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Dear Client, I will be on vacation next week. In lieu of our regular report, we will be sending you a Special Report written by my colleagues Chester Ntonifor, BCA Research’s Chief Foreign Exchange Strategist, and Matt Gertken, Chief Geopolitical Strategist. Their report discusses the threat to the dollar’s reserve status over the next decade. This week, Matt published a timely report entitled “Afghanistan? Watch Iran And China,” examining the global macro significance of the US withdrawal from Afghanistan. I trust you will find both reports insightful.   Best regards, Peter Berezin, Chief Global Strategist Highlights Over the next 12 months, US inflation will decline fast enough to allow the Federal Reserve to maintain its accommodative monetary stance, but not as fast as investors are expecting. A number of structural forces were becoming inflationary even before the pandemic began. The pandemic will only buttress the tide. Even if the virus is eventually vanquished, the pandemic could prop up inflation by permanently reducing labor supply, hastening the retreat from globalization, and keeping fiscal policy looser than it otherwise would have been. Fixed-income investors should maintain a short duration stance. We expect the US 10-year Treasury yield to rebound to about 1.8% by early next year. Long-term bond yields in the other major economies will also rise, although not as much as in the US. In and of itself, higher inflation is not necessarily bad for equities. What makes higher inflation toxic for stocks is when it forces central banks to raise rates to punitive levels. Fortunately, such an outcome is still a few years away, justifying an overweight equity position for now. Upside Risks To Inflation In our July 23rd report, we argued that investors were asking the wrong question about inflation. Rather than asking whether higher inflation is transitory, they should be asking whether inflation will decline faster or slower than what the market is discounting. Chart 1Investors Expect Inflation To Fall Rapidly From Current Levels Chart 1 shows that investors expect inflation to fall rapidly from current levels and to remain subdued thereafter. The widely followed 5-year/5-year forward TIPS breakeven inflation rate currently stands at 2.12%, below the Fed’s comfort zone of 2.3%-to-2.5% (Chart 2).1 Chart 2Below-Target Inflation Expectations And A Low R* Have Restrained Bond Yields Downbeat long-term inflation expectations and the market’s perception that the neutral rate of interest is very low are the two main reasons why bond yields are so depressed. QE programs have also dampened yields, although not nearly as much as widely believed. Chart 3Outside Of A Few Pandemic-Related Sectors, The CPI Has Yet To Return To Trend In our report, we contended that US inflation would come down fast enough over the next few quarters to allow the Federal Reserve to maintain its accommodative monetary stance, but not as fast as investors are expecting. On the one hand, the evidence clearly shows that most of the recent increase in US inflation has been driven by just a few pandemic-related sectors (Chart 3). On the other hand, high levels of excess household savings, the need for firms to expand capacity and rebuild inventories, and continued policy support will boost output and prices. The Long-Term Inflationary Consequences Of The Pandemic We also argued that a variety of structural forces, including the exodus of baby boomers from the labor market, a retreat from globalization, and increasing social unrest, would drive up inflation over the long haul. A key question is how the pandemic will shape these structural forces going forward. As we discuss below, there are three main overlapping channels through which the pandemic could have a lasting impact on inflation: Labor market scarring: Even if the virus is eventually vanquished, the pandemic could still permanently reduce the labor supply. Widespread worker shortages would fuel inflation. Deglobalization: Globalization has historically been a deflationary force. The pandemic could accelerate the retreat from globalization by prompting firms to bring more production back home, while exacerbating geopolitical tensions. Fiscal policy: Big budget deficits could persist in the post-pandemic period. Debt-saddled governments may turn to inflation to erode their debt burdens. Let us assess these three channels in turn.   Channel #1: Labor Market Scarring Despite July’s blockbuster employment report, there are still nearly 4% fewer Americans employed than was the case in January 2020. Yet, US businesses are struggling to hire workers (Chart 4). Nationwide, the job openings rate stands at a record 6.5%, up from 4.5% on the eve of the pandemic (Chart 5). Chart 4US Companies Are Facing A Labor Shortage Chart 5There Are Plenty Of Jobs Available Generous unemployment benefits, less immigration, and the reluctance of many workers to expose themselves to the virus have all helped to reduce labor supply. A marked shift in the composition of spending has increased the demand for workers in some sectors while reducing demand in other sectors (Chart 6). Since labor is not perfectly fungible across sectors, this has caused overall unemployment to rise. Chart 6Which Sectors Have Gained And Which Have Lost Jobs Since The Pandemic? Looking out, labor supply should increase as emergency unemployment benefits expire, immigration picks up, and more people are