Textiles, Apparel and Luxury Goods

Highlights Stay tactically neutral to equities. The market may meet some short-term resistance, especially as a slew of poor earnings are released in the coming weeks. The long-term threat to equities comes from the pandemic’s lasting after-effects, such as financial and corporate distress, and/or a political backlash against the private sector. Long-term investors should prefer equities over bonds, with the caveat that the threat does not materialise. Long-term equity investors should avoid oil and gas and European banks at all costs… …but healthcare, European personal products, and European clothes and accessories should all form core long-term holdings. Fractal trade: long nickel / short copper. Feature Chart of the WeekSales Per Share Must 'Catch Down' With GDP, Just Like In 2008 Sales Per Share Must 'Catch Down' With GDP, Just Like In 2008 Sales Per Share Must 'Catch Down' With GDP, Just Like In 2008 The sharp snapback rally in stock markets has reached an important resistance point – the critical Fibonacci level of a 38.2 percent proportionate retracement of the sell-off.1 Technical analysts define the sell-off in terms of the most recent peak to trough. But we define it differently. We define it in terms of the longest time horizon of investors that capitulated at the sell-off. The market may meet some short-term resistance. The longest time horizon of investors that capitulated at the sell-off’s climax on March 18 was a seven-quarter horizon. Hence, we define the sell-off as the seven-quarter decline to March 18. On that basis, and using the DAX as our benchmark, we would expect the index to meet resistance at around a 21 percent retracement rally from the March 18 low. Which is pretty much where the DAX stands right now (Chart I-2).2 Chart I-22020 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement 2020 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement 2020 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement After A Sharp Snapback Rally What Happens Next? The maximum length of investment horizons that capitulated on March 18 was unusually long at seven quarters. This should comfort long-term investors because of an important investment identity: Financial markets have fully priced a downturn when the longest time horizon of investors that have capitulated = the length of the downturn. So, the good news is that the March 18 bottom should hold if the downturn does not last longer than seven quarters. In this regard, the main risk of a protracted downturn comes not from the pandemic itself. Even if the pandemic returns in second and third waves, any economic shutdowns, full or partial, should last considerably less than seven quarters. Instead, the main risk comes from lasting after-effects, such as financial and corporate distress, and/or a political backlash against the private sector. The long-term threat comes from the pandemic’s after-effects on economic and political systems. But a protracted downturn of what? As we are focussing on the stock market, the downturn is not of GDP per se but its stock market equivalent: sales per share. In the long run, sales per share and GDP advance at the same rate. But the sector compositions of the stock market and GDP are not the same, so over shorter periods sales per share can underperform or outperform GDP. In which case, sales per share must catch up or catch down (Chart of the Week). In 2008, sales per share had to catch down. As a result, world sales per share declined for seven quarters through 2008-10, considerably longer than the decline in GDP (Chart I-3). Hence, the stock market found its bottom in early March 2009 when the longest time horizon of investors that had capitulated had reached seven quarters (Chart I-4). Chart I-32008-10: Sales Per Share Fell For Seven Quarters 2008-10: Sales Per Share Fell For Seven Quarters 2008-10: Sales Per Share Fell For Seven Quarters Chart I-42009 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement 2009 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement 2009 Low: A Seven-Quarter Capitulation Followed By A Fibonacci Retracement From this March 2009 bottom, the Fibonacci retracement equated to a 35 percent advance, which the market achieved by early June 2009. Thereafter, stocks met short-term resistance and gave back some of the snapback rally. Fast forward to 2020. Having likewise reached the Fibonacci retracement, the market may meet some short-term resistance, especially as a slew of poor earnings are released in the coming weeks. Assuming no lasting after-effects from financial distress or political backlash, the next sustained advance will happen later this year. Valuations Flatter Equities, But They Still Beat Bonds Turning to long-term investors the three most important things are: valuation, valuation, and valuation. Our favourite