Netherlands

The Tactical Asset Allocation model can provide investment recommendations which diverge from those outlined in our regular weekly publications. The model has a much shorter investment horizon - namely, one month - and thus attempts to capture very tactical opportunities. Meanwhile, our regular recommendations have a longer expected life, anywhere from 3-months to a year (or longer). This difference explains why the recommendations between the two publications can deviate from each other from time to time. Highlights Chart 1Model Weights bca.gis_taami_2016_10_28_c1 bca.gis_taami_2016_10_28_c1 In October, the model outperformed global equities in USD and local-currency terms; it also outperformed the S&P 500 in local-currency terms, while performing in line with the S&P in USD terms. For November, the model trimmed its allocation to cash and stocks and boosted its weighting in bonds (Chart 1). The model increased its weighting in French, Dutch, and Swedish stocks at the expense of the U.S., Japan, Germany, Switzerland, New Zealand, and Emerging Asia. Within the bond portfolio, allocation to New Zealand and the U.K. was increased, while the allocation to U.S., Australian and Spanish paper was reduced. The risk index for stocks deteriorated in October, while the bond risk index improved noticeably. Feature Performance In October, the recommended balanced portfolio gained 0.6% in local-currency terms, and was down 1% in U.S. dollar terms (Chart 2). This compares with a loss of 1.4% for the global equity benchmark, and a 1% loss for the S&P 500 index. Given that the underlying model is structured in local-currency terms, we generally recommend that investors hedge their positions, though we do provide recommendations from time to time. The higher allocation to EM stocks in October was timely, but the boost to bonds was a drag on the model's performance. Weights The model cut its allocation to stocks from 67% to 66% and increased its bond weighting from 21% to 26%. The allocation to cash was decreased from 12% to 8%, while commodities remain excluded from the portfolio (Table 1). The model reduced its allocation to New Zealand equities by 3 points, Emerging Asia by 2 points and U.S., Japan, Germany and Switzerland by 1 point each. Meanwhile, it increased allocation to Dutch, French and Swedish stocks by 4 points, 3 points and 1 point, respectively. In the fixed-income space, the allocation to U.K. and New Zealand paper was increased by 6 points and 5 points respectively, while allocation to Australia, Spain and the U.S. was cut by 3 points, 2 points and 1 point, respectively. Chart 2Portfolio Total Returns bca.gis_taami_2016_10_28_c2 bca.gis_taami_2016_10_28_c2 Table 1Model Weights (As Of October 27, 2016) Tactical Asset Allocation And Market Indicators Tactical Asset Allocation And Market Indicators Currency Allocation Local currency-based indicators drive the construction of our model. As such, the performance of the model's portfolio should be compared with the local-currency global equity benchmark. The decision to hedge currency exposure should be made at the client's discretion, though from time to time, we do provide our recommendations. The dollar appreciated in October and investors should position for additional dollar strength. Our Dollar Capitulation Index seems to be breaking out to the upside following a pattern of lower highs. Since 2008, such breakouts have been followed by a significant rally in the broad trade-weighted dollar (Chart 3). Chart 3U.S. Trade-Weighted Dollar* And Capitulation bca.gis_taami_2016_10_28_c3 bca.gis_taami_2016_10_28_c3 Capital Market Indicators Our model continues to exclude commodities from the portfolio. The risk index for this asset class remains at the highest level in over two years (Chart 4). For the first time since June 2014, the risk index for global equities is above the neutral line (Chart 5). The higher overall risk reflects deteriorating liquidity and momentum readings. Our model cut its weighting in equities for the third month in a row. Chart 4Commodity Index And Risk Commodity Index And Risk Commodity Index And Risk Chart 5Global Stock Market And Risk bca.gis_taami_2016_10_28_c5 bca.gis_taami_2016_10_28_c5 The value component of the risk index for U.S. stocks improved in October, but this was overshadowed by worsening liquidity and momentum readings. The model slightly trimmed its allocation to U.S. equities (Chart 6). Even after the latest small uptick in the risk index for Dutch equities, it remains one of the lowest among the model's universe. The allocation to this bourse was increased. (Chart 7). Chart 6U.S. Stock Market And Risk bca.gis_taami_2016_10_28_c6 bca.gis_taami_2016_10_28_c6 Chart 7Netherlands Stock Market And Risk bca.gis_taami_2016_10_28_c7 bca.gis_taami_2016_10_28_c7 The risk index for U.K. stocks declined slightly in October, but remains firmly in high-risk territory both compared to its own history and its global peers. This asset class remains excluded from the portfolio (Chart 8). The model slightly upgraded Swedish equities, despite a worsening risk index. The continued favorable liquidity backdrop remains a boon for Swedish stocks (Chart 9). Chart 8U.K. Stock Market And Risk U.K. Stock Market And Risk U.K. Stock Market And Risk Chart 9Swedish Stock Market And Risk bca.gis_taami_2016_10_28_c9 bca.gis_taami_2016_10_28_c9 After declining for four consecutive months, the overall risk index for bonds is not at extreme high-risk levels anymore. The increase in yields has helped completely unwind overbought conditions, as per our momentum indicator. The model used the latest selloff to increase its allocation to bonds (Chart 10). The risk index for U.S. Treasurys declined markedly in October, but a few other markets also feature improved risk readings. As a result, the model downgraded U.S. Treasurys (Chart 11). Chart 10Global Bond Yields And Risk bca.gis_taami_2016_10_28_c10 bca.gis_taami_2016_10_28_c10 Chart 11U.S. Bond Yields And Risk bca.gis_taami_2016_10_28_c11 bca.gis_taami_2016_10_28_c11 The selloff in New Zealand bonds has pushed the momentum indicator into oversold territory, boosting the allocation to this asset class (Chart 12). The risk index for euro area bonds remains firmly in the high-risk zone even after a notable decline. However, there are select bond markets in the common-currency area that have relatively more favorable risk readings (Chart 13). Chart 12New Zealand Bond Yields And Risk bca.gis_taami_2016_10_28_c12 bca.gis_taami_2016_10_28_c12 Chart 13Euro Area Bond Yields And Risk bca.gis_taami_2016_10_28_c13 bca.gis_taami_2016_10_28_c13 Within the euro area, Italian bonds feature a risk reading that has fallen below the neutral line. While the cyclical indicator continues to move into more bond-negative territory, it is currently being offset by the oversold reading on the momentum indicator (Chart 14). U.K. gilt yields moved up as the post-Brexit inflation backdrop became gilt-unfriendly and growth surprised on the upside. Now, with momentum moving from overbought to oversold over just a couple of months, any negative economic surprises could potentially weigh on gilt yields. The model has added this asset class to the portfolio (Chart 15). Chart 14Italian Bond Yields and Risk bca.gis_taami_2016_10_28_c14 bca.gis_taami_2016_10_28_c14 Chart 15U.K. Bond Yields And Risk bca.gis_taami_2016_10_28_c15 bca.gis_taami_2016_10_28_c15 A more hawkish Fed could push the dollar higher. The 13-week momentum measure for the USD remains above, but close to the neutral line. The recovery of the 40-week rate of change from mildly negative levels which have represented a floor since 2012 would suggest that a new leg in the dollar bull market is in the offing (Chart 16). Both the 13-week and 40-week momentum measures for the euro are below the neutral line (Chart 17). Growing monetary divergences could continue weighing on EUR/USD before the technical indicators are pushed into more oversold territory. Fears of hard Brexit knocked down the pound. The 13-week rate of change is now close to its post-Brexit lows, while the 40-week rate of change measure is at the most oversold level since 2000 (excluding the great recession). At these technical levels the pound seems overdue to find a temporary bottom (Chart 18). Chart 16U.S. Trade-Weighted Dollar* bca.gis_taami_2016_10_28_c16 bca.gis_taami_2016_10_28_c16 Chart 17Euro Euro Euro Chart 18Sterling Sterling Sterling Miroslav Aradski, Senior Analyst miroslava@bcaresearch.com

If the U.K. ultimately exits the EU, it will be a major break in the 70 years of European integration. Multipolarity will be reinforced, increasing global geopolitical risk. We expect global risk assets to start taking cues from Europe, not the Fed and China. However, risks of N-Exit - that other EU member states follow suit - may be overstated.

