart 9EU Cases Are Rising EU Cases Are Rising EU Cases Are Rising Chart 10US DXY Strengthening US DXY Strengthening US DXY Strengthening     Footnotes   1     Please see Lower Vol As OPEC 2.0 Gains Control, published September 3, 2020, for additional discussion of vaccine availability. 2     Please see Iron Ore, Steel Poised For Rally, which we published February 13, 2020, for a discussion of the commodity-market implications of China’s dual policy goals of doubling GDP between 2010 and 2020 and preparing for the celebration of the 100th anniversary of the founding of the Chinese Communist Party in 1921. It is available at ces.bcaresearch.com. 3    Please see China's July refined copper imports surge 90% on year boosted by open arbitrage published by S&P Global Platts September 1, 2020. 4    China also accounts for close to 50% of copper ore imports, according to he Observatory of Economic Complexity (OEC). 5    Please see The Impact of the COVID-19 Pandemic on World Copper Supply, published by the International Copper Study Group on May 21, 2020. 6    For an update of the stimulus measures and China’s economic performance, please see China Macro And Market Review published September 9, 2020, by our China Investment Strategy colleagues. It is available at cis.bcaresearch.com. 7     Please see Trump threatens to ‘decouple’ U.S. economy from China, accuses Biden of ‘treachery’ published by marketwatch.com September 7, 2020.       Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Trade Recommendation Performance In 2020 Q2 Lower Vol As OPEC 2.0 Gains Control Lower Vol As OPEC 2.0 Gains Control Commodity Prices and Plays Reference Table Trades Closed in 2020 Summary of Closed Trades Lower Vol As OPEC 2.0 Gains Control Lower Vol As OPEC 2.0 Gains Control

Highlights The EM equity benchmark’s concentration in the top six stocks – that in turn correlate with US FAANGM – has risen substantially. Hence, the outlook for US mega-cap stocks will continue to significantly impact the EM equity benchmark. US FAANGM stocks have been closely tracking the trajectory of – and share many other similarities with – previous bubbles. Hence, it is risky to dismiss the mania thesis. That said, it is impossible to know how long this equity mania will last, how far it will go and what will trigger its volte-face. Odds of a repeat of the 2015 boom-bust cycle in Chinese equities are low. The rally in Chinese stocks and commodities might be due for a pause. Feature Concentration Risk Chart 1EM: Mega-Caps Stocks Versus The Equal-Weighted Index EM: Mega-Caps Stocks Versus The Equal-Weighted Index EM: Mega-Caps Stocks Versus The Equal-Weighted Index The EM equity index's hefty gains since the late-March lows have largely been at the hands of about six stocks: Alibaba, Tencent, TSMC, Samsung, Naspers and Meituan-Dianping (Chart 1). The latter is a Chinese web-service platform company, while Naspers derives 75% of its revenue from its equity ownership in Tencent and 25% from a Russian internet company. For ease of reference, we refer to the big four (Alibaba, Tencent, Samsung and TSMC) as EM ATST. Table 1 illustrates that the top six companies combined account for about 24.3% of the MSCI EM equity market cap. For comparison, US FAANGM (Facebook, Apple, Amazon, Netflix, Google and Microsoft) account for 25% of the S&P 500 market cap. The remainder of the EM equity universe – including all Chinese, Korean and Taiwanese stocks other than the six mega caps listed above – has rallied less (Chart 1). This is very similar to the dynamics in the US equity market, where the equally-weighted index has substantially diverged from the FAANGM index (Chart 2). Table 1Market Cap Weights & Performance Since March Lows EM Equities: Concentration And Mania Risks EM Equities: Concentration And Mania Risks Chart 2US: FAANGM Versus The Equal-Weighted Index US: FAANGM Versus The Equal-Weighted Index US: FAANGM Versus The Equal-Weighted Index   Table 2MSCI EM Stocks: Country Weights EM Equities: Concentration And Mania Risks EM Equities: Concentration And Mania Risks The EM ATST’s exponential rise has also boosted their respective country weightings in the MSCI EM equity benchmark. Table 2 demonstrates that China, Korea and Taiwan together account for 65% of the EM benchmark, India for 8% and all other 22 countries combined for 27%. Note that the market cap ($1.7 trillion) of the remaining 22 countries is almost as large as the market cap of the top six EM individual stocks. On the whole, concentration in the EM benchmark is as high as ever. Apart from global trade and Chinese growth, there are two other forces that will define the direction of EM mega-cap stocks: (1) rising geopolitical tensions between the US and China, and (2) a continuous mania or bust in “new economy” stocks. We discuss the latter in the following section. Escalating tensions between the US and China, including North Korea’s potential assault on South Korea, pose risks to Chinese, Korean and Taiwanese stocks. This is one of the critical reasons why we have been reluctant to chase these markets higher, despite upgrading