vaccinated. The mismatch of workers across sectors should also diminish as goods and services spending rebalances. Nevertheless, there is considerable uncertainty over how quickly all this will happen. According to Indeed, an online job posting site, unemployed workers cited having a “financial cushion” as the most popular reason for not looking for a job in July (Chart 7). Given that American households are sitting on $2.4 trillion in excess savings, it may take some time for this cushion to deflate (Chart 8). Chart 7Americans Are Not Desperate To Find Work Chart 8A Lot Of Excess Savings Chart 9No Jab, No Job Wider vaccine mandates could also impact labor market participation. A host of major companies, ranging from Google to Citigroup, are requiring their employees to be inoculated before returning to the office (Chart 9). The Pentagon has laid out a plan endorsed by President Biden obliging members of the military to get the COVID-19 vaccine. Earlier this week, the Las Vegas Raiders became the first NFL team to require fans to produce proof of vaccination to gain entry to home games. On the one hand, vaccine mandates could encourage more people to get the jab, which should help curb the pandemic and boost employment in the service sector. While the numbers have improved in recent weeks, only 57% of Americans between the ages of 18 and 64 are fully vaccinated (Chart 10). On the other hand, some people might opt for unemployment over a vaccine. According to a recent YouGov poll, about half of all unvaccinated Americans believe that the government is using COVID-19 vaccines to microchip the population (Chart 11). The threat of losing one’s job is unlikely to sway many of them. Chart 10Many Workers Remain Unvaccinated Chart 11One In Five Americans Believes The US Government Is Using The Covid-19 Vaccine To Microchip The Population Pandemic-induced shifts in work-life preferences could also reduce labor supply. According to Ipsos, a polling firm, most employees would prefer to work remotely at least part of the time, with 25% indicating they do not want to return to their workplace at all (Chart 12). The same poll found that 30% of workers would consider looking for another job if their employer required them to work away from home full time (Chart 13). Chart 12Let’s Chat Around The Water Cooler On Tuesdays And Wednesdays Chart 13What Is The Opposite Of A “One Size Fits All” Work Environment? Chart 14Number Of Retired People Jumped During The Pandemic If remote working boosted productivity, as some have claimed, this would not be such a bad thing. However, it is far from clear that this is the case. A recent University of Chicago study of 10,000 skilled professionals from an Asian IT company revealed that work-from-home policies decreased productivity by 8%-to-19%. Early retirement has also reduced labor supply. The share of retirees in the US population rose by 1.3 percentage points between February 2020 and July 2021, with most of the increase occurring early in the pandemic (Chart 14). Based on pre-pandemic demographic trends, the retirement rate should have risen by only 0.5 percentage points over this period.  The good news, as discussed in a recent study by the Kansas City Fed, is that most of the increase in the retirement rate was driven by fewer people transitioning from retirement back into employment. The share of people transitioning from employment to retirement did not change much (Chart 15). This led the authors to conclude that “More retirees may rejoin the workforce as health risks fade, but the retirement share is unlikely to return to a normal level for some time.” Chart 15Increased Retirees: A Closer Look Bottom Line: Labor supply will recover as the pandemic recedes. Nevertheless, the available pool of workers will likely be lower in the post-pandemic period than it would have otherwise been. A shortage of workers will prop up wage growth, helping to fuel inflation.   Channel #2: Deglobalization Globalization was on the back foot even before the pandemic began. Having steadily increased between 1991 and 2008, the ratio of global trade-to-output was basically flat during the 2010s (Chart 16). Ironically, the pandemic has revived global trade by shifting the composition of spending away from non-tradable services towards tradable goods. This shift in spending is the key reason why shipping costs have soared in recent months (Chart 17). Chart 16Globalization Plateaued Over A Decade Ago Chart 17Shipping Costs Have Soared In Recent Months The rebound in trade will not endure. Already, we are seeing companies moving production back home to establish greater control over their supply chains. The pandemic has exacerbated geopolitical tensions between China and the US. Recriminations about how the pandemic began and what China could have done to stop it will not go away anytime soon. Trade bloomed during Pax Britannica, when Great Britain ruled the waves, and then again during Pax Americana, when the US controlled the commanding heights. As BCA’s geopolitical team has long stressed, the shift to a multi-polar world is likely to restrain globalization.2 Historically, globalization has been a deflationary force. Trade has allowed countries such as the US that consistently run current account deficits to satiate excess demand for goods with imports, thereby forestalling inflation. Trade has also raised productivity by allowing countries to specialize in those areas in which they have a comparative advantage, while providing a mechanism to diffuse technological know-how around the world. Standard trade theory predicts that less-skilled workers in developed economies will suffer a relative decline in wages in response to rising trade with developing countries. A number of studies have documented that this is precisely what happened after China entered the global trading system.3  Poor workers tend to spend more of their paychecks than either rich workers or the owners of capital. To the extent that deglobalization shifts the balance of economic power back towards blue-collar workers in advanced economies, this will raise overall aggregate demand. Against the backdrop of muted productivity growth, inflation could increase as a consequence. Bottom Line: Globalization is deflationary, while deglobalization is inflationary. The pandemic is likely to reinforce the trend towards deglobalization.    Channel #3: Fiscal Policy There was once a time when governments trembled in fear of the bond vigilantes. Those days are long gone. After briefly rising to 4% in June 2009, the US 10-year Treasury yield trended lower over the subsequent decade, even though unemployment fell and government debt rose. The pandemic sent the bond vigilantes scurrying for cover. Negative real yields allowed governments to run budget deficits of previously unimagined proportions during the pandemic. Budget deficits will decline over the next few years, but the aversion to deficit spending will not return. Not anytime soon at least. The IMF expects the cyclically-adjusted primary budget deficit in advanced economies to average 2.6% of GDP between 2022 and 2026, up from 1% of GDP in the 2014-19 period (Chart 18). Even that is probably too conservative, since the IMF’s projections do not include pending legislation such as President Biden’s $550 billion infrastructure package and $3.5 trillion reconciliation budget bill. Chart 18Fiscal Policy: Tighter But Not Tight If the growth rate of the economy exceeds the interest rate on government debt, then governments with high debt-to-GDP ratios could run larger budget deficits than governments with low ratios, while still achieving a stable debt-to-GDP ratio over time.4  The problem is that these same governments would face an exponential increase in debt-servicing costs if interest rates were to rise above the growth rate of the economy. This is not a risk for any major developed economy at the moment but could become an issue as spare capacity recedes. At that point, central banks could face political pressure to keep rates low, even if their economies are overheating. The result could be higher inflation. Higher inflation, in turn, would boost nominal GDP growth, putting downward pressure on debt-to-GDP ratios. Bottom Line: While budget deficits will come down over the next few years, governments in developed economies will still maintain looser fiscal policies than before the pandemic. High debt levels could incentivize policymakers to permit higher inflation. Investment Conclusions US inflation will decline over the next 12 months, but not as quickly as markets are discounting. A number of structural forces were becoming inflationary even before the pandemic began. The pandemic will only reinforce the inflationary tide. Fixed-income investors should maintain a short duration stance. We expect the US 10-year Treasury yield to rebound to about 1.8% by early next year as the Delta variant wave fades. Long-term bond yields in the other major economies will also rise, although not as much as in the US. In and of itself, higher inflation is not necessarily bad for equities. What makes higher inflation toxic for stocks is when it forces central banks to raise rates to punitive levels. Fortunately, such an outcome is still a few years away, justifying an overweight equity position for now. The second quarter earnings season was a strong one. Back on July 2nd, analysts expected S&P 500 companies to generate about $45 in EPS in Q2. In the end, they generated at least $52. Analysts expect earnings to decline in absolute terms in Q3 and remain below Q2 levels until the second quarter of next year, when they are projected to grow by a meagre 3.5% year-over-year (Table 1). Table 1US Earnings Estimates Have Upside Earnings estimates usually drift lower over time (Chart 19). BCA’s US equity strategists think there is scope for earnings estimates for the second half of this year to rise materially from current levels. This should support US stocks. Along the same lines, above-trend global growth and attractive valuations should buoy stock markets outside the US. Chart 19Analysts Have Been Revising Up Earnings Estimates This Year Peter Berezin Chief Global Strategist peterb@bcaresearch.com Footnotes 1 The Federal Reserve targets an average inflation rate of 2% for the personal consumption expenditures (PCE) index. The TIPS breakeven is based on the CPI index. Due to compositional differences between the two indices, CPI inflation has historically averaged 30-to-50 basis points higher than PCE inflation. This is why the Fed effectively targets a CPI inflation rate of about 2.3%-to-2.5%. 2 Please see Geopolitical Strategy Weekly Report “Hypo-Globalization (A GeoRisk Update),” dated July 30, 2021; and Special Report, “The Apex Of Globalization - All Downhill From Here,” dated November 12, 2014. 3 For example, economists Katharine Abraham and Melissa Kearney have estimated that increased competition from Chinese imports cost the US economy 2.65 million jobs between 1999 and 2016, almost double the 1.4 million jobs lost to automation. Similarly, David Autor and his colleagues found that increased trade with China has led to large job losses for blue-collar workers in the US manufacturing sector. 4 The steady-state debt-to-GDP ratio can be expressed as p/(r-g), where r is the interest rate, g is trend GDP growth, and p is the primary (i.e., non-interest) budget balance. Thus, for example, if the government wanted to achieve a stable debt-to-GDP ratio of 50% and r-g is -2%, it would need to run a primary budget deficit of 0.5*0.02=1% of GDP. However, if the government targeted a stable debt-to-GDP ratio of 200%, it could run a primary budget deficit of 2*0.02=4% of GDP. See Box 1 in our February 22, 2019 report for a derivation of this debt sustainability equation. Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores

Highlights Global growth is peaking, which makes it important to monitor the risks for signs that it is time to reduce equity exposure. We are especially focused on five risks: 1) The emergence of vaccine-resistant Covid variants; 2) a possible “goods recession”; 3) higher real bond yields; 4) higher US corporate tax rates; and 5) a weaker Chinese economy and regulatory crackdown. For now, we recommend a modest overweight to global equities. We will likely pare back exposure early next year. Stocks And The Business Cycle Our “golden rule” for asset allocation is to remain bullish on equities unless there is a good reason to think that a recession is around the corner. This rule has strong empirical support. Chart 1 shows that equity bear markets rarely occur outside of major business cycle downturns. Chart 1Recessions And Bear Markets Tend To Overlap Nevertheless, there are different shades of bullishness. Stocks generally perform best coming out of recessions; that is, when the economy is weak but improving. Stocks perform worst when the economy is falling into recession. We are currently in an intermediate phase, where global growth is weakening but still solidly above trend. Historically, stocks have posted positive but uninspiring returns during such phases (Table 1). Table 1The Economic Cycle And Financial Assets Monitoring The Risks In “post peak growth” environments, it is important to monitor the risks for signs that it is time to reduce equity exposure. We are especially focused on five risks:   Risk 1: New Covid Variants Chart 2A New Covid Wave The Delta strain continues to roll through the US and a number of other countries (Chart 2). While the new strain does not seem to be any more deadly than other variants, it is a lot more contagious. CDC internal estimates suggest the R0 for the Delta variant is between 5-to-8, similar to that of chickenpox, and 40% higher than the original strain.1 Countries such as Thailand and Vietnam, which were able to keep the pandemic at bay last year, have succumbed to Delta. In Australia, the 7-day average of new cases has climbed above 300, the highest since last August. China has detected the Delta variant in more than a dozen cities since July 20. Even if the country succeeds in quashing the new variant, it will come at an economic cost. Lockdowns in major Chinese cities could further clog a global supply chain that is still reeling from the dislocations caused by the pandemic. While still vulnerable to the Delta variant, the symptoms of vaccinated individuals tend to be mild and non-life threatening. The Lambda variant, which surfaced in Peru this past December, appears more vaccine-resistant than the Delta variant. Fortunately, it is not as contagious as Delta, and has struggled to propagate outside of South America. The risk is that a new variant emerges which is: 1) highly contagious; 2) vaccine resistant; and 3) as or more lethal than the original strain. Chart 3The Divergence Between Goods And Services Spending Our Assessment: The current suite of vaccines confers substantial protection. While a vaccine-resistant strain could emerge, it is likely that vaccine producers will be able to adjust their formula to keep the virus at bay. As such, we see Covid as only a modest risk to global stocks.   Risk #2: A Goods Recession Even if Covid fades from view, the dislocations caused by the pandemic will persist for a while longer. As we discussed last week, the pandemic induced a major reallocation of spending from services to goods: Overall consumer spending in the US is broadly back to its pre-pandemic trend. However, service spending remains below trend while goods spending is above trend (Chart 3). Retail sales, which are dominated by goods, are also firmly above trend (Chart 4). We do not expect spending on goods to drop off anytime soon. A variety of manufactured goods, ranging from automobiles to major appliances, remain in short supply. The need to fill backorders and replenish inventories will keep production elevated for the next four quarters. However, at some point in the second half of 2022, manufacturers and retailers could find themselves with a glut of goods on their hands. Chart 4AUS Retail Spending Is Well Above Trend (I) Chart 4BUS Retail Spending Is Well Above Trend (II) Manufacturing accounts for only 11% of US GDP. However, goods producers account for about a third of S&P 500 market capitalization. Thus, while a slowdown in spending on goods is unlikely to push the US into recession, it could cause S&P 500 earnings growth to slow sharply, similar to what occurred during the 2015-16 manufacturing recession (Chart 5). Our Assessment: A goods recession represents a threat to both US and overseas stocks, particularly manufacturers and retailers. Most likely, however, that threat will not become visible to investors until next year.   Risk #3: Higher Real Bond Yields Stocks represent a claim on future corporate cash flows. Higher real interest rates reduce the present value of those claims, leading to lower stock prices. Chart 6 shows that there is a strong correlation between the US 10-year TIPS yield and the forward P/E ratio for the stock market. Chart 5The 2015-16 Manufacturing Recession Weighed On Earnings Chart 6Higher Real Rates Would Be A Headwind For Equity Valuations US real yields jumped in the wake of July’s stellar employment report. However, they still remain negative and far below pre-pandemic levels. Looking out, real yields could rise for two diametrically different reasons. On the one hand, an adverse demand shock could drive up real yields by pushing down inflationary expectations. This is precisely what happened during the early days of the pandemic.     Such a deflationary shock could arise if a vaccine-resistant variant emerges or if spending on manufactured goods declines faster than we expect. The failure of the US Congress to pass the infrastructure bill and/or a budget reconciliation bill could also exacerbate fiscal tightening next year. Under current law, fiscal policy will subtract around two percentage points from growth next year (Chart 7). Chart 7After A Strong Boost, Fiscal Thrust Is Turning Negative On the other hand, real yields could rise if an overheated economy prompts the Fed to hike rates more aggressively than markets are discounting. The US 10-year yield tends to track expected policy rates three years out (Chart 8). Chart 810-Year Treasurys Track Expected Policy Rates Three Years Out Chart 9Both The Fed And Market Participants Have Revised Down Their Estimate Of The Neutral Rate Of Interest   An increase in the market’s estimate of the terminal rate could also push up real yields. According to the New York Fed’s survey of primary dealers and market participants, investors think that the fed funds rate will top out at around 2%. Not only is this extremely low by historic standards, but it is also lower than the Fed’s estimate of the terminal rate (Chart 9). In the past, we have made a distinction between the strong- and weak-form versions of secular stagnation. The strong-form version is one where an economy is unable to reach full employment even with zero interest rates. Japan is a good example. The weak-form version is one where the economy can achieve full employment but only in the presence of low positive interest rates (Chart 10). Chart 10Strong- Versus Weak-Form Secular Stagnation In many respects, weak-form secular stagnation is better for equities than the normal state of affairs where the economy is at full employment and interest rates are near their historic average. This is because weak-form secular stagnation allows equity investors to have their cake and eat it too – to enjoy full employment and high corporate profits, all with the persistent tailwind of very low rates. Our Assessment: Our baseline view on the US envisions a goldilocks scenario of sorts: An economy that is hot enough to keep deflationary forces at bay, but not so hot that the Fed has to intervene to raise rates. While there are risks on both sides of this view, they are fairly modest. US households are sitting on nearly $2.5 trillion in excess savings, which should support consumption over the next few years. BCA’s geopolitical team, led by Matt Gertken, thinks that there is an 80% chance that Congress will pass an infrastructure bill. Assuming an infrastructure bill passes, they also see a 65% chance that the Democrats will succeed in pushing through a watered-down $3.5 trillion budget reconciliation bill. Meanwhile, as the July CPI report illustrates, inflationary forces are already starting to die down, which should keep rate expectations from rising too rapidly.   Risk #4: Higher US Corporate Tax Rates Chart 11Bettors Expect US Corporate Tax Rates To Rise, But Not By Much Congress’ passage of a budget reconciliation bill would blunt some of the fiscal tightening slated for next year. However, to pay for the additional spending, Democrats will seek to levy more taxes on corporations and higher-income earners. The Biden Administration is aiming to raise the corporate tax rate from 21% to 28%, bringing it halfway back to the 35% level that prevailed prior to the Trump tax cuts. Joe Manchin, a key swing voter in the Senate, has indicated a preference for 25%. PredictIt, a popular betting site, assigns 31% odds to no tax hike. Among bettors forecasting higher tax rates, the median estimate is around 25% (Chart 11). Analyst estimates do not appear to reflect the prospect of higher taxes. This is not surprising. Chart 12 shows that analysts did not adjust their earnings estimates until shortly after President Trump signed the Tax Cuts and Jobs Act into law on December 22, 2017. Chart 12Analysts Have Not Adjusted Their Earnings Estimates To Reflect The Likelihood Of Higher Taxes Chart 13Until Recently, Companies That Stand To Lose The Most From Higher Taxes Have Fared Well It is more difficult to know what markets are discounting. Chart 13 displays the performance of Goldman‘s “Formerly High Tax” and “Formerly Low Tax” equity baskets. The formerly high-taxed companies gained the most from Trump’s tax cuts and presumably would lose the most if the tax cuts were rolled back. While formerly high-taxed companies have underperformed the market since early May, they are still up relative to their low-taxed peers since the Georgia runoff election, which handed control of the Senate to the Democrats. Moreover, companies that are vulnerable to higher taxes on overseas profits – many of which are in the tech space – have continued to fare well. Our Assessment: BCA’s geopolitical team thinks that corporate taxes will rise more than current market expectations suggest. However, even under our baseline scenario, higher tax rates will only cut earnings-per-share for S&P 500 companies by about 5% in 2022. Given that earnings are expected to rise by 9% next year, this would still leave earnings growth in positive territory.   Risk #5: China The Chinese economy grew at an annualized rate of only 3.5% in the first half of 2021 (Chart 14). While stricter Covid restrictions will weigh on growth in Q3, activity should pick up again in the fourth quarter. Chart 14Chinese Growth Was Weak In The First Half of 2021 The degree to which China’s economy recovers later this year will depend on the overall policy stance. Both credit and money growth fell short of expectations in July. Aggregate social financing declined to CNY 1.06 trillion from CNY 3.7 trillion in June, missing expectations of a CNY 1.7 trillion increase. M2 money growth clocked in at 8.3% year-over-year, below consensus estimates of 8.7%. As of July, local governments had used only 37% of their annual bond issuance quota, compared with 61% over the same period last year and 78% in 2019. BCA Chief China strategist, Jing Sima, thinks that local governments were waiting for a clear signal from the Politburo meeting held on July 30th before issuing new debt. If so, the fiscal stance should turn more expansionary over the coming months. Nevertheless, Beijing continues to send conflicting messages – on the one hand, telling local governments that they need to support growth, while on the other hand admonishing them for wasteful spending. Chart 15Chinese Tech Stocks Have Underperformed Their Global Peers This Year Stepped-up regulation of China’s major internet companies has also unnerved investors. Chinese internet stocks have underperformed the global tech sector by more than 40% since February (Chart 15). Our Assessment: With credit growth back down to its 2018 lows, the authorities are likely to ease policy over the coming months. While the crackdown on internet companies will continue, it is unlikely to spill over to other sectors. Unlike Chinese companies in, say, the telecom or semiconductor sectors, Beijing does not see most online platforms as contributing much to the economy. What they do see are companies with the potential to undermine the authority of the Communist Party (and in the case of online education providers, reduce the birth rate by burdening parents with high educational expenses). Investment Conclusions Chart 16Equities Look More Attractive Than Bonds We will likely pare back equity exposure early next year. For now, however, we recommend that asset allocators maintain a modest overweight to global equities. Growth is slowing but will remain solidly above trend for the remainder of the year. The forward earnings yield on the MSCI All-Country World Index stands at 5.2%. While this is not particularly high in absolute terms, it is still very high in relation to bond yields (Chart 16). Stocks outside the US trade at a still-decent earnings yield of 6.4% (compared to 4.6% in the US). Granted, the earnings performance of many non-US companies leaves much to be desired. Nevertheless, relative valuations largely discount this fact. Moreover, continued above-trend global growth, Chinese stimulus, and rising bond yields should benefit cyclical stocks and value names, which are overrepresented in overseas indices. Peter Berezin Chief Global Strategist peterb@bcaresearch.com   Footnotes 1  The basic reproduction number, R0 (pronounced “R naught”), corresponds to the average number of people a carrier of the virus will infect in a population with no natural or vaccine-induced immunity.   Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores

Highlights Advances in tennis, swimming and the high jump came from challenging the ‘best practices’, and finding better ways of doing these things. The pandemic has challenged the best practices on how we should work, do business, and shop, catalysing better ways of doing these things. The productivity boom could be a super-boom because the current disruption is not in just one sector but across the entire economy. A productivity super-boom means that the economy will take longer to reabsorb the unemployed, and that structural inflation will stay depressed. This means that interest rate hikes will be much later and much shallower than the market is pricing. For equity investors, a productivity super-boom plus the market’s overestimation of Fed rate hikes structurally favours growth sectors versus value sectors. Thereby, it also structurally favours the S&P500 versus the Eurostoxx50. Fractal analysis: stocks versus bonds remains fragile, and the rally in tin is very fragile. Feature Chart of the WeekThe Pandemic Has Catalysed A Productivity Boom “I believe that the (Fosbury) flop was a natural style and I was just the first to find it” – Dick Fosbury, on how he revolutionised the high jump Watching the Tokyo Olympics, the flurry of new world records reassures us that human athletic productivity continues to advance. It does so in three ways: better biology, better technology, and better ways of doing the same thing. Better biology comes from advances in nutrition and healthcare – at least, for those that embrace the advances. Better technology means better equipment. For example, more ergonomic bikes, sharkskin-like swimwear that minimises water resistance, and running shoes that re-channel energy back into the legs. Albeit this raises the contentious issue that technological advances are giving some athletes an unfair and unnatural advantage. Case in point, World Athletics (and the Tokyo Olympics) have banned prototype versions of Nike’s Vaporfly running shoe that was used by Eliud Kipchoge to run the first sub-two hour marathon. The banned prototype shoe, containing triple carbon plates inside thick ultra-compressed foam, is claimed to improve running economy by up to four percent. But if technological advances are giving some athletes an advantage, it follows that they must also be giving some firms and economies an advantage. While this is unfair in sporting competition, it is fair in economic competition. An important implication is that firms and economies that embrace disruptive technologies and innovations – such as working from home – are likely to generate superior long-term productivity growth than firms and economies that do not. Productivity Growth Comes From Finding Better Ways Of Doing The Same Thing Yet, looking at the longer-term ‘productivity growth’ in sport, many of the greatest advances have come not from better biology or better technology, but just from finding better ways of doing the same thing. Tennis, swimming, and athletics provide three excellent examples of such innovation. A tennis ball weighs just 50 grams, so anybody can hit a tennis ball hard. The difficult part is hitting the ball hard and landing it within the 78 foot court. In the 1970s, Bjorn Borg revolutionised tennis by hitting with aggressive topspin on both the forehand and backhand as well as the serve. Meaning that rather than having to approach the net as was the ‘best practice’, Borg could win matches from the baseline. All it required was a different way of holding the racket and using his arms (Figure I-1). Figure I-1Challenging The Best Practice In Tennis Boosted Its Productivity Borg’s revolution has a fascinating backstory. Borg’s father, a table tennis champion, won a tennis racket in a table tennis tournament and gave it to the 9-year old Bjorn. Familiar with table tennis and now armed with a tennis racket, the young Borg’s revolution was to play tennis as if it were table tennis – with its trademark topspin on both wings as well as the serve – albeit on a much bigger ‘table.’ And with a racket that was far too heavy for him that he held with both hands. (He eventually switched to a one-handed forehand but kept his two-handed backhand.) Go back a hundred years, and swimming experienced a similar revolution. Until the 1870s, the best practice for European swimmers was the highly inefficient breaststroke. But in 1873, John Arthur Trudgen emulated the technique used by Native Americans whereby the arms moved in a crawl. Later, the Australian Fred Cavill also emulated the Natives’ flutter kick, and thus made mainstream the front crawl, which has significantly increased swimming speed, or swimming ‘productivity.’ All it required was a different way of moving our arms and legs.     But probably the greatest example of athletic innovation came in the 1968 Mexico Olympics, when Dick Fosbury turned the standard high jumping technique on its head – or, more precisely, on its back – to win the gold medal and smash the world record.   Prior to the 1968 Games, the best practice high jump technique had been the ‘straddle’ which involved jumping forward, twisting the body to navigate the bar, and then landing on your feet. Fosbury changed all that forever. He jumped backwards off the wrong foot, arched his back over the bar, and landed on his back (Figure I-2). Figure I-2Challenging The Best Practice In The High Jump Boosted Its Productivity Just like the tennis topspin and swimming’s front crawl, high jump’s ‘Fosbury flop’ has become the mainstream technique in the sport, taking performance and ‘productivity’ literally to new highs. And just like the tennis topspin and swimming’s front crawl, all it required was a different way of using our existing resources – in this case, jumping backwards rather than forwards. Yet in the case of the innovative Fosbury flop, something else also played an important role – a new environment. Until the 1960s, high jumpers cleared the bar and landed on sawdust, sand, or thin mats. Hence, any innovation in high jump techniques was constrained by having to land on your feet. This changed when Fosbury’s high school became one of the first to install deep foam matting for high jump landing. The Fosbury flop could not have been innovated before the introduction of deep foam matting, because jumping backwards and landing on your back depended on the existence of a soft foam mat for a safe landing. The crucial lesson is that a new environment gives us a chance to challenge beliefs on ‘how things should be done’, a chance to discover new ways of doing the same thing differently, and better. To challenge beliefs on how things should be done, what bigger change in the environment can there be than a global pandemic? The Pandemic Has Catalysed Better Ways Of Doing The Same Thing Just like athletic productivity growth, economic productivity growth comes from better biology (which improves both our physical and intellectual capacity), better technology, and finding better ways of doing the same thing. Of these three drivers, the first two are continuous processes but the third, finding better ways of doing the same thing, gets a massive boost from disruptive changes in the environment such as recessions (Chart of the Week and Chart I-2).   Chart I-2Productivity Surges After Recessions In this regard, any technology that is required already generally exists, but the recession is the necessary catalyst for its wholesale adoption. For example, the mass manufacturing of autos already existed well before the Great Depression, but the Depression was the catalyst for its wholesale adoption. Likewise, word processors existed well before the dot com bust, but the 2000 recession was what finally killed the office typing pool. In the same way, the technology for online shopping and remote meetings has been around for years, but it is the pandemic that has catalysed its wholesale adoption (Chart I-3). Chart I-3The Pandemic Has Accelerated The Shift To Online As Fosbury said, he was just the first to find a more natural style of high jumping, yet it required a change of environment to challenge the best practice. Similarly, it has taken a global pandemic for us to challenge the best practice on how we should work, do business, shop, and interact (Chart I-4). Chart I-4The Pandemic Has Accelerated The Shift To Online It is sub-optimal to work in the office or to shop in-person all the time. It is also sub-optimal to do these things remotely all the time. The optimal way is some hybrid of in-person and remote interactions, which will clearly differ for each person. But the pandemic has given us the opportunity to find this more natural and better way, and thereby to give our productivity a massive boost (Chart I-5). Chart I-5The Pandemic Has Challenged The Best Practice On How To Work The productivity boom could be a super-boom because the current disruption has forced us all to find better ways of doing things. This differentiates the current episode from previous post-recession periods where transformations were focussed in one sector. For example, the 80s recession reshaped manufacturing, the dot com bust changed the technology sector, and the 2008 recession transformed the financial sector. By comparison, the current transformation is penetrating the entire economy. The Investment Conclusion A productivity super-boom carries two important implications for policymakers. It will take longer for the economy to reabsorb the unemployed, and it will keep structural inflation depressed. This means that interest rate hikes will be much later and much shallower than the market is pricing (Chart I-6 and Chart I-7). Chart I-6Rate Hikes Will Be Later Than The Market Is Pricing Chart I-7Rate Hikes Will Be Shallower Than The Market Is Pricing The investment conclusion is to buy any of the US interest rate futures that expire from December 2022 out to June 2024. The earlier contracts have the higher probabilities of expiring in profit while the later contracts have the greater potential upside. An alternative expression is to buy the 30-year T-bond, or to go long the 30-year T-bond versus the 30-year German bund. For equity investors, a productivity super-boom plus the market’s overestimation of Fed rate hikes structurally favours growth sectors versus value sectors. Thereby, it also structurally favours the S&P500 versus the Eurostoxx50. Fractal Analysis Update Global stocks versus bonds (MSCI All Country World versus 30-year T-bond) continue to exhibit the fragility on the 260-day fractal structure that started in mid-March. Since then, and consistent with this fragility, global stocks have underperformed bonds by 6 percent (Chart I-8). Chart I-8Stocks Versus Bonds Remains Fractally Fragile But fragility on a 260-day fractal structure implies elevated risk of a reversal through at least the following six months. On this basis, our recommendation is to remain, at most, neutral to global stocks versus bonds through the summer. Among recent trades, short corn versus wheat, and short marine transportation versus market achieved their profit targets of 12 percent and 16.5 percent respectively, but short Austria versus Chile, and short lead versus platinum hit their stop-losses of 7 percent and 6.4 percent respectively. The 6-month win ratio stands at a very pleasing 71 percent. This week’s recommended trade is to reinitiate the stopped-out metals pair-trade in a modified expression – short tin versus platinum – given the very fragile 130-day and 260-day fractal structure (Chart I-9). Set the profit target and symmetrical stop-loss at 16.5 percent. Chart I-9Tin Is Fractally Fragile   Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Fractal Trading System Fractal Trades 6-Month Recommendations Structural Recommendations Closed Fractal Trades Closed Trades Asset Performance Equity Market Performance   Indicators To Watch - Bond Yields Chart II-1Indicators To Watch - Bond Yields ##br##- Euro Area Chart II-2Indicators To Watch - Bond Yields ##br##- Europe Ex Euro Area Chart II-3Indicators To Watch - Bond Yields ##br##- Asia Chart II-4Indicators To Watch - Bond Yields ##br##- Other Developed   Indicators To Watch - Interest Rate Expectations Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations