Sectors

Highlights Increased regulatory scrutiny on the domestic financial sector may continue to create some headline risks and financial volatility, but the real economic impact should be marginal. The recent regulatory crackdown has mainly caused liquidity issues in the domestic market rather than any sort of real growth issue. Chinese shares listed overseas will continue to grind higher. Domestic A shares will remain largely trendless. Domestic corporate bonds are starting to look attractive after the most recent panic selloff. Feature Chinese domestic stocks and bonds have taken a beating of late as the authorities ramped up scrutiny to rein in excesses in the country's financial sector. While it is warranted to control accumulated financial risk - especially associated with shadow banking activity - the "campaign" style administrative crackdown has caused widespread confusion and mini-panics among domestic investors. The actions and corresponding reactions illustrate the authorities' primitive control tools, which are increasingly at odds with the rapidly developing financial sector, and how blanket actions can spur undue financial volatility and provoke unintended consequences. For now, we expect the economic fallout to be limited, unless the financial crackdown causes further spikes in interest rates and a sudden halt in credit flows. Chinese shares listed overseas will continue to grind higher in the absence of a major policy mishap that short-circuits the broad growth improvement and the profit cycle upturn. Domestic A shares will remain largely trendless, while the more richly valued bubbly segments of the market will continue to deflate. Domestic corporate bonds are starting to look attractive after the most recent panic selloff. What Do They Want To Achieve? Policymakers' primary focus has been on cracking down on excessive speculation in financial markets and restricting lending activities that are not in compliance with legal and regulatory requirements. Financial sector deregulation in recent years has increasingly blurred the lines between banks, insurance companies, brokers and trust companies, and regulators are constantly challenged to monitor all the increasingly sophisticated moving parts. From the banking sector's point of view, regulators are concerned that lenders have been aggressively boosting their exposure to other banks and non-bank financial institutions instead of providing credit to the "real economy." Overall commercial banks' claims on other banks and non-bank financial institutions have increased from 12% of their total assets in 2006 to over 25% as of January 2017, while their liabilities to other banks and non-bank financial firms have increased from 7% to 12% (Chart 1). Smaller banks are even more dependent on interbank financing for loanable funds. Interbank transactions and repo activities account for about 14% of smaller lenders' total source of funding, compared with 2% for large banks (Chart 2). Some small banks regularly borrow at lower costs through the interbank market or use negotiable certificate of deposits to purchase "wealth management products" offering higher returns issued by other banks or financial institutions. The duration mismatch leads to constant pressure to roll over these short-term financial instruments. The increasing interdependence among the country's financial institutions also creates the risk of a chain reaction in the financial system should some type of credit event erupt. Chart 1Increasing Interdependence Among Financial Institutions China: Financial Crackdown And Market Implications China: Financial Crackdown And Market Implications The Chinese authorities have long regarded preventing systemic financial risk as a top priority, and the recent growth improvement has provided a window of opportunity for some housecleaning without a major adverse impact on the economy. Therefore, it is unlikely that regulators will back off from tightening regulatory supervision going forward. Overall, the authorities will continue to discourage overtrading within the financial system, and enforce full disclosure of off-balance-sheet items and shadow lending activities. The saving grace is that tightened macro prudential measures have already begun to curtail banks' aggressive expansion to non-bank financial institutions. Commercial banks' claims to these firms have slowed sharply since last year's peak (Chart 3). Meanwhile, the recent rise in interbank rates should also further discourage the perceived "risk-free" funding arbitrage to play the interest rate gap between long- and short-dated financial assets. All of this reduces the pressure of an escalation in the regulatory crackdown. Chart 2Smaller Banks Depend More On##br## Wholesale Funding Smaller Banks Depend More On Wholesale Funding Smaller Banks Depend More On Wholesale Funding Chart 3Banks' Exposure To Non-Bank Financial Firms ##br##Has Been Scaled Back Banks' Exposure To Non-Bank Financial Firms Has Been Scaled Back Banks' Exposure To Non-Bank Financial Firms Has Been Scaled Back Should Investors Be Concerned? In essence, banks' rising claims to other financial institutions means a lengthening of the credit intermediation channel, in which financing goes from credit providers through multiple layers of intermediaries to reach final borrowers in the real economy. In other words, banks, instead of lending directly to borrowers, channel loans to trust companies or securities brokers, who in turn transfer the funds to the real economy through "shadow banking" activities such as trust loans or various forms of "wealth management products", typically at higher rates. From this perspective, cracking down on lending excesses within the financial system in of itself should not have a material impact on credit flows to final corporate borrowers. In fact, streamlining the financial intermediation channel holds the promise of increasing accessibility to bank credit for the corporate sector and reducing its funding cost, which should benefit the overall economy in the long run. In the near term, liquidity tightening and the regulatory crackdown could push up interest rates and disrupt credit flows, which should be closely monitored to assess near-term negative impact on the economy. So far, the impact does not appear material. Chart 4Regulatory Crackdown ##br## Has Not Interrupted Credit Flows Regulatory Crackdown Has Not Interrupted Credit Flows Regulatory Crackdown Has Not Interrupted Credit Flows Interbank rates have increased by about 100 basis points across the board since the beginning of this year, and 10-year government bond yields have risen by 50 basis points - both of which pale in comparison to the significant improvement in overall business activity. Nominal GDP growth expanded by 11.8% in the first quarter, compared with 9.6% in Q4, 2016. Furthermore, the central bank early this week re-started its medium-term lending facility (MLF), which was designed to avoid liquidity overkill in the domestic financial sector. Overall, the risk of overtightening of liquidity is not high. The regulatory crackdown since early this year has not had a meaningful impact on credit expansion. Banks' claims to other financial institutions have slowed sharply, but overall loan growth has been rather stable. Importantly, medium- and long-term loans to the corporate sector, pivotal for overall capital spending, have in fact accelerated (Chart 4). In short, increased regulatory scrutiny on the domestic financial sector may continue to create some headline risks and financial volatility, but the real economic impact should be marginal. We expect the authorities to remain highly vigilant and avoid policy overkill. Reading Market Tea Leaves There have been some notable divergences among different classes of Chinese stocks (Chart 5). Chinext, the domestic small-cap venture board, has suffered heavy losses of late, while large-cap A shares have been much more resilient. Meanwhile, offshore Chinese shares have barely felt any pressure at all. H shares have moved higher of late, while Chinese firms listed in the U.S. have decisively broken out. The divergence between onshore and offshore Chinese stocks' performance confirms the recent regulatory crackdown has mainly caused liquidity issues in the domestic market rather than any sort of real growth issue. Barring major policy mistakes, we expect the Chinese economy to stay buoyant, as discussed in detail in our recent report.1 As such, a few investment conclusions can be drawn. Tighter liquidity will likely continue to place downward pressure on domestic stock prices, but the downside is limited by overall buoyant activity and improving profits. We expect the broad-A share market will remain narrowly range-bound. Overseas-listed Chinese shares are not subject to domestic liquidity constraints, and will likely continue to grind higher supported by growth improvement, profit recovery and low valuation multiples. The small-cap Chinext market has long been viewed as the more speculative segment of the domestic financial market, with higher multiples and greater volatility than large-cap A shares. As such, this market will remain vulnerable to domestic liquidity tightening. Even after the most recent selloff, the bourse's trailing price-to-earnings ratio and price-to-book ratio are still at 38.4 and 4.6, respectively, much higher than for broader onshore and offshore Chinese stocks. The recent selloff in the onshore corporate bond market has also been driven by liquidity pressure, which in our view is overdone. While it's true that economic acceleration justifies higher yields, corporate spreads have also widened sharply, which is at odds with the broad growth acceleration and profit recovery. In addition, after the most recent selloff, Chinese corporate spreads are significantly higher than in most other major markets (Chart 6). In the near term, tighter liquidity may continue to induce more selling pressure in the domestic bond market. Cyclically we expect Chinese corporate bond spreads to narrow. Chart 5Diverging Market Trends Diverging Market Trends Diverging Market Trends Chart 6The Sharp Spike In Chinese Corporate ##br##Spreads Is Overdone The Sharp Spike In Chinese Corporate Spreads Is Overdone The Sharp Spike In Chinese Corporate Spreads Is Overdone Yan Wang, Senior Vice President China Investment Strategy yanw@bcaresearch.com 1 Please see China Investment Strategy Weekly Report, "Has China's Cyclical Recovery Peaked?" dated May 5, 2017, available at cis.bcaresearch.com. Cyclical Investment Stance Equity Sector Recommendations