our outlook on Chinese growth. If these bourses relapse, their sheer weight in the EM benchmark will pull the index down. The EM equity index’s outperformance in recent weeks has been due to the surge in both EM mega-cap stocks and Chinese share prices more broadly. Bottom Line: The EM equity benchmark concentration has risen substantially due to outsized gains in several “new economy” stocks. What’s more, the EM equity index’s outperformance in recent weeks has been due to the surge in both EM mega-cap stocks and Chinese share prices more broadly (we discuss the latter below). If the global mania in “new economy” stocks persists, EM ATST could well drive the overall EM equity index higher. Conversely, if “new economy” shares roll over for whatever reason, the EM equity benchmark’s advance will reverse. A Bubble Or Not? An assessment of the sustainability of the rally in US FAANGM stocks is critical for investors in the EM equity benchmark if for no other reason than the concentration hazard. We present the following considerations in assessing whether the FAANGM and EM ATST rally is or is not a mania: First, the exponential rally in FAANGM stocks is not a new phenomenon: It has been taking place over the past 10 years. Our FAANGM index – an equal-weighted average of six stocks (Facebook, Amazon, Apple, Netflix, Google and Microsoft) – has increased 20-fold in real (inflation-adjusted) US dollar terms since January 2010. Its rise is on par with the magnitude of the bull market in the Nasdaq 100 index in the 1990s and Walt Disney in the 1960s, and well exceeds other bubbles, as illustrated in Chart 3. All price indexes on Chart 3 are shown in real (inflation-adjusted) terms. Chart 3Each Decade = One Mania EM Equities: Concentration And Mania Risks EM Equities: Concentration And Mania Risks All these manias and bubbles started with excellent fundamentals, and price gains were initially justified. Toward the end of the decade, however, their outsized gains attracted momentum chasers and speculators, catapulting share prices exponentially higher. Second, a financial mania requires: (1) solid past performance; (2) a story that can capture investors’ imaginations, and (3) plentiful liquidity. The “new economy” stocks fit all of these criteria: They have delivered super-sized performance over the past 10 years; They easily capture ordinary people’s imaginations – the average person on the street knows that FAANGM and EM ATST stocks benefit from people working from home and spending more time online; The Federal Reserve and many other central banks are injecting enormous amounts of liquidity into their respective economies. Third, there is a striking similarity between the FAANGM rally and previous bubbles: The mania-subjects of the preceding decades assumed global equity leadership early in their respective decade, rose steadily throughout, and went exponential at the very end of the decade. The latest parabolic surge in FAANGM stocks along with its duration (10 years of global equity outperformance and leadership) and magnitude (20-fold price appreciation in real inflation-adjusted terms) conspicuously resembles those of previous bubbles. Interestingly, the majority of previous bubbles peaked and tumbled around the turn of each decade, the exception being Walt Disney – the Nifty-Fifty bubble of the 1960s – which rolled over in 1973. Given FAANGM stocks have been closely tracking the trajectory of previous bubbles, it will not be surprising if 2020 ends up marking the peak for “new economy” stocks. Fourth, the last exponential upleg in the tech and telecom bubble of 1999-2000 occurred amid a one-off demand surge for tech hardware and software. The Y2K scare – worries that computers and networks around the world might malfunction on the New Year/new millennium eve – spurred many companies to order new hardware and upgrade their systems and networks. As a result, there was a one-off boom in orders in the global technology industry in the fourth quarter of 1999 and first quarter of 2000. Chart 4Orders For Computers And Electronics Have Remained Resilient Orders For Computers And Electronics Have Remained Resilient Orders For Computers And Electronics Have Remained Resilient Investors extrapolated this one-off demand surge into the future, mistaking it for recurring growth. As a result, they assigned extremely high valuations to these tech stocks in the first quarter of 2000. Similarly, since March, working and shopping from home has sharply increased demand for web services, online shopping, cloud computing and tech hardware. The top panel of Chart 4 demonstrates that US manufacturing orders for computers and electronic products did not contract in the March-May period, while orders for capital goods have plunged since March. Similarly, Taiwanese exports – which are heavy on tech hardware – are holding up well despite the crash in global trade (Chart 4, bottom panel). Some of this demand strength is structural, but part of it is one-off and non-recurring. Certainly, one should not extrapolate their recent growth rates into the future. However, investors are prone to extrapolation and chasing winners. Fifth, valuations of US FAANGM and EM ATST are elevated. Trailing P/E ratios for EM ATST stocks are shown in Table 3. Table 3Price-To-Earnings For Top 6 EM Stocks EM Equities: Concentration And Mania Risks EM Equities: Concentration And Mania Risks All in all, provided both US FAANGM and EM ATST consist of admirable companies with great competitive advantages and business models, it is tempting to dismiss the bubble argument. Nevertheless, there are enough similarities with previous manias to compel investors to be vigilant. Even great companies have a fair price, and substantial price overshoots will not be sustainable. We sense a growing number of investors deem US FAANGM and EM ATST stocks as invincible. When some stocks are regarded as unbeatable, their top is not far. Our major theme for the past decade – elaborated in the report, How To Play EM In The Coming Decade1 published in June 2010 – has been as follows: Sell commodities / buy health care and technology. Until 2019, we were recommending being long EM tech/short EM resource stocks. Unfortunately, since 2019, the corrections in EM “new economy” stocks have proved to be too short and fleeting, and we were unable to buy-in. Their share prices have lately gone parabolic: They are now in a full-blown mania phase. As to global equity leadership change from growth to value stocks, we maintain that major leadership rotations typically occur during or at the end of an equity selloff, as we elaborated in our October 3, 2019 report (Charts 5 and 6). Chart 5EM vs DM: Leadership Rotation Requires Market Turbulence EM vs DM: Leadership Rotation Requires Market Turbulence EM vs DM: Leadership Rotation Requires Market Turbulence Chart 6Growth vs Value: Leadership Rotation Requires Market Turbulence Growth vs Value: Leadership Rotation Requires Market Turbulence Growth vs Value: Leadership Rotation Requires Market Turbulence Apparently, the February-March selloff did not produce a shift in equity leadership. Barring a major selloff, “new economy” stocks will likely continue to lead. Chart 7Fed Rate Cuts Did Not Prevent The S&P 500 Bubble From Unravelling Fed Rate Cuts Did Not Prevent The S&P 500 Bubble From Unravelling Fed Rate Cuts Did Not Prevent The S&P 500 Bubble From Unravelling Finally, easy money policies encourage speculation and contribute to the build-up of manias. However, when a bubble starts unravelling, low interest rates are often unable to avert the bust. For example, when the tech bubble began bursting in 2000, the Fed cut rates aggressively and US bond yields plunged. Yet, low interest rates did not prevent tech share prices from deflating further (Chart 7). Bottom Line:  It is impossible to know how long this equity mania will last, how far it will go and what will trigger its volte-face. One thing is certain: there is a lot of froth – particularly in terms of valuation and positioning – in these “new economy” stocks. Yet, these excesses could last longer and get larger. A Mania In Chinese Equities? Many commentators have rushed to compare the latest surge in Chinese stocks with the exponential advance in the first half of 2015. We do not think this rally will go on without interruption for another five months like it did back then. Our rationale is as follows:   The Chinese authorities are much more vigilant now, and they will try to induce periodic corrections to avoid another mania and bust similar to those that occurred five years ago. The Chinese authorities are much more vigilant now, and they will try to induce periodic corrections to avoid another mania and bust similar to those that occurred five years ago. Both China’s MSCI Investable and CSI 300 equity indexes are retesting their previous highs (Chart 8). In the past they failed to break above these levels, and this time is likely to be no different, at least for now. The latest spike is more likely to be the final hurrah before a setback. Critically, the 12-month forward P/E ratio for China’s MSCI Investible index has also risen to its previous peaks (Chart 9, top panel). This has occurred with little improvement in the 12-month forward EPS (Chart 9, bottom panel). In short, share prices have run ahead of the business cycle and are already pricing in a lot of profit recovery. Chart 8Chinese Stocks Are At Their Previous Highs Chinese Stocks Are At Their Previous Highs Chinese Stocks Are At Their Previous Highs Chart 9Chinese Investable Stocks: A Rally Driven By P/E Expansion Chinese Investable Stocks: A Rally Driven By P/E Expansion Chinese Investable Stocks: A Rally Driven By P/E Expansion Chart 10Chinese Onshore Stocks: A Two-Tier Market Chinese Onshore Stocks: A Two-Tier Market Chinese Onshore Stocks: A Two-Tier Market Most of the rally since the March lows has been due to “new economy” stocks. Share prices of “old economy” companies did not do that well before July. Tech stocks in the onshore market have gone parabolic (Chart 10, top panel). This contrasts with lackluster performance of materials, industrials, and property stocks (Chart 10, bottom panels). Critically, in the onshore market, tech stocks are trading at the following trailing P/E ratios: the market cap-weighted P/E is 155, and the median P/E is 60. Needless to say, these valuations are outright expensive.   