Correlations

Highlights Portfolio Strategy Swap consumer staples into financials in our pair trade versus the tech sector. Relative profit fundamentals signal that this relative share price ratio will soon come alive. Global growth tailwinds argue for lifting the air freight & logistics index to high-conviction overweight status. Recent Changes S&P Financials/S&P Tech - Switch the long side of the S&P Consumer Staples/S&P Tech pair trade from S&P Consumer Staples to S&P Financials. S&P Consumer Staples - Remove from the high-conviction overweight list. S&P Air Freight & Logistics - Add to the high-conviction overweight list. Table 1Sector Performance Returns (%) Disentangling Pricing Power Disentangling Pricing Power Feature Equities broke out to new highs early last week, and there are good odds that a playable rally will unfold. Investors' jitters have recently focused on the bear market in oil prices and weak core CPI, which have joined forces to push down inflation expectations (Chart 1). However, we have a more bullish interpretation. Unlike in late-2015/early-2016, oil and stock prices have decoupled. True, energy stocks are plumbing multi-decade lows relative to the broad market, but the energy sector comprises less than 6% of the S&P 500's market cap. In fact, the two largest S&P 500 constituents have a greater weight than the 34 stocks in the S&P energy index combined. In other words, the energy sector's broad market influence has been severely diluted. We think it is unlikely that the positive correlation between oil and stock prices reasserts itself. Rather, our sense is that this is likely an energy/commodity-centered deflation that will not have a serious contagion on the rest of the corporate sector. High yield energy spreads continue to widen, but the overall junk spread is flirting with cyclical lows. This stands in marked contrast with the summer of 2014 and late-2015, the last time oil prices melted (second panel, Chart 1). Chart 2 shows that the nonfarm business sector and the GDP implicit price deflators, both of which are reliable corporate sector pricing power proxies, are positively deviating from core CPI. These deflators have historically been excellent leading indicators of inflation and signal that the recent poor inflation prints will likely prove transitory. Importantly, the U.S. is a large closed economy that benefits greatly from lower oil prices, via a boost to discretionary income. Lower energy costs are adding to an already stimulative backdrop owing to the decline in the U.S. dollar and Treasury yields. At the margin, the broad corporate sector also benefits from oil price deflation: energy is a non-trivial input cost. Our more optimistic overall economic and market outlook is also borne out by survey data: economists revised higher their U.S and global GDP growth expectations both for 2017 and 2018, according to Bloomberg estimates (bottom panel, Chart 1). Finally, real yields, the bond market's gauge for economic growth expectations, have climbed close to a 2-year high, and suggest that GDP growth will soon pick up steam (Chart 1). Our view remains that this is a goldilocks scenario for equities, as it may keep the Fed at bay for a while longer and sustain easy financial conditions. This thesis also assumes that the corporate sector will maintain its pricing power gains, and likely pull consumer prices out of their lull. On that front, we have updated our corporate pricing power proxy and while it has lost some steam of late, it continues to expand at a healthy clip (Chart 3). Chart 1Decoupled Decoupled Decoupled Chart 2Implicit Price Deflators Lead Core CPI Implicit Price Deflators Lead Core CPI Implicit Price Deflators Lead Core CPI Chart 3Corporate Pricing Power Is Fine Corporate Pricing Power Is Fine Corporate Pricing Power Is Fine Table 2 shows our updated industry group pricing power gauges, which are calculated from the relevant CPI, PPI, PCE and commodity growth rates for each of the 60 industry groups we track. The table also highlights shorter term pricing power trends and each industry's spread to overall inflation in order to identify potential profit winners and losers. Table 2Industry Group Pricing Power Disentangling Pricing Power Disentangling Pricing Power Our analysis concludes that still ¾ of the industries we cover are enjoying rising selling prices and 43% are also beating overall inflation rates. Admittedly, the inflation rates have come down since our April update, and there was a tick up in the number of deflating industries from 14 to 16, but that figure is still down from the 19 registered in January. Importantly, 27 out of 60 industries have clocked a rising pricing power trend down from 31 in April, but still up from 20 in January, 14 have a flat trend and 19 are falling. Encouragingly, corporate sector selling prices are still comfortably outpacing wage inflation, which suggests that the positive momentum in profit margins has staying power (Chart 3). One theme that stands out from our analysis is that commodity related industries have either falling or flat inflation trends, with the exception of aluminum and chemicals. We take this as confirmation that resources are at the epicenter of deflation/disinflation pressures. Similarly, the majority of tech sub-sectors are still fighting deflation and suffer from a flat or down trend in selling prices. Adding it all up, the recent mild slowdown in corporate sector selling prices is transitory, mostly commodity related and unlikely to infect the broad business sector. There are high odds that an earnings-led playable break out phase in the equity market will develop from here. This week we promote an industrials sub-sector to our high-conviction overweight list and swap a safe haven sector out, and also tweak our long/short pair trade. Pair Trade Tweak: Long Financials/Short Tech Over the past month, we have reduced the extent of our consumer staples overweight, downgrading soft drinks to underweight and hypermarkets to neutral. In contrast, in May we boosted the S&P financials index to overweight on the back of improving earnings fundamentals. As a result, swapping out consumer staples for financials in our existing pair trade versus the tech sector makes sense. This relative share price ratio is at a critical juncture and has dropped to its long term support level (top panel, Chart 4). Importantly, the relative market capitalization differential is at its widest gap since the tech bubble (Chart 5) and a renormalization is in order. Chart 4Long Term Support Should Hold Long Term Support Should Hold Long Term Support Should Hold Chart 5Unsustainable Gap Unsustainable Gap Unsustainable Gap The valuation case is equally compelling: financials are deeply undervalued and unloved compared with the tech sector (Chart 4), such that even a modest shift in sentiment would drive a large relative price swing. The macro outlook is rife with catalysts to trigger a renormalization. Our respective Cyclical Macro Indicators (CMI) signal that financials profits will best tech sector earnings in the coming quarters (top panel, Chart 6). Historically, relative performance has moved in lockstep with relative profitability. The message from our CMIs is that relative earnings will move decisively in favor of the financials sector, thereby producing positive price momentum (bottom panel, Chart 6). A simple relative demand indicator concurs with our CMIs message: bank loan growth should outpace tech capital expenditures in the back half of the year. The middle panel of Chart 6 shows our recently published bank loans and leases regression model compared with our U.S. Capex Indicator (a good proxy for tech spending) and the message is to expect a catchup phase in relative share prices. If our thesis proves accurate, then relative demand will soon show up in relative top line figures. On that front, our forward looking relative sales per share models argue that the budding recovery in relative revenue is sustainable (Chart 7). Relative pricing power dynamics provide another source of support, both in terms of sales and operating profit margins. Firming financials pricing power is the mirror image of chronically deflating tech selling prices (Chart 7). Keep in mind that overall mild price inflation is a boon for financials because it will keep monetary conditions from becoming overly tight, which would undermine credit quality and availability. Using the nonfarm business sector's implicit price deflator as a proxy for overall inflation, the (third panel, Chart 7) shows that relative share prices move in lockstep with overall corporate sector prices. In terms of economic undercurrents, if geopolitical risks remain muted and financial conditions reasonably accommodative, then a further boost in economic and investor sentiment is likely. History shows that the financials/tech share price ratio has benefited when risk premia recede. The same relationship is also evident in the positive correlation with our U.S. sentiment indicator and real 10-year bond yield (Chart 8), and inverse correlation with corporate bond spreads (not shown). Chart 6Heed The Relative##br## CMI Signal Heed The Relative CMI Signal Heed The Relative CMI Signal Chart 7Financials Have##br## The Upper Hand Financials Have The Upper Hand Financials Have The Upper Hand Chart 8Improving Economy = ##br##Go Long Financials/Short Tech Improving Economy = Go Long Financials/Short Tech Improving Economy = Go Long Financials/Short Tech Finally, recent positive bank sector news suggests that financials have the upper hand in this share price ratio. Banks passed the Fed's stringent stress test with flying colors and should become more shareholder friendly, i.e. boost dividend payouts and reinstate/augment share retirement. In addition, even a modest watering down of Dodd-Frank will also lift the appeal of banks and financials at the expense of tech stocks in the coming quarters. Adding it up, we recommend swapping consumer staples with financials in our pair trade versus the tech sector. Relative profit fundamentals suggest that this relative share price ratio will soon spring into action. Bottom Line: Switch consumer staples out and sub financials in the pair trade versus tech stocks. We are also removing the S&P consumer staples index from our high-conviction overweight list for a modest gain of 0.1% since the early-January inclusion. The latter move makes room for an upgrade to high-conviction of a transportation sub-group that has caught fire since our recent upgrade to overweight. Air Freight Stocks Achieve Liftoff! We raised the S&P air freight & logistics group to overweight two months ago, reflecting a lack of recognition in either valuations or earnings estimates that a global trade revival was unfolding and washed out technical conditions. Since then, this transportation sub-group has regained its footing, and firming profit fundamentals now embolden us to add air freight stocks to our high-conviction overweight list. The relative share price ratio has smartly bounced off its GFC lows. Similarly, our Technical Indicator found support at one standard deviation below the historical mean, a typical launch point for playable rallies. Importantly, deeply discounted valuations remain in place, both in terms of P/S and P/E ratios (Chart 9). We expect the rebound in global growth to help unlock excellent value in air freight equities. Global trade is reviving. The synchronized DM and EM economic recovery has buoyed the global manufacturing PMI, which continues to trend well above the boom/bust line. Both global export volumes and prices are expanding. Yet buoyant global trade expectations are still not reflected in tumbling relative sales expectations (Chart 10). Chart 9Unwarranted ##br##Grounding Unwarranted Grounding Unwarranted Grounding Chart 10Buoyant Trade Growth Is Neither Reflected##br## In Collapsing Sales Expectations... Buoyant Trade Growth Is Neither Reflected In Collapsing Sales Expectations... Buoyant Trade Growth Is Neither Reflected In Collapsing Sales Expectations... Chart 11 highlights two additional Indicators to gauge the stage of the global trade recovery. Korea and Taiwan are two small open economies: exports in both countries are accelerating. Meanwhile, our Global Trade Activity Indicator, comprising the economically-sensitive Baltic Dry Index and lumber prices, is also waving a green flag. The upshot is that a number of Indicators confirm that a durable pickup in trade is underway, which should ultimately translate into a recovery in relative earnings expectations (Chart 11). Domestically, business shipments-to-inventories ratios are expanding comfortably in all three major segments: manufacturing, wholesale and retail (bottom panel, Chart 10). Anecdotally, recent news that FedEx beat both top and bottom line estimates also reinforces a firm global activity backdrop. All of this serves as reliable evidence that the budding recovery in global (and domestic) growth has morphed into a sustainable advance. The implication is that air freight pricing power has ample room to grow. Wholesale price momentum has reached a 5-year high. If our thesis plays out, more pricing power gains are in store, which will boost profit margins given the industry's impressive labor cost restraint and high operating leverage (Chart 12). Chart 11...Nor In Depressed##br## Forward EPS ...Nor In Depressed Forward EPS ...Nor In Depressed Forward EPS Chart 12Margin Expansion##br##Phase Looms Margin Expansion Phase Looms Margin Expansion Phase Looms Finally while investors are digesting the Walmart in-store pick up option and Amazon's push for its own delivery service plans, the persistent ascent in online shopping suggests that the structural increase in rapid delivery services will remain intact. Investors should expect pricing power to gravitate toward the long-term trend (bottom panel, Chart 12). Tack on the recent corrective action in the commodity pits and this group also benefits from the fall in fuel costs. Taken together, profit margins should resume expanding. In sum, appealing relative valuations along with a durable synchronized global growth rebound argue for increasing conviction in our overweight position in this transportation sub-group. Bottom Line: Stay overweight the S&P air freight & logistics group (UPS, FDX, CHRW, EXPD), and bump it to the high-conviction overweight list. Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

Highlights Rising equity prices, low and falling bond yields and stable credit spreads are all consistent with today's low growth and inflation backdrop, where the Fed can take its time raising rates. The FOMC is looking through the inflation shortfall for now and is sticking with its rate hike plan. Lower oil prices are the key driver of plunging market-based inflation expectations. We expect the Fed to begin to trim its balance sheet later this year, and be a modest negative for Treasury prices. The latest readings on the health of household balance sheet from the Fed's flow of funds accounts reinforce our view that the consumer sector will provide solid support for the U.S. economy through 2017; the student loan debt situation is not a source of financial systemic risk. Feature We first outlined our view that U.S. assets were in a policy sweet spot back in September 2016, noting that the monetary policy sweet spot won't end for risk assets until interest rates climb above the equilibrium rate. Nine months later, policy remains in the sweet spot, thanks to a beneficial combination of moderate economic growth, healthy corporate profit growth, stable margins and low inflation. Last week's CPI report was disconcerting, but did reinforce the notion that the Fed can take its time. Thus, when investors ask: "How can equity prices and bond prices both be moving higher?" Our answer is: "Because we are still in the sweet spot." Low And Slow Wins The Day Investors are wondering how the equity market can hold up given that the bond market and the dollar appear to be signaling sluggish economic growth. We look at it another way. Rising equity prices, low and falling bond yields and stable credit spreads are all consistent with today's low growth and inflation backdrop, where the Fed can take its time raising rates. The FOMC reaffirmed its intended path for rates at last week's meeting (see below). If the Fed's modest forecasts for growth and inflation are met, the central bank will raise rates gradually and begin to shrink its balance sheet. The implication for investors is that the recent outperformance of stocks over bonds accompanied by positive correlations between the two can persist for some time. Lessons from the 1950s and 1990s are helpful in illustrating this point. During the 1950s (Chart 1A, the Fed was gradually raising rates, but inflation and long rates remained low. Even as rates edged higher, stocks outperformed bonds, despite a booming economy that was near full employment. In the 1990s, long bond yields fell even as equity prices surged. Inflation was well contained for most of that decade (Chart 1B). Chart 1ABond Yields, Stocks, Inflation And The Fed In The 1950s... Bond Yields, Stocks, Inflation And The Fed In The 1950s... Bond Yields, Stocks, Inflation And The Fed In The 1950s... Chart 1B...And In The 1990s ...And In The 1990s ...And In The 1990s At what point will bond market become a problem for stocks? Charts 2 and 3 show that low inflation and low rates are both critical to keeping stock and bond yields positively correlated. The 4.25% level on the 10-year Treasury is a critical level to watch based on the historical relationship between Treasury yields and stock-bond correlations. However, the reason for rising bond yields is as important as the level of yields. An increase in long-dated Treasury yields associated with a pickup in real growth is less of a threat to equities than a rise in yields due to an uptick in inflation, because the latter invites a more aggressive Fed tightening cycle. Chart 2 Chart 3 Chart 3 shows that core inflation around or below 2% supports a positive correlation between stock and bond yields. As inflation begins to move from 2 to 3%, the relationship fluctuates, and above 3% there are very few periods of positive correlation. All signs point to a depressed inflation