valuation measure is price to sales, which has been a good predictor of 10-year prospective returns going back to at least the 1980s (Chart I-5). Chart I-5Price To Sales Might Over-Estimate Prospective Returns In 2020, Just Like In 2008 Price To Sales Might Over-Estimate Prospective Returns In 2020, Just Like In 2008 Price To Sales Might Over-Estimate Prospective Returns In 2020, Just Like In 2008 But the predictive power depends on a crucial underlying assumption – that the past is a good guide to the future. Specifically, today we must assume that the pandemic causes just a brief blip in the multi-decade uptrend in stock market sales and profits. To repeat, the main long-term threat to stock markets comes not from the pandemic itself. The long-term threat comes from the pandemic’s after-effects on economic and political systems – such as crippled banking systems or large-scale nationalisations of the private sector. Furthermore, price to sales will err in its prediction if sales per share have deviated from GDP – implying either a future catch up or catch down. In the 1990s sales per share had underperformed GDP, so future returns outperformed the valuation prediction. However, in 2008 sales per share had outperformed GDP, so future returns underperformed the prediction. Today, just as in 2008, sales per share have become overstretched relative to GDP, so there will be a catch down. Which will weigh down prospective returns relative to what valuations appear to imply. Still, even adjusting for this, equities are likely to produce annualised nominal returns in the mid-single digits, comfortably higher than the yields on long-term government bonds. Hence, with the caveat that the pandemic does not generate lasting after-effects for economic and political systems, long-term investors should prefer equities over bonds. What Not To Buy, And What To Buy If a stock, sector, or stock market maintains a structural uptrend in sales and profits, then a big drop in the share price provides an excellent buying opportunity for long-term investors. In this case, the lower share price is stretching the elastic between the price and the up-trending profits, resulting in an eventual snap upwards. However, if sales and profits are in terminal decline, then the sell-off is not a buying opportunity other than on a tactical basis. This is because the elastic will lose its tension as profits drift down towards the lower price. In fact, despite the sell-off, if the profit downtrend continues, the elastic may be forced to snap downwards! Do not buy sectors whose profits are in major downtrends. This leads to a somewhat counterintuitive conclusion for long-term investors. After a big drop in the stock market, do not buy everything that has dropped. And do not buy the stocks and sectors that have dropped the most if their profits are in major downtrends. Specifically, the profits of oil and gas and European banks are in major structural downtrends (Chart I-6 and Chart I-7). Long-term equity investors should avoid these sectors at all costs. Chart I-6Oil And Gas Profits In A Major ##br##Downtrend Oil And Gas Profits In A Major Downtrend Oil And Gas Profits In A Major Downtrend Chart I-7European Banks Profits In A Major Downtrend European Banks Profits In A Major Downtrend European Banks Profits In A Major Downtrend Conversely, the profits of healthcare, European personal products, and European clothes and accessories are all in major structural uptrends (Chart I-8 - Chart I-10). As such, all three sectors should be core holdings for all long-term equity investors. Chart I-8Healthcare Profits In A ##br##Major Uptrend Healthcare Profits In A Major Uptrend Healthcare Profits In A Major Uptrend Chart I-9European Personal Products Profits In A Major Uptrend European Personal Products Profits In A Major Uptrend European Personal Products Profits In A Major Uptrend Chart I-10European Clothing Profits In A Major Uptrend European Clothing Profits In A Major Uptrend European Clothing Profits In A Major Uptrend Fractal Trading System* Given the outsized moves in markets over the past month, all assets have become highly correlated making it more difficult to find candidates for trend reversals. Chart I-11Nickel Vs. Copper Nickel Vs. Copper Nickel Vs. Copper However, we find that some relative moves within the commodity complex have not correlated with risk on/off. Specifically, the underperformance of nickel versus copper is technically stretched, so this week’s recommended trade is long nickel / short copper, setting a profit target of 11 percent with a symmetrical stop-loss. The rolling 1-year win ratio now stands at 67 percent. 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. * 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.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 0.382 = 1- phi. Where phi is the Golden Ratio, defined as the ratio of successive Fibonacci numbers in the limit. Alternatively, phi =1 / (1 + phi). 2 The seven-quarter sell-off in the DAX (capital only) to March 18 2020 was 39.4 percent, so a full retracement rally equals 65.1 percent, and a 0.382 geometric retracement equals 21.1 percent. Fractal Trading System   Cyclical Recommendations Structural Recommendations 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 - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations  

Dear Client, I am travelling this week so this report is a joint effort juxtaposing two contrasting observations about France. The ‘opulence’ part highlights France as the world’s dominant producer of luxury goods, and makes the case that some of the French luxury goods companies should form a core part of a long-term investment portfolio. The ‘rebellion’ part borrows from a recent Special Report on French politics penned by my colleague Jeremie Peloso. It analyses the recent yellow vest protests in France, and assesses whether they are a cause for concern. Best regards, Dhaval Joshi, Chief European Investment Strategist Feature Opulence Made In France Chart I-1 Global luxury goods sales amount to a quarter of a trillion dollars, and Europe dominates in the production of these luxury goods. Measured by the number of companies, the leading luxury goods country is Italy. But on the more important metric of share of total global sales, the undisputed world leader is France. In fact, just four French companies produce a quarter of the world’s luxury goods sales. The four are: LVMH, Kering, L’Oreal, and Hermes1 (Chart of the Week, Chart I-2, and Table I-1). Chart I-2 Chart I- France’s luxury goods sector is an excellent diversifier for investors. This is because, compared to other goods and services, luxuries follow very different laws of economics: The demand for luxuries has a positive elasticity to price. Put more simply, the desirability of a luxury increases as its price goes up. This is opposite to the demand for non-luxuries which has a negative elasticity to price: for non-luxury items, the demand declines as the price goes up. By definition, you cannot compete with a luxury item by undercutting its price. Given that a luxury implies fine-craftsmanship rather than mass production, the sector is highly resilient to the existential threats confronting other European industries that emanate from out-sourcing to lower cost economies and from automation. Luxury demand is also relatively insensitive to exchange rate movements. The barrier to entry into the luxuries sector is extremely high. It takes years, or even decades, for a luxury item to acquire its premium status based on consistent high quality in materials and craftsmanship. This high barrier to entry makes it much harder for other economies to challenge the European and French dominance in providing these luxury products. Despite these attractive characteristics the sector does still require a source of structural demand. Our premise, expounded in our Special Report “Buying European Clothes: An Investment Megatrend”, is that the feminisation of consumer spending, particularly in Europe, is providing a strong structural tailwind to the demand for ‘soft’ luxury goods. A recent industry study by Deloitte corroborates this thesis, pointing out that the strongest growth in the luxury sector is to be found in cosmetics, fragrances, bags and accessories. On this premise, the four leading French companies are big beneficiaries.2,3   Are market valuations already aware of, and fully discounting, the thesis of feminisation of consumer spending? We think not, as most investors are surprised by the thesis and unaware of the on-going dynamics behind it. On this basis, three of the four French luxury companies, trading on forward PE multiples in the 20s or below, still appear reasonably valued for their growth prospects (Table I-2). The exception is Hermes which, on a multiple of 40, does seem richly priced. Chart I- The bottom line is that the three other leading French luxury goods companies – LVMH, Kering, and L’Oreal – do deserve to be a core part of a long-term investment portfolio. Rebellion Made In France The yellow vest protest movement is not a coherent force led by a clear leadership. What started on the social media as a protest against the fuel tax in rural areas has evolved into a movement against President Macron. This transition occurred in part because a large segment of the population believes that Macron’s reforms have mainly benefited the wealthy. 77 percent of respondents in a recent poll view him as the “president of the rich.” The modification of the ‘wealth tax’ – which mostly shifts the focus toward real estate assets instead of financial assets – was highly criticized for favouring the wealthiest households. It resonated strongly with the perception that past governments helped the wealthiest households to accumulate more wealth on the back of the middle class. But it is not clear how intense or durable this popular sentiment will be, given that this type of inequality is not extreme in France and has not been rising (Chart I-3). Chart I-3What Income Inequality? What Income Inequality? What Income Inequality? Public support for the protests has hovered consistently around 70 percent since they started in November 2018 (Chart I-4). However, there are now more respondents who think that the protests should stop as that they should continue (Chart I-5). As a sign of things to come, a demonstration against the yellow vests and in support of Macron and his government – held by the “red scarves” – managed to gather more people on the streets of Paris than the regionally based yellow vests have done in the capital city.4 Chart I-4 Chart I-5 Who are the yellow vests? They are mostly rural, mostly hold a high school degree (or less), and overwhelmingly support anti-establishment political leaders Marine Le Pen (right-wing leader of the National Rally) or Jean-Luc Mélenchon (left-wing leader of La France Insoumise). This suggests that the movement has failed to cross the ideological aisle and win converts from the centre (Diagram I-1). Chart I- How many French people are actually protesting? Although there was a slight pickup in protests at the beginning of January, the numbers countrywide are not high. In fact, they are far from what they were back in November and therefore would have to get much larger for markets to become concerned anew (Chart I-6). If we are to compare these protests to those in 1995 or 2010, the numbers pale in comparison (Table I-3). For instance, the protest of December 1995 brought a million people onto the streets while the demonstrations against the Woerth pension reform in 2010 lasted for seven months and gathered close to nine million protesters across eight different events (Chart I-7). Chart I-6 Chart I- Chart I-7 We would compare the yellow vest protests to the 15-month long Spanish Indignados in 2011, which gathered between six and eight million protesters overall, and the U.S. Occupy Wall Street protests that same year. The two movements were similarly disorganized and combined disparate and often contradictory demands. In both cases, the governments largely ignored the protesters. Thus the yellow vests should not have a major impact on Macron’s reform agenda. As expected, Macron has not mentioned changing course on his most business-friendly reforms, which we see as a signal to investors that, despite the recent chaos, the plan remains the same. There is no strategic reason why Macron would reverse course. His popularity is already in the doldrums. His only chance at another term is to plough ahead and campaign in 2022 on his accomplishments. Nevertheless, to ensure that he does not plough into a rock, Macron will adjust course to calm the protesters. For example, the recent increase in the minimum wage that the government announced in response to the demonstrations was not supposed to be implemented until later in the presidential term. In a similar vein, pension reforms will likely be postponed given the ongoing protests. Macron hoped to introduce a universal, unified pension system by the middle of 2019 to replace an overly complex and fragmented system in which 42 different types of pension coexist, each one having its own rules of calculation. Though protests (both yellow vest and otherwise) have been unimpressive by historical standards, it might be too risky for the government to push the pension reform so close to these events. Such adjustments to the reform agenda should help reduce the protest movement’s fervour or otherwise its support. The bottom line is that the yellow vest protests were to be expected – they are the natural consequence of Emmanuel Macron’s push to reform the French economy and state. However, when compared to previous efforts to derail government reforms, the numbers simply do not stack up. Their disunited and broad objectives are likely to limit the effectiveness of the movement going forward.5   Dhaval Joshi,  Chief European Investment Strategist dhaval@bcaresearch.com Jeremie Peloso, Research Analyst jeremiep@bcaresearch.com Footnotes 1 In the case of L’Oreal this refers to the L’Oreal Luxe division. 2  Please see the European Investment Strategy “Buying European Clothes: An Investment Megatrend”, dated December 6, 2018 available at eis.bcaresearch.com. 3 Deloitte: Global Powers of Luxury Goods 2018, Shaping the future of the luxury industry 4 According to the government, 10,500 “red scarves” marched in Paris on January 27, 2018. 5 For the full report, please see the Geopolitical Strategy Special Report “France: La March A Suivre?”, dated February 27, 2019, available at gps.bcaresearch.com.  

Highlights Equities can continue to outperform bonds for a few months longer. The pro-cyclical equity sector stance that has worked well since last October can also continue for a few months longer. Overweight pro-cyclical Sweden versus pro-defensive Denmark. The caveat is that these short-term trends are unlikely to persist and will viciously reverse later in the year. European ‘soft’ luxury goods companies are an excellent structural investment opportunity. Take profits on the 75 percent rally in Litecoin and 50 percent rally in Ethereum. Feature Why should European investors care so much about China? The Chart of the Week provides one emphatic answer. For Europe’s $500 billion basic resources sector, the three most important things in the world are: China, China, and China. Through the past decade, the share price performance of the resource behemoths BHP, Anglo American, Rio Tinto, and Glencore have been joined at the hip to China’s short-term credit impulse (Chart I-2 and Chart I-3). Chart of the WeekFor European Basic Resources, The Three Most Important Things In the World Are: China, China, And China For European Basic Resources, The Three Most Important Things In the World Are: China, China, And China For European Basic Resources, The Three Most Important Things In the World Are: China, China, And China Chart I-2BHP, Anglo American, And Rio Tinto Have Been Rallying For Several Months BHP, Anglo American, And Rio Tinto Have Been Rallying For Several Months BHP, Anglo American, And Rio Tinto Have Been Rallying For Several Months Chart I-3BHP Is Joined At The Hip To China's Short-Term Credit Impulse BHP Is Joined At The Hip To China's Short-Term Credit Impulse BHP Is Joined At The Hip To China's Short-Term Credit Impulse But China has a much deeper importance to Europe. According to Mario Draghi, the recent cycle in Europe is ‘made in China’. On the euro area’s domestic fundamentals, Draghi is upbeat, citing “supportive financing conditions, favourable labour market dynamics and rising wage growth”. Yet the economic data have continued to be weaker than expected. Why? Draghi blames a “slowdown in external demand” and specifically, vulnerabilities in emerging markets. He claims that as soon as there is clarity on the exports and the trade sector, much of the euro area’s weakness will wash out.     Federal Reserve Chairman, Jay Powell presented a remarkably similar narrative to justify the recent pause in the Fed’s sequential rate hikes: “The U.S. economy is in a good place… but growth has slowed in some major foreign economies.” If Powell claims that the U.S. domestic economy is in a good place and Draghi points out that the euro area domestic fundamentals are fine, then the explanation for what has happened – and what will happen – can only come from one place: China. Optimistically, Draghi adds: “everything we know says that China’s government is actually taking strong measures to address the slowdown.” The good news is that we can independently corroborate Draghi’s optimism, at least in the near-term (Chart I-4). Chart I-4China's Short-Term Credit Impulse Is Up Sharply, And Commodities Have Rebounded China's Short-Term Credit Impulse Is Up Sharply, And Commodities Have Rebounded China's Short-Term Credit Impulse Is Up Sharply, And Commodities Have Rebounded Why China Matters To Europe Chart I-5 shows the short-term credit impulses in the euro area, U.S., and China through the past twenty years. They are all expressed in dollars to allow an apples for apples comparison between the three major economies. The comparison reveals a fascinating transformation. The dominant short-term impulse – the one with the highest amplitude – charts the shift in global economic power and influence from Europe and the U.S. to China. Chart I-5The Shift In Global Economic Power From Europe And The U.S. To China The Shift In Global Economic Power From Europe And The U.S. To China The Shift In Global Economic Power From Europe And The U.S. To China Before 2008, the short-term impulses in the euro area and the U.S. dominated. But the global financial crisis was a major turning point: the credit stimulus from China dwarfed the responses from the western economies. Then through 2009-12 the impulse oscillations from the three major economies took it in turns to dominate. For example, the 2011-12 global downturn was definitely ‘made in Europe’. However, since 2013 China has taken on the undisputed mantle of dominant impulse. Most recently, last year’s peak to trough decline in China’s short-term impulse amounted to $1 trillion, equivalent to a 1.5 percent drag on global GDP. By comparison, the declines in the euro area and the U.S. amounted to a much more modest $200 billion. Likewise, the recent rebound in the China’s short-term impulse, in dollar terms, has been much larger than the respective rebounds in the euro area and the U.S. Credit Impulses And Speeding Tickets Clients complain that they are confused by the conflicting messages from differently calculated credit impulses. So let’s digress for a moment to present a powerful analogy which should clear the confusion once and for all. Imagine you floored the accelerator pedal of your car (analogous to a huge stimulus). After a hundred metres or so, the stimulus would become very apparent. Your speed over that short sprint would have surged, and possibly have become illegal! But your average speed measured over the previous kilometre would have barely changed. Now imagine a police officer rightfully presents you with a speeding ticket. To protest your innocence, you argue that you couldn’t have floored the accelerator pedal because your average speed over the previous kilometre had barely changed! Clearly, you would never offer such a ludicrous defence for pushing the pedal to the metal. Yet when assessing the impact of an economic stimulus, it is commonplace to make the same mistake.    The crucial point is that a stimulus – like flooring the accelerator pedal of your car – will barely move the needle for a longer-term rate of change, but it will become very apparent in a short-term rate of change. For this reason, financial markets never wait for the long-term rates of change to pick up. They always move up or down on the evolution of short-term rates of change. It follows that the credit impulse calculation that is most relevant is the one that provides the best explanatory power for the cycles that we actually observe in the economic and financial market data. As we described in our Special Report, “The Cobweb Theory And Market Cycles”, both the theory and evidence powerfully identify the 6-month credit impulse as the one with the best explanatory power for the oscillations that we actually observe in the economy and markets.1 For the sceptics, the charts in this report should finally dispel any lingering doubts. China’s 6-month impulse gives a spookily perfect explanation for the industrial commodity inflation cycle, and thereby the share price performance of the basic resources sector, as well as the other classically cyclical sectors (Chart I-6 and Chart I-7). Chart I-6China's Short-Term Impulse Perfectly Explains Industrial Commodity Inflation China's Short-Term Impulse Perfectly Explains Industrial Commodity Inflation China's Short-Term Impulse Perfectly Explains Industrial Commodity Inflation Chart I-7Semiconductors Are A Modern Day Cyclical Semiconductors Are A Modern Day Cyclical Semiconductors Are A Modern Day Cyclical The good news is that China’s short-term impulse has indisputably been in a mini-upswing in recent months, and this is the reason that the classical cyclical sectors have simultaneously rebounded or, at the very least, stabilised. The bad news is that the shelf-life of such mini-upswings averages no more than eight months or so. Intuitively, this is because just as you cannot accelerate your car indefinitely, it is likewise impossible to stimulate credit growth indefinitely. The investment conclusion is that the pro-cyclical equity sector stance that has worked well since last October can continue for a few months longer. This sector stance necessarily impacts regional and country allocation. For example, it is still right to be overweight pro-cyclical Sweden versus pro-defensive Denmark (Chart I-8 and Chart I-9).  Chart I-8Overweight Pro-Cyclical Sweden Versus Denmark... Overweight Pro-Cyclical Sweden Versus Denmark... Overweight Pro-Cyclical Sweden Versus Denmark... Chart I-9...And Versus Norway ...And Versus Norway ...And Versus Norway From an asset allocation perspective, it means that equities can continue to outperform bonds for the time being. But the caveat is that these short-term trends are unlikely to persist, and most likely, they will viciously reverse later in the year. Stay tuned for the signal to switch. Stay Structurally Overweight ‘Soft’ Luxuries A common question we get concerns the European luxury goods sector: is it, just like the basic resources sector, a direct play on China’s growth cycle?  The answer is no. Recently, the connection between the fortunes of ‘soft’ luxury goods brands like LVMH, Hermes, and Kering and China’s growth cycle has been weak (Chart I-10). Broadly, this is also true for ‘hard’ luxury brands – for example, luxury watches – like Richemont (Chart I-11). Chart I-10European 'Soft' Luxuries Are No Longer A China Play... European 'Soft' Luxuries Are No Longer A China Play... European 'Soft' Luxuries Are No Longer A China Play... Chart I-11...Neither Are European 'Hard' Luxuries ...Neither Are European 'Hard' Luxuries ...Neither Are European 'Hard' Luxuries As we highlighted in Buying European Clothes: An Investment Megatrend, the much bigger driver for the ‘soft’ luxury brands is the structural increase in female labour participation rates, and the feminisation of consumer spending. We expect this trend to persist for the next decade.2 Hence, we are happy to buy and hold the European clothes and accessories companies with a dominant or significant exposure to women’s clothes and/or accessories; provided they have a top-end brand (or brands) giving pricing power, and mitigating the very strong deflation in clothes prices. In summary, while European basic resources are a good tactical investment opportunity, European ‘soft’ luxury goods companies are an excellent structural investment opportunity. Fractal Trading System* We are delighted to report that the fractal trading system perfectly identified the sharp recent rebound in cryptocurrencies. Our long Litecoin and Ethereum position has hit its 60 percent profit target with Litecoin up 75 percent and Ethereum up 50 percent since trade initiation on December 19. Additionally, long industrials versus utilities has also hit its profit target. With no new trades this week, the fractal trading system now has five open positions. 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-12 Litecoin Is Oversold On A 65-Day Horizon Litecoin Is Oversold On A 65-Day Horizon 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 Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com Footnote 1 Please see the European Investment Strategy Special Report “The Cobweb Theory And Market Cycles” January 11, 2018 available at eis.bcaresearch.com  2 Please see the European Investment Strategy Special Report “Buying European Clothes: An Investment Megatrend” December 6, 2018 available at eis.bcaresearch.com Fractal Trading System Recommendations Asset Allocation Equity Regional and Country Allocation Equity Sector Allocation Bond and Interest Rate Allocation Currency and Other Allocation 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 - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations

Feature The European stock market has a hidden gem: its clothing and accessories sector. Since the turn of the millennium, the sector’s profits are up by a thousand percent (Feature Chart). In this Special Report we propose that the megatrend has further to run, as its principle driver is still very much in place. Consumption patterns are becoming more female. Feature ChartEuropean Clothes Profits Are Up A Thousand Percent! European Clothes Profits Are Up A Thousand Percent! European Clothes Profits Are Up A Thousand Percent! One of Europe’s major, and largely neglected, success stories is the dramatic rise in the percentage of the working-age population in employment. This major success story stems from another success story: the structural and broad-based increase in the female labour participation rate – which has surged from 57 percent in 1995 to 68 percent today (Chart I-2-Chart I-4). Yet the story is far from over.1 Chart I-2European Male Labour Participation Is Flat... European Male Labour Participation Is Flat... European Male Labour Participation Is Flat...   Chart I-3...But European Female Labour Participation Is Surging ...But European Female Labour Participation Is Surging ...But European Female Labour Participation Is Surging   Chart I-4...So The Percentage Of The European Population In Work Is Surging ...So The Percentage Of The European Population In Work Is Surging ...So The Percentage Of The European Population In Work Is Surging Why Job Creation Favours Women Two things are driving the megatrend in female participation. One is a paradoxical feature of the current technological revolution. As we explained in The Superstar Economy: Part 2, Artificial Intelligence (AI) excels at tasks that we perceive as difficult: those requiring the application of complex algorithms and pattern recognition to a narrowly defined goal, such as making a highly-engineered product or managing a stock portfolio. This poses a big threat to jobs in manufacturing and finance, employment sectors which happen to be male-dominated.2 Conversely, AI still struggles at tasks that we perceive as easy: those requiring adaptable movements, or reading and responding to people’s emotions and intentions. If you are good at controlling a disruptive class of 7-year olds, or calming a nervous patient before giving him an injection, your human skills are still in big demand. But education, healthcare, and social care – the employment sectors that are creating the most jobs – employ three times as many women as men. With AI still in its infancy, the established pattern of job destruction and creation will continue to favour women over men (Table I-1). Table I-1AI Is A Greater Threat To Men Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend The other driver of the megatrend in female participation is a raft of European legislation designed to make work more family friendly: flexible working time, generous paid maternity and paternity leave, and subsidised childcare (Table I-2-Table I-4). Sharing the responsibility of childcare between mothers, fathers and external helpers has allowed tens of millions of European women to enter and remain in the labour force. Table I-2Generous Maternity Pay In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend   Table I-3Improving Paternity Pay In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend   Table I-4Affordable Childcare In Europe And Japan Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend Nevertheless, the megatrend has a lot further to run. For the ultimate end-point, look at the Scandinavian countries which started legislating such policies in the early 1970s, around twenty years before the rest of Europe. As a result, in Sweden, labour force participation rates for women and men have now converged to almost identical: 81 versus 84 percent (Chart I-5). Chart I-5In Sweden, Labour Force Participation For Women And Men Is Almost Identical EU28: Labour Force Participation Rate In Sweden, Labour Force Participation For Women And Men Is Almost Identical EU28: Labour Force Participation Rate In Sweden, Labour Force Participation For Women And Men Is Almost Identical The combination of the two drivers – employment growth favouring female-dominated sectors and employment becoming more family friendly – means that net job creation in Europe will be mostly due to more women joining the workforce. An important consequence is that consumption patterns will continue to become more female. But what does that mean? How Women’s Spending Differs From Men’s Spending In the main spending categories of housing, food and healthcare, women and men tend to show near-identical spending behaviours. But there are three sub-categories where there are significant differences. Men considerably outspend women on vehicle purchases: cars account for around 8 percent of disposable income for men versus 4 percent for women. Against this, women spend more on personal care products and services: 2 percent versus 0.5 percent. This is the reason behind our long-standing successful overweight recommendation in the European personal products sector which we maintain (Chart I-6). However, the sub-category in which women outspend men by even more is clothes and accessories: estimates average around 6.5 percent for women versus 2.5 percent for men.3 Chart I-6Personal Product Profits Set To Grow Very Strongly Personal Product Profits Set To Grow Very Strongly Personal Product Profits Set To Grow Very Strongly It follows that as consumption patterns become more female, we should expect to see a steady rise in spending on clothes and accessories as a share of total consumer spending. Has this been the case? In the U.K. – where the data is easily available – the answer is yes (Chart I-7). Having said that, other factors are also at play. A generalised deflation in clothes prices (Chart I-8) is also generating a strong tailwind to sales volumes (rather than values). More about this later. Chart I-7More Real Spending On Clothes... More Real Spending On Clothes... More Real Spending On Clothes... Chart I-8Partly Because Clothes Prices Are Falling... Partly Because Clothes Prices Are Falling... Partly Because Clothes Prices Are Falling... Of course, the more compelling evidence is the thousand percent growth in the European clothes sector’s profits since the turn of the millennium. However, with the sector dominated by top brands such as LVMH and Hermes, could a more plausible explanation come from strong economic growth, until recently, in the emerging markets such as China? The answer is yes to the extent that many of the emerging economies are experiencing the same structural uptrends in female participation, and this supports our investment thesis. Still, this cannot be the main driver, because in recent years the connection between the fortunes of the emerging economies and the European clothes sector has been weak (Chart I-9).   Chart I-9The Connection Between Emerging Markets And European Clothes Is Weak The Connection Between Emerging MarketsAnd European Clothes Is Weak The Connection Between Emerging MarketsAnd European Clothes Is Weak There is another obvious question: is the market already aware of, and fully priced for, the megatrend? We think not, as most investors we meet are surprised by the structural uptrend in female participation, the on-going dynamics behind it, and the implications for consumer spending patterns. Understandably, the European clothes sector does trade at a valuation premium to the market (Chart I-10). But for many companies, the recent market hiccup has pulled down their valuation premiums to close to, or below, the long-term average from which the price has previously outperformed very strongly. Chart I-10The Valuation Premium On European Clothes Is Close To Its Long-Term Average The Valuation Premium On European Clothes Is Close To Its Long-Term Average The Valuation Premium On European Clothes Is Close To Its Long-Term Average What Is In The Clothes Basket? Pulling all of this together, the companies in our European clothes and accessories basket need to meet several criteria: A dominant or significant exposure to women’s clothes and/or accessories. A top-end brand (or brands) giving the company pricing power, and mitigating the very strong deflation in clothes prices. Avoid ‘fast fashion’. A reputation for sustainable development. A track-record of profit growth during the past decade. A forward price to earnings (PE) multiple of less than 25. A market capitalisation of at least €5 billion. On the basis of these criteria, our European clothes and accessories basket contains four names: LVMH, Kering, Luxottica, and Burberry (Table I-5). Hermes meets most of the criteria but, trading on a forward PE close to 35 is very richly valued. Table I-5The European Clothes Basket Buying European Clothes: An Investment Megatrend Buying European Clothes: An Investment Megatrend To be clear, this is not a short-term trade. Investors who buy the clothes basket outright need to have a multi-year investment horizon. Those investors who must also protect short-term performance should instead overweight the clothes basket relative to the broad market. Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 Please see the European Investment Strategy Special Report “Female Participation: Another Mega-Trend” published on April 6, 2017 and available at eis.bcaresearch.com 2 Please see the European Investment Strategy Special Report, “The Superstar Economy: Part 2”, January 19, 2017 available at eis.bcaresearch.com. 3 Source: Bureau of Labor Statistics Consumer Expenditure Survey 2016 via SmartAsset, and Paymentsense.