Bottom Line: Odds of a repeat of the 2015 boom-bust cycle are low. The rally in Chinese stocks might be due for a pause. On June 18, we upgraded Chinese stocks to overweight from neutral within the EM benchmark, a recommendation that remains intact. We have a much lower conviction on the absolute performance of Chinese stocks in the near-run. China And Commodities An important question to address is whether the rally in commodities in general and copper in particular are signals of a sustainable recovery in the mainland economy. Without a doubt, economic conditions in China have been improving, and infrastructure spending has been accelerating. However, the magnitude of the upswing in copper prices is excessive relative to the strength of the Chinese economy. The spike in resource prices in general and copper in particular has been due to three forces: (1) China’s unprecedented super-strong imports; (2) global investors buying commodities; and (3) output cuts. It is highly unlikely that commodity demand in China is this strong. In our opinion, this reflects restocking. Chart 11 shows that Chinse imports of copper and copper products surged by 100% in June from a year ago, while imports of steel products increased by 100% and oil import volumes rose by 34%. It is highly unlikely that commodity demand in China is this strong. In our opinion, this reflects restocking. Provided cheap credit availability, wholesalers, intermediaries or users of commodities have rushed to buy before prices rise further. In the case of copper, it will take several months before the real economy absorbs that much of the red metal. Hence, China’s copper imports are poised to relapse in the coming months.   Chart 12 illustrates that investors’ net long positions in copper have risen to their highest level since early 2019. Consistently, the July Bank of America/Meryl Lynch Global Fund Manager Survey revealed that as of early July, portfolio managers had built up their largest net long positions in commodities since July 2011.   Not only oil but also copper and iron ore prices have benefitted from production declines. Due to surging COVID infections, Chile and Peru have sharply reduced copper output and Brazil has curtailed iron ore production. Chart 11Chinese Imports Of Commodities Have Surged Chinese Imports Of Commodities Have Surged Chinese Imports Of Commodities Have Surged Chart 12Investors Have Gone Long Copper Investors Have Gone Long Copper Investors Have Gone Long Copper Simultaneous buying of commodities by China and global investors as well as production cuts have considerably benefited resource prices as of late. Our suspicion is that commodities inventories in China have become elevated. This entails reduced purchases by China, and by extension an air pocket in commodities prices in the months ahead. Bottom Line: The rally in resources in general and copper in particular is at risk of a correction. We remain long gold/short copper.     Investment Strategy In absolute terms, the risk-reward of EM share prices is not attractive. However, as we have argued in the past two months, FOMO (fear-of-missing-out) mania forces could take share prices higher. The timing of a reversal is never easy especially when a FOMO-driven mania is alive. For now, for asset allocators we reiterate a below-benchmark allocation in EM stocks within a global equity portfolio. However, a breakdown in the trade-weighted US dollar will prompt us to upgrade EM within the global equity benchmark (Chart 13). The broad trade-weighted dollar is teetering on an edge but has not yet broken down (Chart 14). In sum, global equity portfolios should be ready to upgrade their EM allocation to neutral on signs that the broad trade-weighted US dollar is breaking down. Chart 13EM vs DM: Is The Downtrend Intact? EM vs DM: Is The Downtrend Intact? EM vs DM: Is The Downtrend Intact? Chart 14The Broad Trade-Weighted Dollar Is On An Edge The Broad Trade-Weighted Dollar Is On An Edge The Broad Trade-Weighted Dollar Is On An Edge   As we argued last week, the US dollar could weaken against DM currencies amid the next selloff in global share prices. This is why last week we switched our short positions in an EM currency basket from the US dollar to an equally-weighted basket of the euro, the Swiss franc and Japanese yen. This strategy remains valid. The US dollar is at risk versus DM currencies. However, EM exchange rates may not be out of the woods, given their poor fundamentals on the one hand and potential geopolitical risks in North Asia on the other. We are neutral on both EM local currency bonds and EM sovereign and corporate credit.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes 1    Please see Emerging Markets Strategy Special Report "How To Play EM In The Coming Decade," dated June 10, 2010. Equities Recommendations Currencies, Credit And Fixed-Income Recommendations