Highlight Even alarmists like us have been surprised by the referendum outcome; The referendum is a major break in the 70 years of European integration; It will reinforce multipolarity and increase global geopolitical risk; The U.K., however, is an outlier in terms of Euroskepticism; No other EU country is likely to vote to leave the EU, though tail risks are up; Watch for the "Who is Next" premium to be applied to European assets, and the "reflation trade" is likely over for the time being. Feature "Since they will overload my shoulders," quoth John, "I shall throw down the burden with a squash amongst them, take it up who dares." - John Arbuthnot, complaining about Europe's treatment of Britain, The History of John Bull (1712) Chart 1So Much For Crowd Wisdom bca.bcasr_sr_2016_06_24_c1 bca.bcasr_sr_2016_06_24_c1 British voters have chosen to leave the European Union. The outcome caught most forecasters by surprise, including the "smart money" of the betting markets (Chart 1). We are not as surprised, since we raised the possibility that the conventional view was wrong as early as March and called the referendum "too close to call" in our last missive.1 However, we also thought that the narrow polling would push voters towards the status quo in the last minute. In this analysis, we offer our view on three questions: What is next for the U.K.? Who is next in the EU? Is a risk premium even appropriate? What does this mean for broader global stability? We conclude with investment implications. What Next For The U.K.? In our report last week, "Break Glass To Brexit," we outlined some of the likeliest next steps after Brexit. These have not changed: Cameron's Fate and the Tories: Leaders who stake their credibility on a referendum typically resign if they lose the vote, as with Jacques Parizeau in Quebec or Alex Salmond in Scotland. Cameron has similarly stated that he will resign by October. This introduces greater political risk into British politics. In particular, any economic risks emanating from the referendum will be blamed on the Tories. The Labour Party stands to benefit. Under Jeremy Corbyn it has turned more left-wing than any opposition party since the 1980s. But Labour MPs could also ditch Corbyn in an effort to capitalize on Tory disintegration. British politics will be a rollercoaster for quite some time. The last time the Conservative Party imploded over Europe, a Tony Blair-led Labour waited in the wings. This is not the case today. Article 50 of the Lisbon Treaty: The process of leaving the EU requires the departing member-state to invoke this article, which provides for a two-year period to negotiate an exit that should take account of the state's obligations and future relations with the union. No country has done this before so it is not clear how exactly it will happen. A meeting of the European Council next week provides an opportunity for Cameron to announce the country's intentions. But the government has an incentive to wait before initiating the two-year countdown process until it has formed a negotiation plan, since the EU is likely to take a hard line on the U.K.'s access to the common market. It should be noted that the two-year negotiation timeframe is not firm - the U.K. could withdraw precipitously, or, with approval from all member states, it could negotiate for more than two years. Another Referendum: Yes, it is possible for another referendum to be held. In fact, the likely successor to David Cameron, and "Leave" vote champion, former Mayor of London Boris Johnson, raised the possibility of a second referendum when he announced his support for exit. In other words, even the likely new prime minister and pro-Brexit leader is open to another referendum. Perhaps one could be held after the U.K. ends its negotiations with the EU. The problem is that we doubt the EU will concede much, since that could lead to a chain reaction in Europe. As such, it will depend on the U.K.'s political circumstances whether a new referendum is held. An Act of Parliament: Formal withdrawal will require an act of parliament, since, for instance, the 1972 European Communities Act ensures that the U.K. automatically incorporates EU directives into law and has hitherto been interpreted as establishing the priority of EU law where it contradicts British law. That is a key motivation of the sovereignty argument behind Brexit; the law will have to be replaced if Britain leaves. Notably, the referendum itself does not have any legal consequences. It is a dead letter without a government decision to enact it. That decision should be forthcoming in a mature democracy where the result is clear and uncontested. However, the political aftermath could lead to a parliamentary dissolution, with some groups hoping to delay the country's exit or hold a second referendum. Chart 2Scottish Independence:##br##A Yearning Not Yet Laid To Rest bca.bcasr_sr_2016_06_24_c2 bca.bcasr_sr_2016_06_24_c2 Scottish Referendum: Scots voted 62% to stay in the EU, versus England's 53% to leave, which throws into stark relief the differences in points of view between the