environment over the next year, which is one of the keys to keeping bond yields and stock prices positively correlated. We expect core CPI to move back up to 2% in the medium term, and the Fed agrees. The central bank's latest forecast puts inflation at just 2% for the next two years and in the long run. Bottom Line: Stocks can handle rising bond yields as long as higher yields are driven by better growth and not inflation. With inflation low and bonds yields at 2.15%, we are a long way from where bond yields become a problem for the stock market. FOMC: Sticking With The Roadmap For Now It was a wild ride in the Treasury market last week as bonds first rallied hard on the heels of some data releases, before selling off after the FOMC failed to deliver a fully "dovish hike". May retail sales were decent below the surface. The "control group" measure that feeds into the GDP figures was flat in May, but was revised up to a 0.6% gain in April (Chart 4). The result was a solid 4.3% annualized gain over the past three months. This suggests that, although not booming, consumer spending growth is solid in the second quarter. U.S. household balance sheets are in solid shape, as we highlight below. The FOMC was probably not swayed by this report. The CPI report was another story (Chart 5). The energy component pulled down the headline rate as expected, but the softening of inflation is widespread in the index. The annualized 3-month rate of change in the core rate fell virtually to zero in May. Disinflation can be seen in areas that have little to do with the output gap, such as shelter and medical care. But it is also showing up in other services, a segment of the CPI that is most highly correlated with wage growth and labor market pressure. The sudden broad-based change in direction is difficult to explain and, at a minimum, presents a challenge to the view that the U.S. economy is approaching its non-inflationary limits. Chart 4Consumer Spending##BR##Remains Solid Consumer Spending Remains Solid Consumer Spending Remains Solid Chart 5Disinflation In Core Services##BR##Is A Challenge To Fed's View Disinflation In Core Services Is A Challenge to Fed's View Disinflation In Core Services Is A Challenge to Fed's View Bonds rallied heading into the FOMC meeting on the view that the Fed would deliver a rate hike as promised, but would revise down the "dot plot" or, at a minimum, would play up concerns about the inflation undershoot. In the event, the Fed did neither. Chart 6Labor Market Continues To Tighten Labor Market Continues To Tighten Labor Market Continues To Tighten The statement acknowledged the disappointing inflation readings, but also revealed a determination to normalize interest rates in the face of a tight labor market. In the press conference, Chair Yellen downplayed the inflation shortfall, pointing to some one-off factors. She stressed that the FOMC makes policy for the "medium term," and should not over-react to short-term wiggles in the data. Given the tight labor market, the Fed Chair argued that the conditions are in place for inflation to move higher. Indeed, the median FOMC forecast for headline and core inflation was revised down for this year only; the outlook for 2018 and 2019 was left unchanged at 2%. Growth was revised up a little for 2017. We agree with the FOMC that the labor market is tight enough to gradually push up inflation. The underlying trend in wage growth has accelerated from 1.2% in 2010 to 2.4% today according to our wage tracker, in line with the narrowing of the unemployment gap over the period (Chart 6). The FOMC trimmed its estimate of the full-employment level of unemployment by 0.1 percentage points to 4.6%, but it revised down its forecast for the actual unemployment rate by a larger 0.3 percentage points over the next two years. This means that the projected amount of excess labor demand is now greater than in the March projection. By itself, this should make the FOMC more predisposed to tightening, especially since financial conditions have been easing. That said, the May CPI report was admittedly disconcerting due to the broad-based nature of the disinflationary pulse. This is contrary to Chair Yellen's assertion that the inflation disappointment reflects one-off factors. The May CPI report could be a head-fake, related to normal randomness in the data. But it is not clear why there would be a sudden and widespread moderation of inflation. Inflation Expectations Plunge A large portion of the decline in long-term Treasury yields since March reflected a decline in inflation expectations. The 10-year CPI swap rate has dropped by 35 basis points over the period. BCA's fixed-income strategists point out that the decline in long-term inflation expectations has been widespread across the major countries, irrespective of whether or not actual inflation is trending up or down.1 Given all these diverging signals within the national inflation data, it is odd that there has been such a uniform decline in inflation expectations across the major bond markets. That leads us to look to the oil price decline as the main driver. Weaker energy prices have been part of a broader move lower in commodity prices that is likely related to less reflationary monetary and fiscal policies out of the world's biggest commodity consumer, China. However, our commodity strategists have noted that export and import volumes in the emerging economies accelerated sharply in the first quarter of 2017. Given that there is a strong correlation between trade volumes and oil demand in the emerging markets, this bodes well for a rebound in global oil demand. Combined with the "OPEC 2.0" production cuts, the demand-supply balance in world oil markets is likely to turn positive in the months ahead, which will allow oil prices to return to a range close to $60/bbl by year-end. A move in oil prices back to that level would help arrest the downturn in overall commodity price indices, and stabilize goods CPI inflation in the developed economies in the latter half of 2017. This should also boost global inflation expectations and bond yields, especially since inflation expectations have fallen too far relative to underlying non-energy inflation pressures. This forecast also applies to the U.S. bond market, although one cannot blame the deceleration in inflation entirely on energy in this case. We expect inflation to move higher in line with the tight labor market, but we may have to change our view if service sector inflation continues to move lower in the next few of months. Balance Sheet News Chart 7Main Risk To Bond Yields Is To The Upside Main Risk To Bond Yields Is To The Upside Main Risk To Bond Yields Is To The Upside The Fed also provided some details on plans to shrink the balance sheet in terms of the size of the monthly "run off". If the economy evolves as the Fed expects, the balance sheet will start to shrink later this year. Reducing the Fed's balance sheet will be negative for Treasury prices as we argued in the May 22, 2017 Weekly Report, but the impact of this adjustment on its own will be modest. As the FOMC dials back monetary stimulus it will be concerned with overall monetary conditions, including short-term rates, long-term rates and the dollar. If long-term rates and/or the dollar rise too quickly, policymakers will moderate the pace of rate hikes and use forward guidance to talk down the long end of the curve so as to avoid allowing financial conditions get too tight, too quickly (i.e. the term premium would rise, but would be partly offset by a lower expected path for the fed funds rate). Thus, the path of short-term rates is dependent on the dollar and the reaction of the long end of the curve. The bottom line is that the FOMC is looking-through the inflation shortfall for now and is sticking with its rate hike plan. The evolution of inflation in the coming months will obviously be key. Nonetheless, given that only one more rate hike is expected over the next year, inflation expectations are back to U.S. pre-election levels, and that the 10-year U.S. term premium is well below zero again, it appears that the main risk for bond yields is to the upside (Chart 7). The equity market should benefit in the short-term to the extent that market expectations for a flatter rate hike cycle are driven by lower inflation expectations, rather than a slower growth outlook. If we are correct that inflation expectations will bounce later this year, the associated bond sell-off may present a small headwind for stocks. Nonetheless, we do not believe this will derail the rally in risk assets until inflation has reached the Fed's 2% target, and bond yields and the dollar are significantly higher. The Consumer Comeback Continues The latest readings on the health of household balance sheet from the Fed's flow of funds accounts reinforce our view that the consumer sector will provide solid support for the U.S. economy through 2017 and beyond. Household net worth continues to rise and is well above average at this point in a long expansion (Chart 8). While the total wealth effect for consumer spending is lagging behind prior cycles, it remains supportive. Debt to income ratios are at multi-decade lows. The result of the ongoing balance sheet repair is that FICO scores have hit an all time high (Chart 8, panel 4). The most recent Fed Senior Loan Officer's Survey also suggests that the banking sector is willing to lend to households and that consumers themselves are open to borrowing, although household demand for loans has weakened in recent quarters (Chart 9). Chart 8Support For Consumer Remains In Place Support For Consumer Remains In Place Support For Consumer Remains In Place Chart 9Senior Loan Officers Survey Still Supportive Senior Loan Officers Survey Still Supportive Senior Loan Officers Survey Still Supportive Consumer spending intentions also remain in an uptrend, and while consumers do not always do what they say, the 10-year high readings on "plans to buy" a house and a car are telling. (Chart 10, panels 1 and 2). Overall measures of consumer confidence also remain at 16 year highs (Chart 10, panel 3). Chart 10Consumers Are In A Good Mood Consumers Are in A Good Mood Consumers Are in A Good Mood The sturdy labor market, modest wage growth, and low inflation are all factors that support a solid pace of real income growth, adding another support to the spending backdrop (Chart 10, panel 4). Rising rates do not pose a threat to spending for two main reasons, at least in the early stages of the Fed tightening cycle. First, we expect Fed rate hikes to be gradual this year and next, putting only modest upward pressure on longer-dated Treasury yields that anchor consumer loan rates for mortgages, autos, and personal loans. Our colleagues in The Bank Credit Analyst concluded that household interest payment burdens will rise only modestly, and from a low level, in the next couple of years even if borrowing rates increase immediately by 100bps for today's levels. According to their analysis, it would require a much more significant shock, i.e. 300bps or greater, to move interest payments as a share of GDP back toward historical averages.2 We continue to receive many questions from clients on the risks posed by the rise in student debt levels. The Bank Credit Analyst publication covered the topic in a comprehensive report back in November 2016.3 The key takeaway from that report for investors was that student debt is a modest drag for economic growth, but is not a source of risk for U.S. government finances and does not represent the next subprime crisis. More than half a year later, our conclusions remain the same, though the concern among investors has not abated. A recent report4 by the Federal Reserve Bank of New York provides some data on student loans through Q1 2017. More specifically, the report noted that student debt levels continued to rise in Q4 2016 and Q1 2017, and that student loan delinquencies remain high by historical standards but moved sideways in recent years. We will continue to monitor the student loan and all other forms of consumer indebtedness as we assess the risks in the U.S. economy. However, the elevated level of student loan delinquencies does not change our overall assessment of the impact of student loans on the economy and the financial system. Student loans are only a mild economic headwind, and do not represent a source of financial systemic risk. Bottom Line: The consumer - a key driver of the U.S. economy and corporate earnings - will provide a solid backdrop for the economy through 2017 and beyond. This climate will allow the Fed to raise rates one more time this year and begin to pare its balance sheet. The solid underpinnings for the consumer will sustain corporate earnings growth and, ultimately, higher stock prices. John Canally, CFA, Senior Vice President U.S. Investment Strategy johnc@bcaresearch.com Mark McClellan, Senior Vice President The Bank Credit Analyst markm@bcaresearch.com 1 Please see BCA Global Fixed Income Strategy Weekly Report "Alternative Facts In The Bond Market," dated June 13, 2017, available at gfis.bcaresearch.com. 2 Please see The Bank Credit Analyst Special Report "Global Debt Titanic Collides With Fed Iceberg?," dated February 2017, available at bca.bcaresearch.com. 3 Please see The Bank Credit Analyst Special Report "Student Loan Blues: Can't Replay What I Borrowed," dated October 2016, available at bca.bcaresearch.com. 4 Please see "Quarterly Report On Household Debt And Credit", dated May 2017, available at https://www.newyorkfed.org/medialibrary/interactives/householdcredit/data/pdf/HHDC_2017Q1.pdf

Highlights The main driving force behind EM risk assets this year has been downshifting U.S. interest rates and a weak U.S. dollar. These factors have more than offset the relapse in commodity prices and the deteriorating growth outlook for China/EM. Going forward, odds favor a rise in U.S. interest rates and a stronger dollar. If this scenario materializes, the EM rally will reverse. Meanwhile, China's liquidity conditions have tightened, warranting a meaningful slowdown in money/credit and economic growth. Altogether, the outlook for EM risk assets is extremely poor, and we reiterate our defensive strategy. In Argentina, we continue favoring local currency bonds and sovereign credit, especially relative to their EM counterparts. Feature What Has Not Worked In This Rally Financial market actions of late have been rife with contradictions, and momentum trades have been prevalent. In the past few months we have been highlighting that EM risk assets - stocks, currencies and bonds - have decoupled from most of their historically reliable indicators such as commodities prices, China's money and credit impulses and China/EM manufacturing PMI.1 This week we highlight several additional indicators and variables that EM risk assets have diverged from. Chinese H shares - the index that does not contain internet/social media stocks - have decoupled from the Chinese yield curve (Chart I-1). The mainstream press have been focused on inversion in the 10/5-year Chinese yield curve, but we do not find it to be a particularly credible or useful indicator for the economy. Our preference is the 5-year to 3-month yield curve to gauge the cyclical growth outlook. Chart I-1China's Yield Curve Heralds Lower Share Prices China's Yield Curve Heralds Lower Share Prices China's Yield Curve Heralds Lower Share Prices Not only has the yield curve been flattening, but it has also recently inverted, suggesting an impending downturn in China's business cycle (Chart I-2). Chart I-2China's Yield Curve Inversion Points To A Growth Slump China's Yield Curve Inversion Points To A Growth Slump China's Yield Curve Inversion Points To A Growth Slump In China, commercial banks' excess reserves at the People's Bank of China (PBoC) have begun shrinking since early this year, reflecting the PBoC's liquidity tightening (Chart I-3, top panel). Banks' excess reserves are the ultimate liquidity constraint on banks' ability to originate new credit/money and expand their balance sheets. Meanwhile, Chinese commercial banks are stretched and overextended, as illustrated by the record-high ratios of both M2 and commercial banks' assets-to-excess reserves (Chart I-3, bottom panel). These are true measures of the money multiplier, and they have surged to very high levels. Besides, financial/bank regulators are clamping down on speculative activities among banks and other financial intermediaries, and are also forcing banks to bring off-balance-sheet assets onto their balance sheets. Faced with dwindling liquidity (excess reserves), rising interest rates and a regulatory clampdown, banks will slow down credit / money origination. Slower credit growth will cause a considerable slump in capital spending, and overall economic growth will downshift. On a similar note, interest rates lead money/credit growth in China, as evidenced in Chart I-4. Chart I-3China: Dwindling Excess Reserves ##br##Will Cause A Credit Slowdown China: Dwindling Excess Reserves Will Cause A Credit Slowdown China: Dwindling Excess Reserves Will Cause A Credit Slowdown Chart I-4China: Interest Rates ##br##And Money Growth China: Interest Rates And Money Growth China: Interest Rates And Money Growth The considerable - about 200 basis points - rise in Chinese money market and corporate bond yields since November heralds a deceleration in money/credit growth. Historically, interest rates affect money/credit growth and ultimately economic activity with a time lag. There is no reason why this relationship will not hold in China this time around. Given that Chinese companies are overleveraged, credit growth is likely to be more sensitive to rising than falling interest rates. Hence, the lingering credit excesses in China make rising interest rates more dangerous. Industrial commodities prices have reacted to liquidity tightening in China sensibly by falling since early this year (Chart I-5A and Chart I-5B). Chart I-5AWidespread Decline In Commodities Prices (II) Widespread Decline In Commodities Prices (I) Widespread Decline In Commodities Prices (I) Chart I-5BWidespread Decline In Commodities Prices (I) Widespread Decline In Commodities Prices (II) Widespread Decline In Commodities Prices (II) The weakness in commodities prices since early this year is especially noteworthy because it has occurred at a time of U.S. dollar weakness and dissipating Federal Reserve tightening concerns. When and as the U.S. dollar gains ground again, the selloff in commodities will escalate. Outside commodities, there are early signposts that another Chinese slowdown is beginning to unfold - slowing exports in May from Korea and Taiwan to China, being one glaring example (Chart I-6). This chart corroborates our argument that the surge in Chinese imports in late 2016 and the first quarter 2017 was a one-off growth boost, and appeared very strong because of the low base from a year ago. Consistently, Taiwan's manufacturing shipments-to-inventory ratio has rolled over, which correlates well with the tech-heavy Taiwanese stock index (Chart I-6, bottom panel). With respect to the broader EM universe, EM equities and currencies have decoupled from U.S. inflation expectations (Chart I-7). Chart I-6Shipments To China Have Rolled Over Shipments To China Have Rolled Over Shipments To China Have Rolled Over Chart I-7EM And U.S. Inflation Expectations: ##br##Unsustainable Decoupling? EM And U.S. Inflation Expectations: Unsustainable Decoupling? EM And U.S. Inflation Expectations: Unsustainable Decoupling? Historically, falling U.S. inflation expectations have reflected dropping oil prices and caused real rates (TIPS yields) to rise. In turn, lower oil prices and/or rising TIPS yields weighed on EM risk assets. The decline in U.S. Treasurys yields since last December has been largely due to inflation expectations rather than real rates. Such a mixture has historically been ominous for EM risk assets. Notwithstanding, EM risk assets have rallied a lot, despite such a hostile backdrop year-to-date. Finally, the Brazilian and South African exchange rates and their bonds have been among the more stellar performers in the past 12 months. Nevertheless, first quarter GDP releases in Brazil and South Africa have confirmed that there has been little domestic demand recovery in either country. Remarkably, in both countries, agriculture and mining volumes boomed in the first quarter, boosting GDP growth, yet final domestic demand remained shockingly depressed, as illustrated in Chart I-8. This discards the popular EM rally narrative that improving global growth will lift EM economies. Neither a poor domestic growth backdrop and political volatility nor falling commodities prices have prompted a meaningful plunge in either the Brazilian or South African exchange rate. Chart I-9 portends that the BRL and ZAR have historically been correlated with commodities prices but have recently shown tentative signs of decoupling. Chart I-8Not Much Recovery In Brazil ##br##And South Africa's Domestic Demand Not Much Recovery In Brazil And South Africa's Domestic Demand Not Much Recovery In Brazil And South Africa's Domestic Demand Chart I-9BRL And ZAR And Commodities BRL And ZAR And Commodities BRL And ZAR And Commodities Bottom Line: EM financial markets have veered away from many traditional indicators. These constitute important contradictions and raise the question of whether this time is different. We do not think so. What Has Driven This EM Rally: U.S. Rates And The U.S. Dollar The variables that have explained the EM rally in the past six months have been falling U.S. interest rate expectations and a weaker U.S. dollar, as well as the global technology mania. We elaborated on the tech rally in recent weeks,2 and this week re-visit EM's link with U.S. interest rates and the greenback. The main driving force behind EM risk assets, year -to-date, has been U.S. TIPS yields and the greenback (Chart I-10). In short, it has been the carry trade that has transpired since the Fed's meeting on December 15, 2016 - regardless of EM growth dynamics and fundamentals. Going forward, barring a major growth relapse in China/EM growth and an associated U.S. dollar rally, the odds favor a rise in U.S. interest rates in general and U.S. TIPS yields in particular: The U.S. composite capacity utilization gauge (Chart I-11, top panel) - constructed by our Foreign Exchange Strategy team based on the unemployment gap and industrial capacity utilization - is moving above the zero line, denoting that there is little slack in the U.S. economy. Chart I-10U.S. TIPS Yields, Dollar And EM U.S. TIPS Yields, Dollar And EM U.S. TIPS Yields, Dollar And EM Chart I-11The U.S. Economy: Is It The Time To Bet On Higher Bond Yields? The U.S. Economy: Is It The Time To Bet On Higher Bond Yields? The U.S. Economy: Is It The Time To Bet On Higher Bond Yields? Any time the indicator has moved above the zero line in the past 55 years - the shaded periods on Chart I-11 - inflationary pressures, wages and bond yields have typically risen, and vice versa. The message from this indicator is unambiguous: U.S. inflationary pressures will become evident soon, and interest rates will rise. In this context, U.S. interest rate expectations are too low. Re-pricing of U.S. interest rates will shake off lingering complacency across many financial markets worldwide. Notably, the U.S. mortgage purchase index is surging, job openings are very elevated (Chart I-12), financial and property markets are buoyant and the dollar has been weak. If the Fed does not normalize interest rates now, when will it? Finally, both nominal and inflated-adjusted U.S. bond yields are at their technical support, and will likely bounce from these levels (Chart I-13). Chart I-12Are U.S. Rate Expectations Too Low? Are U.S. Rate Expectations Too Low? Are U.S. Rate Expectations Too Low? Chart I-13U.S. Bond Yields Are At A Critical Juncture U.S. Bond Yields Are At A Critical Juncture U.S. Bond Yields Are At A Critical Juncture Chart I-14U.S. Growth Underperformance Is Late U.S. Growth Underperformance Is Late U.S. Growth Underperformance Is Late Rising U.S. interest rates will trigger another up leg in the U.S. dollar. Notably, the relative economic surprise index between the U.S. and the G10 is close to its post-crisis lows (Chart I-14). The relative U.S. growth underperformance versus DM is late and will turn around very soon. While it does not always define the fluctuations in the U.S. dollar, we would still expect it to lend some support to the greenback. BCA's Emerging Markets Strategy service believes the broad trade-weighted U.S. dollar is still in a bull market, especially versus EM, DM commodities currencies and Asian currencies. We have less conviction on the magnitude of the downside in the euro, but the latter at minimum will not rally above 1.14 -1.15 for now. Finally, various EM currencies are facing an important technical resistance (Chart I-15A and Chart I-15B). We expect these technical levels to mark their top. Chart I-15AEM Currencies Are Facing Technical Resistance (II) EM Currencies Are Facing Technical Resistance (I) EM Currencies Are Facing Technical Resistance (I) Chart I-15BEM Currencies Are Facing Technical Resistance (I) EM Currencies Are Facing Technical Resistance (II) EM Currencies Are Facing Technical Resistance (II) At the same time, the precious metals index seems to be rolling over at its 200-day resistance level (Chart I-16). A top in the precious metals index would be consistent with a bottom in U.S. TIPS yields and the U.S. dollar. Chart I-16Precious Metals Are Facing ##br##A Major Resistance Precious Metals Are Facing A Major Resistance Precious Metals Are Facing A Major Resistance Bottom Line: U.S. interest rate expectations are too low and are set to rise. Rising interest rates will remove a major support underpinning the EM rally. A Resolution There are three potential scenarios as far as the ongoing EM rally is concerned: The goldilocks scenario of low interest rates in the U.S., a weaker dollar and steady-to-improving growth in EM/China. The markets have already priced in a lot of good news, but the rally could feasibly continue for some time if this scenario transpires. Re-pricing of the Fed. U.S. interest rates will rise and the dollar will get bid up. The rationale is the modest U.S. inflationary pressures will become evident amid solid U.S. growth. This will weigh on EM risk assets, even if EM/China growth does not falter. The basis for this is the EM rally year-to-date has been driven by diminishing U.S. interest rates expectations. Deflation trade redux. China/EM growth will deteriorate meaningfully (for reasons discussed above), causing a considerable downshift in commodities prices and EM risk assets. This could well occur even if U.S. rates stay low. In fact, this is the main plausible reason to bet against a rise in U.S. interest rate expectations from current levels. Investing is about assigning probabilities. We assign much lower probability to the first scenario (no more than 20%), while we see the odds of either the second or third scenarios playing out in the short term at closer to 40%. In the medium term (nine-to 12 months), scenario 3 will be the most prevalent one. If conditions in scenario 2 (rising U.S. bond yields) coincide with a deflationary shock emanating from China, EM financial markets will face a perfect storm. Bottom Line: We continue to recommend a defensive investment strategy for absolute-return investors, and recommend an underweight allocation towards EM within global portfolios across stocks, credit and currencies. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com 1 Please refer to the Emerging Markets Strategy Weekly Report titled, "EM: Is This Time Different?", dated June 7, 2017, link available on page 19. 2 Please refer to the Emerging Markets Strategy Weekly Report titled, "Can Tech Drive EM Stocks Higher?", dated May 17, 2017, and Emerging Markets Strategy Weekly Report titled, "EM: Is This Time Different?", dated June 7, links available on page 19. Argentina: Favor Local Bonds And Sovereign Spreads EM fixed-income portfolio should continue to overweight Argentine local currency bonds and sovereign credit based on the following reasons: Policymakers continue pursuing credible orthodox policies. The central bank has been accumulating foreign exchange as a part of its explicit program to increase international reserves from 10% to 15% of GDP and keep the peso competitive. At the same time, the monetary authorities have partially siphoned off liquidity via reverse repos (Chart II-1). On a net-net basis, monetary stance is rather tight as evidenced by money and credit contraction in real (inflation-adjusted) terms (Chart II-2). Chart II-1Argentina: Rising Reserves ##br##And Reverse Sterilization Argentina: Rising Reserves And Reverse Sterilization Argentina: Rising Reserves And Reverse Sterilization Chart II-2Argentina: Inflation-Adjusted Money ##br##And Credit Are Contracting Argentina: Inflation-Adjusted Money And Credit Are Contracting Argentina: Inflation-Adjusted Money And Credit Are Contracting Rapid disinflation is proving difficult to achieve due to inflation inertia and high inflation expectations. However, the authorities are holding their position steady in wage negotiations. Wages in both the public and private sectors are contracting in real terms (Chart II-3). Provided wages are a major driver of inflation, employee compensation growing at a slower pace than inflation signals lower inflation ahead. The economy is not yet recovering as evidenced by Chart II-4 and lingering economic stagnation will foster disinflation. Chart II-3Argentina: Lower Wage Growth ##br##Is Critical To Anchor Inflation Argentina: Lower Wage Growth Is Critical To Anchor Inflation Argentina: Lower Wage Growth Is Critical To Anchor Inflation Chart II-4Argentina: The Economy ##br##Is Still In Doldrums Argentina: The Economy Is Still In Doldrums Argentina: The Economy Is Still In Doldrums A change in our fundamental view on inflation would require an irresponsible central bank tolerating run away money and credit growth. We find this scenario unlikely and hold the view that the inflation outlook will improve (Chart II-5). Chart II-5Argentina: Inflation Is On The Right Track Argentina: Inflation Is On The Right Track Argentina: Inflation Is On The Right Track In regard to the currency, the Argentine central bank will allow the peso to depreciate as maintaining a competitive exchange rate is a major policy priority for them. This is especially true if commodities prices fall and the regional currencies (BRL and CLP) depreciate versus the greenback. The current account and fiscal deficits are large but Argentina is seeing significant FDI and foreign portfolio capital inflows. Hence, funding will not be a problem for some time. The eventual economic recovery and the cheap currency, as well as slow but progressing reforms, will make Argentina a more attractive destination for foreign investors and ensure foreign capital inflows. Overall, there are many challenges, but the outlook for Argentina is much better compared with EM economies in general, and Brazil in particular. Hence, we recommend staying long Argentinian assets on a relative basis versus EM counterparts, particularly Brazil. Specifically, we maintain the following positions: Long ARS versus BRL. We do not expect the currency to depreciate more than what the NDF market is pricing in the next 12 months, and believe it will outperform the BRL on a total return basis (including carry). Stay long Argentine 7-year local currency government bonds. Stay long Argentine / short Brazilian and Venezuelan sovereign credit. Overweight Argentine stocks within the emerging and frontier market universes. Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights Crude oil prices will find support from stronger EM trade volumes, which broke out of an extended low-growth period at the end of last year and finished 1Q17 on a very strong note. Sustained growth in EM trade volumes will boost inflation at the consumer level in the U.S. and Europe, and will lift the Fed's preferred inflation gauge, provided the Fed does not constrict the growth of money supply this year and next. Energy: Overweight. We remain long Dec/17 WTI and Brent vs. short Dec/18 WTI and Brent, expecting the extended OPEC 2.0 production cuts and stronger oil demand to drain inventories this year. Base Metals: Neutral. China's Caixin manufacturing PMI for May fell below 50, indicating the manufacturing sector may be contracting. We will wait to see if this is confirmed this month and next, but for now this keeps us neutral with a negative tilt on the base metals complex. Precious Metals: Neutral. A weaker USD, and market expectations the Fed will be constrained in lifting interest rates later this year is supporting our strategic gold portfolio hedge, which is up 5.1% since it was initiated May 4, 2017. Ags/Softs: Underweight. Front-month corn is trading through the top of the $3.55 to $3.75/bushel range it has occupied since the beginning of the year. We are not inclined to play the momentum. Feature EM import and export volumes moved sharply higher in 1Q17 after breaking out of an extended low-growth funk late last year (Chart of the Week). The year-on-year (yoy) increase in the volume of imports and exports for EM economies reported by the CPB World Trade Monitor were up on average 8.74% and 5.29% in 1Q17, respectively, versus 12-month moving average levels of 2.2% and 2.5%.1 EM trade volumes are highly correlated with EM oil demand (Chart 2), particularly in the post-Global Financial Crisis (GFC) era, when EM import and export growth made significant gains relative to DM trade volumes (Chart 3).2 Indeed, EM imports and exports both grew at twice the rate of DM trade between the end of 2010 and the end of 1Q17: EM import volumes grew 22% vs. DM growth of 10% over the period, while EM export volumes grew 21% vs. DM growth of 11%. Chart of the WeekEM Imports And Exports##BR##Surge In 1Q17 EM Imports And Exports Surge In 1Q17 EM Imports And Exports Surge In 1Q17 Chart 2EM Oil Demand Closely##BR##Tracks Trade Volumes EM Oil Demand Closely Tracks Trade Volumes EM Oil Demand Closely Tracks Trade Volumes Chart 3EM Trade-Volume Growth##BR##Surpasses DM Growth EM Trade-Volume Growth Surpasses DM Growth EM Trade-Volume Growth Surpasses DM Growth We expect EM demand will account for some 80% of ~1.53mm b/d of global oil demand growth this year. If the strong 1Q17 performance in EM trade were to carry into 2Q, we will be raising our estimated oil-demand growth for the year significantly. We will be updating our global supply-demand balances next week. Coupled with the extension to end-March 2018 of the 1.8mm-barrel-per-day crude-oil production cuts recently agreed by the OPEC 2.0, the strong EM oil-demand growth could accelerate the draw-down in global storage levels, putting the WTI and Brent forward curves into backwardation sooner than the late-2017/early-2018 timeframe we currently expect.3 EM Trade Growth Will Stoke Oil Prices And Inflation Because EM demand is the driving force of global oil-demand growth, a continuation of the strong trade performance from this sector will support oil prices going forward, and likely will lift inflation as the year progresses. In the post-GFC period, we would expect a 1% increase in EM import and export volumes to boost oil prices by a little more than 2%, and vice versa.4 This is almost twice the effect an increase in trade produces in estimates beginning pre-GFC in 2000; most likely, it reflects the increase in EM trade volumes relative to DM trade volumes post-GFC.5 Our modeling confirms key inflation gauges - particularly the Fed's preferred gauge, the core PCE; the U.S. CPI; and EMU Harmonized CPI - all are highly sensitive to EM oil demand, as expected, and, no surprise, to EM trade volumes.6 In the post-GFC period, a 1% increase (decrease) in EM oil demand can be expected to lift (drop) core PCE and the U.S. CPI by a little more than 50bps; for the EMU CPI, a 40bps increase (decrease) can be expected.7 In addition, we have found the EM trade data also is a highly explanatory variable for these inflation gauges. Imports explain ~ 84%, 91% and 89% of core PCE (Chart 4), U.S. CPI (Chart 5), and EMU CPI (Chart 6), respectively, in the post-GFC period, while exports explain 94%, 93% and 81% of these inflation gauges. The elasticities for the U.S. gauges is ~ 50bps, similar to the EM oil demand estimates, and ~35bps for the EMU CPI. Chart 4Core PCE Is Highly Sensitive To EM Trade Volumes... Core PCE Is Highly Sensitive To EM Trade Volumes... Core PCE Is Highly Sensitive To EM Trade Volumes... Chart 5...As Is U.S. CPI... ... As Is U.S. CPI ... ... As Is U.S. CPI ... Chart 6...And EMU CPI ... And EMU CPI ... And EMU CPI A continued expansion of EM trading volumes this year can be expected to lift inflation in the U.S. and Europe. We also would expect this to hold for China as well, given the results of our earlier research.8 Fed Could Kill The Party Chart 7U.S. M2 Is Important To EM Trade Volumes U.S. M2 Is Important To EM Trade Volumes U.S. M2 Is Important To EM Trade Volumes One variable we are watching closely is U.S. money supply, M2 in particular, vis-à-vis EM trade volumes (Chart 7). We find that in the post-GFC world, EM trade volumes are highly sensitive to M2, with M2 explaining 92% of EM exports and 82% of imports. This relationship did not exist in the pre-GFC world, or in estimates starting pre-GFC and extending to the present day. This no doubt is related to massive monetary accommodation and QE experiments post-GFC, but, as of this writing, we are not at all sure how this relationship will evolve going forward. Bottom Line: EM trade volumes have broken out of a long-term funk, which will be supportive of crude oil prices and will lift inflation going forward. Strong EM trade growth at the pace at which it ended 1Q17 would cause us to lift our expectation for global oil demand significantly for this year. This, combined with the extension of the OPEC 2.0 production cuts to March 2018 could normalize global inventories faster than markets currently expect. EM trade is, importantly, highly exposed to U.S. monetary policy, particularly to what happens to U.S. M2 money supply. This is a feature of the global trade picture that was not present pre-GFC. Our research affirms our conviction on the bullish oil exposure we have on - chiefly the long Dec/17 Brent and WTI vs. short Dec/18 Brent and WTI backwardation trades. Our results also support remaining long gold as a strategic portfolio hedge against inflation and geopolitical risk, and remaining long commodity-index exposure. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com 1 The CPB World Trade Monitor is published monthly by the CPB Netherlands Bureau for Economic Policy Analysis. Please see https://www.cpb.nl/en/worldtrademonitor for data and documentation. We use CPB's volumetric data for EM imports and exports in our analysis, which are indexed to 2010 = 100; we converted these data to USD values to see how the composition of imports and exports was changing so as to better see how the relative shares of EM and DM are evolving. 2 EM export and import volumes are cointegrated with non-OECD oil consumption, our proxy for EM oil demand, in regressions starting pre- and post-GFC, meaning they share a common trend and are in a long-term equilibrium. The adjusted R2 coefficient of determination for EM oil demand as a function of EM export volumes is 0.91 for estimates starting in 2003 and 2010 (the pre- and post-GFC periods); for EM imports, it is 0.84 post-GFC, and 0.90 pre-GFC. Post-GFC, we estimate a 1% increase (decrease) in EM import and export volumes translates to an 88bp and 85bp gain (decline) in EM oil demand. The read-through on this is EM trade volumes are closely tied to income growth, given the income-elasticity of demand for oil is ~ 1.0 in non-OECD economies, according to the OECD. Please see "The Price of Oil - Will It Start Rising Again?" OECD Economics Department Working Paper No. 1031, p. 6 (2013). In our modeling, we assume the GFC ended in 2010. 3 Please see our discussion of this production-cut extension in the joint report we did with BCA Research's Energy Sector Strategy on June 1, 2017, entitled "Extending OPEC 2.0's Production Cuts Will Normalize Global Oil Inventories." It is available at ces.bcaresearch.com. 4 The R2 coefficients of determination for the cointegrating regressions of Brent prices on EM export and import volumes are 0.90 and 0.93, respectively, for post-GFC estimates. For estimates beginning in 2000, the R2 coefficients are 0.88, while the elasticities are ~1.20 for the EM trade variables. These models also include a parameter for the broad trade-weighted USD, which, post-GFC, has become more important to the evolution of Brent prices: A 1% increase in the currency parameter translates to a price decline of more than 5%, which is approximately twice the value of the estimates starting pre-GFC. 5 Our estimates for WTI produce similar results for the pre- and post-GFC periods. 6 We examined this in our August 4 and 11, 2016, in "Memo To The Fed: EM Oil, Metals Demand Key To U.S. Inflation," and "Global Inflation And Commodity Markets." Both are available at ces.bcaresearch.com. 7 The R2 coefficients of determination for the core PCE, U.S. CPI and EMU CPI estimates as a function of EM oil demand are 0.97, 0.94 and 0.85, respectively. It is interesting to observe that prompt measures of inflation are not correlated to oil prices, but that 5-year 5-year CPI swaps remain highly correlated with oil prices, the 3-year forward WTI futures contract in particular; the R2 for the estimate of the 5y5y CPI swap as a function of the 3-year WTI contract is 75%. 8 In the August 11, 2016, article "Global Inflation And Commodity Markets," we found Chinese inflation to be equally sensitive to EM oil demand. We will be exploring this further when we look at base metals demand vis-à-vis EM trading volumes in forthcoming research. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed In 2017 Summary of Trades Closed in 2016 Strong EM Trade Volumes Will Support Oil Strong EM Trade Volumes Will Support Oil Strong EM Trade Volumes Will Support Oil Strong EM Trade Volumes Will Support Oil

Highlights Although it is tempting to argue that emerging markets are in a new era where past correlations no longer matter, our belief is that it is only a matter of time until fundamentals reassert themselves. Several measures of equity markets have reached or are close to their previous structural peaks. In the second half of 1990s, booming U.S. and European growth as well as the tech mania, did not preclude a bear market in commodities and EM financial markets. Overall, EM risk assets will not be immune to selling off considerably from the current overbought levels if Chinese growth and commodities prices surprise to the downside, as we expect. Falling commodities prices will weigh on Indonesia's terms of trade. Equity investors should maintain an underweight position in this market and currency traders should continue shorting the rupiah. Feature A New Era? Money has been flowing into EM financial markets, irrespective of the evolution of many economic and financial variables that have in the past shaped markets dynamics. Indeed, EM share prices and currencies have refused rolling over despite a relapse in a number of variables they have historically been correlated with. EM share prices have continued to surge, even though the aggregate EM manufacturing PMI has rolled over (Chart I-1). Chart I-1Unsustainable Decoupling Unsustainable Decoupling Unsustainable Decoupling The recent relapse in the EM manufacturing PMI has not hurt EM currencies either (Chart I-2, top panel). In addition, EM currencies have diverged from commodities prices, an unprecedented historical occurrence (Chart I-2, bottom panel). The same applies to EM versus DM relative equity performance. Chart I-3 demonstrates that EM share prices have outperformed their DM counterparts year to date, even though the EM manufacturing PMI considerably underperformed DM's. Chart I-2Untenable Divergence Untenable Divergence Untenable Divergence Chart I-3Relative Share Prices And Relative PMIs Relative Share Prices And Relative PMIs Relative Share Prices And Relative PMIs Notably, EM stock prices have even defied the recent setback in EM net earnings revisions (Chart I-4). Typically, the latter correlate with swings in share prices, but this time both variables have diverged. Finally, it is important to note that this phenomena of decoupling cannot be explained by the performance of technology stocks. EM share prices excluding technology companies have still rallied, albeit much less, despite the decline in EM net earnings revisions and the EM manufacturing PMI. Remarkably, China's H shares - the index that does not include U.S.-listed Chinese internet/social media companies and is instead "heavy" in banks and "old economy" stocks - have still ignored both the drop in China's manufacturing PMI and rising local interest rates (Chart I-5). Chart I-4Even Analysts' Net EPS ##br##Revisions Have Rolled Over Even Analysts' Net EPS Revisions Have Rolled Over Even Analysts' Net EPS Revisions Have Rolled Over Chart I-5Puzzling... Puzzling... Puzzling... One could argue that the dominant macro drivers of EM in recent months have been the U.S. dollar and U.S. bond yields, both of which have downshifted since mid-December 2016. If the greenback and expectations of Federal Reserve policy continue to shape EM performance, the outlook is not much better. The basis is that the Fed will likely continue to hike interest rates if global stocks continue to rally. Notably, U.S. corporate bond yields/spreads are very low, the dollar is already down quite a bit, U.S. asset prices are reflating and U.S. economic growth is decent. If the Fed does not normalize interest rates now, when and under what conditions will it? Similarly, investor sentiment on the U.S. dollar is no longer bullish, and the market expects only 44 basis points in Fed rate hikes over the next 12 months. The latter is a low bar. We maintain that the dollar's selloff - even though it has lasted longer than we previously expected - is late, especially versus EM currencies. Bottom Line: Although it is tempting to argue that emerging markets are in a new era where past correlations no longer matter, our belief is that it is only a matter of time until fundamentals reassert themselves. As and when this happens - our hunch is that it is a matter of weeks not months - EM risk assets will sell off materially and underperform their DM counterparts. Signs Of A Top? Or Is This Time Different? The EM equity rally has been facilitated by the tech mania occurring worldwide as well as by falling financial market volatility and risk premia - leading investors to bet on EM carry trades. A relevant question is whether these trends are close to the end or have much further to go. We have the following observations: EM share prices in local currency terms, as well as the KOSPI and Taiwanese TSE indexes in U.S. dollar terms, all are testing their previous highs which they have never broken out from (Chart I-6). The question we would ask is: Why should this time be different, or why would these indexes break out this time around? In our opinion, EM fundamentals, including the outlook for EPS growth, remain poor. We have elaborated on this issue at length in previous reports1 and stand by our assessment. On many metrics, the U.S. equity market is expensive, and the rally is overstretched (Chart I-7). Chart I-6Facing A Major ##br##Technical Resistance Facing A Major Technical Resistance Facing A Major Technical Resistance Chart I-7U.S. Stocks Are Expensive ##br##And Overstretched U.S. Stocks Are Expensive And Overstretched U.S. Stocks Are Expensive And Overstretched These charts do not provide clues for the timing of a reversal, but when all these ratios reach their previous secular tops, investors should be critically examining the investment outlook. Our take is as follows: Without a broad-based U.S. corporate profit recession, a major bear market in the S&P 500 is not likely, but share prices could soon hit a major resistance and correct meaningfully from the current expensive and overbought levels. While EM stocks are not expensive, the outlook for their share prices is negative because we expect EM earnings to shrink again by early next year1. Finally, not only is U.S. equity market volatility extremely muted but EM equity as well as U.S. bond market volatility are testing their previous lows (Chart I-8). When implied volatility reached these low levels in the past, it marked a major market reversal. Bottom Line: Several measures of equity market performance have reached or are close to their previous structural peaks and financial markets volatility is at record lows. While one can make the case that this time is different and this EM equity rally will persist, we continue to err on the side of caution. Tech Mania And EM In The 1990s A recent narrative in the marketplace has been as follows: given the share of tech stocks' market cap has risen to 26%, and commodities sectors presently account for only 14% of the EM MSCI benchmark, it makes sense that EM equities have decoupled from commodities prices and have become correlated with tech stocks and DM growth. In this respect, it is instrumental to revisit what happened in the second half of the 1990s, when global tech/internet and telecom stocks were in the midst of a mania like social media/tech stocks nowadays. We have the following observations on this matter: EM share prices, currencies, and bonds plunged in the second half of the 1990s, even though U.S. and European real GDP growth was extremely strong - 4.5% and 3% on average, respectively (Chart I-9, top panel) - and the S&P 500 was in a full-fledged bull market. Chart I-8Volatility: As Low As It Gets Volatility: As Low As It Gets Volatility: As Low As It Gets Chart I-9EM Stocks And DM Growth In The 1990s EM Stocks And DM Growth In The 1990s EM Stocks And DM Growth In The 1990s EM share prices collapsed in 1997-'98, even though U.S. and European import volumes were expanding at a double-digit rates (Chart I-9, middle panel). Furthermore, the crises originated in emerging Asian countries such as Thailand, Korea and Malaysia that were large exporters to advanced economies. Besides, the share and importance of the U.S. and European economies was much larger 20 years ago than it is now. Back then, China was negligible in terms of its impact on EM in general and commodities in particular. The question is, if an economic boom in the U.S., and Europe in the second half of the 1990s did not preclude crises in export-oriented economies in East Asia, why would moderate DM growth today - as well as their much smaller share of global trade - boost EM share prices from already elevated levels. Twenty years ago, EM share prices fell along with declining U.S. bond yields (Chart I-10). The Fed hiked rates only once by 25 basis points in March 1997. In the past 18 months, the Fed has already hiked 3 times. In fact, the U.S. dollar was in a bull market in the second half of the 1990s, despite falling U.S. bond yields during that period. EM stocks collapsed along with falling commodities prices in 1997-'98 (Chart I-11, top panel) even though the S&P 500 was in the midst of a major bull market (Chart I-11, bottom panel). Chart I-10The 1990s: EM Bear Market ##br##Was Not Due To Rising U.S. Bond Yields The 1990s: EM Bear Market Was Not Due To Rising U.S. Bond Yields The 1990s: EM Bear Market Was Not Due To Rising U.S. Bond Yields Chart I-11EM Stocks, Commodities And The S&P 500 EM Stocks, Commodities And The S&P 500 EM Stocks, Commodities And The S&P 500 Importantly, the mania sectors of the late 1990s - technology and telecom - accounted for approximately 33% of EM market cap in January 2000. Presently, following an exponential rally and outperformance, technology and social media/internet stocks make up 27% of the EM MSCI benchmark. In addition, the market cap of energy and materials companies stood at 19% of the MSCI EM equity benchmark in January 2000, compared with 14% presently (Chart I-12). Hence, the market cap of commodities sectors was not substantially larger in the late 1990s than today. Chart I-12 Finally, Korean and Taiwanese bourses have historically had a high positive correlation with both oil and industrial metals prices (Chart I-13). The reason for this relationship is that both economies are leveraged to the global business cycle, and commodities prices are often driven by global trade cycles. Chart I-13Asian Bourses And Commodities Prices Asian Bourses And Commodities Prices Asian Bourses And Commodities Prices Bottom Line: In the late 1990s, EM crises/bear markets occurred despite booming U.S. and European growth, and at a time when these economies were much more important to EM than they are today. The EM bear market also occurred amid the S&P 500 bull market and falling U.S. bond yields. To be sure, we are not suggesting that everything is identical between today and the 1990s, but all the above suggests to us that EM risk assets will not be immune to selling off considerably from the current overbought levels if Chinese growth and commodities prices surprise to the downside, as we expect. Arthur Budaghyan, Senior Vice President Chief Emerging Markets Strategist arthurb@bcaresearch.com 1 Please refer to the Emerging Markets Strategy Weekly Report titled, "EM Profits, China And Commodities Redux", dated May 31, 2017, link available on page 16. Indonesia: Facing Commodities Headwinds (Again) Decelerating Chinese growth and falling commodities prices will weigh on Indonesia's exchange rate (Chart II-1). In turn, not only will the currency depreciation undermine foreign currency returns to investors in stocks and local bonds, but it will also exert upward pressure on local rates. The latter will extend the credit downturn and weigh on domestic demand. Chinese imports of Indonesian coal have begun falling in volume terms (Chart II-2). Consistently, Chinese thermal coal prices - the type of coal that China buys from Indonesia - have also rolled over decisively after rallying sharply in 2016. Chart II-1Indonesia Currency ##br##And Commodities Prices Indonesia Currency And Commodities Prices Indonesia Currency And Commodities Prices Chart II-2Indonesia's Coal Exports ##br##To China And Coal Prices Indonesia's Coal Exports To China And Coal Prices Indonesia's Coal Exports To China And Coal Prices Indonesia's exports of base metals and oil/gas to China are also declining in U.S. dollar terms. Commodities exports account for around 30% of Indonesia's total exports. As such, falling commodities prices will lead to negative terms of trade for this nation. On the domestic front, consumer demand remains sluggish. Although auto sales have revived, motorcycles sales are still declining for a fourth consecutive year (Chart II-3). Meanwhile, capital expenditures are tame. Capital goods imports are no longer contracting, but there has been no recovery so far (Chart II-4). Chart II-3Consumer Spending: ##br##Auto And Motorcycle Sales Consumer Spending: Auto And Motorcycle Sales Consumer Spending: Auto And Motorcycle Sales Chart II-4Indonesia: Capex Is Sluggish Indonesia: Capex Is Sluggish Indonesia: Capex Is Sluggish Bank loan growth has not recovered much (Chart II-5) despite low interest rates and a benign external backdrop since early 2016, specifically the revival in commodities prices and large foreign portfolio inflows. NPLs on banks' balance sheet will rise further due to weak growth and lower commodities prices. That, in turn, will dent banks' willingness to grow their loan book. In regard to the credit cycle, Indonesia might be following India's example with a several year lag. In India's banking system, high NPLs have curtailed public banks' desire to lend and, consequently, capital spending has been in disarray. Similarly, Indonesia's credit-sensitive consumer spending and investment expenditure growth will disappoint in the next 12 months as credit growth slows anew. Finally, at a trailing price-earnings ratio of 19.6, equity valuations are not attractive. The poor growth outlook that we foresee does not justify such high multiples. Besides, relative performance of this bourse versus the overall EM equity benchmark is stuck between technical support and resistance (Chart II-6). We are biased to believe that it will relapse from the current juncture. Chart II-5Indonesia's Credit Cycle Is Not Out Of The Woods Indonesia's Credit Cycle Is Not Out Of The Woods Indonesia's Credit Cycle Is Not Out Of The Woods Chart II-6Indonesian Equity Relative Performance Indonesian Equity Relative Performance Indonesian Equity Relative Performance Bottom Line: Weaker commodities prices emanating from slower Chinese growth will hurt Indonesia's currency. We recommend equity investors to keep an underweight position in this bourse. Also, we remain short IDR versus the U.S. dollar and underweight local currency bonds within the EM universe. Ayman Kawtharani, Associate Editor ayman@bcaresearch.com Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights Portfolio Strategy Upgrade capital markets stocks to overweight and put them on the high-conviction list. Capital formation is poised to accelerate in the second half of the year. Our Indicators suggest that demand for media services will continue to improve. Stay overweight both the movies and entertainment and cable and satellite indexes. Recent Changes S&P Investment Banking & Brokerage - Upgrade to overweight and add to the high-conviction overweight list. S&P Consumer Finance - Remove from the high-conviction overweight list. Table 1Sector Performance Returns (%) Falling Correlations Falling Correlations Feature The S&P 500 continues to churn near its highs. Following a robust earnings season, the onus is now on the economy to provide confidence that the corporate profit recovery will prove durable, thereby justifying thinning equity risk premia. While slumping commodity prices suggest that global end-demand has downshifted a notch, the former boost real purchasing power and provide a reflationary support for stocks, particularly since resource-dependent sectors do not have a market leadership role. In fact, financial conditions remain sufficiently accommodative to expect a growth reacceleration in the back half of the year. It is notable that the recent selloff in the Treasury market has been driven by the real component, while inflation expectations have moved sideways. As a result, there is little pressure on the Fed to normalize at a faster pace than currently discounted in the forward curve. Thus, we expect the window for additional equity price appreciation to remain open this summer, unless growth reaccelerates sufficiently to stir inflation fears. Nevertheless, selectivity will become even more critical. Cross asset correlations have collapsed. Diminishing global macro tail risks have reduced the dominance of the beta-oriented "risk on/risk off" trade as a source of return. Empirical evidence suggests that asset correlations and the broad equity market are inversely correlated. This message is corroborated by falling correlations between regional stock market returns. Receding equity index correlations have been associated with positive S&P 500 returns (middle panel, Chart 1). This inverse correlation is also mirrored in the CBOE's implied correlation index, which tracks the correlation of the S&P 500 stocks with one another: tumbling correlations imply solid overall equity returns (top panel, Chart 1). These relationships are intuitive. Diminished macro tail risks bring earnings fundamentals to the forefront as the key driver of returns, and reward differentiation and discrimination in sector/region/asset class selection. While an eerie calm has dominated markets of late, as our Asset Class Volatility Indicator has collapsed to a multi-decade low (bottom panel, Chart 1), a more bullish explanation is that all-time highs in equities are synonymous with all-time lows in the VIX. This can be viewed as a contrary warning sign, but history shows that the VIX can stay depressed for a prolonged period. Our Equity Market Internal Dynamics Indicator (EMIDI), first introduced in late-March, has tentatively troughed, suggesting that sub-surface dynamics are becoming more supportive of the broad market (Chart 2). The EMIDI, which comprises relative bank, relative transport, small/large and industrials/utilities share prices, has been coincident to the leading market indicator, especially since the GFC. Chart 1Tumbling Correlations = Rising Stock Returns Tumbling Correlations = Rising Stock Returns Tumbling Correlations = Rising Stock Returns Chart 2Sub-Surface Dynamics Have Turned The Corner Sub-Surface Dynamics Have Turned The Corner Sub-Surface Dynamics Have Turned The Corner In that light, this week we are further augmenting our cyclical portfolio exposure by lifting another interest rate-sensitive group to overweight and are also updating the early cyclical media index and its major components. Capital Markets Stocks Have Rally Potential Two weeks ago, we recommended using this year's financial sector underperformance to boost allocations to overweight. This week we are further augmenting our exposure by upgrading the S&P investment banks & brokerage index to above benchmark. While the equity bull market is in the later innings, our view is that the overshoot will be extended for a while longer as a consequence of the overall sales and profit recovery and low probability that monetary conditions will tighten meaningfully in the near run. If this plays out, there is an opportunity for capital markets stocks to recover from their recent consolidation. This sub-index thrives when investor risk appetites are healthy and the business sector is moving from retrenchment to expansion mode, and vice versa. The outlook for increased capital formation has improved considerably. The corporate sector financing gap is beginning to widen anew (Chart 3), reflecting the surge in business and consumer confidence since the pro-business U.S. Administration took power. The widening financing gap is particularly notable because it is occurring alongside improving profit growth. In other words, the wider financing gap reflects accelerating capex demand, not weak corporate cash flows. This is confirmed by BCA's Capital Spending Indicator, which signals an increase in business investment ahead. Consequently, corporate sector demand for external capital should accelerate. The latter is the lifeblood of capital markets profitability. The nascent recovery in total bank credit growth after a period of malaise reinforces that working capital requirements are on the upswing (Chart 3).1 As businesses shift from maintenance capital spending to a more expansionist mindset, and companies reach further for growth to justify high stock valuations, capital markets activity could accelerate in the second half of the year. After all, investor confidence is high. Corporate bond spreads have tightened and corporate bond issuance is soaring. The Equity Risk Premium is steadily narrowing (shown inverted, second panel, Chart 4), reducing the cost of equity capital. New stock issuance is following on the heels of corporate bond issuance. Stocks are outperforming bonds by a comfortable margin and total mutual fund assets have grown sharply (Chart 3). The upshot is that access to corporate sector capital should stay healthy. As flows into equities advance, it will fuel a reacceleration in M&A activity (Chart 5). Chart 3Capital Markets Activity Is... Capital Markets Activity Is... Capital Markets Activity Is... Chart 4...Firing On All Cylinders ...Firing On All Cylinders ...Firing On All Cylinders Chart 5ROE On The Upswing ROE On The Upswing ROE On The Upswing Capital markets return on equity (ROE) is highly levered to business and investor risk appetite. Fees earned on M&A activity heavily influence overall profitability. As such, it is normal for ROE to expand when M&A activity picks up, and shrink when financial conditions tighten and takeovers dry up. Currently, M&A transactions represent an historically elevated share of GDP, but that is not a barrier to an increased rate of takeover activity. Companies are no longer using their balance sheets to repurchase their own shares en masse. Instead, there is an incentive to pursue business combinations as the global economy reaccelerates, underscoring that capital allocation should shift in favor of capital markets firms. Indeed, Chart 5 shows that ROE also follows the trend in our global leading economic indicator, and the current message is bullish. Even capital markets companies themselves confirm that their pipelines are full. Hiring activity remains robust. Pro-cyclical firm headcount rises quickly alongside revenue opportunities, and is just as quick to shrink when the outlook darkens. Ergo, we interpret headcount growth as a net positive. While trading activity is always a wildcard, and could be a source of weakness if bond market, and generalized asset class, volatility stays muted, the upbeat outlook for fee generation from increased capital formation provides us with confidence to use share price weakness as an opportunity to build a bigger position. Bottom Line: Lift the S&P investment banking & brokerage index to overweight, adding to our recent decision to upgrade the overall financials sector to above-benchmark. The ticker symbols for the stocks in this index are BLBG: S5INBK - GS, MS, SCHW, RJF, ETFC. Media Stocks: Temporary Pressure Media stocks have come under pressure recently, giving back all of this year's relative gains. Investor worries have centered around two thorny issues: cord-cutting and ad spending. Cord-cutting is not new, but weak overall Q1 TV subscriber numbers have refocused investors' attention on the secular challenges ahead. In addition, a number of companies noted softening ad spending on Q1 conference calls. According to media executives, this slowdown is not isolated to the automotive segment. Is it time to pull the plug or is a worst case scenario already priced into the group? We side with the latter. In aggregate, demand for media services is brisk. Consumer outlays on media have soared to a two decade high, hitting a double digit annual growth rate. S&P media sales are tightly correlated with media spending (second panel, Chart 6). Despite coming off the boil recently after hitting unusually high growth rates, media pricing power also remains in expansionary territory. Importantly, buoyant demand is boosting industry productivity gains. The third panel of Chart 6 shows that our media productivity proxy has reaccelerated. Meanwhile, an improving economic backdrop also bodes well for media earnings prospects. The ISM services new orders sub component has been an excellent leading indicator of relative profit growth expectations and the current message is positive (middle panel, Chart 7). If the overall economy bounces smartly from the weak Q1 print, as we expect, then an earnings-led recovery should sustain the valuation re-rating phase (bottom panel, Chart 7). Chart 6Buoyant Media Demand Buoyant Media Demand Buoyant Media Demand Chart 7Valuation Re-Rating Looms Valuation Re-Rating Looms Valuation Re-Rating Looms Our Ad Spending Indictor (ASI) incorporates all of these key media profit drivers, including consumption and overall corporate profits. The ASI has recently hooked up, signaling that earnings estimates should continue to rise (bottom panel, Chart 8). Nevertheless, sub-media group returns have been bifurcated, with the S&P movies and entertainment index exerting downward pressure on the overall sector of late. Relative performance has mostly treaded water since our upgrade last summer, but hit a soft patch after recent quarterly results. Before rushing to make a bearish judgment, it is notable that the relative forward P/E remains close to an undervalued extreme, signaling that it will be increasingly difficult to disappoint. Historically cheap valuations exist despite depressed expectations, which should serve to artificially inflate valuations: both top and bottom line are expected to lag the broad market, representing a very low hurdle (Chart 9). Chart 8Rosier EPS Prospects Lie Ahead Rosier EPS Prospects Lie Ahead Rosier EPS Prospects Lie Ahead Chart 9Unloved And Undervalued Unloved And Undervalued Unloved And Undervalued Beyond the positive consumer spending backdrop (Chart 10), we are inclined to stick with overweight positions in this sub-component for four major reasons. First, merger and acquisition activity should reduce capacity, and by extension, support pricing power, especially if the AT&T/Time Warner deal clears the regulatory hurdle. There is scope for additional M&A that could further reduce shares outstanding (Chart 11). Chart 10Improving Demand... Improving Demand... Improving Demand... Chart 11...And M&A Activity Are An EPS Tonic ...And M&A Activity Are An EPS Tonic ...And M&A Activity Are An EPS Tonic Second, content providers are adapting to the competitive threat. New online-only offerings and slimmer/nimbler packages should stem the drag from the likes of Netflix and other streaming services. Consumer spending on electronics continues to surge, suggesting that content providers have ample opportunity to fill increasing demand. Third, there is no substitute for live TV. News and live sports are two sticky offerings that will continue to be cash cows for the industry and drive select subscriber growth. Fourth, media giants have stepped up focus on other segments with higher growth potential, such as studios and franchises highlighting increasingly diversified revenue streams. Moreover, CEOs have been aligning cost structures to the new realities of cord-cutting, exercising strict cost control. Companies have also been careful with capex allocation decisions. All of this suggests that any shakeout in this media subgroup is a good entry point for building new positions with a compelling valuation starting point. Unlike the S&P movies and entertainment index, the S&P cable and satellite group has been relentlessly grinding higher, underpinning the broad media index. The multiyear share price advance has been cash flow driven. As a consequence, cable stocks still trade at a 25% discount to the broad market on a price/cash flow basis and the relative multiple is hovering near the historical mean (third panel, Chart 12). Cable and satellite sales growth has surged to healthy low double-digit growth rates after a one year lull. Encouragingly, soaring pricing power signals that recent revenue momentum is sustainable (second panel, Chart 12). As mentioned above, consumer outlays on cable services have had a V-shaped recovery, underscoring that the latest upleg in selling prices is demand driven (bottom panel, Chart 12). It is remarkable that the industry has consistently raised selling prices at a faster pace than overall inflation for decades (Chart 13). This impressive track record reflects cable operators' ability to continually evolve offerings and provide attractive content, even in the face of cord-cutting. Chart 12Cash Flow Driven Outperformance Cash Flow Driven Outperformance Cash Flow Driven Outperformance Chart 13The Cable Signal Is As Strong As Ever The Cable Signal Is As Strong As Ever The Cable Signal Is As Strong As Ever Meanwhile, content inflation rates have remained within the range of the past few years, underscoring that threats to robust profit margins are limited (bottom panel, Chart 13). More recently, news that Comcast and Charter will come together and cooperate on a wireless offering adds another layer of defense in effectively combating cord-cutting. How? By increasing the bundle offering beyond cable and internet services, cable providers are positioned to attract new clients by offering a one stop shop triple-play solution. A move into wireless service offerings would also assist in retaining existing customers. In sum, most of our indicators suggest that the demand outlook for media services continues to improve. Our Ad Spending Indicator is climbing, underscoring that fears of a deep and widespread slump are overblown. Bottom Line: The media index remains an overweight and we continue to recommend an above benchmark exposure both in the S&P movies and entertainment and S&P cable and satellite sub-groups. The ticker symbols for the stocks in these two indexes are BLBG: S5MOVI - DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. 1 Please see BCA U.S. Bond Strategy Weekly Report, "The Payback Period In Corporate Bonds," dated April 11, 2017, available at usbs.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

Please note that we are publishing a Special Report today titled "EM Local Bonds: Looking At Hedged Yields". Feature Commodities prices have plunged lately, even though the U.S. dollar, up until this past week, has been weak versus European currencies. Hence, the recent selloff in the commodities complex cannot be attributable to U.S. dollar strength. Something else has been at work. Furthermore, EM share prices and currencies have decoupled from both commodities prices and DM commodities currencies such as the AUD, NZD and the CAD (Chart I-1). Chart I-1Unsustainable Divergence Unsustainable Divergence Unsustainable Divergence Is this time different, and are we entering a new era in EM investing? We do not think so. This divergence is unsustainable and reflects irrational exuberance and fund flows into EM. The decoupling is already overstretched - although it could last another several weeks, it will not continue for much longer. We have the following observations: The commodities selloff has been very broad-based, and has been especially intense in commodities that are trading in China as well as those that are leveraged to Chinese growth (Chart I-2A & Chart I-2B). Such a simultaneous gap down in various commodities prices can be explained either by a decline in speculative long positions in commodities or weakness in real demand. It cannot be attributed to supply because the selloff has transpired at the same time across various commodities. Commodities' supply dynamics are idiosyncratic. China's central bank has been tightening liquidity, forcing deleveraging in the financial system. It is very plausible that this has led to an unwinding of long positions in commodities trading in China. Chart I-2AWidespread Carnage In Commodities Widespread Carnage In Commodities Widespread Carnage In Commodities Chart I-2BWidespread Carnage In Commodities Widespread Carnage In Commodities Widespread Carnage In Commodities China bulls would correctly argue that the selloff in commodities is indicative of a reduction in speculative trading activities - not in final demand. However, to be consistent, we should also accept that that the commodities rally in 2016 was not entirely due to demand improvement in China. Instead, it was at least partially due to speculative investment demand. It is impossible to quantify the magnitude of speculative activity in China's commodities markets, yet it has probably been a non-trivial force supercharging both last year's rally as well as the latest selloff. In regard to commodities demand from the real economy, China's growth has not yet turned decisively down. That said, the growth outlook is downbeat as credit growth downshifts in response to the ongoing policy tightening. Chart I-3 illustrates that the annual growth in the number and value of newly started projects has recently contracted. This heralds weaker demand for commodities, materials and capital goods in the months ahead. The surge in new projects launched last year marked the beginning of an upturn in industrial activity, and could well be indicative of a budding downtrend now. Besides, Chinese imports of industrial metals (excluding iron ore) has by and large been flat since 2010 (Chart I-4). The mainland's iron ore imports have been strong because inefficient/expensive domestic production has been shut down, leading to an increase in imports. Chart I-3China: Capital Spending To Slump Again China: Capital Spending To Slump Again China: Capital Spending To Slump Again Chart I-4China: No Growth In Industrial Metals' Imports China: No Growth In Industrial Metals' Imports China: No Growth In Industrial Metals' Imports Although China's oil imports have been strong (Chart I-5, top panel), underlying final demand has been weaker as there is evidence that the country has used imports of crude to increase inventories (Chart I-5, bottom panel). Provided that inventories are mean-reverting, such a large build-up in crude inventories poses a risk to China's oil demand and oil prices in the months ahead. Remarkably, the Brazilian real and South African rand have recently decoupled from the overall commodities price index and platinum prices, respectively (Chart I-6). These divergences represent a substantial departure from historical correlations. We cannot find any explanation other than the ongoing irrational exuberance in EM financial markets. Finally, signposts of potential growth deceleration are not only limited to the commodities complex. For example, Taiwanese narrow money (M1) impulse has decisively rolled over; it typically leads Taiwanese exports and correlates well with the equity market (Chart I-7). Chart I-5China's Oil Imports And An Inventories Proxy China's Oil Imports And An Inventories Proxy China's Oil Imports And An Inventories Proxy Chart I-6EM Commodity Currencies And Commodities Prices EM Commodity Currencies And Commodities Prices EM Commodity Currencies And Commodities Prices Chart I-7Taiwanese Export Growth And Equities Are At Risk Too Taiwanese Export Growth And Equities Are At Risk Too Taiwanese Export Growth And Equities Are At Risk Too Bottom Line: The recent decoupling between commodities prices and EM risk assets is unsustainable. This divergence reflects irrational exuberance that typically transpires around a major market top. While not chasing this rally has been painful, there is no point in doing so at current levels. We recommend investors maintain a negative stance on EM risk assets. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights Duration: U.S. growth expectations have become overly pessimistic. A Q2 rebound will lead to higher global bond yields and a steeper U.S. Treasury curve. UST / Bund Spread: The extreme divergence between the European and U.S. economic surprise indexes is not sustainable, especially in the face of weakening Chinese economic data. The Treasury / Bund spread is biased wider in the near term, though could tighten in the second half of this year as the ECB shifts to a less accommodative policy. USD Hedging Costs: Declining hedging costs driven by interest rate differentials and negative basis swap spreads make international bond investment very attractive for U.S. investors. Feature Chart 1Global Recovery Will Persist Global Recovery Will Persist Global Recovery Will Persist The synchronized global recovery that took hold in the second half of 2016 has stalled so far this year. Measures of economic sentiment, such as the Global ZEW survey and our own Boom/Bust Indicator, have rolled over from high levels and global bonds have clawed back some of last year's lost returns (Chart 1). Year-to-date, the Bloomberg Barclays Global Government Bond index has returned +3%, after having lost more than 9% between the July trough in the Global ZEW index and the end of last year. In our view, a repeat of early 2016's global growth slowdown and bond market rally, which saw the Global ZEW index fall below zero and the Global Government Bond index return 11.6% in 2016H1, is not in the cards. The global economy is on much firmer footing than at this time last year. U.S. Growth: Past Peak Pessimism First quarter U.S. GDP growth was a disappointing 0.7%, but is poised to bounce back strongly in Q2. The volatile inventories component subtracted 0.9% from overall Q1 growth, harsh weather wreaked havoc on the March employment report and there continue to be problems with residual seasonality depressing first quarter GDP data.1 The outlook is much brighter moving forward. The latest employment report showed that the U.S. economy added a healthy 211k jobs in April and our model is pointing toward a further acceleration (Chart 2). Economic growth can be thought of as a combination of aggregate hours worked and labor productivity (Chart 3). With aggregate hours worked growing at 1.7% year-over-year and labor productivity growth having averaged 0.6% (annualized) per quarter since 2012, real U.S. GDP growth of around 2.3% seems like a reasonable forecast. Chart 2Labor Market Still Strong Labor Market Still Strong Labor Market Still Strong Chart 3Look For Above 2% Growth Look For Above 2% Growth Look For Above 2% Growth There is even some reason to suspect that labor productivity could strengthen during the next few quarters. A recent IMF paper2 attributed weak post-crisis productivity growth to a combination of structural and cyclical factors, but also noted that weak investment in physical capital may be responsible for lowering total factor productivity growth by nearly 0.2 percentage points per year in advanced economies during the post-crisis period. With leading indicators pointing to still further gains in fixed investment (Chart 3, bottom panel), we would not be shocked to see productivity growth enjoy a modest late-cycle rebound. Chart 4Stronger Productivity = Steeper Curve Stronger Productivity = Steeper Curve Stronger Productivity = Steeper Curve All else equal, a late-cycle rebound in productivity growth would slow the increase in unit labor costs. Unit labor costs are a combination of wages (compensation-per-hour) and productivity (output-per-hour), and have historically tracked changes in the slope of the U.S. yield curve (Chart 4). Faster wage growth tends to coincide with Fed tightening, and slower wage growth with Fed easing. For this reason, all wage measures perform reasonably well tracking changes in the yield curve. But unit labor costs perform best because they also incorporate productivity growth, and low productivity growth can flatten the yield curve by pulling down long-dated yields. Rapid increases in compensation-per-hour and muted productivity growth have combined to give the yield curve a strong flattening bias during the past several years. Any increase in productivity growth would slow the uptrend in unit labor costs relative to other wage measures, allowing the yield curve to steepen. In fact, we continue to recommend that investors position for a steeper U.S. yield curve by going long the 5-year Treasury note and shorting a duration-matched barbell consisting of the 2-year and 10-year notes. This trade produces positive returns when the 2/10 slope steepens (Chart 4, panel 3), but has also returned +19 bps since we initiated the position last December, even though the curve has flattened since then. The reason for the trade's strong performance in an unfavorable curve environment is that the 5-year yield had been unusually elevated compared to the rest of the curve. Our model of the 2/5/10 butterfly spread versus the 2/10 slope showed that the 5-year note was one standard deviation cheap on the curve as recently as mid-March (Chart 4, bottom panel). This undervaluation has mostly dissipated and the 5-year note now appears only slightly cheap. For our curve trade to outperform from here, it will likely require the 2/10 slope to steepen.3 Bottom Line: With weak Q1 GDP now in the rearview mirror, we are likely past the point of peak pessimism on U.S. growth. Expect global bond yields to rise and the U.S. yield curve to steepen as the economic data start to reflect an environment of above-trend growth, in the neighborhood of 2% - 2.5%. European Growth & The Risk From China While the U.S. data have disappointed in recent weeks, as evidenced by the U.S. Economic Surprise Index having dipped below zero (Chart 5), the European economy has consistently bested expectations (Chart 5, panel 2). As a result, the Treasury / Bund spread has narrowed from high levels during the past few months. In practice, economic surprise indexes tend to mean revert because positive data surprises beget increasingly optimistic expectations. Eventually, overly optimistic expectations become too high a hurdle and the data start to disappoint. In our view, U.S. expectations have become unduly pessimistic while the Eurozone surprise index appears overdue for a correction. Against this back-drop, we expect the Treasury / Bund spread to widen in the near term as the large divergence between the U.S. and European surprise indexes starts to narrow. Further making the case for a wider Treasury / Bund spread is the recent performance of the Chinese economy. Our Foreign Exchange Strategy service recently observed that growth differentials between the U.S. and Europe are highly correlated with indicators of Chinese growth.4 This should not be overly surprising since Europe trades more with China and other Emerging Markets than does the United States. Along those lines, the IMF has calculated that a 1% growth shock to Emerging Markets impacts European growth by nearly 40 basis points, while it impacts U.S. growth by only 10 basis points.5 The worry at the moment is that Chinese monetary conditions have started to tighten, and China's Manufacturing PMI is rolling over alongside weaker commodity prices. These trends usually coincide with the underperformance of Europe relative to the U.S. (Chart 6). Chart 5Surprise Indexes Will Converge Surprise Indexes Will Converge Surprise Indexes Will Converge Chart 6Look To China To Trade UST / Bund Spread Look To China To Trade UST / Bund Spread Look To China To Trade UST / Bund Spread Our China Investment Strategy service highlights the importance of the trade-weighted RMB as a driver of Chinese growth.6 The RMB's 30% appreciation between 2012 and 2015 applied a massive deflationary force to China's economy, while its more recent depreciation helped boost producer prices, enhance profit margins and reduce the real cost of funding (Chart 7). Chart 7Monetary Conditions ##br##Still Fairly Stimulative Monetary Conditions Still Fairly Stimulative Monetary Conditions Still Fairly Stimulative More recently, the pace of the RMB's depreciation has slowed and this likely explains the weakness in China's Manufacturing PMI and commodity prices. Our China strategists are quick to note that while the pace of RMB depreciation has slowed, it is still not appreciating, and real interest rates deflated by the producer price index remain negative. In other words, monetary conditions have become somewhat less stimulative, but they should still be supportive of further economic growth. Although the Chinese economic data are likely to moderate in the coming months, barring the major policy mistake of aggressive tightening, Chinese growth will avoid a collapse and remain reasonably buoyant. Similarly, we would also expect European growth expectations to soften in the coming months, but growth is very likely to remain above trend and the ECB is still on track to adopt a less accommodative policy stance over the next year. In the most likely scenario, a few hints will be given at the June ECB meeting, and then an announcement that asset purchases will be tapered in 2018 will be made at the September meeting. The market will correctly assume that rate hikes will follow the taper, and this re-pricing of rate expectations will open up a window in the second half of this year when the Treasury / Bund spread can tighten. However, it is still too soon to adopt this position. Bottom Line: The extreme divergence between the European and U.S. economic surprise indexes is not sustainable, especially in the face of weakening Chinese economic data. The Treasury / Bund spread is biased wider in the near term, though could tighten in the second half of this year as the ECB shifts to a less accommodative policy. U.S. Bond Investors Should Expand Their Borders Divergences that have opened up between U.S. short-term interest rates and short-term rates in other developed countries mean that U.S. bond investors now face much lower currency hedging costs. In addition, increasingly negative cross-currency basis swap spreads have become a permanent feature of the post-crisis investment landscape, and unless significant regulatory changes occur, we expect they are here to stay. Combined, both of these factors make it incredibly attractive for U.S. bond investors to swap their U.S. dollars for foreign currencies and invest in foreign government bonds. In this week's report we explain why this is an attractive trade for U.S. investors and why it will likely remain so for quite some time. What Is The Basis Swap Spread? An excellent definition of the cross-currency basis comes from the Bank for International Settlements (BIS) who define it as "the difference between the direct dollar interest rate in the cash market and the implied dollar interest rate in the [currency] swap market".7 In essence, the existence of a negative basis swap spread should mean that there is an opportunity to arbitrage the difference between interest rates in the cash market and implied interest rates in the currency swap market. However, post-crisis regulatory constraints on bank balance sheets appear to have made this arbitrage prohibitive. Banks are either unable or unwilling to arbitrage the basis swap spread back to zero, and this increases the cost of U.S. dollars in FX swap markets. As a quick example, we can calculate the 10-year German Bund yield hedged into U.S. dollars using currency forwards. Hedged yield = Unhedged yield - Cost of hedging Where: Cost of hedging = forward exchange rate / spot exchange rate In this case, we define the exchange rates as euros per 1 U.S. dollar. By covered interest rate parity, we can also calculate the cost of hedging as: Cost of hedging = (1 + euro interest rate + basis swap spread) / (1 + USD interest rate) Using current 3-month interest rates, this means that the cost of hedging from euros into U.S. dollars is: Cost of hedging = (1 - 0.36% - 0.3%) / (1 + 1.18%) = -1.82% This means that the 10-year German Bund yield rises from 0.42% to 2.24%, from the perspective of a U.S. dollar investor, after hedging the currency on a 3-month horizon. In other words, U.S. investors can significantly increase the average yield of their portfolios by lending U.S. dollars over short time horizons and investing the proceeds into non-U.S. bonds. In Chart 8 we show the difference this currency hedging makes for German, Japanese and French 10-year government bonds. Current hedged 10-year yields for all the major bond markets are also shown on page 13 of this report. But for how long can this trade continue? In short, it can continue for as long as U.S. short-term interest rates increase relative to non-U.S. short-term interest rates and for as long as basis swap spreads move further into negative territory. At the moment there is no widespread agreement on what drives the day-to-day fluctuations in the basis swap spread. The BIS has posited a model where dollar strength weakens the capital positions of bank balance sheets, causing