Equities

Highlights The relaxation of lockdown measures, along with mass protests over the past two weeks, have made a second wave of the pandemic more likely than not in many countries. Unlike during the first wave, most governments will not shutter their economies in response to a renewed spike in infection rates. For better or for worse, the “Sweden strategy” will become commonplace. As today’s stock market selloff illustrates, a second wave could significantly unnerve investors, especially since it is coming on the heels of a substantial rally in stocks. However, global equity prices will still rise over a 12-month horizon. Easy monetary policy, improving labor market conditions, and significant amounts of cash on the sidelines should allow the equity risk premium to decline, especially outside the US where valuations remain quite cheap. The US dollar has entered a cyclical bear market. This is especially positive for commodities, economically-sensitive equity sectors, and non-US stocks. Opening The Hatch Chart 1Governments Are Lifting Lockdown Restrictions Three months after the virus burst out of China, countries around the world are starting to relax lockdown measures. Our COVID-19 Government Response Stringency Index, created by my colleague Jonathan LaBerge and showcased in last week’s Global Investment Strategy report, has been on an easing course since May. A similar measure developed by Goldman Sachs broadly shows the same loosening pattern. Reflecting these developments, the Dallas Fed’s index of “mobility and engagement” has been slowly returning to normal (Chart 1). The reopening of economies is taking place despite limited success in containing the virus. While some countries have seen a considerable drop off in the number of new cases and deaths, others continue to experience an increase in both metrics (Chart 2). Globally, the number of new cases has begun to trend higher after remaining flat for most of April. The number of deaths — which lags new cases by about three weeks but is less vulnerable to statistical distortions caused by changes in testing prevalence — has also ticked higher after falling for nearly two months. Mass protests starting in Minneapolis and spreading to much of the western world have the potential to further increase the infection rate. As Jonathan noted last week, large gatherings have been an important vector of transmission for the virus. While the protests have occurred outdoors, many protestors did not wear masks while singing and shouting nor practise social distancing. Chart 2Globally, The Number Of New Cases and Deaths Has Started To Trend Higher Again A Risky Gambit How markets react to a second wave of the pandemic will depend a lot on how policymakers and the broader public respond. For better or for worse, the patience for continued lockdowns has waned. The US and a number of other countries appear to be moving towards the “Swedish model” of trying to keep a lid on the virus without imposing draconian lockdown restrictions. It is a risky gambit, especially in light of the jump in infections that Sweden has reported in the past two weeks. While some countries such as China and New Zealand, which have effectively eradicated the virus, can allow most activities – with the exception of international travel – to resume, others should arguably wait longer until they too have defeated the disease. As Professor Peter Doherty, renowned immunologist and co-recipient of the 1996 Nobel Prize for Medicine, discussed in a webcast with my colleague Garry Evans on Monday, significant progress has been made towards developing a vaccine for COVID-19. Opening up economies now could cause a lot of needless death before a vaccine becomes available. Near-Term Risks To Stocks… Chart 3Earnings Estimates Have Taken It On The Chin Even if governments continue opening up their economies despite rising infection rates, some people will increase the amount of social distancing they practise regardless of official recommendations. Airline, cruise ship, and restaurant stocks had rallied mightily off their March lows before giving up some of their gains over the past few days. If a second wave occurs, they will fall further. The rally in stocks linked to the reopening of the economy occurred alongside a retail investor speculative frenzy. In one of the more bizarre episodes in financial history, stocks of bankrupt or soon-to-be-bankrupt companies surged on Monday as novice day traders snapped up shares of companies that most institutional equity investors had left for dead. Meanwhile, earnings estimates have taken it on the chin (Chart 3). Many companies chose not to provide guidance for the second quarter, citing unprecedented uncertainty over the near-term business outlook. Since Q2 will be the worst quarter for economic growth, it will probably also be a very bad quarter for earnings. The prospect of a slew of poor earnings reports in July could further dent investor sentiment, exacerbating the stock market correction we have seen over the past few days. All this suggests that global equities could experience some further weakness over the next few months. …But Still Sticking With Our 12-Month Overweight To Equities Chart 4Economic Activity Has Started Rebounding Despite these short-term risks, we are not ready to abandon our cyclical overweight view on stocks. While many people have remarked that the equity market has diverged from the economy, in fact, the rebound in the stock market has tracked the peak in initial unemployment claims and the trough in current activity indicators quite closely (Chart 4). A second wave would certainly slow the economic rebound. However, it would probably not reverse it completely given that the mortality rate from the virus now appears to be somewhat lower than initially feared and an increasing number of medical treatments are becoming available. If output and employment keep rising, stocks are likely to trend higher. A Deep Hole This does not mean that everything will return to normal soon. Even though global growth appears to have bottomed in April, the level of employment remains at depression-like levels (Chart 5). About 12% of US workers are employed in the hospitality, restaurant, and travel sectors. A return to normalcy in those sectors will take several years at best. Nevertheless, the recovery will not be nearly as drawn out as the one following the Global Financial Crisis. The Congressional Budget Office expects that it will take another eight years for the US unemployment rate to fall back to 5% (Chart 6). That seems unduly pessimistic. Chart 5Employment Remains At Depression-Like Levels Chart 6CBO Projects The Unemployment Rate Will Fall Very Slowly Cyclical Versus Structural Unemployment Chart 7Residential Construction Accounted For Less Than 20% Of The Job Losses During The Great Recession Commentators like to talk about structural unemployment, but the truth is that large increases in joblessness usually reflect deficient labor demand rather than insufficient supply. For example, the decline in residential construction employment and related sectors accounted for less than one-fifth of the job losses during the Great Recession (Chart 7). You don’t have to fill a half-empty pool through the same pipe from which the water escaped. As long as there is enough demand throughout the economy, workers who lose their jobs will likely find new jobs elsewhere, whether it be at an Amazon distribution center or any number of manufacturing companies that will benefit from the repatriation of production back onshore. The shift in jobs from one sector to the next is not instantaneous, but it need not drag on for years either. Policy Will Stay Stimulative This is where the role of monetary and fiscal policy takes center stage. Despite the improving economic outlook, government bond yields have barely moved off their lows as investors have become increasingly convinced that central banks will keep rates at rock-bottom levels (Chart 8). This week’s FOMC meeting made it clear that the Fed has no intention of raising rates through 2022. “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” Fed Chairman Jerome Powell declared during his press conference. Granted, the zero lower bound has prevented yields from falling as much as they normally would. Fortunately, fiscal policy has stepped in to fill the void. Chart 9 shows that governments have eased fiscal policy much more this year than they did in 2008-09. If governments tighten fiscal policy prematurely like they did after the Great Recession, the recovery will indeed be sluggish. Such a risk cannot be ignored. BCA’s geopolitical team, led by Matt Gertken, has argued that Republican Senators will initially resist the proposed $3 trillion in new stimulus, until they are forced to act by a major new round of financial or social turmoil. Nevertheless, Matt thinks that the Republican Senate will ultimately buckle under the political pressure, knowing full well that a large dose of fiscal largess could prevent a Democratic sweep in November. Chart 8Yields Remain Close To Recent Lows Chart 9Will It Be Enough? Chart 10China Has Ramped Up Stimulus Outside the US, fiscal support shows little sign of being scaled back. Germany has pushed forward with additional stimulus, going so far as to propose a risk-sharing arrangement via the creation of an EU Recovery Fund. On Wednesday, the Japanese House of Representatives approved a draft supplementary budget of 32 trillion yen ($296 billion) providing additional funding for small businesses and medical workers. Jing Sima, BCA Research's chief China strategist, expects Chinese credit formation as a share of GDP to reach the highest level since 2009 and the budget deficit to widen to the largest on record (Chart 10). The upshot is that we may find ourselves in an environment over the next few years where global GDP and corporate profits are moving back to trend, while interest rates (and the implied discount rate used for valuing stocks) stay at very low levels. If profits return back to normal but interest rates do not, the surreal implication is that the pandemic could end up increasing the fair value of the stock market. Ample Cash On The Sidelines Stocks also have another factor working in their favor: huge amounts of cash on the sidelines (Chart 11). The combination of massive fiscal income transfers and low spending has led to a surge in private-sector savings. The US personal savings rate reached 33% in April, the highest on record. Reflecting this increase in savings, private sector bank deposits have ballooned (Chart 12). Chart 11Sizable Amount Of Dry Powder Chart 12Savings Have Spiked Amid Stimulus     Investors often talk about cash “flowing” in and out of the stock market. This is a somewhat misleading characterization. Setting aside the impact of corporate buybacks and public share offerings, the decision by one person to buy shares requires a corresponding decision by someone else to sell shares. The buyer of the shares loses some cash, while the seller gains some cash. On net, there is no inflow of cash into the stock market. Rather, what happens is that the price of shares adjusts to ensure that there is a seller for every buyer. If people feel that they have too much cash relative to the value of their equity holdings, they will bid up the price of stocks until enough sellers come forward. This will cause the amount of cash that people hold as a percentage of their total wealth to shrink, even if the dollar value of that cash remains the same. The process will only stop when the amount of cash that people hold is in line with their preferences. The amount of cash held in US money market funds and personal cash deposits has surged by $2.6 trillion since February. Despite the rally in equities, cash holdings as a percent of stock market capitalization remain near multi-year highs. This suggests that the firepower to fuel further increases in the stock market has not been exhausted. Start Of The Dollar Bear Market After peaking in March, the broad trade-weighted US dollar has weakened by 5.3%. The dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of the global business cycle (Chart 13). While the dollar could strengthen temporarily in response to a second wave of the pandemic, global growth should continue to recover in the second half of the year provided that severe lockdown measures are not reintroduced. Stronger global growth will push the greenback lower. Chart 13The US Dollar Is A Countercyclical Currency Unlike last year, the dollar no longer has support from higher US interest rates. Indeed, US real rates are below those of many partner countries due to the fact that US inflation expectations are generally higher than elsewhere (Chart 14). Chart 14The Dollar Has Been Losing Interest Rate Support A Weaker Dollar Will Support Non-US Stocks The combination of a weaker dollar and stronger global growth should disproportionately help the more cyclical sectors of the stock market, particularly commodity producers. Since cyclical stocks tends to be overrepresented outside the US, non-US equities should outperform their US peers over the next 12 months. A weaker dollar will also reduce the local- currency value of dollar-denominated debt. This will be especially helpful for emerging markets. Despite the recent rally, the cyclically-adjusted PE ratio for EM stocks remains near historic lows (Chart 15). EM equities should fare well over the next 12 months.   Chart 15EM Stocks Are Very Cheap Peter Berezin Chief Global Strategist peterb@bcaresearch.com Global Investment Strategy View Matrix Current MacroQuant Model Scores

Overweight While we are neutral the S&P tech sector, we continue to employ a defensive over aggressive tech strategy and prefer software and services to hardware and equipment. The S&P software index in particular has proven its resilience during the COVID-19 sell-off and recovery and has now broken out to fresh all-time highs both in absolute and relative terms. Upbeat profit fundamentals underpin software buoyancy. Relative capex spending remains in a secular uptrend, spring-boarding the share price ratio. Our relative macro earnings growth model is also gaining steam highlighting that the earnings driven outperformance phase has staying power. Bottom Line: Stay overweight the S&P software index.  

Please note that yesterday we published Special Report on Egypt recommending buying domestic bonds while hedging currency risk. Today we are enclosing analysis on Hungary, Poland and Colombia. I will present our latest thoughts on the global macro outlook and implications for EM during today’s webcast at 10 am EST. You can access the webcast by clicking here. Yours sincerely, Arthur Budaghyan Hungary Versus Poland: Mind The Reversal Conditions are set for the Hungarian forint to outperform the Polish zloty over the coming months. We recommend going long the HUF against the PLN. Hungarian opposition parties criticized the government about the considerable depreciation in the forint. As a result, we suspect that political pressure from Prime Minister Viktor Orban led monetary authorities to alter their stance since April. Critically, the main architect of super-dovish monetary policy Marton Nagy resigned from the board of the central bank on May 28. In line with tighter liquidity, interbank rates have risen above the policy rate. This is marginally positive for the forint. The Hungarian central bank (NBH) tweaked its monetary policy in April after the currency had plunged to new lows against the euro, underperforming its Central European counterparts. The NBH widened its policy rate corridor by hiking the upper interest band to 1.85% and keeping the policy rate at 0.90%. The wider interest rate corridor makes it more costly for commercial banks to borrow reserves from the central bank. Hence, such liquidity tightening is positive for the forint. For years, Hungary was pursuing a super-easy monetary policy and consumer price inflation rose to 4% (Chart I-1). With the NBH keeping interest rates close to zero, real rates have plunged well into negative territory (Chart I-2, top panel). Chart I-1Hungary: Inflation Could Pause For Now Chart I-2Hungary Vs. Poland: Real Rates Reversal Is Coming     In brief, the central bank has been behind the inflation curve. As a result, the forint has been depreciating against both the euro and its central European peers. In such a situation, the key to reversal in the exchange rate trend would be the monetary authority’s readiness to raise real interest rates. The NBH has made a small step in this direction. Going forward, the central bank will be restrained in its quantitative easing (QE) program and will not augment it any further. So far, QE uptake has been slow: around half out of the available HUF 1,500 billion has been tapped by commercial banks and corporates. Importantly, the NBH announced its intention to sterilize its government and corporate bond purchases. Already, the commercial banks excess reserves at the central bank have fallen to zero, which suggests that liquidity is no longer abundant in the banking system (Chart I-3). In line with tighter liquidity, interbank rates have risen above the policy rate. This is marginally positive for the forint. Hungarian authorities have become more cognizant of the economic and financial risks associated with their ultra-accommodative policies. For instance, they initiated a clampdown on real estate speculation, which is leading to dwindling real estate prices. This will lead to a decline in overall inflation expectations and, thereby, lift expected real interest rates. The open nature of Hungary’s economy – whereby exports of goods and services constitute 85% of GDP - makes it much more sensitive to pan-European tourism and manufacturing cycles. With the collapse in its manufacturing and tourism revenues, wage growth in Hungary is bound to decelerate rapidly (Chart I-4). Chart I-3Hungary: Central Bank Has Drained Liquidity Chart I-4Economic Growth: Hungary Is More Vulnerable Than Poland   Rapidly deteriorating wage and employment dynamics reduces the odds of an inflation breakout anytime soon. This will cool down inflation and, thereby, increase real rates on the margin. The central bank in Poland will stay super accommodative while the National Bank of Hungary will be a bit less aggressive. Bottom Line: Although this monetary policy adjustment does not entail the end of easy policy in Hungary, generally, it does signal restraint on the part of monetary authorities resulting from a much reduced tolerance for currency depreciation. This creates conditions for the forint to outperform. Poland In the meantime, Polish monetary authorities have switched into an ultra-accommodative mode. Recent policy announcements by the National Bank of Poland (NBP) represent the most dramatic example of policy easing in Central Europe. Such a policy stance in Poland will produce lower real rates than in Hungary, which is negative for the Polish zloty against the forint. The NBP is set to finance the majority of a new 11% of GDP fiscal spending program enacted by the government amid the COVID-19 lockdowns. This amounts to de-facto public debt and fiscal deficit monetization. The latter will not be sterilized unlike in Hungary and will therefore lead to an excess liquidity overflow in the banking system. The Polish central bank has cut interest rates by 140 bps to 10 bps since March. Pushing nominal rates down close to zero has produced more negative real policy rates than in Hungary (Chart I-2, top panel on page 2). Also, Polish prime lending rates in real terms have fallen below those in Hungary (Chart I-2, bottom panel). Chances are that inflation in