two countries. The U.K. vote has reinvigorated calls for independence almost immediately, with the First Minister Nicola Sturgeon already calling for a new referendum. The failure of the Scottish independence referendum in 2014 has not extinguished the desire to leave (Chart 2), although we suspect the collapse of oil prices may at least raise the economic bar of independence. The Scottish National Party has swept into almost total control of the Scots parliament since the referendum failed. Scotland, by comparison with the U.K., is a disproportionate beneficiary of EU transfers. During the 2014 referendum, the EU pushed against Scots independence, but it may not do so the second time. The loss of Scotland would jeopardize British energy and naval advantages as well as create various internal political risks across the British Isles for the future. Tensions in Ireland: Northern Ireland, like Scotland, benefits from EU funds (like farm subsidies) and voted 56% to remain. It too has groups aggravated by England's vote carrying the day. Any separation of Scotland would motivate forces both in Northern Ireland and in the Republic of Ireland to push for a unified Irish island state. That will aggravate political and sectarian tensions that have only quieted down since 1998 and were even showing a few signs of heating back up before Brexit. Thus Brexit will force Westminster to devote greater attention and resources to re-establishing the U.K.'s compact with its constituent countries. Bottom Line: Political uncertainty will rise across the U.K. due to Brexit. If the decision to leave the EU stays, we believe that the U.K. may cease to exist as a unitary state. However, the referendum may not be the last word on EU membership. The likely next prime minister, Boris Johnson himself, has floated the option of a second referendum and thus the idea that the just-concluded referendum is part of a negotiation strategy. Who Is Next? The immediate question investors are asking is, Who is next to try to leave the EU?" Already, the "Who Is Next Premium" is infecting the Mediterranean European bond markets, with peripheral spreads up across the board (Chart 3). Chart 3The 'Who Is Next?' Premium The "Who Is Next?" Premium The "Who Is Next?" Premium To simplify the answer to this forecasting challenge, we developed an EU Dependency Index (Chart 4).2 We combine six economic and financial factors to determine which member states have a high bar to clear in order to leave the EU. Chart 4Constraints To Leaving The EU The Coming EXITentialist Crisis The Coming EXITentialist Crisis As with all indexes, one should take its conclusions with a grain of salt. But generally speaking, the results are helpful. For instance, Hungary is more constrained in leaving the EU than Sweden. Hungary's trade is almost exclusively with EU member states, its interest payments as a percent of GDP are high (and would become higher post-EU exit), and it benefits the most from structural funds from the EU. Leaving the bloc would be a painful decision for Budapest that would undoubtedly leave the country worse off. One set of factors that our index does not measure is geopolitics. Central and Eastern Europe, as well as Cyprus, are members of the EU for more than just economic benefits. In the case of countries like Romania and Poland, the EU is seen as another layer - on top of NATO membership - of security guarantees vis-à-vis Russia. (For Cyprus, the EU is a form of security arrangement against Turkey.) In the oft-cited 2016 Pew Research poll showing a decline of support for the EU, Poland remains the most supportive with a 72% favorable rate (Chart 5). Hungary is not far behind. Both countries are led by rhetorically Euroskeptic right-of-center parties, but the reality is that they will not contemplate exit. By focusing on the lower end of the dependency index, we can isolate the countries that are the least constrained economically in pursuing a break with the union. We will therefore focus on the Netherlands, Austria, Greece, Spain, Italy, Finland, Germany, Denmark, France, and Sweden. This is not to say that the other countries on the index do not have Euroskeptic movements, but only that we do not take them seriously. How do our selected EU member states stack up against the U.K.? First, as we argued earlier this year, the U.K. stands out for Euroskepticism. In our view, it has the lowest political, economic, financial, and geographic constraints to exiting the bloc. This is born out in data. In particular: Identity: The British have never felt comfortable defining themselves as European (Chart 6). Meanwhile, the sense of "Europeanness" has actually risen in the rest of Europe since 2010. Chart 5Falling Support For The EU bca.bcasr_sr_2016_06_24_c5 bca.bcasr_sr_2016_06_24_c5 Chart 6British Identity Has Always Stood Apart bca.bcasr_sr_2016_06_24_c6 bca.bcasr_sr_2016_06_24_c6 EU Immigration: In our view, the issue of intra-EU immigration carried the day for "Leave" on June 23. Polling data revealed that this issue, perhaps more than any other, was a source of consternation among