them to back away from providing liquidity to the FX swap market, and leading to increasingly negative basis swap spreads (Chart 9, top panel). Chart 8Higher Yields Via Currency Hedging Higher Yields Via Currency Hedging Higher Yields Via Currency Hedging Chart 9Basis Swaps, Reserves And The Dollar Basis Swaps, Reserves And The Dollar Basis Swaps, Reserves And The Dollar Meanwhile, Zoltan Pozsar from Credit Suisse has identified a link between basis swap spreads and reserves on the Fed's balance sheet (Chart 9, bottom panel).8 Specifically, as the Fed winds down its balance sheet it will be draining cash reserves from the banking system and replacing them with Treasury securities. This could cause money to leave the FX swap market and flow into Treasuries. The result is less liquidity in the FX swap market and increasingly negative basis swap spreads. Interestingly, the run-up to the debt ceiling in the U.S. has presented a test of this view. To stay under the debt ceiling the U.S. Treasury department has drawn down its cash account at the Fed and removed T-bill supply from the market. The result has been a temporary increase in reserve balances. As the theory would have predicted, basis swap spreads have moved closer to zero as reserves have increased. Going forward, the Fed is very likely to start winding down its balance sheet later this year. In all likelihood this will serve to pressure basis swap spreads even further below zero. Meanwhile, short-term interest rates in the U.S. will probably continue to rise more quickly than in most other developed markets. This means that the cost of hedging should become increasingly negative for U.S. investors. In Chart 10 we show that as the cost of hedging becomes more negative, total returns from a USD-hedged position in German bunds tend to outpace total returns from a position in U.S. Treasuries. Similarly, Chart 11 shows that USD-hedged Japanese government bonds (JGBs) also tend to outperform U.S. Treasuries when the cost of hedging falls. Chart 10Hedging Costs & Bond Returns: Germany Hedging Costs & Bond Returns: Germany Hedging Costs & Bond Returns: Germany Chart 11Hedging Costs & Bond Returns: Japan Hedging Costs & Bond Returns: Japan Hedging Costs & Bond Returns: Japan We should note that the relationships between hedging costs and relative total returns shown in Charts 10 & 11 are not perfect, and there will be instances when Treasuries can outperform even if hedging costs continue to decline. However, in the long run, as long as short-term U.S. interest rates continue to rise more quickly than short-term interest rates in the Eurozone or Japan, and especially if the Fed's upcoming balance sheet contraction leads to more deeply negative basis swap spreads, then U.S. investors should continue to boost their yields by lending dollars and investing in bunds and JGBs. Bottom Line: Declining hedging costs driven by interest rate differentials and negative basis swap spreads make international bond investment very attractive for U.S. investors. Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com 1 Our U.S. Investment Strategy service took up the issue of residual seasonality in a recent report. Please see U.S. Investment Strategy Weekly Report, "Spring Snapback?", dated April 24, 207, available at usis.bcaresearch.com 2 IMF Staff Discussion Note, "Gone with the Headwinds: Global Productivity", https://www.imf.org/en/Publications/Staff-Discussion-Notes/Issues/2017/04/03/Gone-with-the-Headwinds-Global-Productivity-44758 3 Our outlook for the U.S. yield curve was discussed in detail in a recent report. Please see U.S. Bond Strategy Weekly Report, "The Yield Curve On A Cyclical Horizon", dated March 21, 2017, available at usbs.bcaresearch.com 4 Please see Foreign Exchange Strategy Weekly Report, "ECB: All About China?", dated April 7, 2017, available at fes.bcaresearch.com 5 IMF Multilateral Policy Issues Report: 2014 Spillover Report https://www.imf.org/external/np/pp/eng/2014/062514.pdf 6 Please see China Investment Strategy Weeky Report, "Has China's Cyclical Recovery Peaked?", dated May 5, 2017, available at cis.bcaresearch.com 7 http://www.bis.org/publ/work592.pdf 8 https://ftalphaville.ft.com/2017/04/13/2187317/where-would-you-prefer-your-balance-sheet-banks-or-the-federal-reserve/ Fixed Income Sector Performance Recommended Portfolio Specification

Highlights We are going long spot gold at tonight's closing price, given our view that inflation and inflation expectations will continue to move higher going into 2018. In the U.S., we expect higher fiscal spending and tax cuts hitting the economy next year to have a significant effect on an economy already at or very close to full employment, boosting real wages and inflationary pressures. As a safe-haven, gold also is well suited to hedging geopolitical risks, which also are rising. Lastly, gold exposure has the added benefit of providing a hedge to equity positions. Energy: Overweight. The ~ 10% correction in benchmark crude oil prices from 1Q17 levels likely has run its course, as representatives of key states that are party to the November 2016 production cut deal signal it will be extended at the upcoming May 25 meeting in Vienna. We remain long Dec/17 Brent $65/bbl calls vs. short the Dec/17 Brent $45/bbl puts, which is down $0.88/bbl, and will be getting long Dec/17 Brent $55/bbl calls vs. Dec/17 $60/bbl calls at tonight's close. We expect Dec/17 Brent to reach $60/bbl by year-end, with WTI trading ~ $2.00/bbl lower. Base Metals: Neutral. Indonesia's state mining company PT Aneka Tambang is expected to resume nickel exports, reversing a three-year ban on outgoing trade. We remain neutral base metals. Precious Metals: Neutral. We are recommending an allocation to gold outright as a strategic hedge against higher inflation, particularly emanating from the U.S., and geopolitical risk in Europe (see below). Underweight. Markets remain well stocked with indications stocks-to-use data will continue to weigh on prices. We remain bearish. Feature Recent indications inflation and inflation expectations are ticking higher will persist into 2018 (Chart of the Week). U.S. fiscal spending and tax cuts expected next year will lift real wages and boost spending power. The American economy already is at or very close to full employment, and U.S. rate hikes are lagging wage growth, which will, all else equal, boost inflation and inflation expectations (Chart 2). Although we expect the Fed to raise rates at least two more times this year - perhaps three - we believe the central bank will continue to keep rate hikes behind wage growth, and will not try to get out in front of inflation (Chart 3). Chart Of The WeekGlobal CPI Inflation Continues To Percolate Global CPI Inflation Continues To Percolate Global CPI Inflation Continues To Percolate Chart 2Rate Hikes Lagging Wage Growth Rate Hikes Lagging Wage Growth Rate Hikes Lagging Wage Growth Chart 3Fed Likely Won't Get Ahead Of Inflation Fed Likely Won't Get Ahead Of Inflation Fed Likely Won't Get Ahead Of Inflation On the political and geopolitical fronts, looming Italian elections are a risk that is all but being ignored by financial markets. Our colleague Marko Papic, head of BCA's Geopolitical Strategy service, identifies next February's Italian elections as "the highest probability risk to European integration at the moment," given its potential to "reignite Euro Area breakup risk."1 Political risks dog the DM economies: falling support for globalization, which will undermine the benefits of sourcing low-cost inputs (labor and capital) worldwide; tighter immigration policies, which go hand-in-hand with falling support for globalization; a predisposition to monetize debt via higher money supply; and higher minimum-wage demands as income inequality increases all raise inflation and inflation expectations in DM economies.2 This financial and political backdrop again points us toward gold in an attempt to identify safe-haven assets and hedges against the increasing likelihood of renewed inflation. In addition, while our House view does not include a marked equities correction in the near term, it is worthwhile pointing out that gold does hedge equities when they are selling off, and in bear markets generally. A corollary to this property is that in equity bull markets, gold tends to hold value, even if it underperforms stocks in absolute terms. These are powerful properties, which increase the stability of investors' portfolios. Before proceeding, it is useful to distinguish between the specifications mentioned above:3 A safe-haven asset refers to an asset that is negatively correlated (or uncorrelated) with other assets that lose value in times of financial stress. An important feature of a safe-haven asset is that it only exhibit low or negative correlation with financial assets (e.g., equities) in extremely negative market conditions, without specifying any particular behavior when markets are not under stress. In other words, both assets could be positively correlated in bull markets, as long as the correlation turns negative when financial-market conditions deteriorate. We make a distinction between the weak and strong form of safe-havens: The weak form represents an asset that is uncorrelated with the reference asset, while the strong form is negatively correlated.4 A hedge is an asset that is negatively correlated (or uncorrelated) with another asset, on average, over the time interval being examined in a particular analysis. As with safe-haven assets, there is a similar distinction between weak- and strong-form hedges. A diversifier refers to an asset that is positively, but imperfectly, correlated with another asset on average during the period of analysis. Gold Vs. Inflation During inflationary periods, assets that generate returns for investors that offset purchasing-power losses experienced by other assets in their portfolio - i.e., a store of value - traditionally have been preferred. Gold has been used as a store of value during inflationary episodes, and for this reason is viewed as a safe haven. Fundamentally, gold's supply is relatively inelastic, and consists of above-ground physical stocks comprising public and private holdings. The world gold council estimates physical gold stocks were ~ 4570.8t at the end of 2016, up 5.8% since 2010. Demand for gold was estimated at 4249.1t at the end of 2016, versus 3281t at the end of 2000. The inelasticity of gold supply makes it difficult to respond to changes in inflation - or to any shocks to the economy, for that matter - by increasing the supply over the short term, as it would be the case with any fiat currencies and other assets. For this reason, price allocates limited supply. During inflationary periods and during a macroeconomic shock, gold's price is bid up, which is the source of returns for holding gold.5 Gold often is seen as a currency; however, it lacks a central bank that can increase its supply via turning up the printing press. This makes the precious metal a so-called "hard currency," and endows it with the ability to maintain its purchasing power during periods of inflation. In addition, it is an asset that is accepted as collateral to support bank lending and margining by the BIS and numerous banks.6 In Table 1, we look at the correlation between year-on-year gold return and U.S. CPI inflation.7 We used a sample period from 1985 to now.8 On average, during the entire sample, we obtained a correlation of 26%. Within the sub-periods gold provides a hedge against inflation, but how much of a hedge depends on other financial factors - chiefly the broad USD TWI and real U.S. interest rates - affecting its performance (Chart 4). We examine these below. Table 1Gold Vs. U.S.##BR##And EU Inflation Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge Chart 4Gold's Inflation-Hedging Properties##BR##Affected By Monetary Conditions Gold's Inflation-Hedging Properties Affected By Monetary Conditions Gold's Inflation-Hedging Properties Affected By Monetary Conditions The hedging relationship between gold returns and the CPI inflation rates does not consistently hold up in all bear markets - e.g., the GFC, when global assets became highly correlated and lost significant value. It is possible, though, that in times of financial stress or downturn, gold's ability to act as a hedge asset to U.S. equities might sometime dominates its ability to hedge inflation, leading to an ambiguous relationship with inflation during bear markets. We delve further into this below. Gold, Inflation And U.S. Monetary Conditions We typically model gold as a function of financial variables, which are sensitive to inflation and inflation expectations and to Fed policy shifts. Given our preference for modeling gold's price evolution as a function of U.S. financial variables - the broad trade-weighted (TWI) USD and real rates, in particular - we looked further into this (Chart 5). The impact of inflation on gold prices is stronger when the dollar experiences large negative shocks and depreciates, and weaker when the USD appreciates (i.e., a large positive shock).9 So, when the USD broad TWI is falling, gold is an effective hedge. When the greenback is appreciating, it is less effective. Next, we examined the ability of gold to hedge inflation risk when U.S. real rates are high and low. To do this, we used 10-year real rates and cut a long-term sample from 1990 to now into two different sub-periods: a high-rate period from 1990 to 2003, and a low-rate period from 2003 to now (Chart 6).10 Chart 5USD's Evolution Is Important To Gold,##BR##As Are U.S. Real Rates USD's Evolution Is Important To Gold, As Are U.S. Real Rates USD's Evolution Is Important To Gold, As Are U.S. Real Rates Chart 6U.S. 10-Year##BR##Real Rates U.S. 10-year Real Rates U.S. 10-year Real Rates During the high-real-rate period, the correlation between gold and inflation is close to zero (0), meaning gold did not act as a strong hedge against inflation, but still could have been acting as a weak hedge (meaning it's uncorrelated). Gold's hedging ability increased significantly in the low-real-rate period (Table 2). Again, this supports our theory that gold's hedging ability depends on U.S. monetary conditions, and that during periods of low real U.S. interest rates gold is an effective hedge against inflation. Table 2Gold Vs. CPI Inflation In High- And Low-Real Rate Environments Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge Gold Vs. U.S. Equities Cutting right to the chase, gold can be used to hedge equities exposure in portfolios, as the correlation analysis in Table 3 demonstrates. Here, we are examining the hedging ability of gold relative to the U.S. stock market (proxied by the S&P 500 Total Return (TR) index). Table 3Gold's Hedging Properties Vs. Equities Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge In our analysis, we find gold and U.S. equities are negatively correlated, on average, over the entire sample (correlation coefficient -0.19). We also tested for time-varying correlation by looking at the correlation separately in different bull- and bear-market sub-periods. Bull (bear) markets are defined as periods in which the U.S. stock index has a positive (negative) move of more than 15% and that lasts for at least 3 months.11 During both bear markets, gold's annualized compound returns were up when the S&P 500 returns were negative (Table 4). This strongly suggests gold is a safe-haven asset in time of extended weakness for equities, all else equal (i.e., we don't have a 100-year global meltdown that takes all correlations to 1.00). Interestingly, the relationship is unclear for bull markets which reflects the non-linearity in gold's hedging ability. We can conclude that during bull markets, gold tends to underperform equity markets; however, this does not imply that holding gold will lead to negative returns. Hence, gold offers protection against bear markets that offsets the costs in terms of returns during bull markets.12 Table 4Gold Hedges U.S. Equities Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge The correlation between month-on-month gold and S&P 500TR returns corroborate the earlier finding. We find that gold is negatively correlated with U.S. equities during equity bear markets, and that it is ambiguous in equity bull markets. Bottom Line: We find gold is a good hedge during inflationary periods, particularly when the USD TWI is weak and real rates are low. We also show gold has excellent safe-haven and hedging properties versus equities (using the S&P 500TR index as a proxy). Based on this analysis, we are recommending a strategic allocation to gold, and will get long at tonight's close. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com Hugo Bélanger, Research Assistant Commodity & Energy Strategy hugob@bcaresearch.com 1 Please see "Political Risks Are Understated in 2018," published on April 12, 2017, by BCA Research's Geopolitical Strategy. It is available at gps.bcaresearch.com. 2 Please see "The End Of the Anglo-Saxon Economy?" published April 13, 2016, by BCA Research's Geopolitical Strategy. It is available at gps.bcresearch.com. 3 Baur, Dirk G.; Brian M. Lucey (2010), "Is Gold a Hedge or a Safe Haven? An Analysis of Stocks, Bonds and Gold". The Financial Review 45, 217-229. 4 Baur, Dirk G.; Thomas K.J. McDermott (2010), "Is Gold a Safe Haven? International Evidence", Journal of Banking & Finance 34, 1886-1898. 5 We would note that the real price of gold increased during the Great Depression, which indicated gold's value during a period of significant deflation appears to increase, perhaps as investors fear the debasement of their currencies and the subsequent loss of purchasing power. 6 Please see Section 4 of "Basel III counterparty credit risk and exposures to central counterparties - Frequently asked questions," published by the BIS December 2012. 7 We use CPI here because it drives the payout of inflation-linked securities in the U.S. 8 We begin our analysis in 1990 for consistency throughout. We also note that several papers take note of an important structural break in U.S. inflation around 1984. Please see Batten, Jonathan A.; Cetin Ciner; Brian M. Lucey (2014), "On The Economic Determinants Of The Gold-Inflation Relation", Resources Policy 41, 101-108; and Stock, James H.; Mark W. Watson (2007), "Why Has U.S. Inflation Become Harder to Forecast?", Journal of Money, Credit and Banking 39 (supplement). For the selection of bear and bull markets, please see "Monthly Economic Report" published on April 2017, by Mackenzie investments. 9 We did this by estimating a regression to see how gold responds when the broad trade-weighted USD is trading in the 5% and 90% quantile of year-on-year U.S. dollar variation over the period 1995 to present. We did this using dummy variables to represent the impact of U.S. inflation in periods of large dollar appreciation and dollar depreciation. The model's adj-R2 is 0.45, and all coefficients are significant below 5%. 10 The mean for the high-rates period is 3.77%; for the low-rates period it is 1.07%. These rates are statistically different between these two sub-periods (using a two-tailed t-test). 11 The selection of bull and bear markets is based on Mackenzie investment analysis. Please see "Monthly Economic Report" published on April 2017, by Mackenzie investments. 12 Our results were supported by further econometric analysis of the variance properties using GARCH modeling. These results are available upon request. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed In 2017 Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge Go Long Gold As A Strategic Portfolio Hedge Summary Of Trades Closed In 2016

Highlights Ongoing monetary tightening in China poses a substantial threat to EM risk assets. Yet financial markets remain highly complacent. Mind the gap between EM risk assets and commodities currencies/various commodities prices. Business conditions in EM ex-China will diverge from the U.S. and European economies and recouple to the downside with China's growth. The pillars of the EM business cycle are China, commodities, and their own domestic credit cycle, rather than the U.S. and Europe. Continue shorting/underweighting the Malaysian currency, stocks and sovereign credit. Feature Chart I-1China: Ongoing Liquidity Tightening China: Ongoing Liquidity Tightening China: Ongoing Liquidity Tightening There is one major underappreciated risk in global financial markets: China's gradual yet unrelenting monetary tightening. Though slow and measured, this policy tightening constitutes a significant risk, particularly for emerging markets. The basis is that it could trigger a disproportionally large negative effect on Chinese growth because it is taking place amid a lingering credit bubble in China.1 Mainland interbank rates and onshore corporate bond yields have risen as the People's Bank of China (PBoC) has reduced its net liquidity injections via open market operations (Chart I-1, top panel). The PBoC's monetary tightening is bound to reduce money/credit growth in China. The bottom panel of Chart I-1 demonstrates that changes in the central bank's claims on commercial banks lead by 3 months asset growth at commercial banks. Diminished liquidity injections by the PBoC will soon push commercial banks to reduce the pace of their balance sheet expansion. Asset growth/loan origination among policy banks2 has already slowed (Chart I-2). On top of this, China's regulatory tightening aimed at curbing speculative (high-risk) financial activity will also curtail commercial banks' loan origination. For example, bank regulators are forcing banks to bring off-balance-sheet assets onto their balance sheets. As a result, money/credit growth is set to decelerate meaningfully. This, in turn, will cause another slump in this credit-addicted economy. It is very probable that the mini-business cycle in China has already reached its peak - our credit and fiscal impulse heralds further drop in the manufacturing PMI (Chart I-3). Chart I-2Commercial Banks And Policy ##br##Banks' Loan Growth To Slow Further Commercial Banks And Policy Banks' Loan Growth To Slow Further Commercial Banks And Policy Banks' Loan Growth To Slow Further Chart I-3China's Growth Has Rolled Over China's Growth Has Rolled Over China's Growth Has Rolled Over While China's monetary tightening is not a direct risk to domestic demand in the U.S. or Europe, it poses an imminent risk to commodities prices and EM risk assets. Consistent with slowing Chinese manufacturing output growth, commodities prices trading in mainland China have lately tanked. Bottom Line: BCA's Emerging Markets Strategy team maintains that ongoing monetary tightening in China poses substantial risks to EM risk assets and commodities. Yet financial markets remain complacent. Perplexing Complacency It is very perplexing that EM risk assets have so far ignored the risks stemming from China's tightening and renewed relapse in commodities prices. It seems portfolio allocation into risk assets, including those in the EM universe, is pushing prices higher irrespective of a major relapse in forward-looking indicators for both China and EM growth. EM stocks, currencies and credit spreads have decoupled from a number of indicators with which they historically had a high correlation: In recent weeks, we have brought to investors' attention that an unsustainable gap has been opening between the commodities currencies index - an equal-weighted average of AUD, NZD and CAD - and both EM exchange rates and EM share prices in local currency terms (Chart I-4A & Chart I-4B). Chart I-4AHeed The Message From Commodities Currencies Heed The Message From Commodities Currencies Heed The Message From Commodities Currencies Chart I-4BHeed The Message From ##br##Commodities Currencies Heed The Message From Commodities Currencies Heed The Message From Commodities Currencies Not only have commodities currencies decisively rolled over, but also commodities prices have begun sliding. Historically, EM risk assets in general and the sovereign credit market in particular have always sold off when commodities prices have drifted lower (Chart I-5). EM equity volatility is back to its lows (Chart I-6). This corroborates reigning complacency in the marketplace. Chart I-5Commodities Prices And ##br##EM Sovereign Spreads Commodities Prices And EM Sovereign Spreads Commodities Prices And EM Sovereign Spreads Chart I-6A Sign Of Complacency A Sign Of Complacency A Sign Of Complacency EM sovereign and corporate spreads have also fallen to their narrowest levels in recent years (Chart I-7). Notably, our valuation model for EM corporate bonds - which is constructed based on our EM Corporate Financial Health Index - posits that EM corporate credit is very expensive (Chart I-8). Chart I-7EM Sovereign And Corporate Spreads EM Sovereign And Corporate Spreads EM Sovereign And Corporate Spreads Chart I-8EM Corporate Credit Is Expensive bca.ems_wr_2017_05_03_s1_c8 bca.ems_wr_2017_05_03_s1_c8 Finally, EM local currency bond yield spreads over U.S. Treasurys have also dropped a lot, signifying complacency on the part of EM investors (Chart I-9). Chart I-9EM Local Bond Yield Spreads ##br##Over U.S. Treasurys Are Low EM Local Bond Yield Spreads Over U.S. Treasurys Are Low EM Local Bond Yield Spreads Over U.S. Treasurys Are Low Bottom Line: EM financial markets are not cheap, and investors are highly complacent. Mind the gap between EM risk assets and commodities currencies/various commodities prices. Can EM Decouple From China? An oft-asked and relevant question is whether EM ex-China can decouple from China itself. Not for the time being, in our view. On the contrary, as we argued in last week's report titled Toward A Desynchronized World,3 China's slowdown will weigh on the majority of the EM investable equity, currency and credit markets. As a result, growth conditions in EM ex-China will diverge from the U.S. and European economies and recouple to the downside with China's growth. The three pillars of EM ex-China growth are commodities, China and their domestic credit cycles. The primary link is via commodities. As China's growth decelerates and its imports relapse, commodities prices will plunge (Chart I-10). Latin America, Africa, the Middle East, Russia, Malaysia and Indonesia are set to experience negative terms-of-trade shocks as commodities prices deflate. As a result, their currencies will depreciate and growth will suffer. Although Mexico is leveraged to the U.S., oil prices still matter for it. This leaves non-commodities producing economies in Asia and central Europe. The latter is too small to matter for EM benchmarks. Central Europe correlates with Europe's business cycle rather than EM. In emerging Asia, Korea and Taiwan - the largest equity market cap weights after China in the MSCI EM index - sell much more to China than to the U.S. and Europe combined. Korea's shipments to China account for 25% of total exports while those to the U.S. and Europe combined make up 22%. For Taiwan the numbers are 27% and 20%, respectively. Thailand sells to China as much as it does to the U.S. This by and large leaves only three mainstream EM economies that are not substantially exposed to China: India, the Philippines and Turkey (Table I-1). Indian and Philippine stocks are expensive, and these nations confront their own unique problems. Turkey in turn is facing major political, economic and financial predicaments. Chart I-10Industrial Metals Prices To head Lower bca.ems_wr_2017_05_03_s1_c10 bca.ems_wr_2017_05_03_s1_c10 Table I-1Export To China And U.S. Perplexing Complacency: Underappreciated EM Risk Perplexing Complacency: Underappreciated EM Risk In short, among mainstream EM countries, there are very few plays not exposed to China or commodities and offer a reasonable risk/return profile. Investors also often ask if commodities importing economies in Asia can rally in absolute terms when and as commodities prices drop. Chart I-11 illustrates the Korean and Taiwanese equity indexes have historically (in the past 20 years) been strongly correlated with oil and industrial metals prices. The reason is that commodity price swings partially reflect global growth conditions. Being heavily dependent on exports, Korea and Taiwan are highly sensitive to fluctuations in global growth. We expect global trade to slow down anew, driven by weakness in China/EM imports, even if U.S. and European demand remains resilient. We elaborated on this theme in last week's report.4 Therefore, Korean and Taiwanese export shipments are set to slow as well. We are not bearish on Korean and Taiwanese domestic demand - we are in fact overweight these bourses within the EM equity universe, with a focus on technology and domestic sectors. That said, consumer and business spending in these economies is relatively small in a global context to make a difference for other EM markets. In addition, given these economies' mature phase of development, the pace of their income and domestic demand growth will be moderate. Many EM countries have experienced excessive credit growth in the past 15 years, but their banking systems have not restructured - i.e. banks have not sufficiently provisioned for non-performing loans. Until they do so, domestic loan growth remains at risk of weakening. There has been modest deleveraging in Brazil, Russia and India (Chart I-12). However, there is no evidence that these economies have embarked on a new credit cycle. Chart I-11Korean And Taiwanese Stocks ##br##Correlate With Commodities Korean And Taiwanese Stocks Correlate With Commodities Korean And Taiwanese Stocks Correlate With Commodities Chart I-12Some Moderate Deleveraging ##br##In Brazil, Russia And India Some Moderate Deleveraging In Brazil, Russia And India Some Moderate Deleveraging In Brazil, Russia And India Case in point are Indian state-owned banks: their experience shows that deleveraging can be more protracted and painful than one might initially expect. The reason is that it takes time for banks to acknowledge non-performing loans, be recapitalized and get ready to boost loan growth again. In addition, Brazil and Russia are still commodities plays at the mercy of commodities price dynamics. Besides, Brazil needs to undergo painful fiscal adjustment/reforms. In other developing countries, bank loan growth remains elevated and bank loan-to-GDP ratios continue to rise (Chart I-13). In these economies, credit retrenchment and even a mild deleveraging has not yet occurred. Prominently, as EM currencies come under downward pressure, interest rates in many economies running current account deficits will be pressured higher. This will lead to a slowdown in bank credit growth and will depress demand. Finally, if it were not for the pick-up in Chinese imports, the EM ex-China business cycle and commodities prices would not have ameliorated in the past 12 months. Notably, excluding China, Korea and Taiwan, developing nations' retail sales volumes and new vehicle sales remain dormant (Chart I-14). Similarly, there has not been much recovery in capital spending and, consistently, imports of capital goods in EM ex-China, Korea and Taiwan (Chart I-15). Chart I-13No Deleveraging In Many EMs No Deleveraging In Many EMs No Deleveraging In Many EMs Chart I-14EM Ex-China, Korea And Taiwan: ##br##Stabilization But No Revival EM Ex-China, Korea And Taiwan: Stabilization But No Revival EM Ex-China, Korea And Taiwan: Stabilization But No Revival Chart I-15EM Ex-China, Korea And Taiwan: ##br##Not Much Of Recovery EM Ex-China, Korea And Taiwan: Not Much Of Recovery EM Ex-China, Korea And Taiwan: Not Much Of Recovery As credit growth slows or fails to pick up in these economies, domestic demand recovery will be tepid, and will certainly disappoint market expectations. Bottom Line: Given budding divergence between U.S./Europe and Chinese growth, EM ex-China growth will fail to recover and will surprise to the downside. The basis is that the pillars of the EM's business cycle are China, commodities and their own domestic credit cycle, rather than the U.S. and Europe. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com 1 Please refer to the Emerging Markets Strategy Special Reports from October 26, 2016, November, 23 2016, and January 18, 2017, the links are available on page 16. 2 Policy banks are China Development Bank, Agricultural Development Bank and Export-Import Bank of China. 3 Please refer to the Emerging Markets Strategy Weekly Report titled, "Toward A Desynchronized World", dated April 26, 2017, link available on page 16. 4 Please refer to the Emerging Markets Strategy Weekly Report titled, "Toward A Desynchronized World", dated April 26, 2017, link available on page 16. Malaysia: Not Out Of The Woods Arenewed relapse in Chinese growth later this year coupled with lower commodities prices will once again expose Malaysia's vulnerabilities. Notably, 26% of Malaysia's exports are related to commodities - mainly crude oil, natural gas, petroleum products and palm oil. Another downleg in the ringgit's value along with lower commodities prices will cause domestic interest rates to rise. However, Malaysia is in no position to tolerate higher interest rates. Leverage has risen considerably in the past ten years in Malaysia, and is very high (Chart II-1A). Indeed, the country has one of the highest debt-servicing costs in the EM universe, according to BIS data (Chart II-1B). Chart II-1A...And Debt Servicing Costs High Leverage... High Leverage... Chart II-1BHigh Leverage... High Leverage... High Leverage... If the Malaysian central bank attempts to cap interest rates by injecting local currency liquidity into the system, the ringgit will plunge even further. Chart II-2 shows that in recent years local interbank rates have tended to rise when the central bank curtailed its net liquidity injection. If on the other hand the Bank Negara of Malaysia (BNM) does not inject liquidity into the banking/financial system, interest rates will rise as the currency depreciates. Interestingly, despite strong inflows into EM generally, the BNM has continued to inject local liquidity into the economy - albeit at a slower pace than in recent years - to keep local rates tame (Chart II-2). Additionally, despite the significant growth slowdown that has occurred in the past two years in Malaysia, banks' NPLs have not risen much (Chart II-3). As banks start acknowledging loan losses and setting provisions for them, their profitability will decline, capital will be eroded, and loan origination will fall. Chart II-2BNM Has Been Injecting Liquidity ##br##To Control Interest Rates BNM Has Been Injecting Liquidity To Control Interest Rates BNM Has Been Injecting Liquidity To Control Interest Rates Chart II-3Malaysian Banks Haven't ##br##Acknowledged Enough Losses Yet Malaysian Banks Haven't Acknowledged Enough Losses Yet Malaysian Banks Haven't Acknowledged Enough Losses Yet Meanwhile, even though global trade and commodities prices have picked in the past 15 months, Malaysia's economy has failed to recover. This reflects the country's underlying economic vulnerability as the borrowing/credit spree of the past decade has come to a halt: Commercial and passenger vehicle sales are shrinking. Retail trade and employment are also still anemic. Property sales volumes and housing construction approvals are collapsing (Chart II-4). Capital expenditures are depressed (Chart II-4, bottom panel). On the external side, the semiconductor/electronics sector has boomed in Asia since early 2016, but Malaysia has failed to benefit much. Indeed, the recovery in Malaysia's electronics sector has been weak compared to other technology hubs such as Taiwan and Korea. This confirms why Malaysia has been losing market share in electronics products to Korea, Taiwan and the Philippines (Chart II-5). Chart II-4Cyclical Growth Remains Anemic Cyclical Growth Remains Anemic Cyclical Growth Remains Anemic Chart II-5Malaysia Is Losing Tech Market ##br##Share To Its Asian Competitors Malaysia Is Losing Tech Market Share To Its Asian Competitors Malaysia Is Losing Tech Market Share To Its Asian Competitors Bottom Line: Continue shorting MYR versus the U.S. dollar and the Russian ruble. Equity investors should continue to underweight Malaysian stocks within an EM equity portfolio. Relative value traders should maintain our long Russian / short Malaysia equity trade. Buy/hold Malaysian CDS or underweight this sovereign credit market within an EM credit portfolio. Ayman Kawtharani, Associate Editor aymank@bcaresearch.com Equity Recommendations Fixed-Income, Credit And Currency Recommendations