Highlights The structural theme of overweighting technology stocks within the overall equity benchmark, and relative to other cyclical sectors such as commodities and machinery stocks, remains intact. However, in absolute terms, EM tech/semi share prices have become overbought and have already priced in a lot of good news. They will likely sell off soon due to the potential slowdown in the pace of semiconductor demand. Continue overweighting EM tech stocks, Taiwanese and Korean bourses within EM equity portfolios. We also reiterate our long-standing long tech / short materials strategy. Feature EM technology stocks have surged to all-time highs (Chart I-1, top panel), contributing significantly to the ongoing EM rally. In fact, excluding tech stocks, EM share prices have not yet surpassed a major technical hurdle, as shown in the bottom panel of Chart I-1. BCA's Emerging Markets Strategy (EMS) team has been recommending that investors overweight tech stocks since June 8, 2010. In our report titled, How To Play EM Growth In The Coming Decade,1 we contended that the structural bull market in commodities was over, and that in the coming decade (2010-2019) the winners would be health care and technology (Chart I-2). We also identified a potential mania candidate - i.e., a segment that was poised for exponential price gains. We reasoned that the fusion between technology and health care - health care equipment stocks - could experience exponential price moves. This strategy has paid off exceptionally well. Consistently, within the EM equity benchmark, we have been overweighting Taiwanese and Korean tech stocks since 2007 and 2010, respectively (Chart I-3). Chart I-1EM Tech Stocks Have ##br##Surged To All Time Highs EM Tech Stocks Have Surged To All Time Highs EM Tech Stocks Have Surged To All Time Highs Chart I-2EMS Strategy Since 2010: ##br##Long Tech / Short Materials EMS Strategy Since 2010: Long Tech / Short Materials EMS Strategy Since 2010: Long Tech / Short Materials Chart I-3Taiwanese & Korean Tech ##br##Stocks Relative To Overall EM Taiwanese & Korean Tech Stocks Relative To Overall EM Taiwanese & Korean Tech Stocks Relative To Overall EM After such enormous gains, a relevant question is whether technology share prices will continue to rally in absolute terms, boosting the EM equity benchmark, or whether their absolute performance and/or relative performance will roll over. Chart I-4EM Tech Stocks Are Overbought EM Tech Stocks Are Overbought EM Tech Stocks Are Overbought Before we proceed in laying out our analysis, a caveat is in order: we can offer thematic long-term views on various sectors, but investors should realize the investment calls on many technology, internet and social media companies are driven by bottom-up - not macro - views. From a top-down perspective, we can offer little insight on whether EM internet and social media stocks such as Alibaba, Tencent and Baidu are cheap or expensive, whether their business models are or are not proficient, or what their profit outlooks might be. The reason is that these and other global internet/social media companies' revenues are not driven by business cycle dynamics and top-down analysis is less imperative in forecasting their performance. In this report we will shed some light on the business cycle in the global/Asian semiconductor industry. The latter is subject to both business cycle swings as well as sector-specific factors. Again, sector-unique factors for the semi industry are also beyond our top-down approach. The five largest constituents of the EM MSCI tech sector are Samsung (4.3% of EM MSCI market cap), Tencent (4.0%), Taiwan Semiconductor Manufacturing Company (3.5%), Alibaba (3.0%), and Baidu (1.0%). Chart I-4 shows their share prices. In short, they have become a large part of the EM benchmark and are also extremely overbought, increasing the risk of correction. Technology's Structural Bull Market Is Intact... Even though EM tech prices have skyrocketed in both absolute and relative terms, odds are that the structural bull market has further to run. There are no structural excesses in the technology sector that would warrant a bust for now. Even in China, credit/leverage excesses are concentrated in the old industries, not among the tech and new economy segments. Demand for tech products in general and semiconductors in particular is not very dependent on the credit cycle in EM. In both developed market (DM) and EM economies, spending on many tech gadgets is contingent on income gains rather than credit growth. Our bearish view on EM/China growth is primarily due to our expectations of a credit downturn that will affect spending that is financed by credit. Investment expenditures driven by credit are much more important for commodities and industrial goods than technology products. While the share prices of technology and new economy companies are overbought and may be expensive, global/EM economic demand growth will be skewed toward new industries and technologies rather than commodities. In brief, the outlook for global tech spending remains positive, both cyclically and structurally. Having outperformed all other sectors by a large margin, the EM technology sector presently accounts for 26% of the EM MSCI benchmark, while at its previous structural peak in 2000 its market share stood at 22% (Chart I-5, top panel). During the 1999-2000 tech bubble, the U.S. and DM tech sector’s share of market cap reached 34% and 24% of the U.S. MSCI and DM MSCI benchmark market caps, respectively (Chart I-5, middle and bottom panels). Despite being stretched, it is possible that the technology sector's market cap will rise further before another structural top transpires. Hence, we are not yet ready to call the top in the tech's share of the overall market cap either in EM or DM. From a very long-term perspective (since 1960), the relative performance of the U.S. technology sector against the S&P 500 has not yet reached two standard deviations above its time trend, as it did in the year 2000 during the tech bubble. Conversely, the same measure for energy, materials and machinery stocks is not yet depressed enough to warrant a mean reversion bet (Chart I-6). Chart I-5Tech Stocks Market Cap Share ##br##Of Overall Equity Benchmarks Tech Stocks Market Cap Share Of Overall Equity Benchmarks Tech Stocks Market Cap Share Of Overall Equity Benchmarks Chart I-6Relative Performance Of ##br##U.S. Sectors Vs. S&P 500 Relative Performance Of U.S. Sectors Vs. S&P 500 Relative Performance Of U.S. Sectors Vs. S&P 500 Finally, secular leadership rotations within global equities typically occur during market downturns. Chart I-7 shows that commodities stocks and tech leadership changed in 2001 and 2008. It is possible that new sectoral leadership will emerge in global equities during the next bear market/severe selloff. However, it is too early to bet on it now. The current character of equity markets - which favors technology over commodities - will persist. Bottom Line: The structural theme of overweighting technology stocks within the overall equity benchmark and relative to other cyclical sectors such as resources/commodities and machinery stocks remains intact. ...But The Semi Cycle Upswing Is Advanced The semiconductors industry is cyclical, and as such business cycle analysis is pertinent here. The rest of the technology sector, however, is not correlated with overall business cycles. Therefore, there is little value that macro analysis can deliver on the outlook for non-semi tech areas. This is why this section is focused on semiconductors rather than the overall tech sector. There is no basis as to why semiconductor/tech cycles should correlate with commodities cycles. However, when they do, the amplitude of global business cycle fluctuations rises. Indeed, Asian exports and global trade tumbled in 2015 and have subsequently improved over the past 12 months for the following reason: the 2015 downturn and the ensuing recovery in the semiconductor cycle overlapped with similar swings in commodities and Chinese