Fiscal

Highlights The global manufacturing cycle has averaged about three years in length (peak-to-peak). We are near the bottom of the current cycle, which should set the stage for a recovery phase lasting around 18 months. The global economy will start to slow in 2021, culminating in a recession in 2022. The long-term global disinflationary cycle is drawing to a close. Investors should remain bullish on risk assets for the next two years, but expect subpar returns over a longer-term horizon.  Feature The Wheels Are Turning BCA Research has a long and proud history of analyzing economic and financial market cycles. Three types of cycles, in particular, have proven to be important to investors: Short-term manufacturing cycles lasting roughly three years. Medium-term business cycles affecting the entire economy. Long-term supercycles that can span decades. These often involve significant economic, social and political changes. What Really Caused The Global Manufacturing Downturn? The latest global manufacturing downturn has been widely attributed to the escalation of the trade war, the Chinese deleveraging campaign, and the end of the “sugar rush” from the Trump tax cuts. We have no doubt that all these factors exacerbated the downturn. However, it is not clear whether they caused it. As Chart 1 illustrates, the Chinese deleveraging campaign began in late 2016, more than a year before the global manufacturing sector peaked. The trade war only heated up in the spring of last year, after manufacturing activity had already begun to roll over. The jury is still out on the extent to which U.S. corporate tax cuts spurred capital spending, as opposed to being funnelled into retained earnings and share buybacks. Regardless, the fact that capex has weakened less in the U.S. than abroad over the past 18 months suggests that the fading impact from U.S. tax cuts was not the main culprit (Chart 2). Chart 1Chinese Credit Growth Deceleration Preceded The Global Manufacturing Slowdown Chinese Credit Growth Deceleration Preceded The Global Manufacturing Slowdown Chinese Credit Growth Deceleration Preceded The Global Manufacturing Slowdown Chart 2The Capex Slowdown Has Been Less Severe In The U.S. The Capex Slowdown Has Been Less Severe In The U.S. The Capex Slowdown Has Been Less Severe In The U.S.   A Predictable Cycle Chart 3The Global Manufacturing Cycle Has Likely Reached A Bottom The Global Manufacturing Cycle Has Likely Reached A Bottom The Global Manufacturing Cycle Has Likely Reached A Bottom Lost in the discussion over the cause of the slowdown is that global manufacturing activity follows a fairly predictable three-year growth cycle: up for the first 18 months, down for the second 18 months (Chart 3). This is not an immutable law of nature, but it is a handy rule of thumb. The last growth cycle began in the late spring of 2016 and reached a crescendo in December 2017 (based on the global manufacturing PMI). For now, the global manufacturing sector remains in the doldrums, with this week’s worse-than-expected Markit PMI readings for both the U.S. and the euro area being prime examples. However, if history is any guide, activity should begin to rebound over the coming months. Global manufacturing activity follows a fairly predictable three-year growth cycle. The large improvement in the Philly Fed manufacturing PMI – arguably the most important of all the regional Fed manufacturing surveys1 – in July, strong U.S. core capital goods orders, as well as the slight uptick in Korean exports on a month-over-month basis, are positive signs in that regard. The same goes for the sales outlook of two manufacturing bellwether companies which reported earnings this week: United Technologies and Texas Instruments. The former manufactures Otis elevators, Carrier air conditioning/HVAC, and Pratt & Whitney jet engines. The latter’s components are widely used throughout the global semiconductor industry. Chart 4 shows that the semiconductor cycle closely tracks the overall manufacturing cycle. Chart 4Semiconductor And Manufacturing Cycles Tend To Overlap Semiconductor And Manufacturing Cycles Tend To Overlap Semiconductor And Manufacturing Cycles Tend To Overlap Cycles And Feedback Loops What drives the short-term manufacturing cycle? The answer is the same thing that drives all cycles: The existence of self-limiting feedback loops. In the case of the manufacturing cycle, the feedback loop is fairly straightforward to describe. A pickup in manufacturing sales boosts profits and creates new jobs. This causes consumer and business confidence to rise. Improving confidence leads to more sales, which generates even higher confidence. If that were all there was to the story, this virtuous cycle would never end. This is where the “self-limiting” part comes in. Most manufactured goods are durable goods, meaning that they retain value for some time after they are purchased. When spending on, say, automobiles or computers rises to a high level for an extended period of time, a glut will form, requiring a period of lower production. This, in turn, will generate a negative feedback loop where falling sales lead to lower confidence and so forth. The glut will eventually shrink. Once enough pent-up demand has accumulated, a new upcycle will begin.  The Role Of Finance Banks and other financial institutions play a critical role in both perpetuating, and ultimately short-circuiting, the feedback loop described above. Business lending tends to ebb and flow with capital spending (Chart 5). It is not so much that one causes the other. It is better to think of the two as locked in a self-reinforcing tango: Faster output growth leads to more lending, and more lending leads to faster output growth. Chart 5The Ebb And Flow Of Lending And Capex Go Hand In Hand The Ebb And Flow Of Lending And Capex Go Hand In Hand The Ebb And Flow Of Lending And Capex Go Hand In Hand The amount of time it takes for the music to end, and for the dancers to part ways, varies from episode to episode. If both lenders and borrowers are feeling skittish, the party may never reach a fever pitch. While that may sound like a bad thing, it has the redeeming feature that imbalances never get a chance to reach critical levels. This brings us to today: Unlike in the pre-financial crisis period, when banks held Chuck Prince’s view that “as long as the music is playing, you’ve got to get up and dance,” lenders are more circumspect. This is a critical reason why we think the next U.S. recession is not imminent. Private-Sector Imbalances Remain Low In The United States Despite this being the longest U.S. expansion on record, the ratio of private debt-to-GDP is still well below where it was at the start of the decade (Chart 6). Chart 6U.S. Private Sector Leverage Remains Below Its Previous Peak U.S. Private Sector Leverage Remains Below Its Previous Peak U.S. Private Sector Leverage Remains Below Its Previous Peak Granted, corporate debt levels have scaled new highs. However, thanks to low interest rates, interest coverage ratios remain above their post-1980 average. This is true for the economy as a whole, as well as for the broad equity market (Chart 7). Chart 7AInterest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (I) Interest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (I) Interest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (I) Chart 7BInterest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (II) Interest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (II) Interest Coverage Ratios Are Not Particularly Stretched In Most Equity Sectors (II) Spending on business equipment, new homes, and consumer durables also remains restrained. This explains why the average age of the U.S. capital stock has increased sharply since the Great Recession (Chart 8). Chart 8The Capital Stock Is Aging The Capital Stock Is Aging The Capital Stock Is Aging Public-Sector Imbalances On The Rise, But Not Yet At Critical Levels Chart 9The Private Sector Is Not Living Beyond Its Means The Way It Was Before The Last Two Recessions The Private Sector Is Not Living Beyond Its Means The Way It Was Before The Last Two Recessions The Private Sector Is Not Living Beyond Its Means The Way It Was Before The Last Two Recessions The one area where clear imbalances in the U.S. are present is in public finances. The tentative deal between the Trump Administration and Congress to raise spending caps and increase the debt ceiling ensures that fiscal policy will stay accommodative for the foreseeable future. Unfortunately, the cost of this fiscal largesse is a budget deficit that is set to swell to $1 trillion (4.5% of GDP) in FY2020, up from $586 billion (3.2% of GDP) in FY2016. Financing this deficit over the next few years is unlikely to pose serious challenges because the private sector remains an ample source of savings (Chart 9). However, once this reservoir of savings starts to recede, bond yields could rise sharply.   Chinese Imbalances: How Much Of A Concern? Economic and financial imbalances are more pronounced abroad. In China, fixed investment spending has averaged 44% of GDP over the past decade. Debt levels have soared over this period. That said, much of this debt-financed investment should be regarded as a form of stimulus for an economy that suffers from a chronic shortfall of consumption. So far this year, the decline in Chinese private-sector fixed-asset investment has been counterbalanced by an increase in infrastructure spending (Chart 10). As in the U.S. and many other economies, abundant Chinese savings have allowed interest rates to stay low, thereby ensuring that borrowers are able to tap credit at favorable terms. We expect the Chinese authorities to continue stimulating their economy. Unlike in early 2017, credit growth is only modestly above trend nominal GDP growth (Chart 11). In addition, a stronger economy would give the Chinese government more leverage over trade negotiations. Chart 10China: Declining Private-Sector Investment Counterbalanced By Increasing Infrastructure Spending China: Declining Private-Sector Investment Counterbalanced By Increasing Infrastructure Spending China: Declining Private-Sector Investment Counterbalanced By Increasing Infrastructure Spending Chart 11China: The Deleveraging Campaign Has Been Put On The Backburner China: The Deleveraging Campaign Has Been Put On The Backburner China: The Deleveraging Campaign Has Been Put On The Backburner   A Turn In The Long-Term Inflationary Cycle? While the unemployment rate has returned to pre-recession levels in many economies, the scars from the Great Recession still remain. Nowhere is this more manifest than in the hypersensitivity that central banks have displayed towards bad economic news. Just as central bankers in the 1960s were fixated on avoiding the mass unemployment that accompanied the Great Depression, today’s central bankers are laser-focused on propping up demand at all costs. The new conventional wisdom is that the Phillips curve is dead. Chart 12 casts doubt on this assertion: It shows that the relationship between wage growth and various measures of labor market slack still seems very much alive and well. Chart 12A Tighter U.S. Labor Market Has Been Translating Into Stronger Wage Growth... A Tighter U.S. Labor Market Has Been Translating Into Stronger Wage Growth... A Tighter U.S. Labor Market Has Been Translating Into Stronger Wage Growth... Chart 13...But No Imminent Threat Of A Wage-Price Inflationary Spiral ...But No Imminent Threat Of A Wage-Price Inflationary Spiral ...But No Imminent Threat Of A Wage-Price Inflationary Spiral Admittedly, faster wage growth has failed to push up inflation. However, this may be simply because productivity growth has sped up. In the U.S., unit labor cost inflation has actually decelerated sharply since late 2017 (Chart 13). If wage growth continues to grind higher, firms will have no choice but to start raising prices. This could set the stage for an upleg in the longer-term inflationary cycle.   Structural Forces: Not So Deflationary Anymore Once inflation starts to move higher, a number of structural forces could help it along. The period of hyperglobalization, which began with the collapse of the Soviet Union and the integration of China into the global economy, is over. The ratio of global trade-to-GDP has been flat for over a decade (Chart 14).  Chart 14Globalization Has Peaked Globalization Has Peaked Globalization Has Peaked Demographic trends are shifting from deflationary to inflationary. Now that baby boomers are starting to retire, they will begin running down their savings. Chart 15 shows that ratio of workers-to-consumers globally has begun to fall after a four-decade ascent. Chart 15The Worker-To-Consumer Ratio Has Started Shrinking Globally The Worker-To-Consumer Ratio Has Started Shrinking Globally The Worker-To-Consumer Ratio Has Started Shrinking Globally As more people retire, aggregate savings will fall. The shortage of savings will put upward pressure on the neutral rate of interest. If central banks drag their feet in raising policy rates in response to an increase in the neutral rate, monetary policy will end up being too stimulative. As economies overheat, inflation will pick up. The political winds are also blowing in the direction of higher inflation. Populism is on the rise. Whether it be right-wing populism or left-wing populism, the result is usually bloated budget deficits, compromised central bank independence, and productivity-reducing policies. Stagflation may once again rear its head. Investment Conclusions The path to higher interest rates is paved with lower rates, meaning that the longer a central bank keeps rates below their neutral level, the more economies will overheat, and the larger the eventual inflation overshoot will be. We expect the Fed to cut rates by 25 basis points next week, with another cut possible in September. The ECB and most other central banks are also in easing mode. The good news is that inflation is a notoriously lagging indicator (Chart 16). It will probably take at least a year for clear evidence of overheating to emerge in the U.S., and even longer abroad. The bad news is that once inflation breaks out, it could do so quite dramatically. The market is not prepared for this (Chart 17). Chart 16   Chart 17   Investors should maintain a bullish stance towards risk assets for the next 12-to-18 months, before starting to scale back exposure. Not only are central banks becoming more dovish, but the global manufacturing cycle is about to turn up. Stronger global growth will lead to a weaker U.S. dollar (Chart 18). EM and European stocks will start to outperform U.S. stocks (Chart 19). Cyclicals will trump defensives. Chart 18The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency Chart 19EM And Euro Area Equities Outperform When Global Growth Improves EM And Euro Area Equities Outperform When Global Growth Improves EM And Euro Area Equities Outperform When Global Growth Improves     As global yield curves steepen anew, bank stocks will power higher. U.S. small caps, with their relatively high weighting in regional banks, will outperform their large cap brethren (Chart 20). Chart 20Big Has Crushed Small Big Has Crushed Small Big Has Crushed Small   Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com Footnotes 1    The manufacturing segment in the region covered by the Philadelphia Fed is representative of the national manufacturing sector and hence tracks the ISM manufacturing index better than the other regional Fed surveys. Strategy & Market Trends MacroQuant Model And Current Subjective Scores Chart 21 Tactical Trades Strategic Recommendations Closed Trades

Highlights Six months into a credit expansionary cycle, China’s economic recovery remains fragile. Lack of government support for the auto and property sectors is undermining a cyclical recovery. Accommodative monetary policy is not enough to lift the Chinese economy out of its doldrums, particularly as households and companies remain restrained in levering up and spending. Fiscal policy has become more proactive this year by front-loading local government bond financing in the first half of 2019. But if policymakers are to stick to their budget deficit target for the year, the second half of the year will see fiscal tightening. Early signs suggest China is positioning for a further loosening of fiscal spending. However, the Chinese leadership will likely only allow limited additional stimulus this year, resulting in a “W-shaped” economic trajectory for the rest of 2019. In the near-term, the risk to Chinese equity underperformance is high. But over the coming 6-12 months, odds are that the economy will have weakened enough for the Chinese government to make concerted efforts to stimulate. An overweight stance on Chinese stocks is hence warranted over that time horizon. Feature China’s credit growth bottomed in December last year. Six months later, however, China’s economy is showing few signs of emerging from the woods: official GDP growth in the second quarter of this year rang in at its lowest pace in 27 years. Our monthly gauge of China’s business activity, after a brief improvement earlier this year, has flat-lined. The growth of investable earnings per share has fallen into negative territory (Chart 1).More concerning, however, is that manufacturing output has been trending straight down following a first-quarter blip (Chart 2). Chart 1Not Yet Out Of The Woods Not Yet Out Of The Woods Not Yet Out Of The Woods Chart 2Turning The Corner In Q3? Turning The Corner In Q3? Turning The Corner In Q3? As we mentioned in our July 10th, 2019 China Investment Strategy Weekly,1 while keeping monetary policy accommodative, China’s central bank has not been particularly proactive at significantly stimulating the economy. We believe the People’s Bank of China will continue to sit on the sidelines until the economy deteriorates further, and until they receive more clear guidance from China’s top leadership. The Politburo mid-year economic review meeting in late July will likely shed some light on any upcoming policy shift. Chart 3 In the meantime, fiscal policy has taken a more proactive role in supporting the economy this year: unprecedented tax cuts that account for about 1.7% of GDP started on January 1st, and local government bond issuance accelerated in the first half of 2019 relative to the past two years (Chart 3). Nevertheless, reflationary efforts in the past six months measured by aggregate credit growth as a percentage of nominal GDP have been “half-measured” compared to previous credit expansions. As a result, it is taking longer for China’s economy to find its footing.  The Missing Two “Prongs” It is convenient to blame the ongoing U.S.-China trade war for the sluggishness in the Chinese economy, especially in the manufacturing sector. But in our view, the trade war has only magnified what was already a weak and deteriorating domestic Chinese economy due to previously tight policy.2 What’s more, the magnitude of the stimulus so far has not been large enough to fully reverse the decline in Chinese domestic demand growth. The imbalances in China’s “old economy” have also stymied the effectiveness of the stimulus. Among the three “prongs” that supported a “V-shaped” economic recovery in 2015-2016 (stepped-up infrastructure spending, and support for the auto and real estate sectors), the latter two have been missing in the current episode3: Automobile. Both car sales and production have been contracting for almost a year. The contractions deepened in the second quarter from the first quarter, despite accommodative monetary and credit conditions. This is in sharp contrast from what happened in the 2015-2016 cycle: As credit growth picked up in mid-2015, year-on-year growth in auto sales and production both turned positive three months later and stayed mostly in positive territory until 2018 (Chart 4). Chart 4Auto Sector Has Not Responded To Stimulus Auto Sector Has Not Responded To Stimulus Auto Sector Has Not Responded To Stimulus Chart 5ALess Demand For Autos Less Demand For Autos Less Demand For Autos BCA’s Emerging Markets Strategy team has written at length on this topic.4 From their lens, both secular and cyclical factors have contributed to this year’s auto sector slump: First, a sharply higher automobile ownership rate in recent years has cyclically reduced household demand for cars (Chart 5A); Second, the central government has only allowed regional governments to loosen up policy restrictions on automobile purchases and license applications, as opposed to providing monetary incentives through sales tax reductions and subsidies in both 2009 and 2016. Another important contributing factor to depressed auto sales is the constraint on Chinese households’ balance sheets (Chart 5B). The rapid growth in mortgage and consumer borrowing from 2015-2017 has pushed Chinese household debt to nearly 120% of disposable income, higher than that in the U.S. (Chart 5C). Chart 5BSlower Pace In Leveraging For Chinese Households... Slower Pace In Leveraging For Chinese Households... Slower Pace In Leveraging For Chinese Households... Chart 5C...Following A Borrowing Binge ...Following A Borrowing Binge ...Following A Borrowing Binge Real Estate. The real estate sector was another “prong” that was crucial to the 2015-2016 cyclical recovery in China’s economy. Property sales picked up sharply in 2015, along with ballooning mortgage loans (Chart 6). In this cycle, however, housing sales have been sluggish, and real estate developers have been struggling to complete projects they have started (Chart 7). The three factors that drove property demand in 2015-2017 are now absent: Chart 6Property Market Was Red Hot In 2015-2016 Property Market Was Red Hot In 2015-2016 Property Market Was Red Hot In 2015-2016 Chart 7The Party Did Not Repeat In Current Cycle The Party Did Not Repeat In Current Cycle The Party Did Not Repeat In Current Cycle Skyrocketing mortgage lending. As mentioned above, the acceleration in household leveraging is unlikely to repeat in the current cycle. Real estate developers’ access to funding was the key to the strength of construction activity in the property market in 2016. Presently, real estate developers lack access to credit, including financing through shadow banking (Chart 8A). The China Banking and Insurance Regulatory Commission (CBIRC) has stepped up in real estate financing regulations and supervisions: It recently issued window guidance to curb certain borrowing activities among real estate developers in the offshore market, and also from obtaining financing through shadow banking domestically. Government subsidies are missing. Most importantly, subsidies from China’s central bank to the real estate sector was another key pillar of support for the property boom in the previous cycle. Our calculations indicate that about 20% of floor space sold (in volume terms) in 2017 was due to the Pledged Supplementary Lending5 (PSL) facility designed for slum area reconstruction.6 As of June, PSL has remained deeply in negative territory for 11 straight months (Chart 8B). Chart 8ARestrictive Lending Environment Unlikely To Change Soon Restrictive Lending Environment Unlikely To Change Soon Restrictive Lending Environment Unlikely To Change Soon Chart 8BGovernment Subsidies Are Missing Government Subsidies Are Missing Government Subsidies Are Missing The high level of leverage in both the household and property sectors have been focal points in the Chinese leadership’s financial deleveraging and de-risking campaign. Indeed, the restrictive financing environment for both sectors reflects the Chinese authorities’ determination to curb excessive borrowing and speculation in the housing market. Bottom Line: Two of the three impetuses that supported the upswing in the Chinese economy in 2015-2017 – auto sales and real estate – have so far been subdued or have acted as a drag on the economy in the current cycle. China will have to rely on the third pillar – infrastructure spending – to support the economy. Fiscal Policy “China will continue to implement a proactive fiscal policy, a prudent monetary policy and an employment-first policy, while making good use of counter-cyclical regulation tools and carrying out anticipatory adjustments and fine-tuning when necessary.” - Premier Li Keqiang, July 15, 2019. Fiscal policy has been proactive this year, but so far has failed to catalyze a recovery in investment spending. More importantly, the existing institutional framework on fiscal policy suggests that unless the Chinese government is willing to remove budgetary constraints, we will see fiscal tightening in the second half of the year. During the first half of this year, 70% of 2019’s total budgeted local government bonds were issued, double the amount issued in the same period last year.7 According to the Ministry of Finance, 65% of total local government bonds issued (including both general and special-purpose bonds) were invested in infrastructure projects.8  However, the growth figure for fixed-asset investment (including infrastructure) for the first six months of 2019 was the weakest in the past five years. The considerable deceleration in infrastructure investment since late 2017 can be attributed to three factors: a.  Sharply shrinking shadow banking. Local government spending has been stymied by the central government’s financial deleveraging efforts (Chart 9A). This affects both on-book fiscal spending and off-book spending by local government financing vehicles (LGFV). Although the exact impact on the latter is hard to quantify, the cracking down on shadow banking, a major financing channel for LGFV, coincides with the peak of infrastructure investment growth. Chart 9AShadow Banking Was A Crucial Funding Source For Infrastructure Investment Shadow Banking Was A Crucial Funding Source For Infrastructure Investment Shadow Banking Was A Crucial Funding Source For Infrastructure Investment Chart 9BA Thinner Wallet This Year A Thinner Wallet This Year A Thinner Wallet This Year   b.  Lower government revenue. Sluggish land sales have undermined local governments’ revenue streams. Land sales account for three quarters of local government revenue. Chart 9B shows that both land sales and government revenue decelerated in mid-2018, as lending conditions for the property sector became restrictive. In addition, as part of its fiscal stimulus efforts, the Chinese authorities stepped up on tax cuts to businesses and individuals this year. Tax cuts are estimated to augment the government’s 2019 deficit by 0.2 percentage points of GDP. As a result, government revenue from tax income in the first half of 2019 only grew by 0.9% year-on-year, way below the 14% growth clocked last year (Chart 9B, middle panel). By law, local governments cannot exceed their annual budgetary deficit by more than their quote of general purpose bond issuance. Lower revenue from slower land sales and tax cuts have impeded local governments’ spending capabilities. A bigger concern for investors is that the Chinese central and local governments are approaching their annual budgetary limits. By the end of June, while central and local governments have spent half of their budgeted expenditures for 2019, local governments had reached 70% of their total debt limits for the year. If the Chinese government is to stick to its 2019 budget, the fiscal impulse will lose steam in the second half of 2019: fiscal policy will actually tighten through the remainder of the year. Chart 10A and 10B illustrate that under such scenario, both fiscal spending and local government bond issuance will be trending down.  Chart 10AFiscal Impulse Losing Steam In 2H? Fiscal Impulse Losing Steam In 2H? Fiscal Impulse Losing Steam In 2H? Chart 10 Increasing spending by raising the budgeted deficit target ceiling is an option, though the least likely one. The basis is that a mid-year budgetary deficit revision would need the National People’s Congress’ approval, which has not occurred in the past 30 years.9  Nonetheless, the tone from the latest policy announcements suggests that the Chinese leadership is increasingly willing to work around these constraints and is positioning for a further loosening of fiscal spending. Chart 11Additional Funds Could Help, A Lot Additional Funds Could Help, A Lot Additional Funds Could Help, A Lot On June 11th, the Ministry of Finance made a policy announcement, relaxing financing restrictions on local government infrastructure spending. Local governments can now use proceeds from special-purpose bonds as capital to finance new spending on infrastructure projects.10 The new policy only applies to non-land development related infrastructure projects, which can make a maximum of 800 billion yuan available for infrastructure investment.11 As Chart 11 shows, if all of the additional 800 billion yuan is invested, a simple calculation suggests that it could lift infrastructure spending by as much as 4 percentage point before year end.  The government is also preparing for another round of local government off-balance-sheet debt swaps. The plan, which is still being formulated by the authorities, is to allow financial institutions to either extend or swap maturing local government off-balance-sheet debt with bank loans that carry lower interest rates and longer maturities. There are strict criteria as to what debt qualifies to be swapped. But with an estimated 30-40 trillion yuan of local government implicit debt, the size of this program could potentially be comparable to that of 2015-2016.12 But if the Chinese government were to allow the program to morph into a meaningful stimulus effort, it would require concerted effort from the central bank to equip commercial banks with the required liquidity. This would mean a further loosening in monetary conditions. Bottom Line: There are “soft constraints” hindering China from broadening its scope of fiscal spending for the year. For investors to feel confident that the policy response will lead to a meaningful re-acceleration in economic activity, these constraints will have to be overcome. Investment Implications As we pointed out in our previous China Investment Strategy Weekly,13 even with June’s large number in bank lending and total local government bond issuance, the cumulative progress in credit growth for the first half of the year is still closer to 27% of nominal GDP (assuming 8% nominal GDP growth for the remainder of 2019). This still falls into our “half-strength” credit cycle scenario relative to past reflationary episodes (Chart 12A & 12B).  Chart 12 Chart 12 Our bias is that the Chinese leadership will only allow limited additional stimulus this year, and are likely to wait until the economy weakens further before removing all budgetary and regulatory constraints. This will put the economy and financial market on a “W-shaped” trajectory for the rest of 2019. Therefore we recommend an underweight position in Chinese stocks for the remainder of the year. Ultimately, though, policymakers will respond if the economy weakens meaningfully further. The odds are good that the economy will have weakened enough for the Chinese government to make a concerted effort to fuel its economy over the coming 6-12 months. Thus, an overweight on Chinese stocks over a cyclical horizon is warranted, but the journey to eventual outperformance will be a turbulent one.   Jing Sima China Strategist JingS@bcaresearch.com     Footnotes: 1      Please see China Investment Strategy Weekly Report, “Threading A Stimulus Needle (Part 1): A Reluctant PBoC”, dated July 10, 2019, available at cis.bcaresearch.com. 2      Please see China Investment Strategy Weekly Report, “Trade Is Not China’s Only Problem”, dated November 21, 2018, available at cis.bcaresearch.com. 3      In 2015, nominal GDP growth bottomed 5 months following a pickup in credit growth. 4      Please see Emerging Markets Strategy and China Investment Strategy Special Report, “The Chinese Auto Market: Moderate Recovery Ahead”, dated February 13, 2019, available at cis.bcaresearch.com. 5      Pledged supplementary lending (PSL) scheme refers to China’s central bank’s direct lending to the real estate market. 6      The People’s Bank of China (PBoC) released RMB 698 billion in 2015 and RMB 971 billion in 2016 in the form of PSL injections into the real estate market as part of its attempts to revive the property market. 7      Including both general and special-purpose bonds, but discounting bonds issued for debt-to-bond swap or refinancing purposes. 8      Ministry of Finance Mid-Year Budgetary Press Conference, July 15, 2019 9      The last time the Chinese government issued a mid-year budget revision was following the Tiananmen Square Massacre, the only year China had a classical business cycle. It did NOT revise the budget during the 2008-‘09 global financial crisis, though. 10     Special-purpose bonds must be used for projects that are proven to make certain returns on investment and are supposed to be repaid with returns from the specific projects they are invest in, rather than fiscal revenue. Previously, local governments were prohibited from using borrowed money as capital in infrastructure projects. http://www.mof.gov.cn/zhengwuxinxi/caizhengxinwen/201906/t20190610_3274511.htm 11     The non-land development portion accounts for about 30% of total special-purpose bonds. 12     Some estimates suggest about 3-4 trillion yuan of local government implicit debt is qualified for the new swap program. 13     Please see China Investment Strategy Weekly Report, “Threading A Stimulus Needle (Part 1): A Reluctant PBoC”, dated July 10, 2019, available at cis.bcaresearch.com. Cyclical Investment Stance Equity Sector Recommendations

Highlights So What? U.S. policy uncertainty adds to a slew of geopolitical reasons to remain tactically cautious on risk assets. Why? U.S. fiscal policy should ultimately bring market-positive developments – though the budget negotiation process could induce volatility in the near-term. We expect spending to go up and do not expect a default due to the debt ceiling or another prolonged government shutdown. Former Vice President Joe Biden remains the frontrunner for the Democratic Party’s presidential nomination in 2020. But left-wing progressive candidates are gaining on him and their success will trouble financial markets. With Persian Gulf tensions still elevated, go long Q1 2020 Brent crude relative to Q1 2021. Feature Chart 1U.S. Politics Poses Risks Through Next November U.S. Politics Poses Risks Through Next November U.S. Politics Poses Risks Through Next November Economic policy uncertainty is rising in the United States even as it falls around the world (Chart 1). Ongoing budget negotiations and the Democratic primary election give equity investors another reason to remain cautious in the near term. We expect more volatility. There also remain several persistent global threats to markets posed by unresolved geopolitical risks – rising Brexit risks with Boris Johnson likely to take the helm in the United Kingdom; oil supply threats amid Iran’s latest rejection of U.S. offers to negotiate its missile program; and a major confirmation of our theme of geopolitical risk rotation to East Asia, with Japan, South Korea, Hong Kong, Taiwan, and the South China Sea all heating up at once. In sum, political and geopolitical risks are showing investors a yellow light, even though the macroeconomic outlook still supports BCA’s cyclical (12-month) equity overweight. U.S. Fiscal Policy Will Remain Accommodative While U.S. monetary policy has taken a dovish turn – supported by other central banks – fiscal spending is now coming into focus for investors. We expect the budget battle to be market-relevant this year, injecting greater economic policy uncertainty, but the end-game should be market-positive. Brinkmanship will not get as bad as during the debt ceiling crises of 2011 and 2013, though market jitters will be frontloaded if Pelosi and the White House fail to conclude a deal immediately. Chart 2The 'Stimulus Cliff' Awaits President Trump The 'Stimulus Cliff' Awaits President Trump The 'Stimulus Cliff' Awaits President Trump The U.S. budget process is always rocky and is usually concluded well into the fiscal year under discussion. This year the fight will be more important than over the past few years because, as the two-year bipartisan agreement of 2018 lapses, the so-called “stimulus cliff” looms over the U.S. economy and will get caught up in the epic battle over the 2020 election. The stimulus cliff is the automatic imposition of fiscal spending cuts (“sequestration”) in FY2020 that would take effect as a result of the Budget Control Act of 2011. Standard estimates of the U.S. budget deficit expect that the deficit will shrink in 2020 if the spending caps are not raised, resulting in a negative fiscal thrust (Chart 2). The result would be to decrease aggregate demand at a time when the risk of recession is relatively high (Chart 3). Chart 3Recession Odds Still High Over Next 12 Months Recession Odds Still High Over Next 12 Months Recession Odds Still High Over Next 12 Months This is clearly not in President Trump’s interest, since a recession would devastate his reelection odds. Hence, Treasury Secretary Steve Mnuchin and other White House officials are pushing for a budget deal before the House of Representatives goes on recess on July 26 and the Senate on August 2. Ideally, an agreement would raise the spending caps, appropriate funds for the rest of the budget, and lift the “debt ceiling,” the statutory limit on U.S. debt. But it would be surprising if a deal came together as early as next week. A failure to agree on a budget deal before Congress goes on recess will make the market increasingly jittery. Congress can cancel the August recess, or wait until September 9 when they reconvene, but a failure to agree on something between now and then will make the market increasingly jittery. The U.S. has already surpassed the current debt limit and the latest estimates suggest that the Treasury Department’s “extraordinary measures” to meet U.S. debt payments could be exhausted by early-to-mid September.1 This would give Congress only a week in September to raise the debt limit. There are three main reasons to expect that the debt ceiling fight will not get out of hand: Chart 4Americans Stopped Worrying And Love Debt Americans Stopped Worrying And Love Debt Americans Stopped Worrying And Love Debt First, a technical default on U.S. debt could result in a failure to meet politically explosive obligations, such as sending social security checks to seniors. No one in Washington would benefit from such a failure and President Trump would suffer the most. Second, the public is not as worried about national deficits and debt today as it was in the aftermath of the financial crisis (Chart 4). Democrats, as the pro-government party, do not have an incentive to stage a showdown over the debt like Tea Party Republicans did under the previous administration. To be fair, they did do so in January 2018, but backed off after merely two days due to high political costs. Third, the one budget conflict that could create a catastrophic impasse – funding for Trump’s border wall – can be assuaged by Trump’s use of executive action, as he demonstrated by declaring a national emergency and appropriating military funds for fencing. Trump is fighting a general election in 2020 and is unlikely to use the debt ceiling as leverage to the point that the U.S. defaults on its obligations. The risk to investors, however, is that he goes back to threatening a 25% tariff on Mexico if it fails to staunch the flow of immigrants from Central America. What if the Republicans and Democrats cannot agree on the budget and spending caps? Democrats say they will not raise the debt limit unless they get non-defense spending increases. House Democrats need to reward their constituents for voting for them in 2018 and want to increase non-defense spending at “parity” with increases to defense spending. They also want to reduce the defense increases that Republicans seek in order to pay for non-defense increases. President Trump and the Republicans have a higher defense target and a lower non-defense target. The truth is that the Republicans and Democrats have agreed three times to increase spending caps beyond the levels required under the 2011 law – and they have done so most emphatically under President Trump with the FY2018-19 agreement (Chart 5). This year the two parties stand about $17 billion apart on defense and $30 billion apart on non-defense spending.2 We would expect both sides to splurge on spending and get what they want, but they could also split the difference: the amounts are small but the acrimony between the two parties could extend the talks. Congress may have to pass one or more “continuing resolutions” (stopgap measures keeping spending levels constant) to negotiate further. A continuing resolution could at least raise the debt ceiling and leave the rest of the budget negotiation until later, removing the majority of the political risk under discussion. Chart 5 Chart 6 Is another government shutdown possible? Yes, but not to the extent of early 2019. Trump saw a sharp drop in his approval ratings during the longest-ever government shutdown last year (Chart 6). Brinkmanship could lead to another shutdown, but he is likely to capitulate before it becomes prolonged. In early 2020, he wants to be lobbing grenades into the Democratic primary election rather than giving all of the Democrats an easy chance to criticize him for dysfunction in Washington. Ultimately, Trump can simply refrain from vetoing whatever the House and Senate agree – it is not in his interest to shrink the budget deficit in an election year. The Democrats’ spending increases would boost aggregate demand and are thus in President Trump’s personal interest. Trump is the self-professed “king of debt” – he is not afraid to agree to a deal that will be criticized by fiscal hawks. The latter have far less influence in Congress anyway since the 2018 midterm election. Why should House Democrats extend the economic expansion knowing that it would likely improve President Trump’s reelection chances? Because Trump will capitulate to most of their spending demands; voters would punish them if they are seen deliberately engineering “austerity”; and they need to show voters that they can govern. As for the 2020 race, they will focus on other issues: they will attack Trump on trade and immigration and focus on social policy: health care, the minimum wage, taxes and inequality, climate change, and student debt. What will be the fiscal and economic impact of a budget deal? The budget deal under negotiation ($750 billion in defense discretionary spending, $639 billion in non-defense discretionary spending) would raise the spending cap by about $145 billion – this is slightly above the $112 billion negative fiscal thrust expected in 2020.3 The result is that the U.S. fiscal drag expected in 2020 will at least be eliminated (if not turned into a fiscal boost), helping to prolong the cycle. The removal of fiscal drag will coincide with monetary easing, which is positive for markets since inflation is subdued. The Federal Reserve abandoned rate hikes this year (after four last year) because of the asymmetric risk of deflation relative to inflation (Chart 7). The FOMC believes that they can always jack up interest rates to combat an inflation overshoot, as their predecessors did in the 1980s, but that they are constrained by the zero lower-bound in interest rates. They may never recover from a loss of credibility and collapse of inflation expectations, so an insurance policy is necessary. The result is likely to be one or two rate cuts this year, which has already improved financial conditions. Chart 7The Fed Fears The Asymmetric Threat Of Deflation The Fed Fears The Asymmetric Threat Of Deflation The Fed Fears The Asymmetric Threat Of Deflation Bottom Line: Budget brinkmanship could become a near-term source of volatility but it is ultimately likely to be resolved with the pro-market outcome of less fiscal drag in 2020. The debt ceiling debate is unlikely to result in a U.S. default and any government shutdown is likely to resemble the short one of 2018 more than the long one of 2019. We expect U.S. equities to grind higher over the 12-month cyclical horizon, but we remain exceedingly cautious on a three-month tactical horizon. The price of Trump’s capitulation on border funding could be a renewed threat of tariffs against Mexico. The Budget Deal, Geopolitics, And The Dollar Chart 8China Shifts From Reform To Stimulus China Shifts From Reform To Stimulus China Shifts From Reform To Stimulus What does this fiscal outlook imply for the U.S. dollar? Near-term moves will probably be negative, since the fiscal boost outlined above will not be comparable to 2018-19, and meanwhile our view on China’s stimulus is bearing out reasonably well (Chart 8). Improvements in global growth, Fed cuts, and rising oil prices will weigh on the greenback even though later we expect the dollar to recover on the back of renewed U.S.-China conflict and global recession in 2021 or thereafter. Beyond the recession, two of our major political and geopolitical themes continue to point to large downside risk to the dollar: populist politics and multipolarity, or geopolitical competition among the world’s great powers. Beyond the recession, two of our major political and geopolitical themes continue to point to large downside risk to the dollar: populist politics and multipolarity. Populism and the Fed: Domestically, the United States is seeing a rise in populism that is continuing across administrations and political parties. This is conducive to easier monetary policy. Left-wing firebrand Alexandria Ocasio-Cortez’s (AOC) recent exchange with Fed Chairman Jay Powell highlights the trend. AOC asked one of the most frequent questions that BCA’s clients ask: Does the Phillips Curve still work? Powell answered that in recent years it has not. President Trump’s Economic Director Larry Kudlow applauded AOC, saying “she kind of nailed that” (obviously the administration is pushing for lower rates). If inflation is not a risk, monetary policy need not guard against it. This interchange should be taken in the context of President Trump’s attempts to jawbone Powell into rate cuts and the notable monetary promiscuousness of his ostensibly “hard money” Federal Reserve nominees. The extremely different ideological and institutional profiles of these various policymakers suggests that a new consensus is forming that is conducive to more dovish monetary policy than otherwise expected over the long run. Populists of any stripe, from Trump to AOC, would like to see lower interest rates, higher nominal GDP growth, and a lower real debt burden on households. We are reminded of an oft-overlooked point about the stagflation of the 1970s. Fed Chair Arthur Burns is usually depicted as a lackey of President Richard Nixon who succumbed to political influence and failed to raise interest rates adequately to fight inflation. But this is only part of the story. Leaving aside that the Fed only had a single mandate of minimizing unemployment at that time, Burns was conflicted. He saw the need to fight inflation, but he had more than Nixon’s wrath to fear. He also dreaded the impact on the Fed’s credibility and popular support as an institution if he hiked rates too aggressively and stoked unemployment (Chart 9).4 Chart 9Rate Hikes Are Hard To Defend Amid High Unemployment Rate Hikes Are Hard To Defend Amid High Unemployment Rate Hikes Are Hard To Defend Amid High Unemployment In other words, populism can constrain the Fed from the bottom up as well as from the top down in a context of rising unemployment.5 Multipolarity and Currency War: Since President Trump’s election we have highlighted that dollar depreciation is likely to be the administration’s ultimate aim if President Trump’s overall economic strategy is truly to stimulate growth, reduce the trade deficit, and repatriate manufacturing. Jacking up growth rates relative to the rest of the world while disrupting global trade via tariffs is a recipe for a strong dollar that undermines the attempt to bring jobs back from overseas. We have always argued that China would not grant the U.S. “shock therapy” liberalization and market opening – and that neither China, nor Europe, nor Japan would or could engage in currency appreciation along the lines of a new Smithsonian or Plaza Accord. The U.S. does not have as much geopolitical clout as it had in the 1970s-80s when it forced major currency deals on its allies and partners. The remaining option is for the U.S. to attempt unilateral depreciation. The combination of profligate spending, easy monetary policy, and populism may do the trick. But it is also possible that President Trump will attempt to engineer depreciation through Treasury Department intervention. If a slide toward recession threatens his reelection – or he is reelected and hence gets rid of the first-term reelection constraint – his unorthodox policies pose a significant risk to the dollar. Bottom Line: The U.S. dollar faces near-term risks as growth rebalances towards rest of the world, but will probably resume its rise in the impending recessionary environment and expected re-escalation of tensions with China. Over the long run, it faces severe risks due to fiscal mismanagement, domestic populism, and geopolitical struggle. A Progressive Overshoot Will Hurt Democrats … And Equities Chart 10A Democratic Win Will Weigh On Animal Spirits A Democratic Win Will Weigh On Animal Spirits A Democratic Win Will Weigh On Animal Spirits The Democratic Party’s primary election is also a risk to the equity rally. We see a 45% risk that President Trump will be unseated in November 2020 and hence that the U.S. will once again experience a dramatic policy reversal (as in 2000, 2008, and 2016). The risks are to the downside because the market is at all-time highs and Democratic proposals include raising taxes on corporations and re-regulating the economy (Chart 10). Whether you accept our 55% odds of Trump reelection, the race will be a continual source of uncertainty for investors going forward. How extreme is the uncertainty? Former Vice President Joe Biden remains the frontrunner in the race, though he has lost his initial bump in opinion polls (Chart 11). Biden’s success is market-positive relative to the other Democratic candidates since he is an establishment politician and a known quantity. Given his age, a Biden presidency would likely last for one term and focus on repudiating Trumpism and consolidating the Obama administration’s signature achievements (the Affordable Care Act, Dodd-Frank, the Joint Comprehensive Plan of Action, environmental regulation, etc). Greater predictability in the health care sector and a return to lower-level tensions with Iran would be market-positive. The financial sector would be consoled by the fact that nothing worse than Dodd-Frank would be in the offing. Chart 11 A Biden victory would be more likely to yield Democratic control of the senate than a progressive candidate’s victory.6 This means that the risk of Democrats taking full control of government and passing more than one major piece of legislation after 2020 increases with Biden. Yet any candidate capable of defeating Trump is likely to take the senate in our view; and Biden’s legislative initiatives are likely to be more centrist.7 So as long as Biden remains in the lead in primary polling, he increases his chances of winning the nomination, maximizes the 45% chance of Democrats winning the White House, and decreases the intensity of the relative policy uncertainty facing markets. The risk to the Democrats is … a left-wing or progressive overshoot that knocks out Biden in the primary, replacing him with a progressive candidate who may not be as electable in the general election.  Chart 12 The risk to the Democrats is that the leftward policy shift within the party (Chart 12) may lead to a left-wing or progressive overshoot that knocks out Biden in the primary, replacing him with a progressive candidate who may not be as electable in the general election. This would give President Trump the ability to capitalize on his advantage as the incumbent by inveighing against socialism. Most of the major progressive candidates are electable – they have a popular and electoral path to the White House – as revealed by their successful head-to-head polling against Trump in battleground state opinion polling (Chart 13). But these pathways are narrower than Biden’s. Biden is the only candidate whose name has been on the ballot in two presidential elections carrying the critical Rust Belt swing states Michigan, Pennsylvania, and Wisconsin (not to mention Ohio and Florida). He is from Pennsylvania. And he is more competitive than most of his rivals in the American south and southwest, giving him the potential to pick up Florida or Arizona in the general election. But none of this matters if Biden cannot win the Democratic nomination first. Chart 13 The risk of a progressive overshoot is growing at present. Biden is losing his lead in the primary polling, as mentioned. Progressive candidates taken together are polling better than centrists, contrary to previous Democratic primaries (Chart 14). This is true even if we define centrists broadly, for instance to include Buttigieg (Chart 15). Biden is in a weaker position than Hillary Clinton in 2007 – and the more progressive candidate Obama ultimately defeated her (Chart 16). Biden has now slipped to second place in one national poll and some state polls. Chart 14 The second round of Democratic debates on July 30-31 will be a critical testing period for whether Biden can maintain frontrunner status. The first round fulfilled our expectation of boosting the progressives at his expense, especially Elizabeth Warren. It surprised us in dealing a blow to the campaign of Bernie Sanders, the independent Senator from Vermont who initiated the progressive left’s surge with his hard-fought race against Hillary Clinton in 2016. Chart 15 Chart 16 Sanders is more competitive than the other progressives in the Rust Belt, and in the general election, based on his head-to-head polling against Trump. Yet he has fallen behind in recent Democratic primary polling, ceding ground to Warren, Harris, and Buttigieg, who are all his followers in some sense. The second debate is a critical opportunity for him to arrest the loss of momentum. Otherwise he is likely to be fatally wounded: a collapse in polling beneath his floor of about 15%, and relative to other progressives, despite extensive name recognition, will make it very difficult for him to recover in the third round of debates in September. His votes will go toward other progressives, particularly Buttigieg – the other white male progressive-leaning candidate who is competitive in the Midwest.8 Our 55% base case that Trump is reelected rests on the high historical reelection rate for incumbents, particularly in the event of no recession during the first term – yet discounted due to Trump’s relatively low nationwide popularity, as it is reminiscent of a president in a recessionary environment (Chart 17). Trump has his ideological base more fired up than Obama did (Chart 18), which helps drive voter turnout, although as a result he risks losing support from the rest of the population. Still, Trump’s approval rating is in line with Obama’s at this stage in his first term. As long as the economy holds up and Trump does not suffer a foreign policy humiliation, he should be seen as a slight favorite. Chart 17 Chart 18 A Trump victory is not positive for risk assets, aside from a relief rally on policy continuity. This is because in a second term he cannot reproduce the same magnitude of pro-market effects (huge tax cuts and deregulation) yet, freed from the need for reelection, he has fewer political constraints in producing higher magnitude anti-market effects (tariffs and/or sanctions on China, Iran, Russia, and possibly the EU and Mexico). This view dovetails with the BCA House View which remains overweight equities relative to bonds and cash over a cyclical (12 month) horizon but underweight over the longer run with the expectation that a recession will loom. Bottom Line: The Democratic Primary election should start having an impact on markets – the general election is likely to be too close for market participants to have a high conviction, driving up uncertainty. Uncertainty will be especially pronounced if, and as, leftwing or progressive candidates outperform in the primary races and poll well against Trump in the general election. This dynamic is negative for business sentiment and the profit outlook, especially if Biden’s polling falls further in the wake of the second debate. Investment Conclusions We recommend staying long JPY-USD, long gold, and short CNY-USD. We remain overweight Thai equities within emerging markets, a defensive play. And we would not close our tactical overweight in health care sector and health care equipment sub-sector relative to the S&P 500. The rally in Chinese equities – despite China’s Q2 GDP growth rate of 6.2%, the worst in 27 years – brings full circle the view we initiated in April 2017 that Chinese President Xi Jinping’s consolidation of power would result in a major deleveraging drive that would drag on the global economy. Since February we have argued that the U.S. trade war has pushed Chinese policymakers to favor stimulus over reform – but we have also maintained that the effectiveness of stimulus is declining, especially as a result of the trade war hit to sentiment. Nevertheless, as a result of this turn in Chinese policy – along with the turn in U.S. monetary and fiscal policy – we see the global macroeconomic outlook improving. Combining this view with ongoing tensions in the Persian Gulf and the expectation that oil markets will tighten, we recommend our Commodity & Energy Strategy’s trade of going long Brent crude Q1 2020 versus Q1 2021.   Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Footnotes 1 See U.S. Department of Treasury, “Secretary Mnuchin Sends Debt Limit Letter to Congress,” July 12, 2019, home.treasury.gov. Jordan LaPier, “New Projection: Debt Limit “X Date” Could Arrive in September,” July 8, 2019, bipartisanpolicy.org. 2 See Jordain Carney and Niv Elis, White House, Congress inch toward debt, budget deal,” July 17, 2019, thehill.com. 3 See the Congressional Budget Office, “The Budget and Economic Outlook: 2019 to 2029,” January 2019; “Final Sequestration Report for Fiscal Year 2019,” February 2019; and Theresa Gullo, “Discretionary Appropriations Under the Budget Control Act,” Testimony before the Committee on the Budget, United States Senate, February 27, 2019, www.cbo.gov. 4 See James L. Pierce, “The Political Economy of Arthur Burns,” The Journal of Finance 34: 2 (1979), pp. 485-96, esp p. 489 regarding a congressional testimony: “Interestingly, no questions were raised or innuendo offered that monetary expansion would be excessive to support Richard Nixon’s reelection efforts. Instead, Burns was urged by the Democrats to follow an expansionary monetary policy in order to reduce the level of unemployment.” See also Athanasios Orphanides and John C. Williams, “Monetary Policy Mistakes and the Evolution of Inflation Expectations,” Federal Reserve Bank of San Francisco, Working Paper 2010-12 (2011), www.frbsf.org. 5 An analogy might be drawn with the Supreme Court, whose independence as one of three constitutional branches is much more firmly grounded in U.S. law than the Fed’s, but nevertheless cannot make decisions in an ivory tower. It must consider the effects of its judgments on popular opinion, since universally deplored decisions would reduce the court’s credibility and legitimacy in the eyes of the public over time and ultimately the other government branches’ adherence to those decisions. 6 This is both because Biden is more electable (thus more likely to bring a vice president who can break a tie vote in the senate) and because his candidacy can help Democrats in all of the senate swing races – for example, Arizona as well as Colorado and Maine. Harris is not as helpful in Maine while Warren and Sanders are not as helpful in Arizona. 7 Biden would return to the 39.6% top marginal individual tax rate and double the capital gains tax on those earning incomes of more than $1 million. See Biden For President, “Health Care,” joebiden.com. 8 Conversely, if Biden somehow collapses, Buttigieg unlike Sanders has the option of moving toward the political center to absorb Biden’s large reservoir of support.