U.K. voters (Chart 7). The feeling is not mutual across Europe (Chart 8), although France and Italy are similarly split on the issue. Chart 7EU Emigration: A Concern In Britain bca.bcasr_sr_2016_06_24_c7 bca.bcasr_sr_2016_06_24_c7 Chart 8Not Everyone In Europe Is Concerned About EU Emigration The Coming EXITentialist Crisis The Coming EXITentialist Crisis Geopolitics: Europeans do not see the EU as a vehicle towards "economic prosperity," but rather a project for "peace" and a "stronger say in the world" (Chart 9). Therefore, for much of the EU, the bloc has a geopolitical component that gives the EU a "geopolitical imperative for integration," as we argued in 2011.3 This is not the case in the U.K., which is the world's fifth largest economy, a nuclear power, a permanent UN Security Council member, and a geographically isolated island. It needs the EU the least in the geopolitical sense. Chart 9The U.K. Does Not Perceive The EU As A Geopolitical Project The Coming EXITentialist Crisis The Coming EXITentialist Crisis Confidence: British voters do not see a life outside the EU as a big threat, perhaps revealing why the "Stay" campaign strategy of emphasizing the economic costs of exit was a mistake. When asked whether they thought "their country could better face the future outside the EU," British respondents have consistently answered in the affirmative (Chart 10). This is not the case for any other country in Europe. It is an important point because holding a negative view of the EU is not the same as wanting to leave it. Greece is a good example. While 38% of Greeks see the EU in a negative light, 56% do not think the country would do better outside of it (Chart 11). Denmark, Sweden, Finland, and the Netherlands - all frequently cited as "Euroskeptic" candidates for a future EU-exit - also score surprisingly low on confidence that they would be successful outside of the EU. However, Italian confidence in a future sans Europe appears to be growing, and Austrian confidence has always been high. Chart 10AThe U.K. Is Confident About ##br##Life Outside The EU bca.bcasr_sr_2016_06_24_c10a bca.bcasr_sr_2016_06_24_c10a Chart 10BThe U.K. Is Confident About ##br##Life Outside The EU bca.bcasr_sr_2016_06_24_c10b bca.bcasr_sr_2016_06_24_c10b Chart 11Not Everyone Who Is Angry##br## Wants A Divorce The Coming EXITentialist Crisis The Coming EXITentialist Crisis Currency: The U.K. is not a member of the euro area and therefore does not have to deal with the redenomination risk of exit. For countries in the Mediterranean, such a risk would see household wealth redenominated into pesetas, lira, and francs. For Germany, it would mean a 20-30% deutschmark appreciation and a devastating blow to its export-driven economy. Support for membership in the euro area remains surprisingly high in the countries that are members of the currency union (Chart 12). In fact, support for the euro is at or near its highest levels ever in Finland, France, Germany, the Netherlands, Spain, and even Greece! Again, Italy stands as a dangerous outlier. Chart 12ASupport For The Euro Remains Strong bca.bcasr_sr_2016_06_24_c12a bca.bcasr_sr_2016_06_24_c12a Chart 12BSupport For The Euro Remains Strong bca.bcasr_sr_2016_06_24_c12b bca.bcasr_sr_2016_06_24_c12b From the polling data we can conclude that the U.K. stands alone in consistently lying on the Euroskeptic side of each political category. However, we can also make five general observations: Italy has clearly seen a significant rise in Euroskepticism over the past decade; Austria has always lacked enthusiasm for the EU, although its support of the euro remains high; Concerns over the Nordic countries are overstated, there is no evidence that they are Euroskeptics; France is mixed, scoring high on Euroskepticism when it comes to immigration, but low on other issues. Germany is committed to European institutions. So, who is next? With great respect to the history made on June 23 and to the growing anti-establishment sentiment around the world, we suspect that nobody will follow in the U.K.'s footsteps and actually vote to leave. In fact, European policymakers are likely to push against the June 23 vote with a new treaty that takes into account many of the grievances of Euroskeptics around the continent. But the point is that the economic, financial, political, and geopolitical costs of exit are much higher for every other EU member state. Nevertheless, given the success of the U.K.'s referendum, the probability that another vote on EU membership will be held has increased. That alone will be enough for the markets to apply a "Who is Next" premium to European assets, which explains the European asset sell-off the day after the referendum. We are in particular focused on five countries: Chart 13Italian Politics: A Rising Risk bca.bcasr_sr_2016_06_24_c13 bca.bcasr_sr_2016_06_24_c13 Italy: Unlike its Mediterranean peer Spain, Italy has not seen any improvement in competitiveness and remains embroiled in sub-par growth. The constitutional referendum in October - on streamlining governance, a necessary step before embarking on painful structural reforms - could fail, leading to an early election late this year or early next. At the moment, the anti-establishment Five Star Movement (5SM) is closing in on the ruling Democratic Party in the polls (Chart 13). Its leader, Beppe Grillo, has called for an EU referendum, but its rising political star - and new mayor of Rome - Virginia Raggi has rejected Euroskepticism. If an early election this or next year produces a 5SM government, a political crisis will ensue. The Netherlands: According to the survey data we reviewed in this analysis, the Netherlands would not vote to leave the EU. That is our high conviction view. However, the Euroskeptic Party for Freedom is leading in the polls for the upcoming Dutch general election, set to be held no later than March 15, 2017. Its leader Geert Wilders has said that he would call for an EU membership referendum if he were to win the election. Austria: According to the data reviewed in this analysis, Austrian Euroskepticism is on the rise. The next general election is set for the end of 2018 and will likely see the Euroskeptic Freedom Party win the largest share of the vote. This leaves the possibility of an EU membership referendum open for 2019. France: Presidential elections in France are set for April and May 2017 (two rounds). Marine Le Pen appears to have peaked in popularity in 2013 and thus has very little chance of winning (Chart 14). However, her likely progress into the second round could put French Euroskepticism in the spotlight. Investors should remember that French Euroskepticism is not at all a novel concept, so greater changes would need to be forthcoming (Chart 15). Chart 14Has Marine Le Pen Peaked? Has Marine Le Pen Peaked? Has Marine Le Pen Peaked? Chart 15France Has A Tradition of Euroskepticism The Coming EXITentialist Crisis The Coming EXITentialist Crisis Germany: No, we do not think there is any chance of a referendum on the EU or euro membership in Germany. If there was one, it would fail to produce an exit on both accounts. However, Germany is the key country to watch because the future of the EU depends on it. Without a shift from Berlin on the bloc's adherence to strict budget discipline, the EU may not survive. Germans have crossed their "red lines" numerous times in order to preserve the euro area, suggesting that they are quite flexible (Table 1). However, it has always taken a major crisis for them to move. Table 1Europe: The Hurdle To Heterodoxy Is Low The Coming EXITentialist Crisis The Coming EXITentialist Crisis Another important notice here is that the European migration crisis likely had an influence on the U.K. referendum result. But the numbers show that the crisis has not only abated, but that it has effectively ended. The overall figures show that migration flows peaked at 220,000 in October 2015, whereas they were only 9,354 in June (Chart 16). Breaking down the flows by destination (Greece vs. Italy) does not reveal any new information (Chart 17). The migration flows have therefore not shifted from the Balkan route to the Italian one. Chart 16The Migration Crisis Is Over!##br## (Did Anyone Tell The Voters?) bca.bcasr_sr_2016_06_24_c16 bca.bcasr_sr_2016_06_24_c16 Chart 17Migrants Are Not ##br##Coming Via Libya bca.bcasr_sr_2016_06_24_c17 bca.bcasr_sr_2016_06_24_c17 As such, it is possible that by the time an Austrian, Dutch, or Italian referendum on EU membership is called, the issue of migration may no longer be front-and-center on voters' minds. In fact, EU efforts to intercept refugee flows at the bloc's external borders could be seen as successful by that point. Bottom Line: A "Who is Next" premium will undoubtedly be applied to European assets now that the U.K. has voted to leave the EU. However, it will likely overstate the risks of other countries following suit. The U.K. has the least political, economic, financial, and geopolitical constraints to exiting the bloc. Broad Political And Geopolitical Implications The decision by the U.K. electorate to leave the EU is going to increase both political and geopolitical volatility. It strikes at the stability of the European Union, which is one of the core post-World War Two institutions that have kept peace in the Western world for the past seventy years. As such, its implications - if London goes ahead with Brexit - will be profound. The U.K. referendum will have implications for multipolarity, a major theme of BCA's Geopolitical Strategy. The world lacks global leadership as the U.S. wanes in relative geopolitical power. From an investor's perspective, this is a negative process as multipolarity is empirically and theoretically proven to be a harbinger of inter-state conflict. Today, this process has largely been assuaged by the existence of Cold War-era institutions that allow the U.S. to amplify its power. The EU, NATO, and financial institutions such as the IMF and the World Bank are such entities. By leaving the EU, the U.K. does not necessarily undermine this global order, but it does show that a 43 year-old geopolitical relationship can end. It will weaken the EU as a global player, given the U.K.'s obvious hard power, and aid Europe's geopolitical rivals. And if it further leads to disintegration of the EU, which is not our base case, it will massively increase global geopolitical risk. We suspect our clients will have to brush up on obscure geographical references - such as Alsace-Lorraine, Silesia, and South Tyrol - by the time this process is over, if it ever begins. This is a profoundly negative outcome, if it were to occur. Generations that thought they would never see another armed conflict on the European Peninsula may be in for a surprise. On the domestic political front, the rise of the anti-establishment - particularly in the U.S. and U.K. - has been one of the most talked-about themes in the financial community in 2016. However, it is unclear how to price the risk, if any, of non-centrists coming to power. In part, the reason is that investors have had widespread disbelief that populism could win any major election in any major economy. That has now changed with the U.K. choosing to exit the EU. Chart 18Debt Replaced Income Debt Replaced Income Debt Replaced Income We suspect that the focus over the next several months - in terms of assigning risk premia - will remain on Europe. However, the reality is that middle class malaise may be the most advanced in the laissez-faire economies of the U.S. and the U.K., especially now that the debt supercycle is no longer available to assuage the pain of decade-long stagnant wages (Chart 18). In a way, anti-globalization policies are merely the politically right-of-center approach to redistributing income. The last three decades of free trade and laissez-faire policies have led to growing income inequality as winners of globalization captured most of the gains and losers were left to face the consequences, and the painful adjustment, without much redistribution. Take the vote on EU membership, which saw all of England vote to leave except for the financial capital of the world, London. For Bernie Sanders and Jeremy Corbyn - as well as Podemos in Spain and SYRIZA in Greece - the answer is to dial up the redistribution. For Donald Trump, UKIP, and Marine Le Pen in France, the answer is to wall off their economies and hope to stave off redistribution by shifting the blame for tepid growth to the outside world. Both policies will be equally bad for equity markets and risk assets, as they will erode profit margins one way or another. The 1990s consensus on deregulation, privatization, low taxes, budgetary discipline, and free trade is over. The median voter is shifting to the left-of-center and demanding economic policies that are in contravention of the 1990s "Third Way" consensus (Diagram 1). According to the median voter theory, policymakers will shift with the median voter to a new center and will not shift back to the old center once they capture power.4 Thus, even if the establishment wins in the U.S. this year and France and Germany next year, it will have moved away from the laissez-faire and globalization consensus. Diagram 1Median Voter Theorem The Coming EXITentialist Crisis The Coming EXITentialist Crisis This is bad news for emerging markets. It is also bad news for the shares of global companies who have benefited tremendously from the steady dismantling of barriers to the free flow of goods, capital, and labor. In the long run, the decline of globalization will also usher in higher inflation. Globalization has effectively produced the largest supply-side shock in the history of mankind. As such, it is a major deflationary force. But if policymakers respond to populism with protectionism and fiscal expenditure, then the deflationary forces of globalization will reverse. Perhaps sooner than the market expects. Bottom Line: The Goldilocks era for investors - in terms of the economic policy consensus - is over. When combined with the hegemonic instability of a multipolar order, Brexit means that politics and geopolitics will become an ever more relevant analytical lens for investors. The apex of globalization has come and gone.5 Investment Implications At BCA, we have long maintained that at times such as this, it makes sense to take a cold shower and resist making any rushed investment decision. Brexit, if it were to go ahead as currently planned, has the potential to change the world, but it is not clear precisely how. The current market sell-off offers a buying opportunity, at least in the short term. Policymakers are already responding with renewed stimulus. The G7 communique issued on the heels of the referendum has essentially given a green light to Japan and Europe to intervene in the currency markets. The Fed funds rate futures are now pricing in a 15% probability of a U.S. rate cut by the end of the year, whereas the probability was zero just one day ago. Nevertheless, the damage has been done. Peter Berezin, Chief Strategist of BCA's Global Investment Strategy, fears that the "reflation trade" that began in February may be over. Certainly the data out of China is becoming more difficult to square, with declining credit growth and leading indicators (like excavator sales) taking a plunge. Reflation by policymakers may eventually combine with the pervasive "search for yield" to buoy risk assets. At the moment, however, all eyes will be turned to Europe and the "Who is Next" premium likely to creep into assets. We suspect that global assets will take cues not from the Fed or China in the short term, but Europe and the usual bellwether of the continent's future: Mediterranean economies. In terms of U.K. assets, several immediate investment strategies exist: Currency: BCA's Foreign Exchange Strategy recommends buying the GBP/USD at 1.32. Short FTSE 250/FTSE 100: The FTSE 250 has outperformed the FTSE 100 since 2000 (Chart 19), closely reflecting the performance of the U.K. economy relative to the euro area. Uncertainty caused by a vote in favor of Brexit will weigh on consumer and business confidence in the U.K., hurting the FTSE 250's performance, while a weaker GBP/USD should give a boost to the globally-oriented FTSE 100. Long FTSE 100 "exporters" / FTSE 100 "financials": While negative for the pound, Brexit should represent a boon to export-oriented industries. British real net exports increased during the period of sterling weakness following "Black Wednesday" - the pound's exit from the European Exchange Rate Mechanism (ERM) in September 1992 - reaching a level that they have been unable to regain since (Chart 20). Meanwhile, the greatest uncertainty would surround the financial sector, which would face both the potential loss of market access in the euro area and negative political consequences. Chart 19Go Long U.K. Exporters bca.bcasr_sr_2016_06_24_c19 bca.bcasr_sr_2016_06_24_c19 Chart 20Weak Pound Is Good For Exports Weak Pound Is Good For Exports Weak Pound Is Good For Exports Buy inflation protection: We favor getting long 10-year U.K. CPI swaps / short 10-year U.S. CPI swaps (Chart 21). BCA's Global Fixed Income Strategy team argues that inflation could surprise to the upside in the U.K. First, the labor market is tightening and firms are having increasing difficulty recruiting (Chart 22). A weaker pound will also lead to higher inflation through higher import prices. To counter the negative economic effects, the Bank of England will now likely cut interest rates, and perhaps even engage in renewed quantitative easing, which means that monetary policy will not curb but feed the inflationary impulses of Brexit. Chart 21Buy Inflation Protection bca.bcasr_sr_2016_06_24_c21 bca.bcasr_sr_2016_06_24_c21 Chart 22U.K. Labor Market Is Tightening U.K. Labor Market Is Tightening U.K. Labor Market Is Tightening Play the corporate bond market: The U.K. corporate bond market has not priced in Brexit (Chart 23). Investors should underweight U.K. financials versus euro area financials and/or underweight U.K. financials versus U.K. industrials. Ahead of the referendum, U.K. financial spreads had only widened mildly versus peers in the U.S. and the euro area. They were not even showing signs of stress against U.K. industrials. The Brexit vote will likely push these spreads wider. Play the yield curve: If Brexit happens, the yield curve will most likely steepen. As more interest rate cuts are priced in the short end of the curve, inflationary pressures will bubble up and push the longer part of the curve higher. The belly of the curve will profit from these conditions (Chart 24). Chart 23Corporate Bond Market ##br##Has Not Priced In Brexit Corporate Bond Market Has Not Priced In Brexit Corporate Bond Market Has Not Priced In Brexit Chart 24Long Bullet Vs. ##br##The Wings bca.bcasr_sr_2016_06_24_c24 bca.bcasr_sr_2016_06_24_c24 Marko Papic, Managing Editor marko@bcaresearch.com Matt Gertken, Associate Editor mattg@bcaresearch.com 1 Please see BCA Special Report, "Break Glass To Brexit: A Fact Sheet," dated June 17, 2016, and BCA Geopolitical Strategy and European Investment Strategy Special Report, "With Or Without You: The U.K. And The EU," dated March 17, 2016, available at gps.bcaresearch.com. 2 The six factors are trade balance with the EU, exports as percent of GDP, debt interest payments, gross government debt, foreign direct investment, and net transfers to the EU. 3 Please see BCA's The Bank Credit Analyst, "Europe's Geopolitical Gambit: Relevance Through Integration," dated October 19, 2011, available at bca.bcaresearch.com. 4 Please see BCA Geopolitical Strategy Monthly Report, "Introducing: The Median Voter Theory," dated June 8, 2016, available at gps.bcaresearch.com. 5 Please see BCA Geopolitical Strategy Special Report, "The Apex Of Globalization - All Downhill From Here," dated November 12, 2014, available at gps.bcaresearch.com.

The latest conclusions from the sector-based (right) way to pick stock markets. Plus some important conclusions for credit markets.

No significant change in allocation was made. Direction wise, weights in Spain and Switzerland were increased slightly at the expense of Netherland and Sweden.

Cutting through the hype that will surround policy initiatives today, the ECB is caught between a rock and a hard place. We explain why, and what it means for investors.