capital goods demand (Chart I-8). This has increased the amplitude of the global business cycle's swings in the past two years. Chart I-7Secular Leadership ##br##Rotation: Tech Vs. Energy Secular Leadership Rotation: Tech Vs. Energy Secular Leadership Rotation: Tech Vs. Energy Chart I-8Chinese Capital Goods Imports & ##br##Global Semiconductor Cycle Chinese Capital Goods Imports & Global Semiconductor Cycle Chinese Capital Goods Imports & Global Semiconductor Cycle We remain bearish on Chinese capital spending in general and construction in particular. This entails weaker demand for commodities and industrial goods. Yet we are not bearish on Chinese demand for semiconductors and tech devices. The semiconductor cycle has experienced a mini boom in the past 12-18 months. Demand for electronic products in the U.S. has been exceptionally strong (Chart I-9, top panel). Moreover, European production and sale of overall high-tech products as well as computer and electronic products have been robust (Chart I-9, bottom panel). In China, retail sales of communication appliances have also been extremely healthy (Chart I-10, top panel). By extension, the mainland's production of electronics has also boomed (Chart I-10, bottom panel). Chart I-9DM Demand For Tech Is Strong... DM Demand For Tech Is Strong... DM Demand For Tech Is Strong... Chart I-10...And So Is China's ...And So Is China's ...And So Is China's One soft spot for semi demand, however, could emanate from the global auto sector. U.S. auto sales have begun to contract, and auto production will likely shrink as well (Chart I-11, top panel). In addition, the growth rate of auto sales in both China and Europe may have reached a peak (Chart I-11, middle and bottom panels). Annual vehicle sales have reached 25 million units in China, and 17 million vehicles in both the U.S. and euro area. Overall global auto production is set to decelerate and this will weigh on semiconductor demand given that autos consume a lot of electronics. In addition, there are several other indications that suggest a mini-slowdown will likely transpire in the global semiconductor sector later this year: Taiwan's narrow money (M1) growth impulse has historically been correlated with the tech-heavy TSE index and has led export cycles (Chart I-12). This money impulse currently heralds a major top and relapse in both share prices and exports. Chart I-11Global Auto Production Global Auto Production Global Auto Production Chart I-12Taiwanese M1 Money Impulse Is Signaling A ##br##Growth Slowdown And Risk To Stocks Taiwanese M1 Money Impulse Is Signaling A Risk To Stocks Taiwanese M1 Money Impulse Is Signaling A Risk To Stocks The semiconductor shipments-to-inventory ratio has peaked in Korea and Taiwan (Chart I-13). This indicates that the best of the semi upswing may be behind us. Consistently, both global semiconductor producers' and semiconductor equipment stocks' forward EPS net revisions have already surged, and are elevated. This implies that a lot of earnings optimism has been priced in. Historically, when forward earning net revisions have reached these levels, global semi share prices have rolled over or entered a consolidation period (Chart I-14). Chart I-13Korea's & Taiwan's Semi ##br##Cycle Is Topping Out Korea's & Taiwan's Semi Cycle Is Topping Out Korea's & Taiwan's Semi Cycle Is Topping Out Chart I-14Semiconductors' Forward EPS ##br##Revisions Are Elevated Semiconductors' Forward EPS Revisions Are Elevated Semiconductors' Forward EPS Revisions Are Elevated Bottom Line: We expect a moderation in semi demand, but not recession. Semi share prices may react negatively to slower demand growth as the former have become extremely overbought and have already priced in a lot of good news. Investment Conclusions Semiconductor stocks have become overbought and a marginal slowdown in demand might be enough to cause a shake-out. The same is true for the overall tech sector. That said, we continue to recommend that investors overweight EM tech stocks, Taiwanese and Korean bourses within the EM equity portfolios. We also reiterate our long-standing long tech / short materials strategy. Remarkably, the KOSPI and Taiwanese TSE indexes - highly leveraged to semiconductors - have rallied to their previous highs (Chart I-15). In the past, they failed to break above these levels and we expect them to struggle again. If these equity indexes pull back and tech stocks correct, the overall EM stock index will roll over too. The rest of EM equity universe has much poorer fundamentals than tech companies. Financials and commodities sectors make 25% and 7% of the EM MSCI benchmark's market cap, respectively. The former is at risk from credit slowdown in EM and the latter is at a risk from lower commodities prices (Chart I-16). Chart I-15KOSPI & TSE Have Reached ##br##Major Resistances KOSPI & TSE Have Reached Major Resistances KOSPI & TSE Have Reached Major Resistances Chart I-16Industrial Metals ##br##Prices To Head Lower bca.ems_wr_2017_05_17_s1_c16 bca.ems_wr_2017_05_17_s1_c16 On the whole, we believe the recent divergence of EM risk assets from commodities prices and the EM/China credit cycles does not represent a structural regime shift in EM fundamentals, it rather reflects complacency in the marketplace. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com Ayman Kawtharani, Associate Editor aymank@bcaresearch.com 1 Please refer to the Emerging Markets Strategy Special Report titled, "How The Play Emerging Market Growth In The Coming Decade", dated June 8, 2010, available at ems.bcaresearch.com. Equity Recommendations Fixed-Income, Credit And Currency Recommendations

We used this year’s underperformance in the financial sector to boost positions to overweight two weeks ago. Similarly, we recommend buying capital markets equities on price weakness. This sub-index thrives when investor risk appetites are healthy and the business sector is moving from retrenchment to expansion mode, and vice versa. The outlook for increased capital formation has improved considerably. The corporate sector financing gap is beginning to widen anew, reflecting the surge in business and consumer confidence since the pro-business U.S. Administration took power. The widening financing gap is particularly notable because it is occurring alongside improving profit growth. In other words, the wider financing gap reflects accelerating capex, not weak corporate cash flows. This is confirmed by BCA’s Capital Spending Indicator. BCA’s loan growth model also signals that demand for external capital should accelerate. With M&A activity starting to reaccelerate, capital markets return on equity is poised to climb further. We recommend shifting to a high-conviction overweight position. Please see yesterday’s Weekly Report for more details. The ticker symbols for the stocks in this index are BLBG: S5INBK - GS, MS, SCHW, RJF, ETFC. Capital Markets Shares Are Ready To Resume Their Rally Capital Markets Shares Are Ready To Resume Their Rally

Media shares have been under pressure of late, as a flare up in cord cutting worries and related concerns about TV ad spending. While these structural headwinds will likely remain intact for the foreseeable future, cheap valuations amidst positive cyclical signs suggest that a contrarily positive stance will be rewarded. In aggregate, demand for media services is brisk. Consumer outlays on media have soared to a two decade high, hitting a double digit annual growth rate. S&P media sales are tightly correlated with media spending (second panel). Importantly, buoyant demand is boosting industry productivity gains (third panel). Importantly, our Ad Spending Indicator, which incorporates key indicators of media demand, consumption and overall corporate profits, has hooked up, signaling that signaling that the path of least resistance for earnings estimates is up (bottom panel). Consequently, we recommend sticking with an overweight bias, please see yesterday’s Weekly Report for more details and analysis of the two major media sub-groups, movies & entertainment and cable & satellite. The ticker symbols for the stocks in these two indexes are BLBG: DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. Media Shares Are Too Cheap To Ignore Media Shares Are Too Cheap To Ignore

Highlights Portfolio Strategy Upgrade capital markets stocks to overweight and put them on the high-conviction list. Capital formation is poised to accelerate in the second half of the year. Our Indicators suggest that demand for media services will continue to improve. Stay overweight both the movies and entertainment and cable and satellite indexes. Recent Changes S&P Investment Banking & Brokerage - Upgrade to overweight and add to the high-conviction overweight list. S&P Consumer Finance - Remove from the high-conviction overweight list. Table 1Sector Performance Returns (%) Falling Correlations Falling Correlations Feature The S&P 500 continues to churn near its highs. Following a robust earnings season, the onus is now on the economy to provide confidence that the corporate profit recovery will prove durable, thereby justifying thinning equity risk premia. While slumping commodity prices suggest that global end-demand has downshifted a notch, the former boost real purchasing power and provide a reflationary support for stocks, particularly since resource-dependent sectors do not have a market leadership role. In fact, financial conditions remain sufficiently accommodative to expect a growth reacceleration in the back half of the year. It is notable that the recent selloff in the Treasury market has been driven by the real component, while inflation expectations have moved sideways. As a result, there is little pressure on the Fed to normalize at a faster pace than currently discounted in the forward curve. Thus, we expect the window for additional equity price appreciation to remain open this summer, unless growth reaccelerates sufficiently to stir inflation fears. Nevertheless, selectivity will become even more critical. Cross asset correlations have collapsed. Diminishing global macro tail risks have reduced the dominance of the beta-oriented "risk on/risk off" trade as a source of return. Empirical evidence suggests that asset correlations and the broad equity market are inversely correlated. This message is corroborated by falling correlations between regional stock market returns. Receding equity index correlations have been associated with positive S&P 500 returns (middle panel, Chart 1). This inverse correlation is also mirrored in the CBOE's implied correlation index, which tracks the correlation of the S&P 500 stocks with one another: tumbling correlations imply solid overall equity returns (top panel, Chart 1). These relationships are intuitive. Diminished macro tail risks bring earnings fundamentals to the forefront as the key driver of returns, and reward differentiation and discrimination in sector/region/asset class selection. While an eerie calm has dominated markets of late, as our Asset Class Volatility Indicator has collapsed to a multi-decade low (bottom panel, Chart 1), a more bullish explanation is that all-time highs in equities are synonymous with all-time lows in the VIX. This can be viewed as a contrary warning sign, but history shows that the VIX can stay depressed for a prolonged period. Our Equity Market Internal Dynamics Indicator (EMIDI), first introduced in late-March, has tentatively troughed, suggesting that sub-surface dynamics are becoming more supportive of the broad market (Chart 2). The EMIDI, which comprises relative bank, relative transport, small/large and industrials/utilities share prices, has been coincident to the leading market indicator, especially since the GFC. Chart 1Tumbling Correlations = Rising Stock Returns Tumbling Correlations = Rising Stock Returns Tumbling Correlations = Rising Stock Returns Chart 2Sub-Surface Dynamics Have Turned The Corner Sub-Surface Dynamics Have Turned The Corner Sub-Surface Dynamics Have Turned The Corner In that light, this week we are further augmenting our cyclical portfolio exposure by lifting another interest rate-sensitive group to overweight and are also updating the early cyclical media index and its major components. Capital Markets Stocks Have Rally Potential Two weeks ago, we recommended using this year's financial sector underperformance to boost allocations to overweight. This week we are further augmenting our exposure by upgrading the S&P investment banks & brokerage index to above benchmark. While the equity bull market is in the later innings, our view is that the overshoot will be extended for a while longer as a consequence of the overall sales and profit recovery and low probability that monetary conditions will tighten meaningfully in the near run. If this plays out, there is an opportunity for capital markets stocks to recover from their recent consolidation. This sub-index thrives when investor risk appetites are healthy and the business sector is moving from retrenchment to expansion mode, and vice versa. The outlook for increased capital formation has improved considerably. The corporate sector financing gap is beginning to widen anew (Chart 3), reflecting the surge in business and consumer confidence since the pro-business U.S. Administration took power. The widening financing gap is particularly notable because it is occurring alongside improving profit growth. In other words, the wider financing gap reflects accelerating capex demand, not weak corporate cash flows. This is confirmed by BCA's Capital Spending Indicator, which signals an increase in business investment ahead. Consequently, corporate sector demand for external capital should accelerate. The latter is the lifeblood of capital markets profitability. The nascent recovery in total bank credit growth after a period of malaise reinforces that working capital requirements are on the upswing (Chart 3).1 As businesses shift from maintenance capital spending to a more expansionist mindset, and companies reach further for growth to justify high stock valuations, capital markets activity could accelerate in the second half of the year. After all, investor confidence is high. Corporate bond spreads have tightened and corporate bond issuance is soaring. The Equity Risk Premium is steadily narrowing (shown inverted, second panel, Chart 4), reducing the cost of equity capital. New stock issuance is following on the heels of corporate bond issuance. Stocks are outperforming bonds by a comfortable margin and total mutual fund assets have grown sharply (Chart 3). The upshot is that access to corporate sector capital should stay healthy. As flows into equities advance, it will fuel a reacceleration in M&A activity (Chart 5). Chart 3Capital Markets Activity Is... Capital Markets Activity Is... Capital Markets Activity Is... Chart 4...Firing On All Cylinders ...Firing On All Cylinders ...Firing On All Cylinders Chart 5ROE On The Upswing ROE On The Upswing ROE On The Upswing Capital markets return on equity (ROE) is highly levered to business and investor risk appetite. Fees earned on M&A activity heavily influence overall profitability. As such, it is normal for ROE to expand when M&A activity picks up, and shrink when financial conditions tighten and takeovers dry up. Currently, M&A transactions represent an historically elevated share of GDP, but that is not a barrier to an increased rate of takeover activity. Companies are no longer using their balance sheets to repurchase their own shares en masse. Instead, there is an incentive to pursue business combinations as the global economy reaccelerates, underscoring that capital allocation should shift in favor of capital markets firms. Indeed, Chart 5 shows that ROE also follows the trend in our global leading economic indicator, and the current message is bullish. Even capital markets companies themselves confirm that their pipelines are full. Hiring activity remains robust. Pro-cyclical firm headcount rises quickly alongside revenue opportunities, and is just as quick to shrink when the outlook darkens. Ergo, we interpret headcount growth as a net positive. While trading activity is always a wildcard, and could be a source of weakness if bond market, and generalized asset class, volatility stays muted, the upbeat outlook for fee generation from increased capital formation provides us with confidence to use share price weakness as an opportunity to build a bigger position. Bottom Line: Lift the S&P investment banking & brokerage index to overweight, adding to our recent decision to upgrade the overall financials sector to above-benchmark. The ticker symbols for the stocks in this index are BLBG: S5INBK - GS, MS, SCHW, RJF, ETFC. Media Stocks: Temporary Pressure Media stocks have come under pressure recently, giving back all of this year's relative gains. Investor worries have centered around two thorny issues: cord-cutting and ad spending. Cord-cutting is not new, but weak overall Q1 TV subscriber numbers have refocused investors' attention on the secular challenges ahead. In addition, a number of companies noted softening ad spending on Q1 conference calls. According to media executives, this slowdown is not isolated to the automotive segment. Is it time to pull the plug or is a worst case scenario already priced into the group? We side with the latter. In aggregate, demand for media services is brisk. Consumer outlays on media have soared to a two decade high, hitting a double digit annual growth rate. S&P media sales are tightly correlated with media spending (second panel, Chart 6). Despite coming off the boil recently after hitting unusually high growth rates, media pricing power also remains in expansionary territory. Importantly, buoyant demand is boosting industry productivity gains. The third panel of Chart 6 shows that our media productivity proxy has reaccelerated. Meanwhile, an improving economic backdrop also bodes well for media earnings prospects. The ISM services new orders sub component has been an excellent leading indicator of relative profit growth expectations and the current message is positive (middle panel, Chart 7). If the overall economy bounces smartly from the weak Q1 print, as we expect, then an earnings-led recovery should sustain the valuation re-rating phase (bottom panel, Chart 7). Chart 6Buoyant Media Demand Buoyant Media Demand Buoyant Media Demand Chart 7Valuation Re-Rating Looms Valuation Re-Rating Looms Valuation Re-Rating Looms Our Ad Spending Indictor (ASI) incorporates all of these key media profit drivers, including consumption and overall corporate profits. The ASI has recently hooked up, signaling that earnings estimates should continue to rise (bottom panel, Chart 8). Nevertheless, sub-media group returns have been bifurcated, with the S&P movies and entertainment index exerting downward pressure on the overall sector of late. Relative performance has mostly treaded water since our upgrade last summer, but hit a soft patch after recent quarterly results. Before rushing to make a bearish judgment, it is notable that the relative forward P/E remains close to an undervalued extreme, signaling that it will be increasingly difficult to disappoint. Historically cheap valuations exist despite depressed expectations, which should serve to artificially inflate valuations: both top and bottom line are expected to lag the broad market, representing a very low hurdle (Chart 9). Chart 8Rosier EPS Prospects Lie Ahead Rosier EPS Prospects Lie Ahead Rosier EPS Prospects Lie Ahead Chart 9Unloved And Undervalued Unloved And Undervalued Unloved And Undervalued Beyond the positive consumer spending backdrop (Chart 10), we are inclined to stick with overweight positions in this sub-component for four major reasons. First, merger and acquisition activity should reduce capacity, and by extension, support pricing power, especially if the AT&T/Time Warner deal clears the regulatory hurdle. There is scope for additional M&A that could further reduce shares outstanding (Chart 11). Chart 10Improving Demand... Improving Demand... Improving Demand... Chart 11...And M&A Activity Are An EPS Tonic ...And M&A Activity Are An EPS Tonic ...And M&A Activity Are An EPS Tonic Second, content providers are adapting to the competitive threat. New online-only offerings and slimmer/nimbler packages should stem the drag from the likes of Netflix and other streaming services. Consumer spending on electronics continues to surge, suggesting that content providers have ample opportunity to fill increasing demand. Third, there is no substitute for live TV. News and live sports are two sticky offerings that will continue to be cash cows for the industry and drive select subscriber growth. Fourth, media giants have stepped up focus on other segments with higher growth potential, such as studios and franchises highlighting increasingly diversified revenue streams. Moreover, CEOs have been aligning cost structures to the new realities of cord-cutting, exercising strict cost control. Companies have also been careful with capex allocation decisions. All of this suggests that any shakeout in this media subgroup is a good entry point for building new positions with a compelling valuation starting point. Unlike the S&P movies and entertainment index, the S&P cable and satellite group has been relentlessly grinding higher, underpinning the broad media index. The multiyear share price advance has been cash flow driven. As a consequence, cable stocks still trade at a 25% discount to the broad market on a price/cash flow basis and the relative multiple is hovering near the historical mean (third panel, Chart 12). Cable and satellite sales growth has surged to healthy low double-digit growth rates after a one year lull. Encouragingly, soaring pricing power signals that recent revenue momentum is sustainable (second panel, Chart 12). As mentioned above, consumer outlays on cable services have had a V-shaped recovery, underscoring that the latest upleg in selling prices is demand driven (bottom panel, Chart 12). It is remarkable that the industry has consistently raised selling prices at a faster pace than overall inflation for decades (Chart 13). This impressive track record reflects cable operators' ability to continually evolve offerings and provide attractive content, even in the face of cord-cutting. Chart 12Cash Flow Driven Outperformance Cash Flow Driven Outperformance Cash Flow Driven Outperformance Chart 13The Cable Signal Is As Strong As Ever The Cable Signal Is As Strong As Ever The Cable Signal Is As Strong As Ever Meanwhile, content inflation rates have remained within the range of the past few years, underscoring that threats to robust profit margins are limited (bottom panel, Chart 13). More recently, news that Comcast and Charter will come together and cooperate on a wireless offering adds another layer of defense in effectively combating cord-cutting. How? By increasing the bundle offering beyond cable and internet services, cable providers are positioned to attract new clients by offering a one stop shop triple-play solution. A move into wireless service offerings would also assist in retaining existing customers. In sum, most of our indicators suggest that the demand outlook for media services continues to improve. Our Ad Spending Indicator is climbing, underscoring that fears of a deep and widespread slump are overblown. Bottom Line: The media index remains an overweight and we continue to recommend an above benchmark exposure both in the S&P movies and entertainment and S&P cable and satellite sub-groups. The ticker symbols for the stocks in these two indexes are BLBG: S5MOVI - DIS, TWX, FOXA, FOX, VIAB and BLBG: S5CBST - CMCSA, CHTR, DISH, respectively. 1 Please see BCA U.S. Bond Strategy Weekly Report, "The Payback Period In Corporate Bonds," dated April 11, 2017, available at usbs.bcaresearch.com. Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

Telecom services shares have been crushed this year, down by over 10% in absolute terms and 17% relative to the broad market. The collapse in relative performance has been entirely earnings driven. While every sector's EPS and sales-per-share metrics grew year-over-year in Q1, telecom services was the sole GICS1 sector that contracted on both fronts. That abysmal showing is a consequence of the aggressive price war that has engulfed the industry. Telecom carriers are at each other's throats, protecting their customer base. To make matters worse, competition appears to have intensified: wireless telecom selling prices have collapsed on a 3-, 6- and 12-month rate of change basis (bottom panel). Worrisomely, recent news from the cable industry that Comcast and Charter would come together and offer wireless services signals that intra- and inter-industry price competition to preserve customers and to win new ones over will remain intact. Under such a backdrop, it is still prudent to avoid telecom services stocks. Telecom Services: Hold The Line Please Telecom Services: Hold The Line Please

Dear Client, I am on the road this week meeting clients. Instead of our regular Weekly Report, we are sending you a piece written by my colleague Brian Piccioni, head of our Technology Sector Strategy Service. In this Special Report Brian discusses how the limitations of Bitcoin and other cryptocurrencies make them extremely speculative investments. Furthermore he discusses the possibilities of blockchain technology for the financial service industry going forward. Best regards, Mathieu Savary, Vice President Foreign Exchange Strategy Feature Summary Modern cryptocurrencies (virtual currencies based on cryptographic methods) originated with the introduction of blockchain technology and the simultaneous launch of Bitcoin. As we noted in our February 9, 2016 Special Report "Bitcoin and Blockchain Technology": Bitcoin has numerous deficiencies which expose its users to fraud; Governments are concerned with use of cryptocurrencies for money laundering, tax evasion, and other criminal activities; The market for Bitcoin is unregulated, liquidity is low, and there is good reason to be suspicious of market quotes for the currency; It is unlikely any virtual currency will become a form of legal tender absent government oversight; and Any investment in Bitcoin related activities should be viewed as highly speculative. In contrast, blockchain technology associated with Bitcoin: Can be applied by the financial services industry to reduce fraud and improve transaction times; Can reduce overhead associated with maintaining a trusted intermediary; Blockchain-related technologies are open and it is hard to imagine that any derivative technology would not be. Therefore, any unusual returns associated with knowledge of the mathematics or applications of blockchain are likely to be transient in nature. The technology itself, however, may lead to significant improvements in the velocity and security of certain types of transactions. Recent Developments Japan Legalizes Cryptocurrencies While we stand by our original analysis, it appears that Japan has allowed the use of virtual currencies effective April 1, 2017, albeit with significant oversight. Requirements include minimum capital levels and annual audits for exchanges. It is unclear to us why the Japanese government saw fit to introduce these changes, and it remains to be seen whether such oversight will be effective. Introduction Of Blockchain As Service Microsoft,1 IBM,2 and Deloitte3 have introduced blockchain services which should facilitate adoption by their traditional clients. We refer readers to the footnotes to explore the quickly changing nature of these firms' offering and we expect that other firms offering software and IT consulting for large enterprise clients will likely also introduce blockchain-related products. Although purists might observe that a centralized approach to blockchain removes the benefits of a distributed leger (see below), it also allows for the correction of many of blockchain's deficiencies (namely anonymity and irreversible transactions). This would make it more applicable in a regulated environment, assuming the implementation incorporates safeguards equivalent to a distributed ledger. Bitcoin Hype Appears To Be Subsiding While Enterprise Interest Is Growing Although we still see some coverage of the day-to-day moves in Bitcoin pricing, we get the sense that hype over cryptocurrencies is subsiding. Online discussions regarding speculating in cryptocurrencies appear to be less excited and neo-Libertarians appear to have moved on. Meanwhile, it seems that financial institutions are taking blockchain technology more seriously, and a large majority of financial services firms expect to deploy blockchain-related technologies over the next few years,4, 5 though some are more cautious on timing.6 Virtual Currencies And Bitcoin According to the ECB, a virtual currency: "... is defined as a digital representation of value, not issued by a central bank, credit institution or e-money institution, which in some circumstances can be used as an alternative to money"7 The IMF has produced Figure 1 which explains the differences between virtual, digital, and cryptocurrencies. Bitcoin was described in a 2008 paper "Bitcoin: A Peer-to-Peer Electronic Cash System".8 The paper outlines a technique (see Figure 2) which does away with the need for a trusted intermediary in executing secure transactions through the use of public key encryption and timestamps. Figure 1Overview Of Virtual Currencies Blockchain And Cryptocurrencies Blockchain And Cryptocurrencies Figure 2Simplified Diagram Of Bitcoin And Blockchain Function Blockchain And Cryptocurrencies Blockchain And Cryptocurrencies Blockchain technology, on which Bitcoin relies, provides: Anonymity of source and destination (neither buyer nor seller need to know each other); Irreversibility, such that no transaction can be reversed without the consent of the parties; and Security, subject to certain limitations, through redundancy and a peer to peer network. The mathematics of blockchain technology creates a verifiable distributed ledger among many computers on a peer to peer network. Because there is no central ledger, costs with maintaining it, arbitrating disputes and compensating for fraudulent transfers are all eliminated. A distributed ledger also means an asset can exist in only one place: there is no chance of embezzlement where an asset is purportedly on one set of books while actually being somewhere else. Bitcoin and blockchain technologies are not synonymous: there are an unlimited number of virtual currencies which can be produced using blockchain-like technologies and blockchain technology can be used to in non-currency applications. Limitations Of Cryptocurrencies Cryptocurrencies present a challenge for governments as anti-money laundering regulations typically require enforcement and monitoring by trusted third parties to report suspicious transactions to authorities. A secure anonymous transaction system such as Bitcoin provides a ready workaround for money laundering and tax evasion, characteristics quickly embraced by the underworld. A complete analysis of the challenges posed by virtual currencies in general and cryptocurrencies in particular can be found in the IMF Staff Discussion Note "Virtual Currencies and Beyond: Initial Considerations".9 Where Theft Isn't Quite Illegal There are three ways to obtain Bitcoin: Exchange "real" money for Bitcoin via an online virtual currency exchange; Exchange good or services for Bitcoin; or "Mine" them using a computer to solve the cryptographic problems. Typically there are more consumers than sellers (i.e. more drug users than drug dealers), so most users convert money to and from Bitcoin via exchanges. Mining still goes on but as the cryptographic hashes become more difficult to solve, and the computing resources and electricity now needed to "mine" Bitcoin require a significant investment.10 Transaction Costs Are Not Insignificant Although blockchain removes the need for a trusted intermediary, introduction of an exchange creates an intermediary. A staggering number of Bitcoin exchanges have been "hacked", most likely by the operators themselves. Lack of regulatory oversight and the anonymous nature of the transactions, including theft, mean that such hacks are rarely solved and victims do not get their Bitcoin back even when they are. It is not clear whether theft of a virtual currency is, in fact, illegal: the question of whether theft of virtual property is theft is a subject of debate,11, 12 suggesting there is no clear answer. Even courts treat the matter differently when there is no issue of criminality besides the alleged theft.13, 14 Besides the money lost to users from fraud, high exchange rates associated with converting Bitcoin to and from "real" currency further add to costs, suggesting that for many users untraceable transactions is more important than transaction costs. Cryptocurrency Can Be Irrevocably Destroyed Or Lost One other feature of Bitcoin which presents a challenge is that it requires a private key or password to transfer it. This means that one can imagine a scenario where an embezzler steals money from a business and immediately converts it into Bitcoin. If caught the embezzler might threaten to destroy the private key, and therefore the money is lost forever. Similarly, the heirs of someone who placed his trust in Bitcoin rather than a bank may discover their inheritance is lost forever unless care was taken to ensure the private key is accessible to the estate after death.15 These issues might arise with any asset secured by a blockchain system unless there are built in safeguards against it. Illiquidity And Unregulated Markets Virtual currency markets have two important characteristics: they are extremely illiquid and unregulated making market manipulation relatively straightforward. Bitcoin, currently has a market cap of about $30B16 but has average daily volume in the range of about 3.4% of the market cap. Note that since transaction costs (though not the exchange rates) associated with Bitcoin are small and optional,17 and since the market is unregulated and anonymous, there is nothing to prevent individuals from wash trading or other forms of market manipulation.18 Chinese Yuan trading volume has rapidly increased since 2013, and up until January 2017 accounted for the overwhelming majority of Bitcoin trading (Chart 1). Although other factors may have influenced the rise in Chinese bitcoin trading, zero-fee trade structures (which lead to wash trading) contributed as well. Chinese Bitcoin trading volume collapsed in January 2017, after exchanges began charging trading fees, likely due to regulatory pressure from the government.19 This had a dramatic impact on the volume of Bitcoins traded globally (Chart 2), although the price has stayed high, indicating that marginal demand from Bitcoin bulls remains high enough to keep them in charge of this market for now. As has happened before in 2013, prices will likely drop once these bulls capitulate. Chart 1Bitcoin Trading Volume* Breakdown##br## (Top 3 Currencies) Blockchain And Cryptocurrencies Blockchain And Cryptocurrencies Chart 2Bitcoin Trading Volumes Collapsed ##br##After Chinese Exchanges Introduced Transaction Fees Bitcoin Trading Volumes Collapsed After Chinese Exchanges Introduced Transaction Fees Bitcoin Trading Volumes Collapsed After Chinese Exchanges Introduced Transaction Fees Unregulated financial systems devolve to fraud, and there is no reason to believe a market dominated by unsophisticated, anonymous, participants trading an intangible asset with uncertain liquidity where fraud or theft is not necessarily illegal is, in any way, an efficient market. Sadly, even mainstream media appear to ignore these realities when covering Bitcoin and related price moves. Distributed Legers And Their Application One of the most significant innovations associated with cryptocurrencies is the concept of a secure, distributed ledger (Figure 3, left panel) in lieu of a centralized ledger maintained by a trusted authority such as a bank or brokerage (Figure 3, right panel). Although the application of distributed ledgers has been with cryptocurrencies, there are many potential applications in traditional financial markets since assets such as stocks and bonds are held by a dealer while ownership can change frequently. Adoption of a distributed ledger system can20 and has been used to "facilitate the issuance, cataloging and recording of transfers of shares of privately-held companies on The NASDAQ Private Market". According to NASDAQ, "Blockchain technology has the potential to assist in expediting trade clearing and settlement from the current equity market standards of three days to as little as ten minutes".21 Aspects of Bitcoin which permit its criminal use are not inherent characteristics of blockchain, or distributed ledger technologies in general. The technology will almost certainly be improved in order to eliminate those problems by incorporating an audit trail (to reduce its use for tax evasion or money laundering), reversibility (to allow for the reversal of trading errors), and so on. Figure 3 Blockchain And Cryptocurrencies Blockchain And Cryptocurrencies Investment Summary And Implications For Currency Markets The long term investment impact of Bitcoin will likely be insignificant as exchanges and mining operations disappear into the dark net (i.e. the part of the Internet used by criminals). Investors should consider a position in Bitcoin, whether the currency or related services such as exchanges or mining, to be highly speculative. Blockchain Technology Is Open To Anyone The profusion of cryptocurrencies shows that blockchain technology can be adapted by anyone with the requisite understanding the mathematics involved. Time and again we find investor interest in certain emerging technologies rapidly dissipates once expertise becomes commonplace, regardless of the broader impact on society. We suspect a similar thing will happen with blockchain technology namely that it will become broadly used in a number of applications, however, besides the few companies which are acquired, few will become significant or profitable and most such acquisitions will be written down not long after they are consummated. Blockchain Technology Will Be Broadly Adopted Blockchain technology has broad implications for the financial services industry as a mechanism to reduce costs and transaction times. These are all unequivocal positives for the industry and society in general, but can be construed as deflationary and not conducive to sustainable profit gains. What Does This All Mean For Currency Investors? The progress in blockchain-related technology is a promising development for the future ease of transaction processing. However, due to the limitation embedded in Bitcoin and other cryptocurrencies, fiat currencies are not yet at risk. For the time being, BTC and co. are still very speculative and volatile instruments that do not qualify as stores of value. In fact, the concerns of global governments with the use of cryptocurrencies for illicit purposes, as well as all the security risks still associated with their ownership, continue to be handicaps. This suggests that when it comes to the need for safety, these cryptocurrencies are not yet alternatives to the dollar, Swiss franc, and government bonds issued by the German and U.S. governments. Instead, gold and precious metals should remain the vehicle of choice for investors concerned with safety and the debasing of fiat currencies that may result from the large debt loads of the advanced economies' governments. As a result, we continue to think of these crypto currencies as high beta plays on the dollar and Chinese capital flows. Since BCA's view is that the dollar bull market is about to resume in full force, this implies that investors should fade the recent BTC rally. Moreover, the capital controls put in place by the Chinese authorities are working, and China is raising the cost of transacting in BTC. With BTC now expensive, and expected returns fading, this combination is likely to prove poisonous for Bitcoin. Another big selloff is thus likely. Final Thoughts A significant barrier to entry in technology markets is Intellectual Property (IP). Blockchain is an open technology, though is likely that extensions to blockchain could be made which the inventors hope will remain proprietary. However, there are several barriers to this happening: Any blockchain system is based on mathematics, and it is not clear when mathematics can be patented22, 23 Distributed ledgers work best when there are many users; and Any blockchain system would have to be open and understood to be trusted. Brian Piccioni, Vice President Technology Sector Strategy brianp@bcaresearch.com Mathieu Savary, Vice President Foreign Exchange Strategy mathieu@bcaresearch.com Paul Kantorovich, Research Analyst paulk@bcaresearch.com 1 https://azure.microsoft.com/en-ca/solutions/blockchain/ 2 https://www.ibm.com/blockchain/ 3 http://rubixbydeloitte.com/ 4 http://www.bain.com/publications/articles/blockchain-in-financial-markets-how-to-gain-an-edge.aspx 5 https://www.ethnews.com/deutsche-bundesbank-optimistic-about-blockchain-for-financial-markets 6 https://www.fnlondon.com/articles/blockchain-for-finance-is-10-years-away-20170410 7 https://www.ecb.europa.eu/pub/pdf/other/virtualcurrencyschemesen.pdf 8 https://bitcoin.org/bitcoin.pdf 9 http://www.imf.org/external/pubs/ft/sdn/2016/sdn1603.pdf 10 http://motherboard.vice.com/read/bitcoin-is-unsustainable 11 www.nzlii.org/nz/journals/CanterLawRw/2011/21.pdf 12 https://virtualcrimlaw.wordpress.com/2013/11/03/alls-fair-in-love-and-wow-virtual-theft-may-elude-real-life-prosecution/ 13 http://www.dailymail.co.uk/news/article-2328922/Teenager-dragged-court-giving-away-friends-VIRTUAL-gold-coins-online-fantasy-game.html 14 http://www.virtualpolicy.net/runescape-theft-dutch-supreme-court-decision.html 15 http://www.dailydot.com/business/what-happens-bitcoin-when-you-die/ 16 http://coinmarketcap.com/ 17 https://en.bitcoin.it/wiki/Transaction_fees 18 http://cointelegraph.com/news/115382/bitcoin-price-analysis-wash-trading-and-rising-volume 19 http://www.coindesk.com/chinas-big-three-bitcoin-exchanges-end-no-fee-policy/ 20 http://ir.nasdaq.com/releasedetail.cfm?releaseid=938667 21 http://ir.nasdaq.com/releasedetail.cfm?ReleaseID=948326 22 http://techcrunch.com/2013/03/28/judge-says-mathematical-algorithms-cant-be-patented-dismisses-uniloc-claim-against-rackspace/ 23 http://www.supremecourt.gov/opinions/13pdf/13-298_7lh8.pdf Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights ECB policy is set to become less dovish relative to other central banks. Stay long the euro; stay underweight German bunds within a global bond portfolio; and overweight euro area Financials within a global Financials portfolio. Female labour participation is surging. The state of the euro area labour market is not nearly as bad as many pessimists would have you believe. Play the mega-trend of rising female labour participation with a structural overweight in the Personal Products sector. Allowing for euro break-up risk, European equities are fairly valued - rather than cheap - versus U.S. equities. Prefer to gain exposure via a 50:50 combination of Germany (DAX) and Sweden (OMX). Feature "Domestic sources of risk to euro area growth have diminished while global, geo-global sources of risk have increased." - Mario Draghi The Cleanest Dirty Shirt Since the end of 2014, an unspectacular 1.9% growth rate1 has been enough to make the euro area the world's top-performing major economy - bettering the U.S., U.K. and Japan (Chart I-2). Chart of the WeekThe Percentage Of The French Population In Employment Is At An All-Time High The Percentage Of The French Population In Employment Is At An All-Time High The Percentage Of The French Population In Employment Is At An All-Time High Chart I-2The Euro Area Is The Top-Performing Economy The Euro Area Is The Top-Performing Economy The Euro Area Is The Top-Performing Economy The euro area economy has achieved this outperformance with exceptionally low volatility. For eight consecutive quarters, growth2 has remained within a very tight 1.2-2.2% band, less than half of the equivalent volatility in the U.S., U.K. and Japan. And growth is now "solid and broad", meaning that it includes all countries. The ECB's dispersion index of value-added growth in different countries stands at a historical minimum. We expect the euro area to remain the cleanest dirty shirt. As Draghi points out, the ECB is less worried about domestic risks and more worried about global risks. Specifically: "Markets are in the course of reassessment of U.S. fiscal policy" - Trumponomics will not be nearly as stimulative as first thought. "How the U.K. economy does post-Brexit has a channel of economic consequences for the euro area." "Possible negative surprises in some emerging market economies" - notably China. If any of the global risks do flare up, the ECB will sit pat, but other central banks will have to become more dovish relative to current expectations. If the risks do not flare up, the ECB will start to reduce its own extreme dovishness - at least with words, if not actions. Either way, ECB policy is set to become less dovish relative to other central banks. And the investment implications are: stay long the euro; stay underweight German bunds within a global bond portfolio; and overweight euro area Financials within a global Financials portfolio. Female Labour Participation Is Surging Chart I-3Rising Participation Boosts Employment Rising Participation Boosts Employment Rising Participation Boosts Employment As Emanuel Macron prepares to become the twenty fifth President of the French Republic, he can take heart from a statistic which may surprise you: The percentage of the French population in employment has never been this high. (Chart of the Week). How can this be when the French unemployment rate is still hovering around 10%? The answer is: as millions of formerly inactive French citizens have entered the labour market, it has lifted the percentage of the population with jobs to an all-time high (Chart I-3). But the flip side of rising participation is that it has kept the unemployment rate elevated - because some citizens who were formerly 'uncounted inactive' are now 'counted unemployed'. Remember that to count as unemployed, a person has to be in the labour market available for work. Some argue that French citizens have simply flooded into the labour market to claim generous and long-lasting unemployment benefits. This argument might hold during downturns, but it cannot explain the 25-year uptrend which also includes economic booms. Unpalatable as it might be to the pessimists, we are left with a more optimistic explanation. France has raised activity levels in the working age population with policies that encourage much greater female participation in the labour market. The important lesson is that when labour participation is rising or falling, we must interpret the headline unemployment rate with extreme care.3 If a country's unemployment rate is high because labour participation has increased - as in France - the labour market is not quite as bad as the high unemployment rate might suggest.4 Conversely, if a country's unemployment rate is low because labour participation has decreased - as in the U.S. (Chart I-4) - the labour market is not quite as good as the low unemployment rate might suggest. Counted unemployment has just been replaced with uncounted inactivity. We propose that the percentage of the working age population in employment is the truer measure of labour utilisation. With surging female participation boosting employment in France and most other European countries (Chart I-5), the state of the euro area labour market is not nearly as bad as many pessimists would have you believe. Chart I-4Participation Down In The U.S.,##br## But Up In Europe... Participation Down In The U.S., But Up In Europe... Participation Down In The U.S., But Up In Europe... Chart I-5...Led By ##br##Women ...Led By Women ...Led By Women Play the mega-trend of rising female labour participation with a structural overweight in the Personal Products sector. Political Risk Is Correctly Priced Many people saw the Brexit and Trump victories as the leading edge of a wave of economic nationalism. However, subsequent election results in the Netherlands, Austria, Finland, Bulgaria and now France have seen economic nationalists consistently underperforming their expectations. In hindsight, the Brexit and Trump victories were idiosyncratic. Both the Remain and Clinton campaigns were lacking in personality or a strong emotional message, and this proved to be their undoing. Nowadays, many voters care about personalities more than policies; emotional appeal matters more than rational appeal. Behavioural psychologist and Nobel Laureate Daniel Kahneman calls the emotional way of thinking "System 1", and the colder rational way of thinking "System 2". Crucially, in a tight contest, both the Brexit and Trump campaigns resonated with the emotional System 1 with passionate pleas such as "Take Back Control" and "Make America Great Again". By contrast, the Remain and Clinton campaigns tried to appeal mainly to the rational System 2. But as Kahneman explains, when rational System 2 competes with emotional System 1, emotional System 1 almost always wins. Chart I-6Euro Break-Up Probability = 5% A Year Euro Break-Up Probability = 5% A Year Euro Break-Up Probability = 5% A Year In more recent elections, candidates and parties opposing the nationalists - including Emanuel Macron - have used a good balance of System 1 and System 2 arguments, thereby helping to prevent shock outcomes. This is also likely to be case in the two round French legislative elections on June 11 and 18 which we do not expect to impact financial markets significantly. Does this mean that political risk is over in Europe? No. Until the euro area turns into a permanent and irreversible political union, there has to be a probability of euro break-up. To value euro area assets, investors must ask: what is this break-up probability? The sovereign bond market says it is 5% a year (Chart I-6). This shows up in a discount on German bund yields, because after a euro break-up a new deutschmark would rise; and a symmetrical premium on Italian BTP yields, because a new lira would fall. For the aggregate euro area bond, the risk largely cancels out because intra-euro currency redenomination would be zero sum. But European equities must trade at a discount for this tail-event. At the peak of the euro debt crisis in 2011, the Eurostoxx600 underperformed the S&P500 by 25% in one year. In an outright break-up, the underperformance would almost certainly be worse, let's conservatively say 30-40%. So assuming the tail-event probability is 5% a year, European equities must compensate with a valuation discount which allows a 1.5-2.0%5 excess annual return over U.S. equities. Today, the valuation discount on European equities relative to U.S. equities implies an excess annual return of 1.8%.6 This makes European equities cheap versus U.S. equities only if the annual probability of euro break-up is less than 5%. Our assessment is that a 5% annual risk is about right. Therefore, European equities are fairly valued - rather than cheap - versus U.S. equities. But to avoid the undesirable sector skews in the Eurostoxx600, a much better way to gain long-term exposure to European equities is via a 50:50 combination of Germany (DAX) and Sweden (OMX) (Chart I-7). Chart I-7Prefer A DAX/OMX Combo To The Eurostoxx50 Or Eurstoxx600 Prefer A DAX/OMX Combo To The Eurostoxx50 Or Eurstoxx600 Prefer A DAX/OMX Combo To The Eurostoxx50 Or Eurstoxx600 Dhaval Joshi, Senior Vice President European Investment Strategy dhaval@bcaresearch.com 1 At an annualized rate. 2 At an annualized rate. 3 Geek's note: the unemployment rate can be expressed as: 100*(participation rate - employment to population rate) / (participation rate). Hence, all else being equal, a rising participation rate will raise the unemployment rate and a falling participation rate will depress the unemployment rate. 4 This lesson applies equally to any studies of labour market slack such as this one: https://www.ecb.europa.eu/pub/pdf/other/ebbox201703_03.en.pdf that do not take into account the dynamics of participation rates. 5 5% multiplied by 30-40% equals 1.5-2.0% 6 Through the next ten years. Please see the European Investment Strategy Weekly Report titled "Markets Suspended In Disbelief" dated April 13, 2017 available at eis.bcaresearch.com Fractal Trading Model The rally in the CAC40 after the French election is technically extended. The recommended technical trade is to short the CAC40 versus the Eurostoxx600. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment's fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-8 Short CAC40 / Long EUROSTOXX600 Short CAC40 / Long EUROSTOXX600 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report "Fractals, Liquidity & A Trading Model," dated December 11, 2014, available at eis.bcaresearch.com Fractal Trading Model Recommendations Equities Bond & Interest Rates Currency & Other Positions Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch##br## - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch ##br##- Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch##br## - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch##br## - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations

The financial sector is poised to make a run to new relative performance highs in the coming months. The combination of slumping credit creation, falling inflation expectations, a narrowing yield curve and sluggish economic growth have undermined the sector in 2017, but these drags should steadily recede as the year progresses. Financial conditions have continued to ease, aided by tightening credit spreads, decline in oil prices, U.S. dollar softness and rise in equity prices. Easier monetary conditions should ensure that the recovery in overall corporate sector profits stays on track. In turn, that will sustain both consumer and corporate credit quality at high levels, and pave the way for a more expansionary mindset. Credit demand already appears to be turning the corner, as evidenced by the budding upturn in total bank credit growth. Thus, financial sector profits will benefit from this year's easing in financial conditions, sustaining the positive correlation between relative performance and the Bloomberg Financial Conditions Index. We reiterate our recent upgrade to overweight. Easing Financial Conditions = Buy Financial Stocks Easing Financial Conditions = Buy Financial Stocks

While homebuilders are discounting selling prices in order to move new product, underscoring that high lumber prices represent a drag on profit margins. The opposite is true for home improvement retailers. Industry sales are running at a healthy single-digit clip, well above the rate of overall retail sales growth. Pricing power for furniture and appliances has soared in recent months, reinforcing that demand remains upbeat. Importantly, high lumber prices will boost profit margins, given that retailers typically earn a fixed spread such that a high dollar value sold will boost profitability. Our home improvement relative performance model has surged in recent months, reflecting both increased productivity and rising leading profit indicators. We reiterate our high-conviction overweight position, especially within the context of subdued relative profit and earnings growth expectations. The ticker symbols for the stocks in this index are: BLBG: S5HOMI - HD, LOW. Home Improvement Retailers Are Still High-Conviction Worthy Home Improvement Retailers Are Still High-Conviction Worthy