Poland will also prove to be stickier than in Hungary due to the minimum wage raise at the beginning of the year and very aggressive fiscal and monetary stimulus since the pandemics has erupted (Chart I-5). Critically, the Polish economy is much less open than Hungary’s, and it is therefore less vulnerable to the collapse of pan-European manufacturing and tourism. This will ensure better employment and wage conditions in Poland. All in all, Poland’s final demand outperformance, versus Hungary, will contribute to a higher rate of inflation there. Bottom Line: The central bank in Poland will stay super accommodative while the National Bank of Hungary will be a bit less aggressive. This is producing a U-turn in both countries’ nominal and relative real interest rates, which heralds a reversal in the HUF / PLN cross rate (Chart I-6). Chart I-5Polish Inflation Will Be Sticker Than In Hungary Chart I-6Go Long HUF / Short PLN   Investment Strategy For Central Europe A new trade: go long the HUF versus the PLN. Take a 3% profit on the short HUF and PLN / long CZK trade. Close the short IDR / long PLN trade with a 20% loss. Downgrade central European bourses (Polish, Czech and Hungarian) from an overweight to a neutral allocation within the EM equity benchmark. Lower for longer European interest rates disfavor bank stocks that dominate central European bourses. Andrija Vesic Associate Editor andrijav@bcaresearch.com Colombia: Continue Betting On Lower Rates Colombia has been badly hit by two shocks: the precipitous fall in oil prices and the strict quarantine measures to constrain the spread of the COVID-19 outbreak. An underwhelming fiscal stimulus in response to the lockdowns will further weigh on private demand. An underwhelming fiscal stimulus in response to the lockdowns will further weigh on private demand. We have been recommending receiving 10-year swap rates in Colombia since April 23rd and this strategy remains unchanged: While oil prices seem to have rebounded sharply, they will remain structurally low (Chart II-1). The Emerging Markets Strategy team's view is that oil prices will average $40 per barrel this year and next.1 After the recent rally, chances of further upside in crude prices are limited. Chart II-1A Long-Term Perspective On Oil Prices Table II-1Colombia’s Fiscal Package Is The Lowest In The Region Colombia's high sensitivity to oil prices is particularly visible via its current account balance. Indeed, Colombia’s net crude exports cover as much as 50% of the current account deficit, such that low oil prices severely affect the currency and produce a negative income shock for the economy. Fiscal policy remains unreasonably tight, especially in the face of the global pandemic. The government’s fiscal response plan amounts to only a meagre 1.5% of GDP. This is low not only compared to advanced economies but also to the rest of Latin America (Table II-1). Moreover, President Duque’s administration has been running the tightest fiscal budget in almost a decade, with the primary fiscal balance reaching 1% of GDP before the pandemic. The country’s COVID-19 response has been fast and effective. Colombia has managed to achieve the lowest amount of infections and deaths among major economies in Latin America (Chart II-2). Chart II-2COVID-19 Casualties Across Latin America Duque’s administration has taken a pragmatic approach to handling the pandemic by enforcing strict lockdowns and banning international and inter-municipal travel since late March, only three days after the country’s first casualty. Further, the nationwide confinement measures have been extended until July 1st, with particularly stringent rules applying to major cities. These have helped the country avoid a nation-wide health crisis, but they will engender prolonged economic pain. Regarding monetary stimulus, the central bank (Banrep) has cut interest rates by 150 basis points since March of this year. It also embarked on the first and largest QE program in the region. Banrep has committed to purchase 12 trillion pesos worth of government and corporate securities (amounting to a whopping 8% of GDP). Consumer price inflation is falling across various core measures and will drop below the low end of Banrep’s target range (Chart II-3). This will push the central bank to continue cutting rates. Despite the monetary easing, nominal lending rates are still restrictive. Real lending rates (deflated by core CPI) remain elevated at 7% (Chart II-4). Chart II-3Colombia: Inflation Will Fall Below Target Chart II-4Colombia: Real Lending Rates Are Still High Chart II-5The Colombian Economy Was Already Under Pressure Importantly, there has not been an appropriate amount of credit support and debt waving programs for SMEs, as there has been in many other countries. Given that SMEs employ a large share of the workforce, and that household spending accounts for about 70% of GDP, consumer spending and overall economic growth will contract substantially and be slow to recover. Employment rates had already been contracting, and wage growth downshifting, before the pandemic started (Chart II-5). Household income is now certainly in decline as major cities are in full lockdown and economic activity is frozen. Investment Recommendations Even though we are structurally positive on the country due to its orthodox macroeconomic policies, positive structural reforms, and low levels of debt among both households and companies, we maintain a neutral allocation on Colombian stocks within an EM equity portfolio. This bourse is dominated by banks and energy stocks. The lack of both fiscal support and bank loan guarantees amid the recession means that banks will carry the burden of ultimate losses. They will suffer materially due to loan restructuring and defaults. For fixed income investors, we reiterate our call to receive 10-year swap rates and recommend overweighting local currency government bonds versus the EM domestic bond benchmark. The yield curve is steep and real bond yields are elevated (Chart II-6). Hence, long-term interest rates offer great value. Additional monetary easing, including quantitative easing, will suppress yields much further. Chart II-6A Great Opportunity In Colombian Rates Chart II-7The COP Has Depreciated Considerably   We are upgrading Colombia sovereign credit from neutral to overweight within an EM credit portfolio. General public debt (including the central and state governments) stands at 59% of GDP. Conservative fiscal policy and the central bank’s large purchases of local bonds will allow the government to finance itself locally. Presently, 40% of public debt is foreign currency and 60% local currency denominated. As a result, sovereign credit will outperform the EM credit benchmark. In terms of the currency, we recommend investors to be cautious for now. Even though the peso is cheap (Chart II-7), another relapse in oil prices or a potential flare up in social protests could cause further downfall in the currency. Juan Egaña Research Associate juane@bcaresearch.com   1 This differs from the view of BCA’s Commodities and Energy Strategy service. We believe structural forces such as the lasting decline in air travel and commuting will impede a recovery in oil demand while, at the same time, US shale production will rise again considerably if crude prices rise and remain well above $40   Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

  In a webcast this Friday I will be joined by our Chief US Equity Strategist, Anastasios Avgeriou to debate ‘Sectors To Own, And Sectors To Avoid In The Post-Covid World’. Today’s report preludes five of the points that we will debate. Please join us for the full discussion and conclusions on Friday, June 12, at 8:00 AM EDT (1:00 PM BST, 2:00 PM CEST, 8.00 PM HKT).   Highlights Technology is behaving like a Defensive. Defensive versus Cyclical = Growth versus Value. Growth stocks are not a bubble if bond yields stay ultra-low. The post-Covid world will reinforce existing sector mega-trends. Sectors are driving regional and country relative performance. Fractal trade: Long ZAR/CLP.   Chart of the WeekSector Defensiveness/Cyclicality = Positive/Negative Sensitivity To The Bond Price 1. Technology Is Behaving Like A Defensive How do we judge an equity sector’s sensitivity to the post-Covid economy, so that we can define it as cyclical or defensive? One approach is to compare the sector’s relative performance with the bond price. According to this approach, the more negatively sensitive to the bond price, the more cyclical is the sector. And the more positively sensitive to the bond price, the more defensive is the sector (Chart I-1).   On this basis the most cyclical sectors in the post-Covid economy are, unsurprisingly: energy, banks, and materials. Healthcare is unsurprisingly defensive. Meanwhile, the industrials sector sits closest to neutral between cyclical and defensive, showing the least sensitivity to the bond price. The tech sector’s vulnerability to economic cyclicality appears to have greatly reduced. The big surprise is technology, whose high positive sensitivity to the bond price during the 2020 crisis qualifies it as even more defensive than healthcare. This contrasts sharply with its behaviour during the 2008 crisis. Back then, tech’s relative performance was negatively correlated with the bond price, defining it as classically cyclical. But over the past year, tech’s relative performance has been positively correlated with the bond price, defining it as classically defensive (Chart I-2 and Chart I-3). Chart I-2In 2008, Tech Behaved Like ##br##A Cyclical... Chart I-3...But In 2020, Tech Is Behaving Like A Defensive This is not to say that the big tech companies cannot suffer shocks. They can. For example, from new superior technologies, or from anti-oligopoly legislation. However, the tech sector’s vulnerability to economic cyclicality appears to have greatly reduced over the past decade. 2. Defensive Versus Cyclical = Growth Versus Value If we reclassify the tech sector as defensive in the 2020s economy, then the post mid-March rebound in stocks was first led by defensives. Cyclicals took over leadership of the rally only in May. Moreover, with the reclassification of tech as defensive, the two dominant defensive sectors become tech and healthcare. But tech and healthcare are also the dominant ‘growth’ sectors. The upshot is that growth versus value has now become precisely the same decision as defensive versus cyclical (Chart I-4). Chart I-4Defensive Versus Cyclical = Growth Versus Value 3. Growth Stocks Are Not A Bubble If Bond Yields Stay Ultra-Low Some people fear that growth stocks have become dangerously overvalued. There is even mention of the B-word. Let’s address these fears. Yes, valuations have become richer. For example, the forward earnings yield for healthcare is down to 5 percent; and for big tech it is down to just over 4 percent. This valuation starting point has proved to be an excellent guide to prospective 10-year returns, and now implies an expected annualised return from big tech in the mid-single digits. Yet this modest positive return is well above the extremes of the negative 10-year returns implied and delivered from the dot com bubble (Chart I-5). Chart I-5Big Tech Is Priced To Deliver A Positive Return, Unlike In 2000 Moreover, we must judge the implied returns from growth stocks against those available from competing long-duration assets – specifically, against the benchmark of high-quality government bond yields. If bond yields are ultra-low, then they must depress the implied returns on growth stocks too. Meaning higher absolute valuations (Chart I-6 and Chart I-7). Chart I-6Tech's Forward Earnings Yield Is Above The Bond Yield, Unlike In 2000 Chart I-7Healthcare's Forward Earnings Yield Is Above The Bond Yield, Unlike In 2000 In the real bubble of 2000, big tech was priced to return 12 percent (per annum) less than the 10-year T-bond. Whereas today, the implied return from big tech – though low in absolute terms – is above the ultra-low yield on the 10-year T-bond. If bond yields are ultra-low, then they must depress the implied returns on growth stocks too. The upshot is that high absolute valuations of growth stocks are contingent on bond yields remaining at ultra-low levels. And that the biggest threat to growth stock valuations would be a sustained rise in bond yields. 4. The Post-Covid World Will Reinforce Existing Sector Mega-Trends If a sector maintains a structural uptrend in sales and profits, then a big drop in the share price provides an excellent buying opportunity for long-term investors. This is because the lower share price stretches the elastic between the price and the up-trending profits, resulting in an eventual catch-up. However, if sales and profits are in terminal decline, then the sell-off is not a buying opportunity other than on a tactical basis. This is because the elastic will lose its tension as profits drift down towards the lower price. In fact, despite the sell-off, if the profit downtrend continues, the price may be forced ultimately to catch-down. This leads to a somewhat counterintuitive conclusion. After a big drop in the stock market, long-term investors should not buy everything that has dropped. And they should not buy the stocks and sectors that have dropped the most if their profits are in major downtrends. In this regard, the post-Covid world is likely to reinforce the existing mega-trends. The profits of oil and gas, and of European banks will remain in major structural downtrends (Chart I-8 and Chart I-9). Conversely, the profits of healthcare, and of European personal products will remain in major structural uptrends (Chart I-10 and Chart I-11). Chart I-8Oil And Gas Profits In A Major ##br##Downtrend Chart I-9Bank Profits In A Major ##br##Downtrend Chart I-10Healthcare Profits In A Major Uptrend Chart I-11Personal Products Profits In A Major Uptrend   5. Sectors Are Driving Regional And Country Relative Performance Finally, sector winners and losers determine regional and country equity market winners and losers. Nowadays, a stock market’s relative performance is predominantly a play on its distinguishing overweight and underweight ‘sector fingerprint’. This is because major stock markets are dominated by multinational corporations which are plays on their global sectors, rather than the region or country in which they have a stock market listing. It follows that when tech and healthcare outperform, the tech-heavy and healthcare-heavy US stock market must outperform, while healthcare-lite emerging markets (EM) must underperform. It also follows that the tech-heavy Netherlands and healthcare-heavy Denmark stock markets must outperform. Sector mega-trends will shape the mega-trends in regional and country relative performance. Equally, when energy and banks underperform, the energy-heavy Norway and bank-heavy Spain stock markets must underperform. (Chart I-12 and Chart I-13). These are just a few examples. Every stock market is defined by a sector fingerprint which drives its relative performance.  Chart I-12Sector Relative Performance Drives... Chart I-13...Regional And Country Relative Performance If sector mega-trends continue, they will also shape the mega-trends in regional and country relative performance – favouring those stock markets that are heavy in growth stocks and light in old-fashioned cyclicals. Please join the webcast to hear the full debate and conclusions. Fractal Trading System*  This week’s recommended trade is to go long the South African rand versus the Chilean peso. Set the profit target and symmetrical stop-loss at 5 percent. In other trades, long Spanish 10-year bonds versus New Zealand 10-year bonds achieved its 3.5 percent profit target at which it was closed. And long Australia versus New Zealand equities is approaching its 12 percent profit target. The rolling 1-year win ratio now stands at 63 percent. Chart I-14ZAR/CLP   When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated  December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System   Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations