Equities

Highlights Global growth should bounce back in the third quarter, as mass COVID-19 testing allows more people to return to work. Temporary layoffs have accounted for the vast majority of the increase in unemployment so far. Ample fiscal and monetary support should prevent these layoffs from becoming permanent. The equity risk premium remains quite high, which warrants overweighting equities relative to bonds over a 12-month horizon. The near-term outlook for stocks is less flattering, given the strong rally in equities over the past two weeks and the fact that earnings estimates are likely to fall sharply once companies begin to report first quarter results. Accordingly, we recommend that investors take some chips off the table in preparation for a temporary stock market pullback. We are also shifting our near-term regional equity allocation and currency views in a somewhat more defensive direction. As Bad As It Gets? Chart 1Nosedive In High-Frequency Activity Indicators The global economy has plunged into a deep recession. The New York Fed’s weekly economic index, which tracks a variety of high-frequency activity indicators such as same-store retail sales, consumer sentiment, fuel sales, and unemployment insurance claims, has plunged below its 2008 lows (Chart 1). Service-sector purchasing manager indices have collapsed to the weakest levels on record (Chart 2). The OECD estimates that the shutdowns have reduced the level of output by between one-fifth and one-quarter in most advanced economies (Chart 3).1 If business closures were to last three months, this would shave between 4-to-6 percentage points from annual growth in the OECD in 2020.   Chart 2Service-Sector Activity Has Collapsed To Unprecedented Lows Chart 3Severe Economic Consequences Resulting From World War V At times like these, it is easy to despair about the future. Yet, there are three reasons to think that the worst of the economic damage will be over within the next few months: The measures necessary to control the virus are likely to be relaxed without this leading to a new wave of infections. Recessions following exogenous shocks, such the one we are currently experiencing, tend to produce faster recoveries than those stemming from endogenous slowdowns. Policy will remain highly supportive, mitigating possible adverse second-round effects. Quarantine Measures Are Likely To Be Relaxed In our recently published Q2 Strategy Outlook, we likened the current situation to one where a cyclist fails to apply the brakes when starting to descend a steep hill. Not only does the cyclist need to squeeze the brake levers to slow down, he needs to squeeze them harder than he would otherwise have in order to compensate for failing to squeeze them at the outset. Only once the bicycle has decelerated to a safe speed can he ease off the brakes a bit. Most countries find themselves in the position of the cyclist. Policymakers were too slow to react at the outset of the pandemic, and now have to compensate for their inaction by imposing draconian containment measures. In epidemiological language, policymakers are seeking to reduce the effective reproduction number – the average number of people a carrier of the virus will infect – from well above one to well below one. As long as the reproduction number stays below one, the number of new infections will keep falling. Once the number of new cases has declined to a level that no longer overwhelms hospitals, policymakers will be able to relax containment measures by just enough to bring the reproduction number back to one. This will create a new steady state where the number of new infections remains at a stable and manageable level.  The good news is that the strategy appears to be working. The number of new cases and deaths have started to decline in both Italy and Spain, the two hardest hit European countries. In the US, while the number of new cases has yet to show a clear downward trend, there are glimmers of hope (Chart 4). For example, the net number of people admitted to New York hospitals has declined sharply since the beginning of April (Chart 5). Chart 4New Cases And Deaths: Have We Turned The Corner? Chart 5Glimmer Of Hope Emanating From The Big Apple? Test, Test, Test While keeping the reproduction number from rising above one will still require a variety of containment measures, the economic burden of these measures will decline over time. Using the bicycle analogy above, this is equivalent to saying that the road will become flatter the further down we go. To some extent, we will be able to relax containment measures because the virus will find it more difficult to propagate as more people are infected. However, unless it turns out that the number of asymptomatic cases is currently much greater than most estimates suggest, the benefits from this effect are likely to be small. The bigger impact will come not from making headway towards herd immunity, but from scaling up existing testing technologies to figure out who is dangerous to others and who is not. Forcing almost everyone who is not deemed to be an “essential worker” to stay at home is hardly an optimal strategy. Rather than trying to isolate most people, it would be preferable to isolate only those who are infected. The problem is that we currently do not know who those people are. That will change as testing capacity ramps up. Right now, we are in the same predicament as if there had been a major terrorist attack using an explosive device that was invisible to conventional detectors. Just like there would have been a temptation to stop all air travel until we figured out how to detect the new type of bomb, we have decided to stop most commerce because we do not know who may be carrying the virus. The good news is that the technology to test people for COVID-19 exists. Abbott Labs has already unveiled a PCR test, which detects specific genetic material within the virus, that can render a positive result in as little as five minutes and a negative one in thirteen minutes. Last Wednesday, the FDA authorized a rapid antibody blood test for COVID-19 developed by Cellex, which can determine if someone previously had the virus and has recovered. Pessimists would highlight that there is currently a severe shortage of test kits. That is true, but we should avoid the trap of linear thinking that got us into this mess to begin with. Producing more tests is an engineering problem that will be solved. As the number of tests performed begins to increase exponentially, testing will become ubiquitous. How much would mass testing help? The answer is a lot. Paul Romer has shown that a strategy of randomly testing everyone roughly once every two weeks would bring down the total number of people who contract the virus to under 20% of the population.2 In his simulation, only 5%-to-10% of the population would need to be quarantined at any given time. In the absence of mass testing, 50% of the population would need to be quarantined to yield the same result (See Appendix 1 for details). The economy can handle isolating 5%-to-10% of its population at any given time. It cannot handle isolating half its population. Just like you have to X-ray your luggage at the airport, you may end up having to take a COVID-19 test before boarding a flight. Children will be tested at school several times a week; first responders more often than that. It will be a nuisance, but the alternative of a Great Depression is much worse. And if it is any consolation, at least this is one test you won’t have to study for! Unemployment Dynamics Following Exogenous Shocks Chart 6Historically, It Has Taken Some Time For Employment To Return To Pre-Recession Levels Economic life is full of asymmetries. It is easier to go bankrupt than to start a new business. It is also easier to lose a job than to find a new one. Once the links between companies and workers are severed, it can be difficult to restore them. This is partly because it is time-consuming and costly to match available workers with open positions. It is also because there are feedback loops at work: If someone is unemployed and not earning an income, they have less money to spend. If people are not spending much, there is less incentive for firms to hire new workers. In the United States, it took more than six years for the level of employment to return to its January 2008 peak. Even during the fairly mild 2001 downturn, employment did not return to pre-recession levels until February 2005 (Chart 6). Given the recent steep drop in output, it is likely that the unemployment rate will eclipse 10% in the US and most other economies during the coming months. Does this mean that it will take many years for the labor market to heal? Not necessarily. So far, most of the workers who have lost their jobs have been furloughed rather than permanently dismissed. According to the Bureau of Labor Statistics, 86% of the roughly 1.2 million US workers who lost their jobs in March were laid off temporarily (Chart 7). As a share of all unemployed, the number of workers on temporary layoff doubled in March to the highest level on record (Chart 8). Chart 7US Job Losses: Furlough Or Permanent Dismissal? Chart 8US Temporary Job Losses Have Skyrocketed The Role Of Stimulus Of course, it is possible that temporary layoffs will turn into permanent ones. This is where governments need to step in. Nothing can be done about the near-term decline in economic activity. That is the price which needs to be paid to keep the virus under control. However, transfers of income from governments to struggling households and firms can alleviate a lot of needless hardship, while making sure there is enough pent-up demand around for when businesses reopen their doors. We have discussed at length the various monetary and fiscal measures that have been introduced to combat the crisis.3 We will not get into the nitty-gritty of that discussion now, other than to note that the sizes of the various rescue packages have generally been in the ballpark of what is needed. And if it turns out that more help is necessary, it will be forthcoming. Chart 9 shows that there is widespread bipartisan support for further stimulus among US voters of all ages and backgrounds. Chart 9US: Support For Further Stimulus Is Widespread The WWII Comparison In some economic respects, the pandemic may end up resembling World War II. Just like today, the volume of nonessential goods and services was greatly curtailed during the war in order to make room for essential production (Chart 10). Instead of an exponential increase in facemasks and test kits, there was an exponential increase in the production of military equipment (Chart 11). Chart 10WW2 Versus World War V Chart 11Now Let's Do The Same For Test Kits And Ventilators Similar to today, the US government ran massive budget deficits to finance the war effort. The ratio of federal debt-to-GDP rose from 45% in 1942 to more than 100% by the end of 1945. Today there is widespread fear that returning workers will find themselves out of a job. Back then, people worried that returning soldiers would be unable to secure work, leading to a second Great Depression. Future Nobel laureate Paul Samuelson warned that the US faced the “greatest period of unemployment and industrial dislocation” unless wartime controls were extended. Gunnar Myrdal, another future Nobel laureate, predicted an “epidemic of violence” stemming from mass unemployment. Looking back, while the unemployment rate did rise briefly after the war, it quickly fell back, as the pent-up demand from years of frugality and a slew of war-time inventions ushered in two decades of unprecedented growth. Policy also did its part. Even though government spending fell by 75% in real terms between 1944 and 1947, the GI Bill, which provided free education, low-cost mortgages, and unemployment benefits to returning soldiers, cushioned the blow. The Marshall Plan also helped rebuild post-war Europe, boosting US exports in the process. We are not predicting that the pandemic will usher in a period of unparalleled prosperity. Nevertheless, just like the bleak forecasts following WWII proved to be unfounded, today’s forecasts of prolonged mass unemployment will likely not materialize. Gauging The Fair Value Of Equities To what extent has the recession reduced the fair value of corporate equities? Let us try to answer this question analytically. Consider a baseline where earnings grow by 2% per year, the risk-free rate is 2%, and the equity risk premium is 5%. Now suppose that the recession temporarily reduces corporate profits by 60% this year, 40% next year, and 20% the year after next relative to the aforementioned baseline, with earnings returning to trend beyond then. Chart 12 shows that such a recessionary shock would reduce the present value of earnings by 5.4%. Now let’s consider a more ominous scenario where corporate profits fall by 60% this year, 40% next year, 20% the year after that, and then remain 10% lower relative to the baseline forever. In that case, the present value of future earnings would fall by 14.1%. One might notice that even in this ominous scenario, the present value of future earnings falls less than one might have assumed. And this is before we take into account any possible mitigating effects from a drop in the risk-free rate. For example, suppose that the risk-free rate declines by one percentage point, which is roughly how much both the US 30-year Treasury yield and our 5-year/5-year forward terminal rate proxy have fallen since the start of the year (Chart 13). In that case, the present value of earnings would increase by 7.3% even if profits followed the ominous path described above.   Chart 12What Happens To Earnings During A Recessionary Shock? Chart 13Long-Term Rates Have Dropped This Year Of course, in practice, stocks tend to fall a lot more during recessions than you would expect based on the sort of fair value calculations described above. This is because the equity risk premium, which we have kept constant in our examples, usually rises in periods of economic turmoil. A higher risk premium increases the discount rate applied to future earnings, leading to lower stock prices. The equity risk premium is mean reverting. This explains why the prospective return to equities is usually highest during recessions and lowest following long economic booms. The equity risk premium is quite high at present, which warrants overweighting equities relative to bonds over a 12-month horizon (Chart 14). That said, the high equity risk premium mainly reflects exceptionally low bond yields. In absolute terms, stocks are not especially cheap, particularly in the US, where the S&P 500 trades at 17.3-forward earnings (Chart 15). That is actually above the P/E ratio of 15.1 that the S&P 500 reached in October 2007 at the peak of the bull market before the start of the Global Financial Crisis. Chart 14The Equity Risk Premium Is Quite High, Especially Outside The US Chart 15US Stocks Are Not Particularly Cheap In Absolute Terms     Moreover, today’s forward P/E ratio is based on stale earnings estimates which will come down over the coming weeks. The bottom-up consensus calls for S&P 500 companies to earn $153 per share this year. Our US equity strategists expect something closer to $100. We noted earlier this month that we would be aggressive buyers of stocks if the S&P 500 fell below 2250, but would turn neutral if the S&P 500 rose above 2750. The index briefly fell below 2250 on March 23, only to surge to 2789 as of the close of trading today. As such, we are downgrading our tactical 3-month view on global equities back to neutral. We are also trimming our tactical 3-month recommendation on the more cyclical currencies and stock markets such as those in Europe and EM. For now, we are maintaining our overweight stance on global stocks over a 12-month horizon, but will consider curbing that too if the S&P 500 rises above 3000 without a corresponding improvement in the news flow. Our full slate of views is shown in the matrix at the end of this report. Going forward, we will use this matrix as the primary tool for communicating our market views, reserving trade recommendations only for special situations that are not well covered by the views expressed in the matrix. To enhance accountability, we will start tracking all the positions in the matrix versus an appropriate market benchmark.   Peter Berezin Chief Global Strategist peterb@bcaresearch.com APPENDIX 1: Testing Versus Mass Quarantines (I) In a series of blog posts, Paul Romer presented a model that simulates and visualizes the effects of various policies aimed at containing the spread of Covid-19. At its core, similar to models used by epidemiologists, Romer’s model shows that without any intervention, a vast majority of populations will end up becoming infected. His simulations suggest that the policy of isolation based on random testing can be as effective in containing the virus as mass indiscriminate isolation. However, the economic and social costs of the latter are much higher than they are for the former. In Romer’s simulations, the policy of test-based isolation keeps the cumulative fraction of the population that is infected at below 20%. This policy relies on frequent testing where 7% of the population is randomly tested every day, equivalent to testing everyone roughly once every two weeks. Those who test positive are isolated. It is further assumed that these tests are imperfect: they yield 20% false negatives and 1% false positives. To achieve a similar profile of virus propagation without tests, Romer finds that a random isolation policy would require an average isolation rate in the population of about 50%. Appendix Chart 1 provides a graphical comparison of the intensity of the quarantining that is required under the two policy simulations. It shows that an isolation policy relying on tests results in much less disruption to normal patterns of social interactions.   Appendix Chart 1 APPENDIX 1: Testing Versus Mass Quarantines (II) The following two animations visualize the differences between the two policies: The blue inverted triangles show those who are vulnerable to catching the virus; the red circles signify those who are infectious; the purple squares mark those who were previously infectious but have now recovered and can neither catch nor transmit the virus; and the hollow orange box illustrates isolation. Isolating Based On Test Results .iframe-container{ position: relative; width 100%; padding-bottom: 56.25%; height: 0; } .iframe-container iframe{ position: absolute; top:0; left:0; width:100%; height: 100%; }   Isolating At Random .iframe-container{ position: relative; width 100%; padding-bottom: 56.25%; height: 0; } .iframe-container iframe{ position: absolute; top:0; left:0; width:100%; height: 100%; }   Source: Paul Romer, “Simulating Covid-19: Part 2,” March 24, 2020. For more details about the models and simulations as well as sensitivity analysis, please visit: https://paulromer.net/. Footnotes 1  “Evaluating The Initial Impact Of Covid-19 Containment Measures On Economic Activity,” OECD, 2020. 2 Paul Romer, “Simulating Covid-19: Part 2,” March 24, 2020. 3 Please see Global Investment Strategy, “Second Quarter 2020 Strategy Outlook: World War V,” dated March 27, 2020. Global Investment Strategy View Matrix Current MacroQuant Model Scores

Highlights Please note that we are publishing an analysis on Vietnam below. The unprecedented depth of this recession entails that many businesses will likely be operating below their break-evens for a while, even after the confinement measures are eased. Consequently, the process of bottoming in this bear market will be drawn out, and share prices will gyrate substantially in the interim. Elevated foreign currency debt levels among some EM corporations, plunging revenues and local currency depreciation combine for a perfect storm in EM corporate credit. Continue underweighting EM stocks and credit within global equity and credit portfolios, respectively. Take profits on the long EM currency volatility trade. Feature If history is any guide, the speed of the rebound in global equities is more consistent with a bear market rally than the beginning of a new bull market. Typically, for a new durable bull market to emerge after a vicious bear market, a consolidation period or a base-building phase is needed. As of now, share prices have not formed such a base. Playing bear market rallies is all about timing, in which fundamental analysis is not useful. Rebounds die as abruptly as they begin. Hence, it is all about chasing momentum on either side. The unprecedented depth of this recession heralds that many businesses will likely be operating below their break-evens for a while, even after the confinement measures are eased. We closed our absolute short position in EM equities on March 19 but we have continued shorting EM currencies versus the US dollar. Even though EM share prices have become cheap based on their cyclically-adjusted P/E ratio (Chart I-1), valuation is not a good timing tool. This is especially true for this structural valuation indicator. Chart I-1EM Equities Are As Cheap As In Previous Bottoms Why The Rebound? After the massive selloff, investor sentiment on risk assets in general, and cyclicals specifically, has become very depressed. In particular: Sentiment of traders and investment advisors on US stocks has plummeted (Chart I-2). That said, net long positions in US equity futures are still above their 2016 and 2011 lows, as we noted last week. Traders’ sentiment on cyclical currencies such as the CAD and AUD as well as on copper and oil has dropped to their previous lows (Chart I-3).  Chart I-2Investor Sentiment On US Equities Is Poor Chart I-3Investor Sentiment On Copper And Oil Is Depressed   Consistently, net long positions of investors in both copper and oil have been trimmed substantially (Chart I-4A and I-4B). Chart I-4AInvestors’ Net Long Positions In Copper... Chart I-4B…And Oil   On the whole, it should not be surprising that after having become very oversold, risk assets rebounded in the past two weeks. Nevertheless, depressed investor sentiment is a necessary but not sufficient condition for a major bear market bottom. As illustrated in Chart I-3, sentiment on oil and copper was extremely depressed in late 2014. Yet with the exception of brief rebounds, both oil and copper prices continued to plunge for about a year before bottoming in January 2016. The necessary and sufficient condition for a durable bottom in global cyclical assets is an improvement in global demand. Chart I-5The S&P 500 And VIX In The Last Two Bear Markets Given the US and Europe are still in strict confinement and the Chinese economy remains quite weak (please see our more detailed discussion on this below), the global recession is still deepening. Further, while the enormous amounts of stimulus injected by policymakers is certainly positive, it is not yet clear whether these efforts are sufficient to entirely offset the collapse in the level of economic activity and its second round effects. Nevertheless, the Federal Reserve and the European Central Bank have probably contained the acute phase of the financial market crisis by buying financial assets and providing credit to the real economy. Odds are that the VIX and other volatility measures will not retest their recent highs. However, this does not mean that risk assets cannot retest their lows or make fresh ones. For example, in the previous 2001-2002 and 2008 bear markets, the S&P 500 re-tested its low in early 2003 and made a deeper trough in early 2009 even though the VIX drifted lower (Chart I-5). Finally, as we discuss below, a unique feature of this recession makes it unlikely that a definite equity market bottom has been established so quickly. How This Recession Is Distinct From an investor viewpoint, this global recession stands out from others in a particularly distinct way: In an average recession, nominal output levels do not contract. In the US, since 1960 it was only during 2008 that the level of nominal GDP contracted (Chart I-6). Presently, we are experiencing the gravest collapse in nominal output/sales since the 1930s – much worse than what transpired in 2008. Chart I-6US Nominal GDP And Corporate Profits Growth When a company’s sales shrink, a critical threshold for sustainability is the level of its revenues relative to its break-even point. The latter is the level of sales where total revenue is equal to total cost – i.e., where profits are nil. Break-even points have ramifications for share prices and the shape of a potential recovery. In an average recession, break-even points for the majority of companies are not breached – i.e., they remain profitable. As a result, a moderate and sequential revival in sales boosts profits, often exponentially. Share prices react positively to even modest sequential growth. Besides, when profits are expanding, managers and owners of these businesses are often quick to augment their capital spending and hiring. A marginal and sequential recovery from this very low point is not sufficient to produce a durable bull market for stocks or corporate credit. When a company’s sales drop below its break-even level, a moderate sequential recovery in sales could be insufficient to make the company profitable. In such a case, the share price may not rally vigorously unless they had priced in a much worse outcome – i.e., a bankruptcy. Crucially, a moderate sequential revival in activity may not lead to more capital spending and hiring. Given US and global nominal GDP are presently contracting at an unprecedented double-digit pace, the revenue of a majority of companies has fallen below costs – i.e., they are presently operating below their break-evens (experiencing losses). This makes this recession distinct from others. On the whole, the loosening of confinement measures and the resumption of business operations may not be sufficient reasons to turn bullish on equities. So long as a company operates below its break-even, its share price may not rally much in response to marginal sequential growth. In short, the pace of recovery will be crucial. Yet, there is considerable uncertainty with respect to these dynamics. Such uncertainty also warrants a high equity risk premium. A U-shaped recovery is most likely, but the latter assumes that many companies will be operating with losses for some time. Consequently, odds are that the process of bottoming in this bear market will be drawn out, and share prices will gyrate substantially in the interim. Taking Pulse Of The Global Economy In our March 19 report, we argued that this global recession is much worse than the one in 2008. High-frequency data are confirming our view: The weekly US economic index from the New York Fed has plunged more than it did in 2008 (Chart I-7). Capital spending plans have been shelved around the world. Odds are many businesses will be operating below their break-evens even after confinement measures are eased. Therefore, they will not rush to invest in new capacity and equipment, or rush to hire. China is a case in point. Commodities prices on the mainland remain in a downtrend, despite the resumption of business activity (Chart I-8). This is a sign of lingering weakness in construction/capital spending. Chart I-7An Unprecedented Plunge In Economic Activity Chart I-8Commodities Prices In China Are Drifting Lower   The world’s oil consumption is presently probably down by more than 35%.  According to INRIX, US car traffic last week was 47% below its level in late February before the confinement measures were introduced. Plus, airline travel has literally ground to a halt worldwide. In China’s major cities, traffic during rush hour is re-approaching its pre-pandemic levels. However, automobile congestion data from TomTom shows that in the afternoons and evenings, traffic remains well below where it was before the lockdown. This reveals that people go to work, spend most of their time at the office, and then quickly return home. They do not go out during lunch time or in the evenings. Hence, we infer that China’s service sector remains in recession.  Chart I-9EM ex-China, Korea And Taiwan: Nominal Growth Was Very Weak Before The Pandemic  The Chinese manufacturing and service PMI indexes registered 51 and 47 respectively in March, revealing that their economic recoveries are very subdued. As per our discussion above, we suspect revenues for many businesses in February dropped below break-even levels. The fact that only about a half of both manufacturing and service sector companies said their March activity improved from February is rather underwhelming. EM ex-China, Korea and Taiwan nominal GDP and core consumer price inflation were at very low levels before the pandemic (Chart I-9). The ongoing plunge in economic activity will produce the worst nominal output recession for many developing economies. Consequently, corporate profits of companies exposed to domestic demand will crash in local currency terms. Bottom Line: The unprecedented depth of this recession heralds that many businesses will likely be operating below their break-evens for a while, even after the confinement measures are eased. Thus, a marginal and sequential recovery from this very low point is not sufficient to produce a durable bull market for stocks or corporate credit. Credit Markets Hold The Key Solvency concerns for companies become acute and doubt about their debt sustainability persist when their revenues drop below their break-evens. Thus, a marginal improvement in revenue – as lockdowns worldwide are relaxed – may not suffice to produce a material tightening in EM corporate credit spreads. Playing bear market rallies is all about timing, in which fundamental analysis is not useful. Rebounds die as abruptly as they begin. Interestingly, equity markets often take their cues from credit markets. Chart I-10 demonstrates that EM US dollar corporate bond yields (inverted on the chart) correlate with equity prices. This chart unambiguously expounds that what matters for EM share prices is not US Treasurys yields but rather their own borrowing costs in US dollars. Chart I-10EM US Dollar Corporate Bond Yields And Stock Prices Presently, there are no substantive signs that US dollar borrowing costs for EM companies or sovereigns are declining. Chart I-11 illustrates that investment and high-yield corporate bond yields for aggregate EM and emerging Asia remain elevated. Remarkably, bank bond yields in overall EM and emerging Asia have not eased much (Chart I-12). The latter is crucial as banks’ external high borrowing costs will dampen their appetite to originate credit domestically. Chart I-11EM US Dollar Corporate Bond Yields Chart I-12EM Banks US Dollar Bond Yields Chart I-13EM Credit Spreads, Currencies And Commodities In turn, the direction of EM corporate and sovereign credit spreads is contingent on EM exchange rates and commodities prices, as demonstrated in Chart I-13. Credit spreads are shown inverted in both panels of this chart. We remain negative on both EM currencies and commodities prices, and argue for a cautious approach to EM credit markets.  Bottom Line: Elevated foreign currency debt levels among some EM corporations, plunging revenues and local currency depreciation combine for a perfect storm in EM corporate credit. To make matters worse, this asset class as well as EM sovereign credit were extremely overbought before this selloff. Therefore, there could be more outflows from these markets as adverse fundamentals persist.  Investment Strategy And Positions We continue to recommend underweighting EM stocks and credit versus their DM counterparts. Importantly, the EM equity index has been underperforming the global equity benchmark in the recent rebound (Chart I-14). Aggressive policy stimulus in the US and Europe have improved investor sentiment towards their credit and equity markets. Yet, the Chinese stimulus has so far been less aggressive than in the past. This will weigh on the growth outlook for emerging Asia and Latin America. The outlook for oil prices is currently a coin toss. Price volatility will remain enormous and it is not worth betting on either the long or short side of crude. Apart from oil, industrial metal prices remain at risk due to subdued demand from China. In general, this is consistent with lower EM currencies (Chart I-15).   Chart I-14Continue Underweighting EM Stocks Versus The Global Benchmark Chart I-15EM Currencies Correlate With Industrial Metals Prices Chart I-16Book Profits On Long EM Currency Volatility Trade In accordance with our discussion above that the most acute phase of this crisis might be over, we are booking profits on our long EM currency volatility trade. We recommended this trade on January 23, 2020 and the JP Morgan EM currency implied volatility measure has risen from 6% to 12% (Chart I-16). While EM currencies could still sell off, we doubt this volatility measure will make a new high. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Vietnamese Stocks: Stay Overweight Like many EM bourses, Vietnamese stocks have plunged 35% over the past two months in US dollar terms. How should investors now position themselves with regard to Vietnamese equities, in both absolute and relative terms? In absolute terms, there are near-term risks to Vietnamese equities: Vietnam’s economy is highly dependent on exports, which amount to more than 100% of the country’s GDP. The deepening global recession entails that overseas demand for Vietnamese exports will be decimated. Chart II-1 illustrates how share prices often swing along with export cycles. Customers from the US and EU, which together account for 40% of Vietnamese exports, have been cancelling their orders. In addition, the number of visitor arrivals has already dropped significantly, and tourism revenue – which amounts to about 14% of GDP – will continue to contract (Chart II-2). Chart II-1Vietnamese Stocks: Risks Are External Chart II-2Tourism Has Crashed   Nevertheless, we expect Vietnamese stocks to outperform the EM benchmark, in USD terms, both cyclically and structurally. First, Vietnam has solid macro fundamentals. The country’s annualized trade surplus has ballooned, reaching $12 billion in March (Chart II-3). Even as exports contract, the current account balance is unlikely to turn negative. Notably, Vietnam imports many of the materials required to produce its exported goods. As such, its imports will shrink along with its exports, which will support its current account balance. Meanwhile, the year-on-year growth of domestic nominal retail sales of goods has slowed down, but remains at 8% as of March, which is quite remarkable (Chart II-4). Chart II-3Vietnam Has Large Trade Surplus Chart II-4Consumer Spending To Slow But Not Contract   Second, the government has announced a sizable policy stimulus package. On March 16, the State Bank of Vietnam cut its policy rate by 50bps, from 4% to 3.5%, and its refinancing rate by 100bps, from 6% to 5%. On April 3, Vietnam's Ministry of Finance passed a fiscal stimulus package worth VND180 trillion (equal to US$7.64 billion, or 2.9% of its GDP). Third, Vietnam has contained the COVID-19 outbreak better than many other countries. With aggressive testing and isolation, the country has so far limited the infection rate to only three out of one million citizens, and reported zero deaths. This reduces the probability that Vietnam will be forced to adopt severe confinement measures that would derail its economy. This nation’s success also contrasts with the difficulties that many emerging and frontier economies are having in their struggle with COVID-19 containment.  We continue to overweight Vietnamese stocks relative to EM due to healthy fundamentals, attractive valuations, a large current account balance and a successful economic and health response to the COVID-19 outbreak. Fourth, the country remains quite competitive in global trade. For some time, multinational companies have been moving their supply chains to Vietnam in order to take advantage of its cheap and productive labor, inexpensive land and supportive government policies. As a result, Vietnamese exports have been outpacing those of China across many industries (Chart II-5). Given the geopolitical confrontation between the US and China is likely to persist over many years, more manufacturing will shift from China to Vietnam. Investment Recommendations In absolute terms, we believe Vietnamese stocks are still at risk. Stock prices falling to their 2016 low is possible over the coming weeks and months, which corresponds to a 10-15% downslide from current levels (Chart II-6, top panel). Chart II-5Vietnam Continues Gaining Export Market Share Chart II-6Vietnamese Stocks: Absolute & Relative Performance   Relative to the EM equity benchmark, however, we continue overweighting Vietnam equities, both cyclically and structurally. Technically, this bourse’s relative performance has declined to a major support line and it could be bottoming at current levels (Chart II-6, bottom panel). Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com     Footnotes   Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Dear Client, Next week, we will send you a special report published by our Geopolitical Strategy service, authored by my colleague Roukaya Ibrahim. Roukaya will provide her insights on the global shortages of medical equipment as well as the risk of food shortages. A significant portion of the special report focuses on China. We trust you will find her report very useful. Additionally, I will be having three webcasts next week, discussing the economic and financial implications of the COVID-19 pandemic on China. The webcasts will be in both English and Mandarin. Please check out the dates and time on our website. Best regards, Jing Sima China Strategist   Highlights China’s official and Caixin manufacturing PMIs in March were weak at best. The indexes underscore that a quick recovery of Chinese and global economic growth is unlikely. A recent re-lockdown of a Chinese county, along with tightened containment measures in other key Asian economies, illustrates the risk of a second wave of infections and a precarious economic “return to normalcy”. Further policy supports announced in the past week suggest that Chinese authorities may be willing to match the size of stimulus from other major economies. In the next three months, risks to Chinese stock prices are still elevated barring a peak in the global pandemic. We maintain a neutral position in both Chinese investable and domestic stocks. Feature Global financial markets are unlikely to sustainably move higher in an environment where it is uncertain whether the COVID-19 virus is abating and business activities can start resuming (Chart 1). China’s economy and stock prices are not insulated from a deep global recession. Price volatility will remain high in Chinese stocks in the next three months and, therefore, we maintain a neutral position in Chinese investable and domestic stocks. Chart 1Close To A Peak In New Cases? In financial markets, cyclical stocks have underperformed defensives since early March. In particular, information technology, materials, industrials and consumer discretionary, all have underperformed the broad market. This reflects a delayed recovery in China’s economic fundamentals. Tables 1 and 2 highlight key developments in China’s economic and financial market performance in the past month. On the growth front, both the official and Caixin PMIs rebounded to above the 50% boom-bust threshold from historic lows in February. However, the indexes suggest that headwinds to China’s economic recovery are not yet subsiding. Table 1China Macro Data Summary Table 2China Financial Market Performance Summary Chart 2Supply Shock Meets A Collapse In Demand The methodology in calculating PMI indexes reflects the net reported improvement in activity relative to the previous month; a reading of 50 represents no month-over-month change. As such, a 52 reading in March’s official PMI suggests that manufacturing activity in China barely ticked up over February. This is concerning given the extremely depressed level of manufacturing activity in February (Chart 2).  Furthermore, two important subcomponents of the PMI remained in contractionary territory even after February’s plunge. While the new orders subcomponent modestly improved in line with the overall index, new export orders and the imports index continued to contract (Chart 2, middle panel). The latter is particularly important for investors who focus on global growth because a modest improvement in Chinese domestic demand that does not translate into import growth is of limited benefit to China's trade partners and global economic activity. In our view, China's March PMI reflects a return to normalcy for the supply side, but it also indicates that domestic demand remains very weak (Chart 2, bottom panel). This is a discouraging result. While March’s economic data in the developed world will likely be uniformly negative, China’s weak PMI readings suggest that its economy may have been impacted by “second-round effects”. This aspect is an ominous sign for developed economies, particularly the US, where the number of new cases continues to escalate. A second wave of infections in China and other Asian nations also underlines the fragility of the rebound, both on the social and economic fronts. Although the pandemic in Asia was largely contained domestically by early March, there is now an increasing number of both imported and domestically transmitted cases. China recently locked down a county of about 600,000 residents and Singapore closed schools and workplaces last week due to a re-emergence of domestic cases.1 There are some encouraging signs in China’s housing market. The monthly real estate sector indicators in Table 1 show the severe impact of the pandemic on China’s property market in the first two months of the year. However, the seasonally adjusted daily data indicate that home sales in China’s 30 large- and medium-sized cities steadily picked up in March (Chart 3). By the end of March, the amount of floor space sold in those cities surpassed the same period of the previous year. A return to normal in housing demand and activity will be crucial for easing property developers’ cash constraints and a recovery in China’s construction sector. On the policy response front, monetary and fiscal stimulus measures continue to roll out. The PBoC chopped its 7-day reverse repo rate by 20bps on March 30, which was the third rate cut in 5 months. It helped to push the 3-month interbank repo rate back to its early-2010 low. We noted in a previous report2  that the 3-month repo rate is China's de facto short-term policy rate and that changes in the rate are strongly linked to average lending rates in the economy (Chart 4). A lowering in the repo rate will help to ease financial conditions and support an eventual rebound in China’s economic activity. Chart 3Signs Of A Gradual Revival In The Housing Market Chart 4Lending Rates Bound To Drop Further Further monetary and fiscal stimulus are also pending. The timing and magnitude of these measures suggest that Chinese policymakers may be willing to step up their efforts to match the size of stimulus from other major economies, such as the US.3 If so, it will support our cyclical (i.e. 6-12 months) overweight investment call on Chinese stocks relative to global benchmarks, even though we believe that the short-term risks to Chinese stock prices are still quite elevated. The PBoC adjusted down the interest rate on financial institutions’ central bank excess reserves from 0.72% to 0.35%, effective April 7. The move is significant: the last time that the PBoC reduced the excess reserve rate was in November 2008 during the global financial crisis. The excess reserve rate drop of 0.37% is also larger than the 0.27% dip in 2008. The cut in excess reserves will free up more liquidity for commercial banks and encourage them to lend to businesses. More importantly, the decrease will lower the floor of PBoC’s “interest rate corridor” and pave the way for further reduction in the MLF (the ceiling of the corridor), LPR, and even the benchmark deposit rate which has remained unchanged for the past five years (Chart 5). Last week’s Politburo meeting approved an increase in this year’s quota of local government special purpose bonds (SPBs) along with a bigger fiscal deficit, and the issuance of special treasury bonds (first time since 2007).  We believe the fiscal support will help facilitate double-digit growth in infrastructure spending this year. The exact quantity of the SPB quota will be approved at the upcoming National People’s Congress (NPC), but we think the quota will be close to 4 trillion yuan. This amount, which is equivalent of 4% of China’s GDP, will almost double the 2.15 trillion yuan SPBs issued in 2019. Chart 5Lowering The Floor Opens The Door Chinese stocks have lost more than 10% of their value year-to-date. In addition, cyclical stocks have underperformed defensives in the past month (Chart 6). We noted in our October 30 Special Report4 that historically these cyclical sectors have been positively correlated with pro-cyclical macroeconomic and equity market variables. Therefore, a return to outperformance in both the aggregate Chinese stocks and cyclical sectors will likely require strong evidence of an upturn in China’s business cycle. Chart 6Cyclicals Vs. Defensives Performance Has Reversed Course Chart 7RMB Depreciated Due To A Dollar Rally... The recent devaluation in the RMB against the USD is linked to the dollar’s strength. In the near term, the downward pressure on the RMB against the greenback will persist because the dollar will strengthen from signs that the global economy is entering a more protracted slowdown5 (Chart 7). We think it is unlikely that the PBoC will intervene in the exchange rate market to prop up the RMB; the weakness in the RMB has been benign and limited compared with a collapse in EM currencies (Chart 8). A strong RMB does not bode well either for China’s export price competitiveness or corporate profits (Chart 9). As such, we think that the PBoC will allow the RMB’s value to remain weak against the dollar. The ongoing race-to-the-bottom in interest rates and competitive currency devaluations have indeed provided a window for the PBoC to cut interest rates even more. Chart 8...But Appreciated Against EM Currencies Chart 9A Strong RMB Is Not Desired In The Current Environment   Qingyun Xu, CFA Senior Analyst qingyunx@bcaresearch.com Jing Sima China Strategist jings@bcaresearch.com       Footnotes 1 https://www.bloomberg.com/news/articles/2020-04-02/chinese-county-back-under-lockdown-after-infection-re-emerges?mc_cid=e33ef3872b&mc_eid=9da16a4859 https://www.scmp.com/week-asia/health-environment/article/3078297/singapore-close-schools-most-workplaces-next-week 2Please see China Investment Strategy Special Report "How To Analyze And Position Towards Chinese Government Bonds," dated January 29, 2020, available at cis.bcaresearch.com 3China has deployed bank re-lending programs and supplementary funds totaling about 1.5% of its 2019 GDP. A 4 trillion yuan local government SPBs will add more than 4% of GDP in fiscal spending. Fiscal deficit is likely to be augmented by 2% of GDP, and the issuance of special treasury bonds and local government general purpose bonds should amount to more than 2% of GDP. 4Please see China Investment Strategy Special Report "A Guide To Chinese Investable Equity Sector Performance," dated October 30, 2019, available at cis.bcaresearch.com 5Please see Foreign Exchange Strategy Weekly Report "Which Are The Most Attractive G10 Currencies?" dated March 27, 2020, available at fes.bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations

The VIX hit 85.47 intraday on March 18th and clocked its highest close since the history of the data. Its sibling the VXO (volatility on the OEX or S&P 100) that predated the VIX hit an intraday high of 172.79 on Tuesday, following Black Monday, October 20, 1987, and suggests that if another crash takes root the VIX can hit triple digits.1  Importantly, vol at 44 translates into a 13% move in the SPX, in either direction, in the next 30 days. The chart below shows that actual SPX realized volatility remains well over a 100, trumping the VIX’s spike. Historically, when realized volatility leaves the VIX in the dust, it is time to sell the VIX; the opposite is also true. Given that we still do not expect a repeat of the GFC, or a depression, we recommend investors with higher risk tolerance continue to deploy long-term oriented capital in the broad equity market with a 9-12 month cyclical time horizon. Footnotes 1     http://www.cboe.com/products/vix-index-volatility/vix-options-and-futures/vix-index/vix-historical-data  

Special Report

Highlights The potential range of book value outcomes for large banks is enormous, … : Total credit losses will be a function of the virus’ persistence, the intensity and duration of the social distancing actions taken to combat it, and the efficacy of monetary and fiscal policy measures meant to mitigate the economic pain. … making it almost impossible to assess their equity valuations: With the uncertainty around each of the three independent variables, estimating default rates and recovery rates is a guessing game. This is the most sudden recession on record, … : Nearly 10 million people have filed initial jobless claims in the last two weeks, more than the average over the first 26 weeks of the last seven recessions. … but the biggest banks have entered it on more stable footing than they typically would, and they have a few things going for them: The biggest banks are nowhere near as extended as they typically are after expansions, with unusually conservative asset portfolios and a large stockpile of equity capital. Feature “It depends” is always the answer to quite a few questions in economics, but right now, it’s the answer to just about all of them. Global economic activity is hostage to the COVID-19 outbreak, and the social distancing measures that have been implemented in an attempt to impede its progress. No one can say for sure how long those measures will have to remain in place, though their impact has been starkly apparent on the broad swath of businesses that they have rendered unviable. Non-essential retailers, pro sports leagues, movie theaters, concert venues, gyms, barbers, nail salons, bars and restaurants have had their revenue streams cut off entirely. Nearly all of them have some fixed costs: rent if they don’t own their space; maintenance, mortgage payments and property taxes if they do. Table 1A Half-Year Of Jobless Claims In Two Weeks Monthly rent and mortgage obligations pose a thorny issue for the banking system, because they could lead to a surge of defaults among retailers and their landlords. The unprecedentedly rapid rise in unemployment (Table 1) could trigger a tsunami of home mortgage, credit card and auto loan delinquencies. Congress, the Fed, and various executive-branch departments and agencies are doing their best to protect the individuals and businesses sucked into the vortex, but the ultimate success of their efforts is uncertain. That uncertainty makes it impossible to project the SIFI banks’ credit losses within a reasonably useful confidence interval. To take an extreme example, what if the collateral securing auto loans were reduced to its scrap value because consumers developed an aversion to previously-owned vehicles? Getting less far-fetched, what if all used cars had to be marked down by 20 or 30% to entice drivers to swallow their discomfort, and the value of soon-to-be-vacant homes and apartments faced similar haircuts? Neither is our base-case scenario, but the fact that the markdown scenario is at least plausible illustrates the difficulty of estimating credit losses, and the challenge of coming up with decent estimates of SIFI banks’ earnings and capital adequacy. For the time being, we cannot say if the SIFI banks are better bought or sold at their current prices because we don’t know how 1Q loan-loss provisions will affect their March 31st book value, or what June 30th book might be. Our thinking has evolved in the week since we published Part 1 of this Special Report on the biggest US banks’ vulnerability. Initially, 50 years of Wells Fargo’s financials led us to believe that the SIFI bank de-rating over the last month and a half was excessive, and we concluded that buying SIFI banks at or below their December 31st tangible book value provided investors with a significant margin of safety. The chance to buy at or below tangible book would be a gift even in a bad recession, but the current episode threatens to go well beyond bad. Though we still lean to buying the SIFIs rather than selling them, we now recommend that investors watch and wait before committing, as they should with risk assets more generally. We hold to that bias because our review of system-wide data revealed ample instances of how the largest banks have entered this recession in better shape than normal. We also take heart from the idea that the Fed and elected officials will vigorously pursue policies that directly and indirectly benefit the banks. The banking system is considerably more solid than it was ahead of the 2007-8 crisis. It’s not immune to the shocks that are roiling the economy, but it will not be a driver of them. A Lack Of Banking Excesses Back in 2007, the last time that a recession/financial crisis was taking aim at the US, a bank-examiner-turned-analyst told us that, “Banks create value on the liability side of the balance sheet [via deposits], and destroy it on the asset side.” At the time, the destruction was centered on subprime mortgages and the securities they spawned, but the story plays itself out in every cycle. Bad loans are made in good times, as bankers let their guard down after an extended period of low defaults and market share takes precedence over lending standards. Banks exercised more restraint over the last 10-plus years than they have in any prior postwar expansion. 11 years of zero- and negative-interest-rate policy have promoted plenty of credit excesses, as many investors have gone far afield in search of yield. Bond covenants have been shredded, and corporate leverage has duly risen. Yet banks have largely stayed out of the fray. Bank lending grew at a markedly slower rate between July 2009 and February 2020 than it has in any other postwar expansion1 (Chart 1, top panel). Chart 1An Especially Restrained Expansion Total loan growth slid all the way to 3.8% annualized versus 9.7% in prior postwar expansions. While real estate lending slowed the most, following the frenzy that precipitated the 2007-8 crisis (Chart 1, bottom panel), C&I (Chart 1, second panel) and consumer lending (Chart 1, third panel) also fell well short of their postwar expansion pace, and only consumer lending failed to set a new postwar expansion low (Table 2). From the examiner-analyst’s perspective, banks behaved less self-destructively in the last ten-plus years than they have in any other postwar expansion. Regulatory efforts to curb banking excesses really did get some traction. Table 2Core Bank Lending Growth During Expansions Setting An Uncharacteristically Good Example Historically, the largest banks are at the center of the excesses that make the banking system vulnerable and help set the stage for crises. It wasn’t a community banker, after all, who smugly declared that countries don’t go bust after having plunged headfirst into lending to shaky Latin American governments. It has been the biggest players who have hatched dubious financial innovations and scaled them to the extremes that trigger systemic rumbles. Since the 2007-8 crisis, however, the biggest banks have demonstrated uncommon restraint. As we noted in Part 1, loan-to-deposit ratios around 100% and above are a sign of instability because they have to be funded with capital flows that are here today but gone tomorrow. Lower loan-to-deposit ratios hold down profits, but they buffer banks’ exposure to the business cycle, provided that deposit funding isn’t diverted to uses that are riskier than straightforward loans. The FDIC and the Fed maintain data series that offer insight into different-sized banks’ use of their lending capacity. The FDIC’s Quarterly Banking Profile, published since the mid-‘90s, breaks out total system loan-to-deposit ratios into categories based on the size of individual banks’ assets. Using its data, we were able to compare the largest banks’ activity with all other FDIC-insured banks’ activity since 1997. The comparison showed that the largest banks performed an about-face after the subprime crisis, going from operating with uniformly higher loan-to-deposit ratios than all other banks to operating with uniformly – and significantly – lower loan-to-deposit ratios (Chart 2). Chart 2The Biggest Banks Are Using Less Of Their Lending Capacity ... The Fed’s commercial bank balance sheet data covering large and small banks extend back another decade. The data do not align perfectly with the FDIC’s, as the Fed’s large-bank subset (the top 25 banks by assets) has been broader than the FDIC’s since 2016 (top 9 or 10 banks) and was narrower in prior years (the FDIC’s top subset included 66 to 119 banks). The Fed’s data do not show large banks making fuller use of their deposit capacity in the ‘90s and most of last decade, but they echo the post-2007-8 drop-off in the FDIC data (Chart 3). The biggest banks have operated with less risk under the Basel 3/Dodd-Frank/Volcker Rule regime, allocating less of their capacity to loans, and considerably more to Treasuries, agencies and cash (Chart 4). Chart 3... No Matter How They're Defined ... Chart 4... And They're Directing It To Safer, More Liquid Assets Banks Are Better Capitalized Than They Used To Be The overall banking system is operating with considerably less leverage than it did in the ‘80s or ‘90s, as equity capital now accounts for 12% of total assets (Chart 5). Wells Fargo’s leverage history as shown in Part 1 suggests that banks were even more thinly capitalized in the ‘70s. An increased proportion of equity capital makes a bank more resilient to loan losses and other operational stumbles. Critically for the stability of the system, the SIFI banks are forced to maintain additional capital buffers. The combination of increased equity capital and increased holdings of liquid assets with little to no credit risk like Treasury and agency securities has made all of the largest banks safer. Chart 5Increased Equity Financing Has Made Banks More Resilient Some Fears Seem Overblown We reiterate from Part 1 that larger banks do not borrow short to lend long, and have not for a long time. According to the latest Quarterly Banking Profile, barely a sixth of the 4,400 banks with assets of less than $1 billion report having any derivatives exposure. A considerable majority of community banks must therefore take their asset and liability maturity profiles as given, leaving them exposed to the vagaries of shifts in the yield curve. No management team at a decently-sized publicly traded bank would dare to run anything more than a very narrow mismatch in asset and liability duration, however, as evidenced by the gargantuan interest-rate swaps market. Bank stocks may trade with 10-year Treasury yields, but the slope of the curve has very little bearing on bank earnings.2 During recessions, banks usually encounter more customers trying to park money than businesses trying to borrow it.  Unused loan commitments have provoked much agita among investors in recent weeks. A floundering company, desperately trying to stay afloat, may well draw down all of its available credit lines. Line drawdowns could force banks to make good on loan commitments made in better times that now have little prospect of repayment. While they do not appear to have been a significant issue in the ’90-’91 or 2001 recessions, lines were drawn down sharply in 2007-8 (Chart 6). Chart 6Much Ado About Nothing? The positive news for banks is that their exposure to untapped commitments is considerably smaller than it was heading into the last recession. They may also be less likely to be drawn, thanks to multiple Fed initiatives aimed at ensuring the availability of credit, like its ambitious plan to backstop investment-grade corporate borrowers, and the CARES Act’s expansion of Small Business Administration funding and provision of loans and loan guarantees for ailing companies in industries related to national security. There are going to be considerably more strapped borrowers, but they will have more non-bank avenues to obtain funding than they have had in prior recessions. Banks know that line demand may spike soon after the business cycle peaks; they reserve for unused commitments and will not be caught entirely unawares. Finally, not all of the unused commitments are to suffering C&I borrowers that investors most fear; Wells Fargo’s commitment history suggests that the largest share of the outstanding commitments are to individual credit card borrowers. Despite rising distress, lending has increased at a fairly modest rate during recessions, as households and businesses broadly shrink from risk, while deposits have grown at a faster rate, as the safety of FDIC-insured accounts gains appeal (Table 3). We do not expect that increased consumption of credit line capacity will materially alter the banking system’s credit exposures. Table 3Core Bank Lending And Deposit Growth During Recessions Investment Implications The banking system, anchored by the SIFI banks, is in considerably better shape now than it was in 2007, and does not pose an active threat to the financial system this time around. The banking system is not only better capitalized than it has been in the past, but large banks have invested far more conservatively. We cannot assess how expensive SIFI stocks are without having a better handle on potential loan losses, however, and we need to get a sense at how successful the Fed’s and Congress’ interventions to stem the building economic distress will be. We hope for the best, but the last-mile issues are complicated, and we expect that the mitigation efforts will have to work out some kinks before they begin to get traction. Don't worry about the banks, but give it some time before buying them. Congress and the Fed are trying to perform challenging new routines, and it's unlikely they'll stick the landing on their first try. Table 4Comfortably In The Money Our no-rush-to-buy take on the broad market applies to the SIFI banks, as well. We have high conviction that Congress and the administration will do whatever it takes to shore up the most vulnerable parts of the economy as they reveal themselves, and the Fed has already moved to a war footing. Stocks can go lower as they climb the learning curve, and may have to do so to signal the need for further intervention. We would not be concerned in the slightest if the SIFI banks were to cut or suspend their dividends. Husbanding cash is a good idea in times of uncertainty, and a couple of quarters without dividends is far preferable to shareholders than a dilutive secondary equity offering or rights issue. To the extent that it may leave elected officials more favorably disposed to the banking sector, it would be a plus. One may as well stay on the good side of legislators doling out goodies. Finally, our newly increased sense of caution does not extend to the put-writing idea we detailed two weeks ago. If implied volatility in the SIFI banks’ stocks returns to the triple-digit level, investors selling put options would be generously compensated for assuming the inherent risks. Even though the SIFIs have stumbled over the last six sessions, time decay and the steep decline in the VIX have the contracts we highlighted well in the money (Table 4).   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 Until the NBER makes the official designation, our working assumption is that the recession began in March. 2 Please see the February 28, 2011 US Investment Strategy Special Report, "Banks And The Yield Curve," available at usis.bcaresearch.com.