Trade / BOP

Highlights Global Investment Strategy View Matrix Time For A Breather Time For A Breather Receding trade tensions; diminished risks of a hard Brexit; reduced odds of a victory for Elizabeth Warren in the US presidential elections; liquidity injections by most major central banks; and improved sentiment about the state of the global economy all helped push stocks higher late last year. Some clouds have formed over the outlook since the start of the year, however. The December US ISM manufacturing index fell to the lowest level since 2009, while the PMIs in the euro area, UK, and Japan gave up some of their November gains. The conflict between the US and Iran also flared up. Although tensions have abated in recent days, BCA’s geopolitical strategists worry that the détente may not last. The US is seeking to shift its military focus towards East Asia in order to counter China’s ascendency. They argue that this could create a dangerous power vacuum in the Middle East. Stock market sentiment is quite bullish at the moment, which makes equities more vulnerable to any disappointing news. While we are maintaining our positive 12-month view on global equities and high-yield credit in anticipation that global growth will rebound convincingly later this year, we are downgrading our tactical 3-month view to neutral. Ho Ho Ho After handing investors a sack of coal last Christmas, Santa was back to his true self this past holiday season. Global equities rose 3.4% in December, finishing the year off with a stellar fourth quarter which saw the MSCI All-Country World index surge by 8.6%. Five forces helped push stocks higher: 1) Receding trade tensions; 2) Diminished risks of a hard Brexit; 3) Reduced odds of a victory for Elizabeth Warren in the US presidential elections; 4) Liquidity injections by the Fed, ECB, and the People’s Bank of China; and arguably most importantly 5) Improved sentiment about the state of the global economy. Tarrified No More Trade tensions subsided sharply after China and the US reached a “Phase One” agreement. The deal prevented tariffs from rising on December 15th on $160 billion of Chinese imports. It also rolls back the tariff rate from 15% to 7.5% on about $120 billion in imports that have been subject to levies since September (Chart 1). Chart 1The Evolution Of The US-China Trade War The Evolution Of The US-China Trade War The Evolution Of The US-China Trade War In addition, the Trump Administration allowed the November 13th deadline on European auto tariffs to lapse. This suggests that the US is unlikely to impose tariffs under the Section 232 investigation of auto imports. The auto sector has been at the forefront of the global manufacturing slowdown, so any good news for that industry is welcome. To top it all off, the US House of Representatives ratified the USMCA, the successor to NAFTA, on December 19th. We expect it to be signed into law in the first quarter of this year. Brexit Risks Fading... Chart 2The Majority Of British Voters Aren't Keen On Brexit The Majority Of British Voters Aren't Keen On Brexit The Majority Of British Voters Aren't Keen On Brexit Boris Johnson’s commanding victory in the UK elections has given him the votes necessary to push a withdrawal bill through parliament by the end of the month. The British government will then seek to negotiate a free trade agreement by the end of the year. A “no-deal” Brexit is unacceptable to the majority of British voters (Chart 2). As such, the Johnson government will have no choice but to strike a deal with the EU. ... While Trump Gains On the other side of the Atlantic, President Trump’s re-election prospects improved late last year despite (and perhaps because of) the ongoing impeachment process. There is an uncanny correlation between the probability that betting markets assign to a Trump victory and the value of the S&P 500 (Chart 3). Chart 3An Uncanny Correlation An Uncanny Correlation An Uncanny Correlation Chart 4Who Will Win The 2020 Democratic Nomination? Time For A Breather Time For A Breather It certainly has not hurt market sentiment that Elizabeth Warren’s poll numbers have been dropping recently (Chart 4). Warren’s best hope was to squeeze out Bernie Sanders as soon as possible, thereby leaving the far-left populist lane all to herself. That dream appears to have been dashed, which suggests that even if Trump loses, a centrist like Joe Biden could emerge as president. An Uneasy Truce It remains to be seen how President Trump’s decision to assassinate General Qassem Soleimani, a top Iranian commander, will affect the election outcome. A YouGov/HuffPost poll taken over the weekend revealed that 43% of Americans approved of the airstrike against Soleimani compared to 38% that disapproved.1 History suggests that the public’s patience for war will quickly wear thin if it results in American casualties or significantly higher gasoline prices. Neither side has an incentive to allow the conflict to spiral out of control. Foreign minister Mohammad Javad Zarif tweeted on Tuesday shortly after Iran lobbed missiles at two US military bases that Iran had “concluded” its retaliatory strike, adding that “We do not seek escalation or war.” Despite claims on Iranian public television that 80 “American terrorists” were killed in the attacks, no US troops were harmed. This suggests that the Iranians may be putting on a show for domestic consumption. The US economy is less vulnerable to spikes in oil prices than in the past. Nevertheless, plenty of things could still go wrong. BCA’s geopolitical team, led by Matt Gertken, has argued that the US is seeking to shift its military focus towards East Asia in order to counter China’s ascendency. This could create a dangerous power vacuum in the Middle East. There is also a risk that President Trump overplays his hand. Contrary to the President’s claims, Soleimani was quite popular in Iran (Chart 5). If Trump begins to mock the Iranian leadership’s feeble response, Iran will have no choice but to take more aggressive action. Chart 5Soleimani Was More Popular In Iran Than Trump Claims Time For A Breather Time For A Breather Chart 6US Economy Is Less Vulnerable To Spikes In Oil Prices Than In The Past US Economy Is Less Vulnerable To Spikes In Oil Prices Than In The Past US Economy Is Less Vulnerable To Spikes In Oil Prices Than In The Past One thing that could embolden Trump is that the US economy is less vulnerable to spikes in oil prices than in the past. US oil output reached as high as 12.9 mm b/d in 2019, allowing the country to become a net exporter of oil for the first time in history (Chart 6). Any increase in oil prices would incentivize further domestic production, which would help bring prices back down. The US economy has also become less energy intensive – it takes less than half as much oil to produce a unit of GDP today than it did in the early 1980s. Finally, unlike in the past, the Fed will not need to raise rates in response to higher oil prices due to the fact that inflation expectations are currently well anchored. In fact, as we discuss below, we expect the Fed and other central banks to continue to provide a tailwind for growth over the course of 2020. The Fed’s “It’s Not QE” QE Program The jump in overnight lending rates in mid-September torpedoed the Federal Reserve’s efforts to shrink its balance sheet. Thanks to a steady stream of Treasury bill purchases since then, the Fed’s asset holdings have swelled by over $400 billion, reversing more than half of the decline observed since early 2018 (Chart 7). Chart 7Fed's Asset Holdings Are Growing Anew Fed's Asset Holdings Are Growing Anew Fed's Asset Holdings Are Growing Anew Chart 8The Fed's Balance-Sheet Expansion Helped Fuel The Dot-Com Bubble The Fed's Balance-Sheet Expansion Helped Fuel The Dot-Com Bubble The Fed's Balance-Sheet Expansion Helped Fuel The Dot-Com Bubble The Fed has insisted that its latest intervention does not amount to a new QE program, stressing that it is buying short-term securities rather than long-dated bonds. In so doing, it is simply creating bank reserves, rather than seeking to suppress the term premium by altering the maturity structure of the private sector’s holdings of government debt. Nevertheless, even such straightforward interventions have proven to be powerful signaling tools. By growing its balance sheet, a central bank is implicitly promising to keep monetary policy very accommodative. It is worth remembering that the run-up in the NASDAQ in 1999 coincided with a significant balance-sheet expansion by the Fed in response to Y2K fears, which came on the heels of three “insurance cuts” in 1998 (Chart 8). Gentle Jay Paves The Way Chart 9Inflation Expectations Remain Muted Inflation Expectations Remain Muted Inflation Expectations Remain Muted In 2000, the Fed moved quickly to reverse the liquidity injection it had orchestrated the prior year. We do not expect such a reversal anytime soon. Moreover, unlike in 2000, when the Federal Reserve kept raising rates – ultimately bringing the Fed funds rate up to 6.5% in May 2000 – the Fed is likely to stay on hold this year. The Fed’s ongoing strategic policy review is poised to move the central bank even closer towards explicitly adopting an average inflation target of 2% over the course of a business cycle. Since inflation tends to fall during recessions, this implies that the Fed will seek to target an inflation rate somewhat higher than 2% during expansions. Realized core PCE inflation has averaged only 1.6% since the recession ended. Both market-based and survey-based measures of long-term inflation expectations remain downbeat (Chart 9). This suggests that the bar for raising rates this year is quite high. More Monetary Easing In The Euro Area And China Chart 10Chinese Monetary Easing Should Help Global Growth Bottom Out Chinese Monetary Easing Should Help Global Growth Bottom Out Chinese Monetary Easing Should Help Global Growth Bottom Out The ECB resumed its QE program in November after a 10-month hiatus. While the current pace of €20 billion in monthly asset purchases is well below the prior pace of €80 billion, the central bank did say it would continue buying assets for “as long as necessary” to bring inflation up to its target. The language harkens back to Mario Draghi’s 2012 “whatever it takes” pledge, this time applied to the ECB’s inflation mandate. Not to be outdone, the People’s Bank of China cut the reserve requirement ratio by 50 basis points last week, a move that will release RMB 800 billion ($US 115 billion) of fresh liquidity into the banking system. Historically, cuts in reserve requirements have led to faster credit growth and ultimately, to stronger economic growth both in China and abroad (Chart 10). The PBOC has also instructed lenders to adopt the Loan Prime Rate (LPR) as the new benchmark lending rate. The LPR currently sits 20bps below the old benchmark rate (Chart 11). Hence, the PBOC’s order amounts to a stealth rate cut. Our China strategists expect further reductions in the LPR over the next six months. In addition, the crackdown on shadow bank lending seems to be subsiding, which bodes well for overall credit growth later this year (Chart 12). Chart 11China: Stealth Monetary Easing China: Stealth Monetary Easing China: Stealth Monetary Easing Chart 12Crackdown On Shadow Banking In China Is Easing Crackdown On Shadow Banking In China Is Easing Crackdown On Shadow Banking In China Is Easing   Rising Economic Confidence Chart 13Recession Fears Amongst Economists Began To Gather Steam At The Start Of Last Year Recession Fears Amongst Economists Began To Gather Steam At The Start Of Last Year Recession Fears Amongst Economists Began To Gather Steam At The Start Of Last Year Chart 14The Wider Public Was Also Worried About A Downturn The Wider Public Was Also Worried About A Downturn The Wider Public Was Also Worried About A Downturn   At the start of 2019, nearly half of US CFOs thought the economy would be in a recession by the end of the year. Similarly, two-thirds of European CFOs and four-fifths of Canadian CFOs expected their respective economies to succumb to recession. Professional economists were equally dire (Chart 13). Households also became increasingly worried about a downturn. Google searches for “recession” spiked to near 2009-highs last summer (Chart 14). The mood has certainly improved since then. According to the latest Duke CFO survey, optimism about the economic outlook has increased. More importantly, CFO optimism about the prospects for their own firms has risen to the highest level in the 18-year history of the survey (Chart 15). Chart 15CFOs Have Become More Optimistic Of Late CFOs Have Become More Optimistic Of Late CFOs Have Become More Optimistic Of Late Show Me The Money Going forward, global growth needs to accelerate in order to validate the improved confidence of CFOs and investors alike. We think that it will, thanks to the lagged effects from the easing in financial conditions in 2019, a turn in the global inventory cycle, a de-escalation in the trade war, easier fiscal policy in the UK and euro area, and re-upped fiscal/credit stimulus in China. For now, however, the economic data remains mixed. On the positive side, household spending is still robust across most of the world, a fact that has been reflected in the resilience of service-sector PMIs (Chart 16). Chart 16AThe Service Sector Has Remained Resilient (I) The Service Sector Has Remained Resilient (I) The Service Sector Has Remained Resilient (I) Chart 16BThe Service Sector Has Remained Resilient (II) The Service Sector Has Remained Resilient (II) The Service Sector Has Remained Resilient (II) Chart 17US Wage Growth Has Picked Up, Especially At The Bottom Of The Income Distribution Time For A Breather Time For A Breather Chart 18US Housing Backdrop Is Solid US Housing Backdrop Is Solid US Housing Backdrop Is Solid The US consumer, in particular, is showing little signs of fatigue. The Atlanta Fed GDPNow estimates that real personal consumption grew by 2.4% in the fourth quarter, having increased at an average annualized pace of 3% in the first three quarters of 2019. Both a strong labor market and housing market have buoyed US consumption. Payrolls have risen by an average of 200K per month for the past six months, double what is necessary to keep up with labor force growth. This week’s strong ADP release – which featured a 29K jump in jobs in goods-producing industries in December, the best since April – suggests that today’s jobs report will remain healthy. In addition, wage growth has picked up, particularly at the bottom of the income distribution (Chart 17). Residential construction has also been strong. Homebuilder sentiment reached the best level since June 1999 (Chart 18). Global Manufacturing: Too Early To Call The All-Clear The outlook for manufacturing remains the biggest question mark in the global economy. The US ISM manufacturing index dropped to 47.2 in December, its lowest level since June 2009. The composition of the report was poor, with the new orders-to-inventory ratio dropping close to recent lows. Chart 19Other US Manufacturing Gauges Are Not As Weak As The ISM Other US Manufacturing Gauges Are Not As Weak As The ISM Other US Manufacturing Gauges Are Not As Weak As The ISM We would discount the ISM report to some extent. The regional Fed manufacturing indices have not been nearly as disappointing as the ISM (Chart 19). The Markit PMI, which tracks US manufacturing activity better than the ISM, clocked in at a respectable 52.4 in December, down only slightly from November’s reading of 52.6. Nevertheless, it is hard to be excited about the near-term outlook for US manufacturing, especially in light of Boeing’s decision to suspend production of the 737 Max temporarily. Most estimates suggest that the production halt will reduce real US GDP growth by 0.3%-to-0.5% in the first quarter. The euro area manufacturing PMI gave up some of its November gains, falling to 46.3 in December. While the index is still above its September low of 45.7, it has been under 50 for 11 straight months now. The UK and Japanese PMI also retreated. Chinese manufacturing has shown clearer signs of bottoming out. Despite dipping in December, the private sector Caixin manufacturing PMI remains near its 2017 highs. The official PMI published by the National Bureau of Statistics is less upbeat, but still managed to come in slightly above 50 in December. The production subcomponent reached the highest level since August 2018. Reflecting the positive trend in the Chinese economy, Korean exports to China rose by 3.3% in December, the first positive growth rate in 14 months (Chart 20). Taiwan’s exports have also rebounded. The manufacturing PMI rose above 50 in both economies in December. In Taiwan’s case, this was the first time the PMI moved into expansionary territory since September 2018. On balance, we continue to expect global manufacturing to recover in 2020. This is in line with our observation that global manufacturing cycles typically last three years, with 18 months of weaker growth followed by 18 months of stronger growth (Chart 21). That said, the weakness in European and US manufacturing (at least judged by the ISM) is likely to give investors pause. Chart 20Some Positive Signs Emerging From Korea And Taiwan Time For A Breather Time For A Breather Chart 21A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle   Investment Conclusions We turned bullish on stocks in late 2018, having temporarily moved to the sidelines during the summer of that year. Global equities have gained 25% since our upgrade. We see another 10% of upside for 2020, led by European and EM bourses. Despite its recent gains, the real value of the MSCI All-Country World Index is only 3% above its prior peak in January 2018. The 12-month forward PE ratio of 16.3 is still somewhat lower than it was back then. The valuation picture is even more enticing if we compare equity earnings yields with bond yields, which is tantamount to computing a rough equity risk premium (ERP). The global ERP remains quite high by historic standards, especially outside the US where earnings yields are higher and bond yields are generally lower (Chart 22). Chart 22The Equity Risk Premium Is Fairly High, Especially Outside The US The Equity Risk Premium Is Fairly High, Especially Outside The US The Equity Risk Premium Is Fairly High, Especially Outside The US Chart 23Stock Market Sentiment Is Quite Bullish Stock Market Sentiment Is Quite Bullish Stock Market Sentiment Is Quite Bullish   Nevertheless, sentiment is quite positive towards stocks at the moment (Chart 23). Elevated bullish sentiment, against the backdrop of ongoing uncertainty about the outlook for global manufacturing and an uneasy truce between the US and Iran, poses a near-term headwind to risk assets. As such, while we are maintaining our positive 12-month view on global equities and high-yield credit, we are downgrading our tactical 3-month view to neutral for the time being. We do not regard this as a major realignment of our views; we will turn tactically bullish again if stocks dip about 5% from current levels.   Peter Berezin Chief Global Strategist peterb@bcaresearch.com   Footnotes 1 Ariel Edwards-Levy, “Here's What Americans Think About Trump's Iran Policy,” TheHuffingtonPost.com (January 6, 2020).   MacroQuant Model And Current Subjective Scores   Time For A Breather Time For A Breather Strategic Recommendations Closed Trades

Feature Recommended Allocation Monthly Portfolio Update: Counting The Milestones Monthly Portfolio Update: Counting The Milestones Since BCA published its 2020 Outlook,1 and the December GAA Monthly Portfolio Update,2 nothing has happened to make us fundamentally change our views. We see the global manufacturing cycle rebounding over the coming quarters, but major central banks remaining dovish. This combination of accelerating growth and easy monetary policy should be positive for risk assets. We accordingly continue to recommend an overweight on equities versus bonds, prefer the more cyclical euro zone and EM equity markets over the US, and selectively like credit (particularly the riskier end of the US junk bond universe). In the 2020 Outlook, we laid out a series of milestones that would indicate how our scenario is playing out: whether we need to reconsider it, or whether we should be adding further to risk (Table 1). Here is how those milestones are progressing. Table 1Milestones For The 2020 Outlook Monthly Portfolio Update: Counting The Milestones Monthly Portfolio Update: Counting The Milestones Chinese growth. Total Social Financing picked up in November (CNY1.75 trillion versus CNY619 billion the previous month) and the most recent hard data (notably retail sales and industrial production) showed improvement. But the momentum of credit creation and activity generally remain weak (Chart 1). We expect that Chinese growth will begin to accelerate in early 2020, due to the lagged effect of monetary stimulus in the first half of last year, and easier fiscal policy. Moreover, December’s annual Central Economic Work Conference pointed to greater government emphasis on growth stability.3 The clampdown on shadow banking also seems to be easing (Chart 2). However, we need to see further signs of Chinese growth accelerating before, for example, we become more bullish on Emerging Markets and commodities. Chart 1Chinese Credit And Activity Remain Weak Chinese Credit And Activity Remain Weak Chinese Credit And Activity Remain Weak Chart 2Clampdown On Shadow Banking Easing? Clampdown On Shadow Banking Easing? Clampdown On Shadow Banking Easing? Trade war. The last-minute agreement to cancel the December 15 rise in US tariffs on Chinese imports represents the “ceasefire” we expected, rather than “phase one” of a more profound agreement. It is still unclear whether previous tariffs will be rolled back (Chart 3). China’s supposed promise to increase imports of US agricultural products from $10 billion a year to $40 billion-$50 billion seems unrealistic. Progress on more fundamental topics such as China’s subsidies for state-owned companies seems far off. For now, President Trump has done enough to minimize the negative impact on the US economy in an election year. But there remains a possibility that trade war reemerges as a risk during 2020. Chart 3How Far The Rollback? How Far The Rollback? How Far The Rollback? Progress against these milestones suggests that our current asset allocation recommendation structure – moderately risk-on, but with hedges against downside risk – is appropriate for now. Global growth. Data confirming the rebound in the manufacturing cycle remain mixed. Economic surprises have generally been positive in the euro zone, but have slipped in the US and Japan, and remain soft in the Emerging Markets (Chart 4). In Germany, the manufacturing PMI slipped back to 43.7 in December, but the Ifo and ZEW surveys both rebounded (Chart 5). There is, however, still little sign that the weakness in manufacturing is spilling over into consumption and services. In Germany, unemployment remains at a record low and wages are strong. In the US, wage growth continues to trend up, and there is no indication in the weekly initial claims data that companies are starting to lay off workers at more than the seasonally normal pace (Chart 6). Market indicators of the cycle are also showing some positive signs. Among commodities, the price of copper – the most cyclical metal – has begun to rise. Chinese cyclical stocks are outperforming defensives. But the US dollar has not yet showed any significant depreciation (Chart 7). Chart 4Economic Surprises Mixed Economic Surprises Mixed Economic Surprises Mixed Chart 5Germany Showing Signs Of Bottoming Germany Showing Signs Of Bottoming Germany Showing Signs Of Bottoming   Chart 6No Problems In The Labor Market No Signs Of Weakening Labor Market No Problems In The Labor Market No Signs Of Weakening Labor Market No Problems In The Labor Market Chart 7Some Positive Signs From The Markets Some Positive Signs From The Markets Some Positive Signs From The Markets     US politics. President Trump’s approval rating has picked up slightly – we warned that its slipping might cause him to get aggressive on trade or foreign policy (Chart 8). Markets might worry at the possibility of “President Warren” given her focus on increased regulation of industries such as finance, energy, and technology. But she has fallen a little in the polls. Even in liberal California (where the primary will be unusually early next year – March 3), she is only level with Biden and Sanders in opinion polls. Our geopolitical strategists see US politics as one of the key geopolitical risks this year,4 but the risk seems subdued for now. Chart 8Trump’s Approval Rating Stable To Rising Monthly Portfolio Update: Counting The Milestones Monthly Portfolio Update: Counting The Milestones Fed tightening. Expansions usually end when inflation rises, either causing the Fed to raise rates to choke it off, or with the Fed ignoring the inflation and allowing debt and asset bubbles to form. Any signs, therefore, that inflation, or inflation expectations, are rising would signal that we are truly in the “end game”. For now, there are no such signs. US inflation is likely to soften over the next six months, as a result of the economic slowdown and strong dollar. And TIPS breakevens imply the market believes the Fed will miss its inflation target by an average of 80-90 BPs a year over the next decade (Chart 9). The Fed is likely to sound very dovish over the coming year. The review of its monetary policy framework, probably to be announced in July, may result in some sort of “catch-up” policy: under this, if inflation undershoots the Fed’s target, the target automatically rises the following year.5 Its efforts to support the repo market, including short-term Treasury securities purchases of $60 billion a month, will increase the Fed’s balance-sheet, and represent a “mini-QE” (Chart 10). The Fed is likely to be reluctant to turn more hawkish ahead of the presidential election. These dovish moves – and continued accommodative policies from the ECB and Bank of Japan – mean that monetary policy will be supportive for risk assets throughout 2020. Chart 9Inflation Remains Subdued Inflation Expectations Driven By Oil Inflation Remains Subdued Inflation Expectations Driven By Oil Inflation Remains Subdued These milestones suggest, therefore, that our current asset allocation recommendation structure – moderately risk-on, but with hedges (long cash and gold) against downside risk – is appropriate for now. Chart 10A "Mini-QE"? A Mini-"QE"? A Mini-"QE"? Equities: We shifted last month to an underweight on US equities, with an overweight on the euro zone, and neutral on Emerging Markets. The US tends to underperform during upswings in the global manufacturing cycle (Chart 11). Europe looks attractive because of its heavy weighting in sectors we like such as Financials, Autos and Capital Goods. Europe’s returns will also be boosted by the appreciation in the euro and pound that we expect (our equity recommendations assume no currency hedging). For EM, we would turn more positive if we saw a clear pickup in Chinese credit and economic growth. Chart 11US Underperforms When Growth Picks Up US Underperforms When Growth Picks US Underperforms When Growth Picks Chart 12Fed Won't Cut As The Market Expects Fed Won't Cut As The Market Expects Fed Won't Cut As The Market Expects   Fixed Income: Our positive view on global growth implies that long-term rates will rise. We see the US Treasury 10-year yield reaching 2.5% by mid-2020. The market still expects the Fed to cut rates once over the next 12 months. If it stays on hold, as we expect, that slight hawkish surprise would be compatible with a moderate rise in rates (Chart 12). Core euro zone rates might rise by a little less, perhaps by 30-40 BPs, and Japanese government bond yields by 10-15 BPs. We, therefore, continue to recommend a small underweight on duration and an overweight on TIPS which look particularly cheaply valued. Within credit, our preferences are for European investment grade (not as expensive as in the US, and with the ECB buying corporate debt again) and the lower end of the US junk-bond universe (since CCC-rated bonds missed out on 2019’s rally). In a rebounding global economy, the US dollar should depreciate, particularly since it looks somewhat over-valued, and with speculative positions long the dollar. Currencies: In a rebounding global economy, the US dollar should depreciate, particularly since it looks somewhat over-valued (Chart 13), and with speculative positions long the dollar (Chart 14). But its performance is likely to vary depending on the currency pair. Our FX strategists expect the dollar to weaken to 1.18 against the euro and 1.40 against the pound over the next 12 months, and even more against currencies such as the NOK, SEK, and AUD.6 But the dollar is likely to strengthen against the yen (an even more counter-cyclical currency) and against currencies in EM, where central banks will continue to cut rates and inject liquidity aggressively to support their economies. Chart 13Dollar Looks Expensive... Dollar Looks Expensive... Dollar Looks Expensive... Chart 14...And Speculators Are Long Monthly Portfolio Update: Counting The Milestones Monthly Portfolio Update: Counting The Milestones     Commodities: Supply in the oil market remains tight, with OPEC deepening its production cuts to 1.7 million barrels/day. The crude oil price was held down in 2019 by weakening demand, which should recover along with the cycle in 2020 (Chart 15). Our energy strategists expect Brent to average $67 a barrel in 2020 (compared to $66 now), with WTI $4 lower. Metal prices could rise in 2020 as Chinese growth recovers and the US dollar depreciates – the two most important factors that drive them (Chart 16). Given the uncertainty over both, we remain neutral for now, but would turn more positive (including on commodity-related assets, such as Australian or EM equities) if we see clear signs of their moving in the right direction. We see gold as a good downside hedge in a world of ultra-low interest rates, especially since central banks may allow inflation to overshoot over the coming years. Chart 15Supply/Demand Balance Points To Higher Oil Price Markets Will Tighten In 2020 Supply/Demand Balance Points To Higher Oil Price Markets Will Tighten In 2020 Supply/Demand Balance Points To Higher Oil Price Chart 16Metals Are Driven By The Dollar And China Metals Are Driven By The Dollar And China Metals Are Driven By The Dollar And China   Garry Evans, Senior Vice President Chief Global Asset Allocation Strategist garry@bcaresearch.com   Footnotes 1 Please see "Outlook 2020: Heading Into The End Game," dated 22 November 2019, available at bca.bcaresearch.com. 2 Please see "GAA Monthly Portfolio Update: How To Position For The End Game," dated 2 December 2019, available at gaa.bcaresearch.com. 3 Please see China Investment Strategy Weekly Report, "A Year-End Tactical Upgrade," dated 18 December 2019, available at cis.bcaresearch.com 4 Please see Geopolitical Strategy "Strategic Outlook: 2020 Key Views: The Anarchic Society," dated 6 December 2019, available at gps.bcaresearch.com 5 For example, if the Fed's inflation target is 2% but inflation is only 1.7% one year, the target would automatically rise to 2.3% the following year. 6 Please see Foreign Exchange Strategy, "2020 Key Views: Top Trade Ideas," dated December 13, 2019, available at fes.bcaresearch.com GAA Asset Allocation  

As 2019 draws to a close, we thank you for your ongoing readership and support. We wish you and your loved ones a happy holiday season and all the best for a healthy and prosperous 2020. Highlights We explore the principal risks to our optimistic 2020 outlook. Trade and the 2020 US Presidential election remain potential landmines. A stronger dollar would tighten global financial conditions and be deflationary. Credit market tremors would end buybacks. Stronger-than-expected inflation would force a cycle-ending Federal Reserve tightening. Weaker-than-expected inflation would first allow for larger bubbles to form at the expense of a more painful recession and deeper a bear market down the road. Hedging against those risks warrants overweighting cash, TIPs and gold. Feature Chart I-1Timing is Ripe For A Recovery Timing is Ripe For A Recovery Timing is Ripe For A Recovery As always, this year’s visit from Ms. and Mr. X was thought-provoking and generated diverse investment ideas.1 While we did not share Mr. X’s fears, his caution may be justified because an aging business cycle, elevated equity multiples and extremely expensive government bonds do not mesh with pro-risk portfolio positioning. With this in mind, we will explore the greatest risks to our positive market outlook, which include politics, the US dollar, problems in the credit market, a quicker resumption of inflation and lower inflation. The Central Scenario To understand how these five risks affect our central thesis, let’s review the key views and themes that underpin our bullish outlook. BCA expects global economic activity to recover in 2020. First, the global inventory contraction is advanced, which increases the chance that the manufacturing cycle will track its usual pattern of an 18-month decline followed by an 18-month acceleration (Chart I-1). Secondly, Chinese policymakers are putting a floor under domestic economic activity and the stabilization in credit growth and the climbing fiscal impulse already augur well for global growth (Chart I-2). Thirdly, global liquidity is in a major upswing, thanks to easing by central banks around the world (Chart I-3). Finally, the trade détente between the US and China agreed last week reduces the odds of a destructive trade war. Chart I-2China's Policy Turnaround China's Policy Turnaround China's Policy Turnaround Chart I-3Easing Abound! Easing Abound! Easing Abound!   US monetary policy will remain accommodative next year. US inflation will remain subdued in the first half of 2020 in response to both the global growth slowdown underway since mid-2018 and the lagged effect of a stronger dollar. Moreover, Fed policy will remain sensitive to inflation expectations. According to BCA’s US Bond Strategy’s model, it could take an extended overshoot in realized inflation before inflation expectations move back to the 2.3% to 2.5% range consistent with achieving a 2% inflation target (Chart I-4). Thus, the Fed will remain on pause for all of 2020. BCA’s positive outlook depends on both China and the US respecting their trade truce. In this context, the dollar will depreciate. The USD is a countercyclical currency and typically suffers when global economic activity rebounds, especially if inflation remains tame (Chart I-5). This behavior is due to the low share of the US economy dedicated to manufacturing and exports, which makes the US less sensitive to global trade and industrial activity. Moreover, when the world economy strengthens, safe-haven flows that boost the dollar in times of duress reverse, which accentuates the selling pressure on the USD. Chart I-4Realized Inflation Will Guide Expectations Realized Inflation Will Guide Expectations Realized Inflation Will Guide Expectations Chart I-5The Dollar Won't Respond Well To Stronger Global Growth The Dollar Won't Respond Well To Stronger Global Growth The Dollar Won't Respond Well To Stronger Global Growth   Global bond prices will be another victim of an improving economic outlook. Global safe-haven securities are extremely expensive and investors are too bullish toward this asset class (Chart I-6). This puts government bonds at risk in the face of positive economic surprises. However, the upside in Treasury yields will be capped between 2.25 and 2.5% because the Fed will be cautious about lifting rates. This move will likely be led by inflation expectations. As a result, we favor TIPs over nominal Treasurys. Chart I-6Safe-Haven Yields Have Upside Safe-Haven Yields Have Upside Safe-Haven Yields Have Upside Chart I-7Investors Aren't Feeling Exuberant About Earnings Growth Investors Aren't Feeling Exuberant About Earnings Growth Investors Aren't Feeling Exuberant About Earnings Growth   Equities will outperform bonds. The S&P 500 is trading at 18-times forward earnings and 2.3-times sales. However, those elevated multiples are due to depressed risk-free rates. Long-term growth expectations embedded in stock prices are only 1%, toward the bottom of this series’ historical distribution (Chart I-7). Therefore, investors are not particularly optimistic on the long-term prospects of per-share earnings. This lack of euphoria implies that stocks are not as expensive as bonds, and that if yields climb because of improving global economic activity, then equities will outperform bonds. Moreover, with a backdrop of easy money and no recession forecast until 2022, the timing still favors positive returns for equities in the coming 12 to 18 months (Table I-1).   Table I-1The End Game Can Be Rewarding January 2020 January 2020 Finally, we favor European equities over US stocks. This regional slant is as much a reflection of the better value offered by European stocks as it is of their sector composition. European stocks are trading at a forward PE of 14, implying an equity risk premium of 846 basis points versus 546 basis points in the US. Moreover, our preference for industrials, energy and financials favors European equities (Table I-2). Additionally, European banks are our favorite equity bet worldwide because they trade at a price-to-book ratio of only 0.6 and the drivers of their return on tangible equity are perking up (Chart I-8). Table I-2Europe: Overweight In The Right Sectors January 2020 January 2020 Chart I-8Brightening Prospects For Euro Area Banks Brightening Prospects For Euro Area Banks Brightening Prospects For Euro Area Banks     Risk 1: Politics BCA’s positive outlook depends on both China and the US respecting their trade truce. However, the two countries are long-term rivals and the rising geopolitical power of China relative to the US will cause tensions to escalate in the coming decades (Chart I-9). This also suggests that China and the US are highly unlikely to ever have an agreement that fully covers intellectual property transfers. Chart I-9China/US Tensions Are Structural China/US Tensions Are Structural China/US Tensions Are Structural The US could still renege on the “Phase One” deal. President Trump faces an election in 2020 and the majority of Democratic hopefuls are also hawkish on China. If Trump’s low approval rating does not improve soon (Chart I-10), he could become a more war-like president, in the hope that electors will rally around the flag. A renewed trade war would hurt business sentiment and undermine consumer spending (Chart I-11). A bellicose approach to international relations, especially on trade, would spark another spike in global policy uncertainty that will hurt global capex intentions. Meanwhile, companies could cut employment, which would weigh on household incomes. A rising unemployment rate could also hurt household confidence, reinforcing the slowdown in consumer spending. This would guarantee an earlier recession. Stocks would decline along with global government bond yields. Chart I-10President Trump Can Still Make It January 2020 January 2020 Chart I-11Households On The Edge Households On The Edge Households On The Edge   The US election creates an additional political risk. Democratic candidates are touting higher corporate taxes, a wealth tax, a greater regulatory burden, antitrust actions, and so on. These policies are worrisome to corporate leaders and business owners. For the time being, our Geopolitical Strategy team favors a Trump victory in 2020 (Chart I-12).2 However, if his odds deteriorate significantly, then business executives would likely curtail capex and hiring. This could also result in a US recession that would invalidate our central scenario for 2020. Chart I-12Our Model Still Favors President Trump January 2020 January 2020 Risk 2: A Strong Dollar A strong US dollar would hurt growth. A continued dollar rally would counteract a large proportion of the easing in liquidity conditions created by accommodative central banks around the world. The dollar affects the global cost of capital. Both advanced economies and emerging markets have USD-denominated foreign currency debt totaling around $6 trillion each. A strong USD raises the cost of servicing this large debt load, which could force borrowers to curtail their spending. A continued dollar rally would counteract a large proportion of the easing in liquidity conditions created by accommodative central banks around the world. Despite our conviction that the US dollar will depreciate in 2020, the following factors may invalidate our thesis: The USD still possesses the highest carry in the G10. When the dollar is supported by some of the highest interest rates in the G10, it often continues to rally (Chart I-13). Chart I-13The Dollar Offers An Elevated Carry The Dollar Offers An Elevated Carry The Dollar Offers An Elevated Carry The global growth rebound may be led by the US. If the US leads the rest of the world higher, then rates of return in the US would climb quicker than in the rest of the world. The resulting capital inflows would bid up the dollar. The shortage of USDs in offshore markets may flare up again. The September seize-up in the repo market was a reminder that because of the Basel III rules, global banks have a strong appetite for high-quality collateral and reserves. This generates substantial demand for the USD, which could put upward pressure on its exchange rate. The US dollar is a momentum currency. Among the G10 currencies, the USD responds most strongly to the momentum factor (Chart I-14).3 The dollar’s strength in the past 18 months could initiate another wave of appreciation. The dollar may not be as expensive as suggested by purchasing power parity (PPP) models. According to PPP estimates, the trade-weighted dollar is 24.2% overvalued. However, according to behavioral effective exchange rate models (BEER), the dollar may be trading closer to its fair value (Chart I-15). Chart I-14The Dollar Is A Momentum Currency January 2020 January 2020 Chart I-15Is The Dollar Expensive? Is The Dollar Expensive? Is The Dollar Expensive?   Why are the five items listed above risks for the dollar, but not our central scenario? Regarding the dollar’s carry, in 1985, 1999, and 2006, the US still offered some of the highest short-term interest rates among advanced economies, nevertheless the dollar began to depreciate. In those three instances, an acceleration in foreign economic activity relative to the US was the key culprit behind the USD’s weakness. In 2020, we expect foreign economies to lead the US higher. Since mid-2018, the manufacturing sector has been at the center of the global slowdown. But now, inventory and monetary dynamics point towards a re-acceleration in manufacturing activity. The US was the last nation to be hit by the growth slowdown; it will also be the last to reap a dividend from the recovery. The marginal buyers of US equities have been US firms. On the danger created by the dollar and the collateral shortage, the Fed is tackling the lack of excess reserves head-on by injecting $60 billion per month of reserves via its asset purchases. Moreover, the US fiscal deficit, which is tabulated to reach $1.1 trillion in 2020, will add a similar amount of dollars to the pool of high-quality collateral around the world, especially as the US current account deficit is widening anew. On the momentum tendency of the USD, the dollar’s momentum seems to be petering off. A move in the Dollar Index below 96 would indicate a major change in the trend for the DXY. Finally, estimates of a currency’s fair value based on BEER fluctuate much more than those based on PPP. If the global growth pick-up allows foreign neutral rates to increase relative to the US over the coming 12 to 24 months, then the dollar’s BEER equilibrium will likely converge toward PPP, putting downward pressure on the USD. Risk 3: Credit Market Tremors A credit market selloff is not our base case, but it would be damaging to risk assets. A deterioration in credit quality would be the main culprit behind a widening in credit spreads. Our Corporate Health Monitor already shows that the credit quality of US firms is worsening (Chart I-16). Moreover, the return on capital of the US corporate sector is rapidly deteriorating. Accentuating these risks, US profit margins have begun to decline because a tight labor market is exerting an upward pull on real unit labor costs (Chart I-17). Furthermore, the near-total disappearance of covenants in new corporate bond issuance increases the risks to lenders and will likely depress recovery rates when a default wave emerges. Chart I-16Deteriorating Fundamentals For US Corporates Deteriorating Fundamentals For US Corporates Deteriorating Fundamentals For US Corporates Chart I-17A Tight Labor Market Is Biting Into Margins A Tight Labor Market Is Biting Into Margins A Tight Labor Market Is Biting Into Margins     Widening credit spreads would signal a darkening economic outlook. Historically, wider spreads have been an excellent leading indicator of recessions (Chart I-18). Wider spreads have a reflexive relationship with the economy: they reflect anticipation of rising defaults by investors, but they also represent a price-based measure of lenders’ willingness to extend credit. Therefore, wider spreads force open the underlying cracks in the economy by depriving funds to weak borrowers. The resulting deterioration in capex and hiring would prompt a decline in consumer confidence and spending, ultimately leading to a recession. Chart I-18Widening Spreads Foreshadow Recessions Widening Spreads Foreshadow Recessions Widening Spreads Foreshadow Recessions Chart I-19Who Is Buying Stocks? Businesses! Who Is Buying Stocks? Businesses! Who Is Buying Stocks? Businesses! US equities may prove to be even more sensitive to the health of the credit market than in previous cycles. The marginal buyers of US equities have been US firms, which have engaged in equity retirements totaling $16.5 trillion since 2010. Since that date, pension plans, foreigners and households have sold a total of $7.7 trillion in US equities (Chart I-19). Both internally generated cash flows and borrowings have allowed for a decline in the equity portion of funding among US firms. Therefore, a weak credit market would hurt equities because a recession would depress firms’ free cash flows and hamper the capacity of firms to buy back their shares. Finally, the tendency of US firms to borrow to buy back their shares means that newly issued debt has not been matched by as much asset growth as in previous cycles. Therefore, borrowing is not backed by the same degree of collateral as in past cycles. If the credit market seizes up, then default and recovery rates will suffer even more than suggested by our corporate health monitor. The VIX will blow up and equities could suffer. Higher US inflation is potentially the most important downside risk for next year. While a widening in credit spreads would have a profound impact on stocks, it is unlikely to materialize when the Fed conducts a very accommodative monetary policy and global growth recovers. Risk 4: Higher Inflation Chart I-20The US Labor Market Is Tight The US Labor Market Is Tight The US Labor Market Is Tight Higher US inflation is potentially the most important downside risk for next year as it would catalyze the aforementioned dangers. Inflation could surprise to the upside because the labor market is tight. At 3.5%, the unemployment rate is well below equilibrium estimates that range between 4.1% and 4.6%. Small firms are increasingly citing their inability to find qualified labor as the biggest constraint to expand production. In the Conference Board Consumer Confidence survey, the number of households reporting that jobs are easily procured is near a record high relative to those preoccupied by poor job prospects. Finally, the voluntary quit rate is at 2.3%, a near record high (Chart I-20). Core PCE remains at only 1.6% year-on-year, but investors should recall the experience of the late 1960s. Through the 1960s, the labor market was tight, yet core inflation remained between 1% and 2%. However, in 1966, inflation suddenly accelerated to 4% before peaking near 7% in 1970. Some inflation dynamics warrant close monitoring. The three-month annualized rate of service inflation excluding rent of shelter has already surged to 4.5% and the same metric for medical care inflation stands at 5.9%. A continued tightening in the labor market could solidify a broadening of these trends because a rising employment-to-population ratio for prime-age workers points toward stronger salaries and ultimately higher domestic demand (Chart I-21). A very weak dollar would also allow this scenario to develop. Chart I-21Household Income Growth Will Accelerate January 2020 January 2020 A sudden flare in inflation would prompt an abrupt tightening in liquidity conditions that would be lethal for the economy. An out of the blue surge in CPI would likely cause a swift reassessment of inflation expectations by households and investors. Under these circumstances, the Fed could tighten monetary policy much faster than we currently envision. If interest rate markets are forced to price in a prompt removal of monetary accommodation, Treasury yields could easily spike above 3.5% by year end, which would hurt both the economy and the expensive equity market. If realized inflation turns out weaker than we expect in 2020, then central banks will maintain accommodative policies beyond next year. For now, this scenario remains a tail risk because the recent economic slowdown will probably continue to act as a dampener on US inflation in the first half of the year. Additionally, we do not expect the USD to collapse by 40% and fan inflation and inflation expectations, as occurred from 1985 to 1987. Instead, inflation expectations are much better anchored than they were in either the 1960s or 1980s, decreasing the risk that the Fed will suddenly have to tighten policy. Risk 5: Weaker-Than-Expected Inflation Chart I-22An Aggressive BoJ Did Not Achieve Inflation An Aggressive BoJ Did Not Achieve Inflation An Aggressive BoJ Did Not Achieve Inflation The last risk is paradoxical, but it is the one with the highest probability. It is paradoxical because it involves greater upside for stocks next year than we currently anticipate, but at the expense of a much deeper bear market in the future. The labor market may be tight, but Japan’s experience cautions us against extrapolating that inflation is necessarily around the corner. In Japan, the unemployment rate has been below 3.5% since 2014 and minimal domestically generated inflation has emerged. Inflation excluding food and energy remains at a paltry 0.7% year-on-year, even as the Bank of Japan has kept the policy rate at -0.1% and expanded its balance sheet from 20% of GDP in 2008 to 102% today (Chart I-22). If realized inflation turns out weaker than we expect in 2020, then central banks will maintain accommodative policies beyond next year. Central banks are currently toying with their inflation targets, discussing allowing inflation overshoots and displaying deep paranoia in the face of deflation. By weighing on inflation expectations, low realized inflation would nail policy rates around the world at currently depressed levels or even lower. Chart I-23Bubbles Destroy Long-Term Return On Capital Bubbles Destroy Long-Term Return On Capital Bubbles Destroy Long-Term Return On Capital In this context, bond yields would have even more limited upside than we envision and risk assets could experience higher multiples than today. In other words, we would have a perfect scenario for another stock market bubble. Vulnerability would escalate as valuations balloon and the perceived risk of monetary tightening dissipates from both investors’ and economic agents’ minds. Elevated asset valuations portend lower long-term expected returns (Chart I-23) and a larger share of the capital stock would become misallocated. Ultimately, the stimulative impact of such a bubble would create its own inflationary pressures. Consumers and companies would accumulate more debt and cyclical spending would rise (Chart I-24). In the end, the Fed would raise rates more aggressively, but the economy would be more vulnerable to those higher rates. Chart I-24Higher Cyclical Spending Creates Vulnerabilities Higher Cyclical Spending Creates Vulnerabilities Higher Cyclical Spending Creates Vulnerabilities Therefore, we would see a larger recession and, because assets are more expensive, a greater decline in prices. This would be extremely destabilizing for the global economy, potentially much more so than if a recession were to emerge today. Moreover, since the resulting slump would be yet another balance-sheet recession, it would likely entail a lack of capacity by central banks to reflate their economies. Conclusion The scenarios above are all risks to our benign view for 2020. The first four represent downside threats for assets next year, but the last one (weaker-than-expected inflation) entails upside potential to our forecast next year with significantly more painful results down the line. These risks are important to consider when protecting our portfolio, which has a pro-cyclical bias. It is overweight stocks, underweight bonds, and favors cyclical equities as well as foreign bourses at the expense of the US. BCA’s Global Asset Allocation service recently published an article on safe havens, which studied the profile of risk assets under various circumstances.4 Treasurys normally are the best safe haven, however, at current levels of yields, this benefit will be small compared with previous cycles. Instead, we favor an overweight position in cash, TIPs and gold. The best defense against short-term gyrations is to think about long-term strategic asset allocation. In this regard, this month’s Special Report – co-authored with BCA’s Equity, Geopolitical and Foreign Exchange Strategists, and Marko Papic, Chief Strategist at Clocktower Group – discusses our top sector calls for the upcoming decade. Mathieu Savary Vice President The Bank Credit Analyst December 20, 2019 Next Report: January 30, 2020   II. Top US Sector Investment Ideas For The Next Decade Every decade a dominant theme captures investors’ imaginations and morphs into a bubble. Massive speculation typically propels the relevant asset class into the stratosphere as investors extrapolate the good times far into the future and go on a buying frenzy. Chart II-1 shows previous manic markets starting with the Nifty Fifty, gold bullion, the Nikkei 225, the NASDAQ 100, crude oil and most recently the FAANGs. Chart II-1Manias: An Historical Roadmap Manias: An Historical Roadmap Manias: An Historical Roadmap What will be the dominant themes of the next decade? How should investors capitalize on some of these big trends? The purpose of this Special Report is to identify and provoke a healthy debate on the prevailing investment themes for the 2020s and to speculate on what the key US sector beneficiaries and likely losers may be. Theme #1: De-Globalization Picks Up Steam The first investment theme for the upcoming decade is the “apex of globalization” or “de-globalization”. We have written about this theme extensively at BCA Research and it is the mega-theme of our sister Geopolitical Strategy (GPS) service. Odds are high that countries will continue looking inward as the US adopts a more aggressive trade policy, China’s trend growth slows, and US-China strategic tensions intensify. The small cap preference is a secular view with a time horizon that spans the next decade. Chart II-2 shows that we are at the conclusion of a period of tranquility. Pax Americana underpinned globalization as much as Pax Britannica before it. The US is in a relative decline after decades of geopolitical stability allowed countries like China to rise to “great power” status and rivals like Russia to recover from the chaos of the 1990s. Chart II-2De-globalization Has Commenced De-globalization Has Commenced De-globalization Has Commenced De-globalization has become the consensus since the election of Donald Trump. But Trump is not the prophet of de-globalization; he is its acolyte. Globalization is ending because of structural factors, not cyclical ones. Three factors stand at the center of this assessment, outlined in our 2014 Special Report, “The Apex Of Globalization – All Downhill From Here”: multipolarity, populism and protectionism. Events have since confirmed this view. One final long-term playable investment idea from the apex of globalization is a structural bull market in defense stocks. The three pillars of globalization are the free movement of goods, capital, and people across national borders. We expect to see marginally less of each in the future. Investment Implication #1: Profit Margin Peak The most profound and provocative investment implication from de-globalization is that SPX profit margins have peaked and will likely come under intense pressure, especially for US conglomerates that – on a relative basis to international peers – most enthusiastically embraced globalization. Chart II-3 shows reconstructed S&P 500 profits and sales data back to the late-1920s. Historically, corporate profit margins and globalization (depicted as global trade as a percentage of GDP) have been positively correlated. Chart II-3Profit Margin Trouble Profit Margin Trouble Profit Margin Trouble As countries are more outward looking, trade flourishes and openness to trade allows the free flow of capital to take advantage of profit-maximizing projects. Following the Great Recession and similar to the Great Depression, trade has suffered and trade barriers have risen. The Sino-American trade war has accelerated the inward movement of countries, including Korea and Japan, and has had negative knock-on effects on trade as evidenced by the now two-year old global growth deceleration. China’s response to President Trump’s election was to redouble its pursuit of economic self-sufficiency, which meant a crackdown on corporate debt and a fiscal boost to household consumption. Trump’s tariffs then damaged sentiment and trade between the two countries. Any deal reached prior to the 2020 US election will remain in doubt among global investors. The longer the trade war remains unresolved, the deeper the cracks will be in the foundations of the global trading system. We are especially worried for the S&P interactive media & services index that includes GOOGL and FB. Such a backdrop is negative for profit margins, as inward looking countries prevent capital from being allocated most efficiently. Moreover, the uprooting of supply chains due to the trade war hurts margins and the redeployment of equipment in different jurisdictions will do the same at a time when final demand is suffering a setback. In addition, rising profit margins are synonymous with wealth accruing to the top 1% of US families and vice versa. This relationship dates back to the late-1920s, as far back as our dataset goes. Using Piketty and Saez data, which exclude capital gains, it is clear that profit margin expansion exacerbates income inequality (top panel, Chart II-4). Chart II-4Heightened Risk Of Wealth Re-distribution Heightened Risk Of Wealth Re-distribution Heightened Risk Of Wealth Re-distribution Expanding margins lead to higher profits. Because families at the top of the income distribution are often business owners, income disparities are the widest when margins are in overshoot territory. Eventually this income chasm comes to a head and generates political discontent. Populism has emerged on both the right and left wings of the US political spectrum – and since the rise of Trump, even Republicans complain about inequality and the excesses of “corporate welfare” and laissez-faire capitalism. Because inequality is extreme – relative to America’s developed peers – and political forces are mobilizing against it, the probability of wealth re-distribution is rising in the coming decades (middle panel, Chart II-4). Labor’s share of national income has nowhere to go but higher in coming years and that is negative for profit margins, ceteris paribus (bottom panel, Chart II-4). Buy or add software stock exposure on any weakness with a 10-year investment time horizon. Drilling beneath the surface, the three secular US equity sector/factor implications of the apex of globalization paradigm shift are: prefer small caps over large caps prefer value over growth overweight the pure-play BCA Defense Index Investment Implication #2: Small Is Beautiful Chart II-5It's A Small World After All It's A Small World After All It's A Small World After All While a small cap bias is contrary to the cyclical US Equity Strategy view of preferring large caps to small caps, the issue is timing: the small cap preference is a secular view with a time horizon that spans the next decade. The small versus large cap share price ratio’s ebbs and flows persist over long cycles. Small caps outshined large caps uninterruptedly from 1999 to 2010. Since then large caps have had the upper hand (Chart II-5). Were the apex of globalization theme to gain traction in the 2020s, small caps should reclaim the lead from large caps, especially in the wake of the next US recession. Similar to the death of the global banking model, companies with global footprints will suffer the most, especially compared with domestically focused outfits. One way to explore this theme is via domestic versus global sector preference. But a more investable way to position for this sea change, is to buy small caps (or microcaps) at the expense of large caps (or mega caps). Small caps are traditionally domestically geared compared with large caps that have significantly more foreign sales exposure. The closest ETF ticker symbols resembling this trade is long IWM:US/short SPY:US. Investment Implication #3: Buy Value At The Expense Of Growth Similar to the size bias, the style bias also moves in secular ways. Value outperformed growth from the dot com bust until the GFC. Since then growth has crushed value, even temporarily breaking below the year 2000 relative trough. This breakneck pace of appreciation for growth stocks is clearly unsustainable and offers long-term oriented investors a compelling entry point near two standard deviations below the historical mean (Chart II-6). Chart II-6Value Has The Upper Hand Versus Growth Value Has The Upper Hand Versus Growth Value Has The Upper Hand Versus Growth Financials populate value indexes, a similarity with small cap outfits. Traditionally, financials are a domestically focused sector with export exposure registering at half of the S&P’s average 40% level of internationally sourced revenues. On the flip side, tech stocks sit atop the growth table and they garner 60% of their revenue from abroad. This value over growth style preference will pay handsome dividends if the de-globalization theme becomes more mainstream as countries become more hawkish on trade and the Sino-American war continues to erect barriers to trade that took decades to lift. We have created a basket of ten stocks that we think will be driven over the long term by the demographic rise of the Millennial. The caveat? President Trump's recent short-term deal with China could set back the de-globalization theme. But our geopolitical strategists do not anticipate it to be a durable deal, and they also expect the trade war to resume in some way, shape or form in 2021-22, regardless of the outcome of the US election. The closest ETF ticker symbols resembling this trade is long IVE:US/short IVW:US. Investment Implication #4: Defense Fortress Chart II-7Stick With Pure-play Defense Stocks Stick With Pure-play Defense Stocks Stick With Pure-play Defense Stocks One final long-term playable investment idea from the apex of globalization is a structural bull market in defense stocks (Chart II-7). The US Equity Sector service's October 2016 “Brothers In Arms” Special Report drew parallels with the late nineteenth century period of European rearmament, and the American and Soviet arms race of the 1960s.5 These movements were greatly beneficial to the aerospace and defense industry. Currently, the move by several countries to adopt more independent foreign policies, i.e. to move away from collaboration and cooperation toward isolationism and self-sufficiency, entails an accompanying arms race. Table II-1 January 2020 January 2020 China’s challenge to the regional political status quo motivates a boost to defense spending globally. In fact, SIPRI data on global military spending by 2030 (Table II-1) increases our conviction that this trade will succeed on a five-to-ten year horizon. Beyond the global arms race, two additional forces are at work underpinning pure-play defense contractors. A global space race with China, India and the US wanting to have manned missions to the moon, and the rise of global cybersecurity breaches. Defense companies are levered to both of these secular forces and should be prime sales and profit beneficiaries of rising space budgets and increasing cybersecurity combat budgets. The ticker symbols for the stocks in the pure-play BCA defense index are: LMT, RTN, NOC, GD, HII, AJRD, BWXT, CW, MRCY. Theme #2: Tech Sector Regulation, US Enacts Privacy Laws The second long-term geopolitical theme that we are exploring is the regulatory or “stroke of pen” risk that is rising on FAANG stocks – Facebook, Apple, Amazon, Netflix, and Google. These companies were this decade’s undisputed stock market winners. The US anti-trust regulatory framework was designed to curb broad anti-competitive actions of trusts. As Lina Khan discusses in her seminal article, these actions “include not only cost but also product quality, variety, and innovation.” However, through subsequent regulatory evolution, the Chicago School has focused the US anti-trust process on consumer welfare and prices. If President Reagan and the courts could change how anti-trust laws were administered in the 1980s, so too can future administrations and courts. Today the US Congress, on both sides of the aisle, is looking into regulatory tightening, while the judicial system will take longer to change its approach. Moreover, the impetus for tougher anti-trust policy is here. It comes from a long period of slow growth, income inequality, and economic volatility – such as in the 1870s-80s. This was certainly the case for Standard Oil in 1911, which became a nation-wide boogeyman despite most of its transgressions occurring in the farm belt states. Today, income inequality is a prominent political theme and source of consumer discontent. A narrative is emerging – which will be super-charged during the next recession – that growth has been unequally distributed between the old economy and the twenty-first century technology leaders. While there are a few ESG related ETFs, we would rather explore this theme’s investment implications of sectors to avoid in the coming decade. With regard to privacy, the news is equally grim for large tech outfits. The EU General Data Protection Regulation (GDPR), which came into force on May 2018, imposes compliance burdens on any company handling user data. In the US, California has signed its own version of the law – the Consumer Privacy Act – which will go into effect in January 2020. These laws give consumers the right to know what information companies are collecting about them and who that data is shared with. They also allow consumers to ask technology companies to delete their data or not to sell it. While tech companies are likely to fight the new California law, and the US court system is a source of uncertainty, we believe the writing is on the wall. The EU is by some measures the largest consumer market on the planet. California is certainly the largest US market. It is unlikely that the momentum behind consumer protection will change, especially with the EU and California taking the lead. The odds of a federal privacy law, following in the footsteps of the Consumer Privacy Act, are also rising. Investment Implication #5: Shun Interactive Media & Services Stocks These risks introduce a severe overhang for FAANG stocks. We are especially worried for the S&P interactive media & services index that includes GOOGL and FB. Chart II-8Regulation Will Squeeze Tech Margins Regulation Will Squeeze Tech Margins Regulation Will Squeeze Tech Margins Tack on the threat of federal regulation and this represents another major headwind for profits and margins that are extremely elevated for these near monopolies. Given that advertising revenue is crucial to the business model of social media companies (GOOGL and FB included), a significant uptick in privacy regulation will likely hurt their bottom line. With regard to profit margins, tech stocks in general command a profit margin twice as high as the SPX. Specifically, FB and GOOGL enjoy margins that are 500 basis points higher than the broad tech sector (Chart II-8)! This is unsustainable and they will likely serve as easy prey for policymakers. Our view does not necessarily call for breaking up these monopolies. The US will have to weigh the economic consequences of anti-trust policy in a context of multipolarity in which China’s national tech champions are emerging to compete with American companies for global market share. Nevertheless, increased regulation is inevitable and some forced sales of crown jewel assets may take place. Moreover, the threat of a breakup will lurk in the background, creating uncertainty until key legislative and judicial battles have already been fought. That will take years. Finally, we doubt the tech sector will be left alone to “self-regulate” its incumbents and negotiate a price on consumers’ privacy. More likely, a new privacy law will loom, serving as a negative catalyst for profit growth. Uncertainty will weigh on the S&P interactive media & services relative performance. The ticker symbols to short/underweight the S&P interactive media & services index are an equally weighted basket of GOOGL and FB (they command a 98% market cap weight in the index). Theme #3: SaaS, Artificial Intelligence, Augmented Reality And Autonomous Driving Are Not Fads The third big theme that will even outlive the upcoming decade is the proliferation of software as a service (SaaS). The move to cloud computing and SaaS, the wider adoption of artificial intelligence, machine learning, autonomous driving and augmented reality are not fads, but enjoy a secular growth profile. In the grander scheme of things today’s world is surrounded by software. Millions of lines of code go even into gasoline powered automobiles, let alone electric vehicles. Autonomous driving is synonymous with software, the Internet of Things (IoT) needs software, the space race depends on software, modern manufacturing and software are closely intertwined, phone calls for quite some time have been a software solution, and the list goes on and on. This tidal effect is hard to reverse and is already embedded in workflows across industries. Opportunities to penetrate health care and financial services more deeply remain unexplored and it is difficult to envision another competing industry unseating “king software”. These secular trends are not only productivity enhancing, but will also most likely prove recession-proof. When growth is scarce investors flock to any source of growth they can come by and we are foreseeing that when the next recession arrives, investors will likely seek shelter in pure play SaaS firms. Investment Implication #6: Software Is Eating The World Chart II-9Software Is Eating The World Software Is Eating The World Software Is Eating The World Buying software stocks for the long haul seems like a bulletproof investment idea. But the recent stellar performance of software stocks has moved valuations to overshoot territory. Our recommended strategy is to buy or add software stock exposure on any weakness with a 10-year investment time horizon. All of these secular trends have pushed capital outlays on software into a structural uptrend. Software related capex is not only garnering a larger slice of the tech spending budgets but also of the overall capex pie. If it were not for software capex, the contraction in non-residential investment in recent quarters would have been more severe (Chart II-9). Private sector software capex is near all-time highs as a share of total outlays. Government investment in software is also reaccelerating at the fastest pace since the tech bubble. When productivity gains are anemic, both the business and government sectors resort to software upgrades in order to boost productivity. Cyber security is another more recent source of software related demand as governments around the globe are taking such risks extremely seriously (bottom panel, Chart II-9). Given this upbeat demand backdrop and ongoing equity retirement, software stocks are primed to grow into their pricey valuations. Finally, this long-term trade will also serve as a hedge to the short/underweight position we recommend in the S&P interactive media & services index. The closest ETF ticker symbol resembling the S&P software index is IGV:US. Theme #4: Millennials Already Are The Largest Cohort And Will Dominate Spending The fourth long-term theme we anticipate to gain traction in the 2020s is the demographic rise of the Millennial generation. Much has been made of preparing for the arrival of the Millennial generation, accompanied by well-worn stereotypes of general "failure to launch" as they reach adulthood. However, "arrival" is a misnomer as this age cohort is already the largest and "failure" is simply untrue. According to the US Census Bureau, Millennials are the US’s largest living generation. Millennials (or Echo Boomers) defined as people aged 18 to 37 (born 1982 to 2000), now number more than 80mn and represent more than one quarter of the US’s population. Baby Boomers (born 1946 to 1964) number about 75mn. Stealthily becoming the largest age group in the US over the last few years, Millennials per-year-birth-rate peaked at 4.3mn in 1990. Surprisingly, the pace matched that of the post-war Baby Boom peak-per-year-birth-rate in 1957 - the per-year average over the period was higher for the Baby Boomers (Chart II-10). Chart II-10Millennials Are The Largest Cohort Millennials Are The Largest Cohort Millennials Are The Largest Cohort This gap is now set to grow rapidly as the death rate of Baby Boomers accelerates. What is more, the largest one-year age cohort is only 25 years old, thus, Millennials will be the dominant generation for many years. It is unclear how these “kids” will impact the market as they become the most important consumers, borrowers and investors, but make no mistake: this is a seismic shift in economic power and it is here to stay. The Echo Boom is a big, generational demographic wave. A difficult and painful delay has not tempered its looming importance. Finally, this wave of echo-boomers is educated, relatively unburdened by debt (please see BOX in the June 11, 2018 Special Report on demystifying the student debt load as it pertains to Millennials), and as they inevitably “grow up”, form new households and have kids. They will borrow, spend, earn, but not necessarily save and invest to the same extent as the Boomers. And this will be an important long-term theme going forward. Near term, we might already be seeing signs of their arrival and firms have begun to pivot accordingly. Investment Implication #7: Buy The BCA Millennials Equity Basket Millennials will boost consumption spending in a number of different ways. The relatively unburdened Millennial cohort will be entering prime home acquisition age soon and this should underpin the long-term prospects of the US housing market and related industries. Furthermore, Millennials consume differently from their parents; social media, online shopping and smart phones are not the consumption categories of the Baby Boomers. With this in mind, we have created a basket of ten stocks that we think will be driven over the long term by the demographic rise of the Millennial. We note that these stocks are heavily weighted to the technology and consumer discretionary sectors, which is logical as Millennial consumption habits tend to be discretionary focused and technology-based. Beginning with consumer discretionary, we are highlighting AMZN, NFLX and SPOT as core holdings in our Millennials basket. AMZN’s heft dwarfs consumer discretionary indexes but it could fall in several categories; the acquisition of Whole Foods makes it a Millennials-focused consumer staples retailer and its cloud computing web services segment is a tech leader. NFLX and SPOT represent the means by which Millennials consume media, by streaming movies and music over the internet. The idea of owning physical media is rapidly becoming an anachronism. The home ownership theme noted in this report leads us to add HD and LEN to the basket. Millennials are “doers” and are set to be the dominant DIYers in the next few years, making HD a logical choice. LEN, as the nation’s largest home builder, should benefit from the Millennials coming of age into home buyers. We are also adding TSLA to our basket as a lone clean tech-oriented equity. TSLA capitalizes on the increasing shift to clean energy of Millennials (the key reason why no traditional energy companies have a spot in our basket). Chart II-11Buy BCA's Millennial Equity Basket Buy BCA's Millennial Equity Basket Buy BCA's Millennial Equity Basket The technology stocks in our Millennials basket are AAPL, UBER (which replaces FB as of today) and MSFT, together representing more than 9% of the total value of the S&P 500. AAPL’s inclusion in the list is predictable as the leading domestic purveyor of devices on which Millennials consume media content. FB is a predictable holding, with more than half of all Americans being monthly active users, dominated by the Millennial cohort. It has served our basket well since inception, but today we are compelled to remove it and replace it with UBER. UBER is a Millennial favorite and the epitome of the sharing economy. In reality UBER is a logistics company and while it is losing money, it is eerily reminiscent of AMZN in its early days. Maybe UBER will dominate all means of transportation and its ease of use will propel it to a mega cap in the coming decade. Our inclusion of MSFT is based on its leadership in cloud computing, a rapidly growing industry. We expect the connectivity and mobile computing demands of Millennials will accelerate. The last stock we are adding to our basket is also the only financial services equity. Though avid consumers, Millennials have shown an aversion to cash, preferring card payment systems, including both debit and credit-based. Accordingly, we are adding the leader in both of these, V, to our Millennials basket (Chart II-11). Investors seeking long-term exposure to stocks lifted by the supremacy of the Millennial generation should own our Millennial basket (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). We would not hesitate to add other sharing economy stocks, including Airbnb, to this basket should they become investable in the near future. Theme #5: ESG Becomes Mainstream Investors are increasingly looking at allocating assets based on environmental, social, and governance (ESG) considerations, and this mini-theme has the potential to become a big trend in the 2020s. There are a number of factors that underpin ESG investing. First, Millennials are climate conscious and given that they already are the largest cohort in the US they will not only dominate spending, but also influence election results. Moreover, via social media Millennials can sway public opinion and participate in the ESG conversation. Second, ECB President Christine Lagarde recent speech to the Economic and Monetary Affairs Committee of the European Parliament is a must read.6 If the ECB were to explicitly focus on climate change policy as part of its monetary policy operations then this is a game changer. Green investment financing including “green bonds” could become mainstream. Keep in mind that as reported in the FT, “the European Parliament has declared a climate emergency; the new European Commission (EC) has taken office on a promise of an imminent “green new deal”, and Commission president Ursula von der Leyen has vowed to accelerate emissions cuts.” Last week, the EC released “The European Green Deal” with a pretty aggressive time table. The EC president said “The green deal is Europe’s man on the moon moment” and presented 50 policies slated to get rolled by 2022 to meet revamped climate goals. The implication is that once ESG takes center stage at a number of these institutions, it will be easier to become mainstream and propagate the world over. Third, large institutional investors are starting to adopt an ESG mindset, especially pension plans. These investors with trillions of dollars at their disposal can not only disfavor fossil fuel investment, but also undertake investments in “green projects” via private and public equity markets. Banks are also moving in the “greening of finance” direction and given that they are the pipelines of the global plumbing system, swift adoption will go a long way in taking ESG mainstream. Finally, the electric vehicle (EV) proliferation is another key driver on how the ESG theme will play out in the 2020s. As a reminder, in the US 50% of all energy consumption is gasoline related linked to automobiles. While battery technology still has limitations, EV is no longer a fad as the German and Japanese automakers are starting to make inroads on TSLA. These car manufacturers do not want to be left out, especially if this shift toward EV becomes mainstream in the 2020s. The Chinese are not far behind on the EV manufacturing front, however government policy can really become a game changer. If a number of countries and/or California mandate a large share of all new vehicles sold be EV, then the investment implications will be massive. Investment Implication #8: Avoid Fossil Fuels, Gambling, Alcohol And Tobacco… While there are a few ESG related ETFs, we would rather explore this theme’s investment implications of sectors to avoid in the coming decade. We are believers that ESG criteria will continue to gain in importance in institutional investment management decisions. Accordingly, we would tend to avoid ‘sin stocks’, including gambling, tobacco and alcohol; demand for their services is unlikely to decline but investment weightings should mean that share prices will underperform. Further, we think a clean energy shift will mean energy stocks will likely continue to be long-term underperformers (Chart II-12). Final Thoughts On The US Dollar In this report, we tried to focus on the upcoming decade’s big themes that we expect to play out, and centered our recommendations on US equities/sectors. We do not want to neglect some macroeconomic variables that tend to mean revert over time. Specifically, the US dollar, interest rates and most importantly US indebtedness, will also be key drivers of investment theses in the 2020s. Currently, debt is rising faster than nominal GDP growth with the government and non-financial business debt-to-GDP profiles on an unsustainable path (second panel, Chart II-13). Chart II-12Areas To Avoid As ESG Becomes Mainstream Areas To Avoid As ESG Becomes Mainstream Areas To Avoid As ESG Becomes Mainstream Chart II-13Unsustainable Debt Profiles Unsustainable Debt Profiles Unsustainable Debt Profiles   Granted, the saving grace has been generationally low interest rates as the debt service ratios have fallen (top panel, Chart II-13). However, if the four decade bull market in Treasurys is over, or may end definitively with the next US recession sometime in the early 2020s, then rising interest rates are the only mechanism to concentrate CEOs’ and politicians’ minds. On the dollar front, Chart II-14 highlights the ebbs and flows of the trade-weighted US dollar since it floated in the early-1970s. The DXY index has moved in six-to-ten year bull and bear markets. The most recent trough was during the depths of the Great Recession, while the (tentative?) peak was in late-2016. If history repeats, eventually the dollar will mean revert lower in the 2020s, especially given the fiscal profligacy of the current administration that may continue into 2024, assuming President Trump gets re-elected next November. Chart II-14Greenback's Historical Ebbs And Flows Greenback's Historical Ebbs And Flows Greenback's Historical Ebbs And Flows The US dollar remains the reserve currency of the world today, but that exorbitant privilege is clearly fraying on the edges as the balance-of-payments dynamics are heading in the wrong direction. Over the next five years, the US Congressional Budget Office (CBO) estimates that the US budget deficit will swell to 4.8% of GDP. Assuming the current account deficit widens a bit then stabilizes (usually happens when global growth improves), this will pin the twin deficits at 8% of GDP. This assumes no recession, which would have the potential to swell the deficit even further. The US saw its twin deficits swell to almost 13% of GDP following the financial crisis, but the difference then was that in the wake of the commodity boom the dollar was cheap (and commodity currencies overvalued). The subsequent shale revolution also greatly cushioned the US trade deficit. Shale productivity remains robust and US output will continue to rise, but the low-hanging fruit has already been plucked. Chart II-15Twin Deficits Will Weigh On The US Dollar Twin Deficits Will Weigh On The US Dollar Twin Deficits Will Weigh On The US Dollar For one reason or another, foreign central banks are diversifying out of dollars. If due to the changing landscape in trade, this is set to continue. If it is an excuse to shy away from the rapidly rising US twin deficits, this will continue as well. In a nutshell, there has been hardly a time in recent history when the twin deficits in the US were rising and the dollar was in a secular uptrend (Chart II-15). Another dollar-negative force is its expensiveness. By rising 35% since its trough, the USD has sapped the competitiveness of the US manufacturing sector, which is accentuating the American trade deficit outside of the commodity sector. If the ESG trend ends up hurting oil prices, the US current account will follow the widening deficit in manufactured products. Moreover, the US is lagging Europe on the green revolution. Either the US will have to import green technologies, or the US government will have to provide more subsidies to the private sector. Either way, both of these dynamics will hurt the US current account deficit further. Historically, the currency market is the main vehicle to correct such imbalances. The apex of globalization will also hurt the greenback. In a world where all the markets are integrated, borrowers in EM nations often use the reserve currency to issue liabilities at a lower cost. This boosts the demand by EM central banks for US dollar reserves to protect domestic banking systems funded in USD. Moreover, some countries like China implement pegs (both official and unofficial) to the US dollar in order to maintain their competitiveness and export their production surpluses to the US. To do so they buy US assets. If the global economy becomes more fragmented and the Sino-US relationship continues to deteriorate structurally as we expect, then these sources of demand for the dollar will recede. Overlay the widening US current account deficit, and you have the perfect recipe for a depreciating trade-weighted US dollar. Finally, the US is likely to experience more inflation than the rest of the world following the next recession. The US economy has a smaller capital stock as a share of GDP than Europe or Japan, and American demographics are much more robust. This means that the neutral rate of interest is higher in the US than in other advanced economies. As a result, the Fed will have an easier time generating inflation by cutting real rates than both the ECB and the BoJ. Higher inflation will ultimately erode the purchasing power of the dollar and prove to be a structurally negative force for the USD.   Anastasios Avgeriou US Equity Strategist Matt Gertken Geopolitical Strategist Marko Papic Chief Strategist, Clocktower Group Chester Ntonifor Foreign Exchange Strategist Mathieu Savary Vice President The Bank Credit Analyst   III. Indicators And Reference Charts With a breakthrough in trade talks and Fed officials changing their language to suggest that policy will remain accommodative until inflation meaningfully overshoots 2%, the S&P 500 decisively broke out. Because it eases global financial conditions and boosts the profit outlook, the recent breakdown in the dollar should fuel the equity rally. Tactically, the S&P 500 may have overshot the mark, but on a cyclical basis, stronger growth and an easy Fed will propel US and global stocks higher. Our Revealed Preference Indicator (RPI) remains cautious towards equities. The RPI combines the idea of market momentum with valuation and policy measures. However, our Willingness-to-Pay (WTP) indicator for the US and Japan continues to improve. In Europe, this indicator has finally hooked up. The WTP indicator tracks flows, and thus provides information on what investors are actually doing, as opposed to sentiment indexes that track how investors are feeling. This broad-based improvement therefore bodes well for equities. Moreover, the pickup in Europe suggests that European stocks are increasingly ripe to outperform their US counterparts. Global yields have turned higher but they remain at exceptionally stimulating levels. Moreover, money and liquidity growth remains very strong as global central banks have adopted strongly dovish slants. Additionally, a Fed that will allow inflation to overshoot before tightening policy is adding to this supportive monetary backdrop. As a result, our Monetary Indicator remains at extremely elevated levels. Furthermore, our Composite Technical Indicator is still flashing a buy signal. Finally, our BCA Composite Valuation index is suggesting that stocks are expensive, but not so much as to cancel out the supportive monetary and technical backdrop. As a result, our Speculation Indicator remains in the neutral zone. 10-year Treasurys yields are becoming slightly less expensive, however, they are no bargain. Moreover, our Composite Technical Indicator is quickly moving away from overbought territory but has yet to flash oversold conditions, indicating that yields are roughly half way through their move. The strengthening of the Commodity Index Advance/Decline line and higher natural resource prices further confirm the upside for yields. Therefore, the current setup argues for a below-benchmark duration in fixed-income portfolios. Small signs that global growth is bottoming, such as the stabilization in the global PMIs, the pick-up in the German ZEW and IFO surveys, or the acceleration in Singapore’s container throughput growth, point to a worsening outlook for the counter-cyclical US dollar. Moreover, the dollar trades at a large premium of 24% relative to its purchasing-power parity equilibrium. Additionally, our Composite Technical Indicator is quickly deteriorating after having formed a negative divergence with the Greenback’s level. Since the dollar is a momentum currency, this represents a dark omen for the USD. In fact, we continue to believe that a breakdown in the dollar will be the clearest signal that global growth is rebounding for good. EQUITIES: Chart III-1US Equity Indicators US Equity Indicators US Equity Indicators Chart III-2Willingness To Pay For Risk Willingness To Pay For Risk Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators US Equity Sentiment Indicators US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Revealed Preference Indicator Revealed Preference Indicator Chart III-5US Stock Market Valuation US Stock Market Valuation US Stock Market Valuation Chart III-6US Earnings US Earnings US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations US Treasurys And Valuations US Treasurys And Valuations Chart III-10Yield Curve Slopes Yield Curve Slopes Yield Curve Slopes Chart III-11Selected US Bond Yields Selected US Bond Yields Selected US Bond Yields Chart III-1210-Year Treasury Yield Components 10-Year Treasury Yield Components 10-Year Treasury Yield Components Chart III-13US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Global Bonds: Developed Markets Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets Global Bonds: Emerging Markets Global Bonds: Emerging Markets   CURRENCIES: Chart II-16US Dollar And PPP US Dollar And PPP US Dollar And PPP Chart II-17US Dollar And Indicator US Dollar And Indicator US Dollar And Indicator Chart II-18US Dollar Fundamentals US Dollar Fundamentals US Dollar Fundamentals Chart II-19Japanese Yen Technicals Japanese Yen Technicals Japanese Yen Technicals Chart II-20Euro Technicals Euro Technicals Euro Technicals Chart II-21Euro/Yen Technicals Euro/Yen Technicals Euro/Yen Technicals Chart II-22Euro/Pound Technicals Euro/Pound Technicals Euro/Pound Technicals   COMMODITIES: Chart II-23Broad Commodity Indicators Broad Commodity Indicators Broad Commodity Indicators Chart II-24Commodity Prices Commodity Prices Commodity Prices Chart III-25Commodity Prices Commodity Prices Commodity Prices Chart III-26Commodity Sentiment Commodity Sentiment Commodity Sentiment Chart III-27Speculative Positioning Speculative Positioning Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop US And Global Macro Backdrop US And Global Macro Backdrop Chart III-29US Macro Snapshot US Macro Snapshot US Macro Snapshot Chart III-30US Growth Outlook US Growth Outlook US Growth Outlook Chart III-31US Cyclical Spending US Cyclical Spending US Cyclical Spending Chart III-32US Labor Market US Labor Market US Labor Market Chart III-33US Consumption US Consumption US Consumption Chart III-34US Housing US Housing US Housing Chart III-35US Debt And Deleveraging US Debt And Deleveraging US Debt And Deleveraging   Chart III-36US Financial Conditions US Financial Conditions US Financial Conditions Chart III-37Global Economic Snapshot: Europe Global Economic Snapshot: Europe Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China Global Economic Snapshot: China Global Economic Snapshot: China   Mathieu Savary Vice President The Bank Credit Analyst   Footnotes 1 Please see The Bank Credit Analyst "OUTLOOK 2020: Heading Into The End Game," dated November 22, 2019, available at bca.bcaresearch.com 2 Please see Geopolitical Strategy Special Report "US Election 2020: Civil War Lite," dated November 22, 2019, available at gps.bcaresearch.com 3 Please see Foreign Exchange Strategy Special Report "Riding The Wave: Momentum Strategies In Foreign Exchange Markets," dated December 8, 2017, available at fes.bcaresearch.com 4 Please see Global Asset Allocation Special Report "Safe Haven Review: A Guide To Portfolio Protection In The 2020s," dated October 29, 2019, available at gaa.bcaresearch.com. 5 Please see US Equity Strategy Special Report "Brothers In Arms," dated October 31, 2016, available at uses.bcaresearch.com 6 https://www.imf.org/en/News/Articles/2019/09/04/sp090419-Opening-Statement-by-Christine-Lagarde-to-ECON-Committee-of-European-Parliament

An analysis on Ukraine is available below.   Highlights A number of liquidity and technical reasons have led us to give benefit of the doubt to the bullish market action and chase this EM rally. We still doubt that the US-China trade truce alone is sufficient to propel a cyclical recovery in global trade and manufacturing. However, it seems the market is operating on a “buy now, ask questions later” principle. Therefore, we are initiating a long position in the EM equity index as of today. Despite the potential for higher EM share prices in absolute terms, we are still reluctant to upgrade EM versus DM stocks. The basis is that EM corporate profits will continue lagging those in DM. Feature We could be in for a replay of the 2012-2014 DM equity rally, where EM stocks rebounded in absolute terms but massively underperformed DM on a relative basis. Chart I-1EM Share Prices: In Absolute Terms And Relative To DM EM Share Prices: In Absolute Terms And Relative To DM EM Share Prices: In Absolute Terms And Relative To DM EM share prices have spiked on the announcement of a trade truce between the US and China. As a result, our buy stop at 1075 on the EM MSCI Equity Index has been triggered, and we are initiating a long position in EM stocks as of today (Chart I-1, top panel). That said, we are still reluctant to upgrade EM versus DM stocks. Regardless of the direction of the market (bull, bear or sideways), EM share prices will likely underperform the global equity benchmark. As we discussed in our report, the primary risk to our view has been that EM share prices get pulled higher as a result of rallying DM markets. Nevertheless, our fundamental assessment remains that EM corporate profits will lag those in DM, heralding EM relative equity underperformance. In fact, we could be in a replay of the 2012-2014 DM equity rally where EM stocks massively underperformed (Chart I-1, bottom panel), as we elaborated in our November 28 report. In this report, we review the indicators that support a bullish stance, the ones that are inconclusive and those that are not confirming the current rally in China-plays in general and EM risk assets in particular. Bullish Liquidity And Technical Settings The following points have led us to give benefit of the doubt to recent market action and to chase this rally: The global liquidity backdrop appears to be conducive for higher share prices. Global narrow and broad money growth have accelerated (Chart I-2). That said, a caveat is in order: These money measures do not always strongly correlate with both global share prices and the global business cycle. There are numerous times when they gave a false signal or were too early or late at turning points. Chart I-2Global Narrow And Broad Money: A Useful But Not Always Reliable Indicator Global Narrow And Broad Money: A Useful But Not Always Reliable Indicator Global Narrow And Broad Money: A Useful But Not Always Reliable Indicator   The technical profile of EM equities is rather bullish. As shown on the top panel of Chart I-1 on page 1, EM share prices have found a support at their six-year moving average. When a market fails to break down below its long-term technical support line, odds are that a major bottom has been reached, and the path of the least resistance is up. The reason we look at these long-term (multi-year) moving averages is because they have historically worked very well for key markets like the S&P 500 and 10-year US Treasury bond yields (Chart I-3A & I-3B). Chart I-3AThe Reason Why We Use Multi-Year Moving Averages The Reason Why We Use Multi-Year Moving Averages The Reason Why We Use Multi-Year Moving Averages Chart I-3BThe Reason Why We Use Multi-Year Moving Averages The Reason Why We Use Multi-Year Moving Averages The Reason Why We Use Multi-Year Moving Averages   As another positive development, both EM share prices in local currency terms and the EM equity total return index in US dollar terms have bounced from their three-year moving averages (Chart I-4). Chart I-4A Bullish Chart Formation For EM Equities A Bullish Chart Formation For EM Equities A Bullish Chart Formation For EM Equities In addition, when a market does not drop below its previous top, this creates a bullish chart configuration (Chart I-4). This seems to be the case with EM share prices currently. Bottom Line: A number of liquidity and technical reasons have led us to give benefit of the doubt to the bullish market action and to chase this rally. Inconclusive Indicators It is rare that all types of indicators – directional market, business cycle, valuation and technical – all line up together to convey the same investment recommendation. Below we present the market indicators and signals that we have been watching to get confirmation of sustainability in the bull market in EM risk assets, commodities and global cyclical equity sectors. They are still inconclusive: The US broad trade-weighted dollar has recently sold off, but it has not broken down technically (Chart I-5). A decisive relapse below its 200-day moving average will signify that the greenback has entered a major bear market. The latter would be consistent with a sustainable and extended bull market in EM risk assets, commodities and global cyclical equity sectors.  Chart I-5The US Dollar Has Fallen But Not Broken Down The US Dollar Has Fallen But Not Broken Down The US Dollar Has Fallen But Not Broken Down Chart I-6Indecisive Signals From Commodities And Commodity Currencies bca.ems_wr_2019_12_19_s1_c6 bca.ems_wr_2019_12_19_s1_c6   Even though copper prices have recently rebounded, they have not yet broken above their three-year moving average (Chart I-6, top panel). The latter can be viewed as the neckline of the head-and-shoulders pattern that has formed in recent years. The same holds true for the overall London Metals Exchange Industrial Metals Price Index, as well as our Risk-On/Safe-Haven currency ratio1 (Chart I-6, middle and bottom panels). Barring a decisive break above their three-year moving averages, the jury is still out on the durability of the rally in commodities prices and EM/China plays.   Finally, global industrial share prices and US high-beta stocks have advanced to their 2018 highs, but have not yet broken out (Chart I-7). The same is true for the euro area aggregate stock index in local currency terms (Chart I-8). A decisive breakout above these levels will confirm that global equities in general and cyclical segments in particular are in an enduring bull market. Chart I-7Decisive Breakouts Here Are Needed To Confirm The EM Rally Decisive Breakouts Here Are Needed To Confirm The EM Rally Decisive Breakouts Here Are Needed To Confirm The EM Rally Chart I-8European Share Prices Are At A Critical Juncture European Share Prices Are At A Critical Juncture European Share Prices Are At A Critical Juncture   Bottom Line: Several cyclical and high-beta segments of global financial markets are at a critical juncture. A decisive breakout from these key technical levels is required for us to uphold that EM risk assets and global cyclical plays are in a medium-term bull market. The Eye Of The Storm? There are a number of leading indicators and market signals that do not corroborate the common narrative of a sustainable improvement in global manufacturing/trade in general and China’s industrial cycle in particular: First, China’s narrow and broad money growth appear to be rolling over (Chart I-9). Notably, the money impulses lead the credit impulse, as illustrated in Chart I-10. Consequently, we expect the credit impulse – which is the main indicator currently portraying a revival in the Chinese economy as well as in the global business cycle – to roll over in early 2020. Chart I-9China: Narrow And Broad Money Growth Are Rolling Over bca.ems_wr_2019_12_19_s1_c9 bca.ems_wr_2019_12_19_s1_c9 Chart I-10China: Money Impulses Are Coincident Or Lead Credit Impulse bca.ems_wr_2019_12_19_s1_c10 bca.ems_wr_2019_12_19_s1_c10   This entails that the recent tentative improvements in China’s manufacturing, its imports and global trade will not be sustained going forward. Crucially, China’s narrow money (M1) growth point to the lack of a cyclical upturn in EM corporate profits in H1 2020 (Chart I-11). In short, EM listed companies’ profit growth rate stabilizing at around -10% is not a recovery. Second, government bond yields in both China and Korea are not corroborating a revival in their respective business cycles (Chart I-12). Chart I-11EM Corporate Profit Growth To Remain Negative In H1 2020 bca.ems_wr_2019_12_19_s1_c11 bca.ems_wr_2019_12_19_s1_c11 Chart I-12Asian Rates Are Not Confirming A Recovery Asian Rates Are Not Confirming A Recovery Asian Rates Are Not Confirming A Recovery   Chinese onshore interest rates have been a reliable compass for both its business cycle as well as EM share prices and currencies as we illustrated in Chart 15 of the November 28 report. For now, the mainland fixed-income market is not predicting an upturn in China’s industrial economy (Chart I-12, top panel). In Korea, exports account for 40% of GDP. Hence, without a considerable export recovery, there cannot be a business cycle revival in Korea. In brief, the latest relapse in local bond yields could be sending a downbeat signal for global trade (Chart I-12, bottom panel). Third, the four-month rise in the Chinese Caixin manufacturing PMI can be partially explained by front-running production and shipments of smartphones, laptops, computers and other electronics ahead of the December 15 round of US tariffs on imports from China. Right after President Trump announced these tariffs in the summer, businesses likely did not take a chance to wait and see. In fact, whether or not these tariffs would have come into effect was unknown till December 13. Manufacturers and US importers of these electronic goods initiated orders, produced and shipped these goods to the US ahead of December 15. Chart I-13Caixin And Taiwanese PMIs Benefited From Front Running Caixin And Taiwanese PMIs Benefited From Front Running Caixin And Taiwanese PMIs Benefited From Front Running Given the focus on that particular round of tariffs was electronics, producers of these goods got a temporary but notable boost from such front-running. Smartphone and electronics manufacturers and their suppliers are predominantly located in Shenzhen and Taiwan. The Caixin manufacturing PMI is a survey of 500 companies, many of which are private enterprises located in Shenzhen. Not surprisingly, the Caixin manufacturing PMI index often fluctuates with Taiwan’s electronics and optical PMI (Chart I-13). In brief, there has been meaningful improvement in China’s and Taiwan’s tech manufacturing. Yet it can be attributed to front-running of production and shipments of electronic products to the US ahead of the December 15 tariff deadline as well as stockpiling of semiconductors by China. The odds are that these measures of manufacturing will slump in early 2020 as the front-running ends. Chart I-14Commodities Prices In China Commodities Prices In China Commodities Prices In China Finally, several commodities prices in China, that troughed in late 2015 ahead of the bottom in global and EM/Chinese equities in early 2016, continue to drift lower or exhibit only a mild uptick. Specifically, these include prices of nickel, steel, iron ore, thermal coal, coke, polyethylene and rubber (Chart I-14). They corroborate that there has been no broad-based amelioration in the mainland’s industrial sector. Bottom Line: In China, narrow and broad money growth has rolled over, onshore interest rates are subsiding and many commodities prices are weak. All of these signify the lack of sustainable growth revival in China in the coming months.  Putting It All Together EM risk assets have rallied on the consensus market narrative that the temporary truce between the US and China will lift global growth. We have written at length that China’s domestic demand – not its exports – has been the epicenter of and basis for the global slowdown over the past two years. Without Chinese domestic demand and imports, not exports, staging a material amelioration, global trade and manufacturing are unlikely to experience a cyclical upturn.   In short, we doubt that the US-China trade truce is alone sufficient to propel a cyclical recovery in global trade and manufacturing. Yet, when the majority of investors perceive things the same way and act on these perceptions, asset prices can move a lot. We continue to believe that China’s industrial sector, global trade, EM ex-China domestic demand and consequently EM corporate profits will continue to disappoint in the first half of 2020. Nevertheless, we presently concede that we need to give benefit of the doubt to markets. We still doubt that the US-China trade truce alone is sufficient to propel a cyclical recovery in global trade and manufacturing. It could be that the EM equity and currency market rallies are not driven by their fundamentals – i.e., corporate profits/exports do not matter. However, it is rather possible that this rally is only stoked by the worst-kept secret in the investment industry: the search for yield. If that is the case, then there is no dichotomy between our fundamental thesis – that EM/China profits/growth will disappoint in H1 2020 – and the rally in EM markets. It seems the market is operating on a “buy now, ask questions later” principle. We had thought that the ongoing and enduring contraction in EM corporate profits (please refer to Chart I-11 on page 8) amid various structural malaises would overwhelm the impact of the global search for yield. However, it seems the market is operating on a “buy now, ask questions later” principle. Overall, we are initiating a long position in the EM equity index as of today. Provided the high uncertainty over the outlook, we are also instituting a stop point at 1050 for the MSCI EM equity index, 5% below its current level. For global equity investors, we continue recommending favoring DM over EM stocks. Finally, our country equity overweights are Korea, Thailand, Russia, central Europe, Pakistan, Vietnam and Mexico. A basket of these bourses is likely to outperform the EM equity benchmark in any market scenario in terms of EM absolute share price performance. We have been and remain neutral on Chinese, Indian, Taiwanese and Brazilian equities. As always, our list of overweight, underweight and market weight recommendations for EM equities, local and US dollar government bonds and currencies are available at the end of our report on pages 17-18 and on our website.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com     Ukraine: Buy Local Currency Bonds EM fixed-income investors should buy Ukraine local currency government bonds as well as overweight Ukraine sovereign credit within an EM credit portfolio. The exchange rate is the key for EM fixed-income investors. The Ukrainian hryvnia will be supported by high real interest rates, improving public debt and balance of payment dynamics, as well as abating geopolitical risks. In turn, a stable currency will keep inflation at bay. In such an environment, investors should favor local currency government bonds, as local interest rates will continue falling.  Chart II-1Inflation Will Fall Further Inflation Will Fall Further Inflation Will Fall Further In turn, a stable currency will keep inflation at bay (Chart II-1). In such an environment, investors should favor local currency government bonds, as local interest rates will continue falling. The primary risk of owning Ukrainian domestic bonds is a major depreciation in the hryvnia stemming from a risk-off phase in EM. However, as a periphery country, Ukraine’s financial markets might not correlate with their EM peers. Besides, these bonds offer high carry, which protects them against moderate currency depreciation. Overall, the case for buying Ukraine local currency government bonds is based on the following: First, Ukraine satisfies the two prerequisites for public debt sustainability, namely (1) it runs a robust primary fiscal surplus and/or (2) the government’s borrowing costs are below nominal GDP growth. The public debt-to-GDP ratio stands at 56% and will continue to fall so long as the above two conditions are satisfied. The primary consolidated fiscal surplus currently amounts to 1.8% of GDP (Chart II-2). The recently approved 2020 budget projects the primary surplus to be above 1% of GDP and the overall fiscal deficit to be close to 2% of GDP.  Local currency interest rates are below nominal GDP growth (Chart II-3). In addition, public debt servicing is at 3.2% and 9% as a share of GDP and total government expenditures, respectively. According to the new budget, the government plans to use close to 12% of total spending for debt repayments in 2020. This will further help reduce the public debt load. Chart II-2A Healthy Fiscal Position A Healthy Fiscal Position A Healthy Fiscal Position Chart II-3Interest Rates Are Below Nominal GDP Growth And Are Falling Interest Rates Are Below Nominal GDP Growth And Are Falling Interest Rates Are Below Nominal GDP Growth And Are Falling Second, the central bank has more scope to cut interest rates because various measures of inflation will continue falling. Real (adjusted for inflation) interest rates are still very elevated. In particular, the prime lending rate is at 17% for companies and 35% for households, both in nominal terms. Provided core inflation is running at 6%, lending rates are extremely high in real terms. Not surprisingly, narrow and broad money growth are sluggish (Chart II-4). Commercial banks are undergoing major balance sheet deleveraging: their asset growth is in the low single digits in nominal terms, while their value is dropping relative to nominal GDP (Chart II-5). Chart II-4Money Growth Is Sluggish Money Growth Is Sluggish Money Growth Is Sluggish Chart II-5Deleveraging In The Banking Sector Deleveraging In The Banking Sector Deleveraging In The Banking Sector Meanwhile, tighter regulations are forcing banks to recognize bad assets and boost their capital. This has led to a sharp drop in the number of registered banks. Such a structural overhaul of the banking system is cyclically deflationary and warrants lower interest rates. Critically, these reforms are a positive for the exchange rate in the long run. Third, receding foreign funding pressures are helping the balance of payments dynamics and are supportive for the currency. Ukrainian exports have been outperforming global exports since 2017 (Chart II-6). Agricultural exports – which represent 40% of total exports – are an important source of foreign currency revenue for the country. Chart II-6Ukraine Exports Are Outperforming Global Trade Ukraine Exports Are Outperforming Global Trade Ukraine Exports Are Outperforming Global Trade Chart II-7Tight Fiscal And Monetary Policies Are Good For The Current Account Balance Tight Fiscal And Monetary Policies Are Good For The Current Account Balance Tight Fiscal And Monetary Policies Are Good For The Current Account Balance The current account deficit has been narrowing due to slowing domestic demand, arising from tight fiscal and monetary policies (Chart II-7). Foreign ownership of local currency government bonds is $4.6 billion and it makes only 12% of total outstanding amount. Consequently, risk of major foreign portfolio capital outflows due to a risk-off phase in global markets is low. Lastly, Ukraine’s foreign debt obligations – the sum of short-term claims, interest payment and amortization – have been declining and are presently well covered by exports. They comprise 34% of total exports. Finally, geopolitical risks will continue to subside over the coming months. Peace talks between Ukraine and Russia will continue. Importantly, two sets of constraints could force Ukraine and Russia towards resolving the conflict. Specifically: Russia is constrained by its commitment to be a reliable gas supplier to the EU. Half of its gas export capacity passes through Ukraine. European demand for Russian gas is falling and Gazprom gas revenues are decelerating. Cutting transit of gas through Ukraine could now severely jeopardize Russia’s relations with Europe. Therefore, as much as Europe is dependent on Russian gas, Russia is as dependent on European demand for its natural gas.   The EU’s support for Ukraine is contingent on reliable transits of Russian gas into EU countries. As such, President Zelensky is under pressure from Europe to assure transmission of Russian gas to Europe. This has led Zelensky into opening a dialogue with Russia and motivated him to seek a new gas transit deal with Gazprom. Given President Zelensky’s high popularity at home, he has political capital to pursue a rapprochement with Russia and attempt to find a resolution to end the conflict in the Donbass. All of these developments have been, and will continue to be, positively perceived by international investors, sustaining the recent stampede into Ukraine’s fixed-income markets. Investment Recommendation We recommend investors purchase 5-year local currency government bonds currently yielding 12%. EM fixed-income investors should also consider overweighting US dollar sovereign bonds in an EM credit portfolio on the back of improving public debt and balance of payments dynamics.   Andrija Vesic Research Analyst andrijav@bcaresearch.com     Footnotes 1    The Risk-On/Safe-Haven currency ratio is the average of high-beta commodity currencies such as the CAD, AUD, NZD, BRL, CLP and ZAR total return (including carry) indices relative to the average of JPY and CHF total returns (including carry). This ratio is dollar-agnostic. Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Dear Clients, In our final publication of the year, we bring you a recap of this past week’s significant events in Sino-US relations and the key messages from the Central Economic Work Conference. Accordingly, we are upgrading our tactical stance towards Chinese stocks from neutral to overweight.  Our publishing schedule will resume on January 9, 2020 with our monthly Macro and Market Review. Our China Investment Strategy team wishes you a happy holiday season and a prosperous New Year! Best regards, Jing Sima, China Investment Strategist Highlights We are upgrading our tactical call on Chinese stocks from neutral to overweight. Recent developments in the Chinese investable equity market point to a risk-on sentiment. The fact the US and China have reached an agreement likely marks the beginning of a truce, which could potentially last through the US presidential election in November 2020. The CEWC statement from last week reinforces our view that China's leadership feels the urgency to stabilize the economy now outweighs the desire to continue financial deleveraging.  Feature Signals from the Chinese investable equity market have titled in a bullish direction. This shift is accompanied by two modestly bullish developments:  First, the annual China Economic Work Conference (CEWC) concluded on December 12 with support for a more reflationary stance for the coming year. Then, a day later, the US and Chinese officials confirmed they have agreed on a Phase One trade deal.  The combination of these developments provides a sufficient basis to upgrade our tactical (0-3 month) stance on Chinese stocks from neutral to overweight (within a global equity portfolio), to be consistent with our bullish cyclical (6-12 month) stance. Equity Market Signals Have Become Bullish In our previous reports, we highlighted that the relative performance of some sectors in the Chinese investable equity market reflects China’s policy direction and financial market conditions, supporting our bullish/bearish calls on Chinese stocks. Recently, two of the three equity market telltale signs that we have been watching have turned favorable for a bullish view on Chinese stocks (Chart 1A and 1B): Chart 1ACountercyclical Sector Stock Performance Points To Improvement In Economic Activity Countercyclical Sector Stock Performance Points To Improvement In Economic Activity Countercyclical Sector Stock Performance Points To Improvement In Economic Activity Chart 1BThe Breakdown Of Defensive Stocks Suggests A Return Of Risk-On Sentiment The Breakdown Of Defensive Stocks Suggests A Return Of Risk-On Sentiment The Breakdown Of Defensive Stocks Suggests A Return Of Risk-On Sentiment Chart 1A (top panel) shows that the relative performance of investable utility stocks have broken down, signifying that market participants anticipate the slowdown in China’s economy will soon bottom.  Investable healthcare stocks have not breached their 200-day trend, but are headed in that direction (Chart 1A, bottom panel). Key equity market signs have turned supportive for a bullish tactical call on Chinese stocks. Cyclical stocks are outperforming defensives in both China’s onshore and offshore markets, reflecting improved investor sentiment towards China’s economic outlook (Chart 1B). Bottom Line: Key equity market signs have turned supportive for a bullish call on Chinese stocks for the next 0 to 3 months. Phase One Trade Deal: Unimpressive But Pragmatic Adding to this bullish shift in equity market signals was the first of two positive fundamental improvements over the past week. The US and China reached agreement on a Phase One deal just a few days before the 15% tariff increase on $160 billion of Chinese export goods to the US was scheduled to come into effect. Reportedly, the two sides agreed to pause the 15% tariff scheduled for December 15 and lower the tariff on about $120 billion of Chinese imports to 7.5%.  However, the 25% tariffs on the first $250 billion of Chinese imports will remain in place (Chart 2). Chart 2Tariff Rollbacks Unimpressive... Tariff Rollbacks Unimpressive... Tariff Rollbacks Unimpressive... Chart 3...But China's Promise To Buy American Goods Helps Trump Claim Victory ...But China's Promise To Buy American Goods Helps Trump Claim Victory ...But China's Promise To Buy American Goods Helps Trump Claim Victory In return, China agrees to, in the next two years, boost imports of American goods and services by a total of $200 billion from their levels in 2017 (Chart 3).  While no specific number has been confirmed from the Chinese side, in a news conference, Chinese officials said that China “will expand imports of some agriculture products currently in urgent need, such as pork and poultry.” Given that both sides picked low hanging fruit in the Phase One deal, the tougher issues to be discussed in Phase Two could lead to a breakdown in negotiations, which potentially could unravel the Phase One tariff rollbacks. Nevertheless, the agreement serves an interim purpose for both President Trump and President Xi: it allows Trump to claim a short-term political victory on his trade negotiations with China, and gives Xi some breathing space to focus on domestic economic challenges.  Bottom Line: While the Phase Two negotiations, when commencing, will be a risk to the Phase One trade deal, the current agreement likely marks the beginning of a truce, which could potentially last through the November’s presidential election in 2020. CEWC: Reinforcing Reflationary Bias For 2020 In addition to the trade deal, another bullish factor for stocks is the fact that Chinese policymakers will proactively fine-tune economic policy to mitigate the impact from the US tariffs that remain in effect and to ensure stable economic growth in the coming year. President Xi at last week’s Central Economic Work Conference (CEWC) urged that Chinese policymakers must “make contingency plans” to combat challenges from both domestic and external environment. At the three-day annual CEWC this year, Chinese central and local government officials set the direction and strategy of China’s economic policy for the coming year. The meeting also reveals the challenges Chinese policymakers are facing, and the areas they will likely mobilize monetary resources to tackle. Investors can therefore benefit from insights into both the direction and constraints of China’s near-term policy framework. We highlight four investment-relevant messages from this year’s CEWC: A Greater Emphasis On Growth Stability The tone from this year’s CEWC reflects an urgency to stabilize the economy and meet growth targets. The tone from this year’s CEWC reflects an urgency to stabilize the economy and meet growth targets. The statement from the meeting mentioned “stability” 31 times, compared with 22 in 2018.1  The statement also reiterated the importance of doubling GDP and per capita income by 2020. This suggests that a growth imperative remains the top priority and reinforces the leadership’s reflationary policy stance for next year. We previously projected that the Chinese government would allow a lower GDP growth target for 2020, between 5.5 and 6.0%. However, we think growth targets to be set at next March’s National People’s Congress (NPC) are more likely to be in a “reasonable range” (verbiage used in the CEWC statement) between 5.8 and 6.2%. As noted in our December 11 report,2 the Chinese economy needs to increase by 6% in 2020 to double its size from the 2010 level in real terms. While China’s real GDP statistics are suspiciously smooth and largely invalid when it comes to equity market pricing, the deviation between market expectations and the actual GDP growth target range set at NPC can help investors gauge how much more (or less) ammunition Chinese policymakers are willing to deploy to support the economy in that year. China is falling short of its target to double real urban per capita income next year from 10 years ago (Chart 4). Nominal wage and salary per capita growth has experienced a sharp drop since the third quarter of 2018 and probably contributed to the subdued appetite for consumption (Chart 5). Chart 4Household Income: Rural Overshooting; Urban Falling Short Household Income: Rural Overshooting; Urban Falling Short Household Income: Rural Overshooting; Urban Falling Short Chart 5Wage Growth Only Started Stabilizing Recently Wage Growth Only Started Stabilizing Recently Wage Growth Only Started Stabilizing Recently   To meet the target, urban per capita income will need to grow at an above-real GDP rate of 10% in 2020, almost doubling the growth in 2018 and 2019.  Given the still weak domestic economic conditions, we are not optimistic that China will be able to double the growth rate of urban income per capita in 2020 from 2019. Additionally, income typically lags economic activity. Even if China’s economic slowdown bottoms in the first quarter of 2020, it is unlikely we will see significant improvement in income until a few quarters later. Therefore, we think policymakers will likely focus on overall economic and employment growth stability, and poverty reduction through improving rural income in 2020 (Chart 4, top panel). A Shift In Policy Priorities The new year marks the final year of the “Three Major Battles” against financial deleveraging, poverty elimination, and pollution. In this year’s CEWC statement, for the first time in three years, the order of the battles has been rearranged with financial deleveraging ranked behind poverty reduction and environment protection. The PBoC will stay on a mild rate-cutting cycle throughout next year. The shift in policy priorities suggests that the pressure to deleverage has greatly eased. Banks’ asset balance sheets will expand at a faster rate, while the pace of reduction in shadow banking will likely continue to moderate (Chart 6). The description of monetary policy stance was amended to “maintaining a flexible and appropriate monetary policy” from last year’s “appropriately loose or tight.” The change points to a more dovish tone, confirming our assessment that the PBoC will stay on a mild rate-cutting cycle to lower corporate funding costs throughout the next year3 (Chart 7). Chart 6In 2020, Expect Faster Bank Balance Sheet Expansion In 2020, Expect Faster Bank Balance Sheet Expansion In 2020, Expect Faster Bank Balance Sheet Expansion Chart 7The PBoC's Rate-Cutting Cycle Will Continue Next Year The PBoC's Rate-Cutting Cycle Will Continue Next Year The PBoC's Rate-Cutting Cycle Will Continue Next Year   At this stage, we do not anticipate the Chinese policymakers will entirely abandon financial risk containment or significantly loosen financial regulations. Rather, we think the reduced pressure on deleveraging and lowering of funding costs will provide moderate support for the private sector, specifically small- and medium-sized enterprises.  A slew of new policies announced before the CEWC, including an adjustment to some of the parameters in the Macro-Prudential Assessment (MPA) framework to encourage lending to the private sector,4 will help strengthen the impact of PBoC’s countercyclical measures. A Bigger Fiscal Push This year’s CEWC statement indicated policymakers will continue to fine-tune a proactive fiscal policy, but unlike last year, the meeting did not specify further cuts to taxes. The statement suggests fiscal support to the economy will mainly focus on infrastructure, and listed transportation, urban and rural development, and the 5G networks to be the government’s main investment projects next year. Chart 8Local Governments Have Borrowed More Than They Spent Local Governments Have Borrowed More Than They Spent Local Governments Have Borrowed More Than They Spent In 2019, infrastructure investment was subdued, despite increased quotas for local government special-purpose bond issuance. Our research shows that local government infrastructure expenditures in 2019 have consistently lagged behind their borrowing (Chart 8). The gap between local government infrastructure funding deficit and borrowing has only started flattening in the third quarter of this year. The delayed conversion from borrowing to spending means local governments have accumulated more spending power for 2020. In order to encourage local governments to speed up spending, the central government is also likely to further loosen up project restrictions. A bigger fiscal push by the central government, coupled with a frontloading of 2020 local government special-purpose bond issuance, will likely boost infrastructure spending to around 10% in the first two quarters, doubling the growth in the first eleven months of 2019.5  More robust fiscal stimulus will lead to an increase in the debt load of local governments, but Chinese policymakers are caught between a rock and a hard place and therefore must choose the least risky tools to stimulate the economy.  In our view, local government bonds are still a better option over local government financing vehicles (LGFVs) or other illicit channels. Social Housing Gets Another Boost Surprisingly,6 last week’s CEWC statement again emphasized the importance of shantytown renovation (Chart 9). While this implies there would likely be a significant monetary boost to social housing in the coming year, the statement also indicated that policymakers would not want property prices to dramatically change in either direction. Even though local governments have been granted more flexibility to fine-tune their local housing policies, we think the possibility of a broad-based regulatory easing in the housing market remains low in 2020. Therefore, government subsidies in social housing in 2020 will unlikely to lead to another property market boom like that of 2016. Chart 9Social Housing Gets Another Fiscal Boost Social Housing Gets Another Fiscal Boost Social Housing Gets Another Fiscal Boost If the scale of the cyclical policy support in 2020 is still moderate, then we think the stimulus may delay, but not entirely derail China’s progress in structural rebalancing, particularly if the current financial regulations remain in place. The CEWC statement also mentioned deepening reforms of state-owned enterprises (SOEs), and a “three-year SOE reform executive plan”, which we will be closely monitoring in the coming year. Last year’s reference to “striving for stronger, better and larger state assets” was replaced this year by “accelerating the reform of SOEs and optimization of SOE resource allocation”, implying there will be a greater emphasis on the quality and efficiency of SOEs’ assets. These plans can potentially impact SOE profit margins and accelerate the pace of industry consolidation among SOEs. The statement also dedicated a lengthy and detailed segment to "promoting high-quality development", covering topics ranging from the reform of the agricultural supply side to accelerating the implementation of regional development strategies. Further details are expected after next March’s NPC in Beijing. At that time, we will have a Special Report to consider some of the strategic and regional planning initiatives discussed at the meeting and their market implications. Bottom Line: The past week’s CEWC reinforces our view, that the Chinese leadership’s urgency to stabilize the economy has shifted to overweigh the desire to continue financial deleveraging.  Monetary policy will only moderately loose further, but fiscal stimulus may overshoot in the first half of 2020.  Investment Conclusions We have been cyclically overweight Chinese stocks on the basis of a bottoming in the economy in the first quarter of 2020, and the likelihood of an eventual trade deal.  Tactically however, we have been more cautious because of the potential for further near-term downside in the economic data, and the uncertainty surrounding the timing and nature of a trade deal. While the tariff reduction in the trade deal announced last week is somewhat disappointing, the combination of a trade agreement, bullish equity market signals, and the positive messages from last week’s CEWC warrant an upgrade to our tactical stance on Chinese stocks from neutral to overweight. As such, our cyclical and tactical calls are now both aligned in favor of Chinese stocks within a global equity portfolio. As a final point, we noted in last week's report that there are decent odds that all of the outperformance of Chinese stocks in 2020 will be frontloaded in the first half of the year. In the new year, we look forward to providing an ongoing assessment of whether Chinese economic growth has more or less potential upside than we currently expect, along with the attendant investment implications of our analysis. Stay tuned!   Jing Sima China Strategist jings@bcaresearch.com   Footnotes 1   http://www.gov.cn/xinwen/2019-12/12/content_5460670.htm http://www.xinhuanet.com/english/2019-12/12/c_138626531.htm 2   Please see China Investment Strategy Weekly Report "2020 Key Views: Four Themes For China In The Coming Year," dated December 11, 2019, available at cis.bcaresearch.com 3, 5 Please see China Investment Strategy Weekly Report "Questions From The Road: Timing The Turn," dated November 20, 2019, available at cis.bcaresearch.com 4   http://www.gov.cn/premier/2019-12/14/content_5461147.htm 6   In our last week’s China Investment Strategy 2020 Outlook report, we had projected less monetary support to this sector in 2020. Cyclical Investment Stance Equity Sector Recommendations

Highlights 2019 was a good year for our constraint-based method of political analysis. Trump was impeached, the trade war escalated, and China (modestly) stimulated – all as predicted. Nevertheless Trump caught us by surprise in Q2, with sanctions on Iran and tariffs on China. Our best trades were long defense stocks, gold, and Swiss bonds. Our worst trade was long rare earth miners. Feature Jean Buridan’s donkey starved to death because, faced with equal bundles of grain on both sides, it could not decide which to eat. So the legend goes. Investors face indecision all the time. This is especially the case when a geopolitical sea change is disrupting the global economy. Two or more political outcomes may seem equally plausible, heightening uncertainty. What is needed is a method for eliminating the options that require the farthest stretch. That’s what we offer in these pages, but we obviously make mistakes. The purpose of our annual report card is to identify our biggest hits and misses so we can hone our ability to combine fundamental macro and market analysis with the “art of the possible,” delivering better research and greater returns for clients. This is our last report for 2019. Next week we will publish a joint report with Anastasios Avgeriou of BCA Research’s US Equity Strategy. We will resume publication in early January. We wish all our clients a merry Christmas, happy holidays, and a happy new year! American Politics: Unsurprising Surprises Chart 1Our 2019 Forecast Held Up Our 2019 Forecast Held Up Our 2019 Forecast Held Up On the whole our 2019 forecast held up very well. We argued that the global growth divergence that began in 2018 would extend into 2019 with the Fed hiking rates, a lack of massive stimulus from China, and an escalation in the US-China trade war. The biggest miss was that the Fed actually cut rates three times – addressed at length in our BCA Research annual outlook. But the bulk of the geopolitical story panned out: the US dollar, US equities, and developed market equities all outperformed as we expected (Chart 1). Geopolitical risk in the Trump era is centered on Trump himself. Beginning in 2017, we argued that the Democrats would take the House of Representatives in the midterm elections and impeach the president. Congress would not be totally gridlocked: while we argued for a government shutdown in late 2018, we expected a large bipartisan budget agreement in late 2019 and always favored the passage of the USMCA trade deal. Still, Congress would encourage Trump to go abroad in pursuit of policy victories, increasing geopolitical risks. We also argued that, barring “smoking gun” evidence of high crimes, the Republican-held Senate would acquit Trump – assuming his popularity held up among Republican voters themselves (Chart 2). These views either transpired or remain on track. The implication is that Trump-related risk continues and yet that Trump’s policies are ultimately constrained by the guardrails of the election. The latter factor helped propel the equity rally in the second half of the year. We largely sat out that rally, however. We overestimated the chances that Senator Bernie Sanders would falter and Senator Elizabeth Warren would swallow his votes, challenging former Vice President Joe Biden for the leading position in the early Democratic Party primary. We expected a significant bout of equity volatility via fears of a sharp progressive-populist turn in US policy (Chart 3). Instead, Sanders staged a recovery, Warren fell back, Biden maintained his lead, and markets rallied on other news. Chart 2Trump Will Be Acquitted How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Chart 3Fears Of A Progressive Turn Did Not Derail The H2 Rally How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Warren could still recover and win the nomination next year. But the Democratic Primary was not a reason to remain neutral toward equities, as we did in September and October. China’s Tepid Stimulus In recent years China first over-tightened and then under-stimulated the economy – as we predicted. But we misread the credit surge in the first quarter as a sign that policymakers had given up on containing leverage. In total this year’s credit surge amounts to 3.4% of GDP, about 1.2% short of what we expected (based on half of the 9.2% surge in 2015-16) (Chart 4). China’s credit surge was about 1.2% short of what we expected, but the direction was correct. While the government maintained easy monetary policy as expected, its actions combined with negative sentiment to snuff out the resurgence in shadow banking by mid-year (Chart 5). Chart 4China's Credit Surge Was Underwhelming China's Credit Surge Was Underwhelming China's Credit Surge Was Underwhelming Still, China’s policy direction is clear – and fiscal policy is indeed carrying a greater load. The authorities are extremely unlikely to reverse course next year, so global activity should turn upward (Chart 6). Our “China Play Index” – iron ore prices, Swedish industrials, Brazilian stocks, and EM junk bonds, all in USD terms – has appreciated steadily (Chart 7). Chart 5China's Shadow Banking Remained Under Pressure China's Shadow Banking Remained Under Pressure China's Shadow Banking Remained Under Pressure   Chart 6Global Activity Should Turn Upward In 2020 Global Activity Should Turn Upward In 2020 Global Activity Should Turn Upward In 2020 Chart 7Our 'China Play Index' Performed Well Our 'China Play Index' Performed Well Our 'China Play Index' Performed Well US-China: Underestimating Trump’s Risk Appetite We have held a pessimistic assessment of US-China relations since 2012. We rejected the trade truces agreed at the G20 summits in December 2018 and June 2019 as unsustainable. Our subjective probabilities of Trump achieving a bilateral trade agreement with China have never risen above 50%. Since September we have expected a ceasefire but not a full-fledged deal. Nevertheless we struggled with the timing of the trade war ups and downs (Chart 8). In particular we accepted China's new investment law as a sufficient concession and were surprised on May 5 when talks collapsed and Trump increased the tariffs. The lack of constraints on tariffs prevailed in 2019 but in 2020 the electoral constraint will prevail as long as Trump still has a chance of winning. Our worst trade recommendation of the year emerged from our correct view that the June G20 summit would lead to trade war escalation. We went long rare earth miners based outside of China. We expected China to follow through on threats to impose a rare earth embargo on the US in retaliation for sanctions against Chinese telecom giant Huawei. Not only did the US grant Huawei a reprieve, but China’s rare earth companies outperformed their overseas rivals. The trade went deeply into the red as global sentiment and growth fell (Chart 9). Only with global growth turning a corner have these high-beta stocks begun to turn around. Chart 8Expect A Ceasefire, Not A Full-Fledged Trade Agreement Expect A Ceasefire, Not A Full-Fledged Trade Agreement Expect A Ceasefire, Not A Full-Fledged Trade Agreement Chart 9Our Worst Call: Long Rare Earth Miners Our Worst Call: Long Rare Earth Miners Our Worst Call: Long Rare Earth Miners Chart 10North Korean Diplomacy Has Not Collapsed (Yet) North Korean Diplomacy Has Not Collapsed (Yet) North Korean Diplomacy Has Not Collapsed (Yet) Our sanguine view on North Korea was largely offside this year. Setbacks in US negotiations with North Korea have often preceded setbacks in US-China talks. This was the case with the failed Hanoi summit in February and the inconsequential summit at the demilitarized zone in June. This could also be the case in 2020, as Washington and Pyongyang are now on the verge of breaking off talks with the latter threatening a “Christmas surprise” such as a nuclear or missile test. It is not too late to return to talks. Beijing is the critical player and is still enforcing crippling sanctions on North Korea (Chart 10). Beijing would benefit if North Korea submitted to nuclear and missile controls while the US reduced its military presence on the peninsula. We view this year as a hiccup in North Korean diplomacy but if talks utterly collapse and military tensions break out then it would undermine our view on US-China talks, Trump’s reelection odds, and US Treasuries in 2020. Hong Kong, rather than Taiwan, became the site of the geopolitical “Black Swan” that we expected surrounding Xi Jinping’s aggressive approach to domestic dissent. We have never downplayed Hong Kong. The loss of faith in the governing arrangement with the mainland began with the Great Recession and shows no sign of abating (Chart 11). We shorted the Hang Seng after the protests began, but closed at the appropriate time (Chart 12). The problem is not resolved. Also, Taiwan can test its autonomy much farther than Hong Kong and we still expect Taiwan to become ground zero of Greater China political risk and the US-China conflict. Chart 11Hong Kong Discontent Is Structural How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Chart 12Our Hang Seng Short Is Done Our Hang Seng Short Is Done Our Hang Seng Short Is Done Chart 13Trump Needs A Trade Ceasefire Trump Needs A Trade Ceasefire Trump Needs A Trade Ceasefire Trump is unlikely to seek another trade war escalation given the negative impact it would have on sentiment and the economy (Chart 13). He could engage in another round of “fire and fury” saber-rattling against North Korea, as the economic impact is small, but he will prefer a diplomatic track. Taiwan, however, cannot be contained so easily if tempers flare. As we go to press it is not clear if Trump will hike the tariff on China on December 15. Some investors would point to his tendency to take aggressive action when the market gives him ammunition (Chart 14). We doubt he will, as this would be a policy mistake – possibly quickly reversed or possibly fatal for Trump. Trump’s electoral constraint is more powerful in 2020 than it was in 2019. Chart 14Trump Ceasefire Will Last As Long As Economy Is At Risk Trump Ceasefire Will Last As Long As Economy Is At Risk Trump Ceasefire Will Last As Long As Economy Is At Risk Chart 15Our 'Doomsday Basket' Captured Trump's First Three Years Our 'Doomsday Basket' Captured Trump's First Three Years Our 'Doomsday Basket' Captured Trump's First Three Years Our best tactical trade of the year stemmed from the geopolitical risk in Asia (and the Fed’s pause): we recommended a long gold position this summer that gained 16%. We also closed out our “Doomsday Basket” of gold and Swiss bonds, initiated in Trump’s first year, for a gain of 14% (Chart 15). Now that the market has digested Trump’s tactical retreat, we have reinitiated the gold trade as a long-term strategic hedge against both short-term geopolitical crises and the long-term theme of populism. Iran: Fool Me Once, Shame On You … This is the second year in a row that we are forced to explain our analysis of Iran – we were only half-right. Our long-held view is that grand strategy will push the US to pivot to Asia to counter China while scaling back its military activity in the Middle East. Two American administrations have confirmed this trend. That said, there is still a risk that President Trump will get entangled in Iran and that risk is growing. Global oil volatility – which spiked during the market share wars of 2014 – declined through the beginning of 2018, until the Trump administration took clearer steps toward a policy of “maximum pressure” on Iran. The constraints on Trump are obvious: the US economy is still affected by oil prices, which are set globally, and Iran can damage supply and push up prices. Therefore Trump should back down prior to the 2020 election. Yet Trump imposed sanctions, waivered on them, and then re-imposed them in May 2019 – catching us by surprise each time (Chart 16). Chart 16Trump Flip-Flopped On Iran Policy Trump Flip-Flopped On Iran Policy Trump Flip-Flopped On Iran Policy Chart 17Iran Tensions Backwardated Oil Markets Iran Tensions Backwardated Oil Markets Iran Tensions Backwardated Oil Markets This saga is not resolved – we are witnessing what could become a secular bull market in Iran tensions. True, a Democratic victory in 2020 could lead to an eventual restoration of the 2015 nuclear deal. True, the Trump administration could strike a deal with the Iranians (especially after reelection). But no, it cannot be assumed that the US will restore the historic 2015 détente with Iran. Within Iran the regime hardliners are likely to regain control in advance of the extremely uncertain succession from Supreme Leader Ali Khamenei and this will militate against reform and opening up. We went long Brent crude Q1 2020 futures relative to Q1 2021 to show that tensions were not resolved (Chart 17) – the attack on Saudi Arabia in September confirmed this view. And yet the oil price shock was fleeting as global supply was adequate and demand was weak. Our current long Brent spot trade is not only about Iran. Global growth is holding up and likely to rebound thanks to monetary stimulus and trade ceasefire, OPEC 2.0 has strong incentives to maintain production discipline (driven by both Saudi Arabian and Russian interests), and the Iranian conflict has led to instability in Iraq, as we expected. The UK: Not Dead In A Ditch British Prime Minister Boris Johnson proclaimed this year that he would "rather be dead in a ditch” than extend the deadline for the UK to leave the EU. The relevant constraint was that a disorderly “no deal” exit would have meant a recession, which we used as our visual illustration of why Johnson would not actually die in a ditch (Chart 18). The test was whether parliament could overcome its coordination problems when it reconvened in September, which it immediately did, prompting us to go long GBP-USD on September 6 (Chart 19). This trade was successful and we remain long GBP-JPY. Chart 18The Reason We Rejected How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Chart 19UK Parliament Voted Down No-Deal Brexit UK Parliament Voted Down No-Deal Brexit UK Parliament Voted Down No-Deal Brexit Populism faltered in Europe, as expected. As we go to press, the UK Christmas election is reported to have produced a whopping Conservative majority. This year Johnson mounted the most credible threat of a no-deal Brexit that we are ever likely to see and yet ultimately delayed Brexit. The Conservative victory will produce an orderly Brexit. The trade deal that needs to be negotiated next year will bring volatility but it does not have a firm deadline and is not harder to negotiate than Brexit itself. The UK has passed through the murkiest parts of Brexit uncertainty. Moreover, our high-conviction view that more dovish fiscal policy would be the end-result of the Brexit saga is now becoming consensus. Europe: Not The Crisis You Were Looking For The European Union was a geopolitical “red herring” in 2019 as we expected. Anti-establishment feeling remained contained. Italy remains the weakest link in the Euro Area, but the political “turmoil” of 2018-19 is the populist exception that mostly proves the rule: Europeans are not as a whole rebelling against the EU or the euro. On France, Italy, and Spain our views were fundamentally correct. Even in the European parliament, where anti-establishment players have a better chance of taking seats than in their home governments, the true Euroskeptics who want to exit the union only make up about 16% of the seats (Chart 20). This is up from 11% prior to the elections in May this year. Chart 20Euroskepticism Was Overstated How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Yet the European political establishment is losing precious time to prepare for the next wave of serious agitation, likely when a full-fledged recession comes. Chart 21Trump Did Not Pile Tariffs Onto Auto Sector Trump Did Not Pile Tariffs Onto Auto Sector Trump Did Not Pile Tariffs Onto Auto Sector Germany is experiencing a slow transition from the long reign of Angela Merkel, whose successor has plummeted in opinion polls. The shock of the global slowdown – particularly heavy in the auto sector (Chart 21) – hastened Germany’s succession crisis. Chart 22Overstated EU Political Risk, Understated Chinese Risk Overstated EU Political Risk, Understated Chinese Risk Overstated EU Political Risk, Understated Chinese Risk There is a silver lining: this shock is forcing the Germans to reckon with de-globalization. Attitudes across the country are shifting on the critical question of fiscal policy. Even the conservative Christian Democrats are loosening their belts in the face of the success of the Green Party and a simultaneous change in leadership among the Social Democrats to embrace bigger spending. The Trump administration refrained from piling car tariffs onto Europe amidst this slowdown in the automobile sector and overall economy. We expected this delay, as there is little support in the US for a trade war with Europe, contra China, and it is bad strategy to fight a two-front war. But if the US economy recovers robustly and Trump is emboldened by a China deal then this risk could reignite in future. With European political risk overstated, and Chinese mainland risk understated, we initiated a long European equities relative to Chinese equities trade (Chart 22), as recommended by our colleagues at BCA Research European Investment Strategy. And now we are initiating the strategic long EUR/USD recommendation that we flagged in September with a stop at 1.18. Japan: Shinzo Abe Has Peaked Japanese Prime Minister Shinzo Abe is still in power and still very popular, whether judged by the average prime minister in modern memory or his popular predecessor Junichiro Koizumi. But he is at his peak and 2019 did indeed mark the turning point – it is all downhill from here. First, he lost his historic double super-majority in the Diet by falling to a mere majority in the upper house (Chart 23). He is still capable of revising the constitution, but now it is now harder – and the high water mark of his legislative power has been registered. Chart 23Abe Lost His Double Super Majority How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card Chart 24Consumption Tax Hike Shows Limits Of Abenomics Consumption Tax Hike Shows Limits Of Abenomics Consumption Tax Hike Shows Limits Of Abenomics Second, he proceeded with a consumption tax from 8% to 10% that predictably sent the economy into a tailspin given the global slowdown (Chart 24). We thought the tax hike would be delayed, but Abe opted to hike the tax and then pass a stimulus package to compensate. This decision further supports the view that Abe’s power will decline going forward. It is now incontrovertible that the Liberal Democrats are eschewing a radical plan of debt monetization in which they coordinate ultra-dovish fiscal policy with ultra-dovish monetary policy. “Abenomics” has not necessarily failed but it is a fully known quantity. Abe will next preside over the 2020 summer Olympics and prepare to step down as Liberal Democratic party leader in September 2021. It is conceivable he will stay longer, but the likeliest successors have been put into cabinet positions, including Shinjiro Koizumi, son of the aforementioned, whom we would not rule out as a future prime minister. Constitutional revision or a Russian peace deal could mark the high point of his premiership, but the peak macro consequences have been felt. Japan suffered a literal and figurative earthquake in 2011. Over the long run Tokyo will resort to more unorthodox economic policies and redouble its efforts at reflation. But not until the external environment demands it. This suggests that the JPY-USD is a good hedge against risks to the cyclically bullish House View in 2020 and supports an overweight stance on Japanese government bonds. Emerging Markets: Notable Mentions India: We were correct that Narendra Modi would be reelected as prime minister, but we did not expect that he would win a single-party majority for a second time (Chart 25). The risk is that this result leads to hubris – particularly in foreign policy and domestic social policy – rather than accelerating structural reform. But for now we remain optimistic about reform. Chart 25 How Are We Doing? ... Geopolitical Strategy 2019 Report Card How Are We Doing? ... Geopolitical Strategy 2019 Report Card East Asia: We are optimistic on Southeast Asia in the context of US-China competition. But we proved overly optimistic on Malaysia and Indonesia this year, while we missed a chance to close our long Thai equity trade when it would have been very profitable to do so. Turkey: Domestic political challenges to President Recep Tayyip Erdoğan have led to a doubling down on unorthodox monetary policy and profligate fiscal policy, as expected. Early in the year we advised clients that Erdoğan would delay deployment of the Russian S-400 air defense system in deference to the US but it quickly became clear that this was not the case. Thus we correctly anticipated the sharp drop in the lira over the autumn (Chart 26). The US-Turkey relationship continues to fray and additional American sanctions are likely. Russia: President Vladimir Putin focused on maintaining domestic stability amid tight fiscal and monetary policy in 2019. This solidified our positive relative view of Russian currency and equities (Chart 27). But it also highlighted longer-term political risks. We expect this trend to continue, but by the same token Russia is a potential “Black Swan” risk in 2020. Chart 26The Lira's Autumn Relapse The Lira's Autumn Relapse The Lira's Autumn Relapse Chart 27Russia's Eerie Quiet In 2019 Russia's Eerie Quiet In 2019 Russia's Eerie Quiet In 2019 Venezuela: Venezuela’s President Nicolas Maduro eked out another year of regime survival in 2019 despite our high-conviction view since 2017 that he would be finished. However, the economy is still collapsing and Russian and Chinese assistance is still limited (Chart 28). Before long the military will need to renovate the regime, even if our global growth and oil outlook for next year is positive for the regime on the margin. Chart 28Maduro Clung To Power Maduro Clung To Power Maduro Clung To Power Chart 29Our 2019 Winner: Global Defense Stocks Our 2019 Winner: Global Defense Stocks Our 2019 Winner: Global Defense Stocks Brazil: We were late to the Brazilian equity rally. While we have given the Jair Bolsonaro administration the benefit of the doubt, a halt to structural reforms in 2020 would prove us wrong. Our worst trade of the year was long rare earth miners, mentioned above. Our best trade was long global defense stocks (Chart 29), a structural theme stemming from the struggle of multiple powerful nations in the twenty-first century. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com Roukaya Ibrahim Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com Ekaterina Shtrevensky Research Analyst ekaterinas@bcaresearch.com Jingnan Liu Research Associate jingnan@bcaresearch.com Marko Papic Consulting Editor marko@bcaresearch.com

  Dear Client, In lieu of our regular report next week, I will be hosting a webcast on Wednesday, December 18th at 10:00 AM EST, where I will discuss the major investment themes and views I see playing out for 2020. This will be the last Global Investment Strategy report of 2019, with publication resuming early next year. On behalf of the entire Global Investment Strategy team, I would like to wish you a Merry Christmas, Happy Holidays, and a Healthy New Year! Best regards, Peter Berezin, Chief Global Strategist   Overall Investment Strategy: Global growth should accelerate in 2020. Favor stocks over bonds. A more defensive stance will be appropriate starting in late 2021. Equities: Upgrade non-US equities to overweight at the expense of their US peers. Cyclical stocks, including financials, will outperform defensives. Fixed Income: Central banks will stay dovish, but bond yields will nevertheless rise modestly thanks to stronger global growth. Favor high-yield corporate credit over investment grade and sovereigns. Currencies: The US dollar will weaken in 2020 against EUR, GBP, CAD, AUD, and most EM currencies. The dollar will be flat against the yen and the Swiss franc. Commodities: Oil and industrial metals prices will move higher. Gold prices will be range-bound next year, but should rally in 2021 once inflation finally breaks out. GIS View Matrix Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead   I. Global Macro Outlook Stronger Global Growth Ahead We turned bullish on global equities last December after temporarily moving to the sidelines in the summer of 2018. Last month, we increased our procyclical bias by upgrading non-US stocks within our recommended equity allocation at the expense of their US peers. The decision to upgrade non-US equities stems from our expectation that global growth will strengthen in 2020. Global financial conditions have eased sharply this year, largely due to the dovish pivot by many central banks. Monetary policy affects the economy with a lag. This is one reason why the net number of central banks cutting rates has historically led global growth by about 6-to-9 months (Chart 1). Chart 1The Effects Of Easing Monetary Policy Should Soon Trickle Down To The Economy The Effects Of Easing Monetary Policy Should Soon Trickle Down To The Economy The Effects Of Easing Monetary Policy Should Soon Trickle Down To The Economy In addition, there is mounting evidence that the global manufacturing cycle is bottoming out (Chart 2). The “official” Chinese PMI produced by the National Bureau of Statistics rose above 50 in November for the first time since May. The private sector Caixin manufacturing PMI has been improving for five consecutive months. The euro area manufacturing PMI increased over the prior month, led by gains in Germany and France. Chart 2A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle A Fairly Regular Three-Year Manufacturing Cycle Chart 3The Auto Sector Is Showing Signs Of Life (I) The Auto Sector Is Showing Signs Of Life (I) The Auto Sector Is Showing Signs Of Life (I)   The PMI data for the US has been mixed. The ISM manufacturing index weakened in November. In contrast, the Markit PMI rose to a seven-month high. Despite its shorter history, we tend to give the Markit PMI more credence. It is based on a larger sample of companies and has sector weights that closely match the actual composition of US output. As such, the Markit PMI is better correlated with hard data on manufacturing production, employment, and factory orders. The auto sector has been particularly hard hit during this manufacturing downturn. Fortunately, the industry is showing signs of life. The Markit euro area auto sector PMI has rebounded, with the new orders-to-inventory ratio moving back into positive territory for the first time since the autumn of 2018. US banks stopped tightening lending standards for auto loans in the third quarter. They are also reporting stronger demand for vehicle financing (Chart 3). In China, vehicle production and sales are improving on a rate-of-change basis (Chart 4). Both automobile ownership and vehicle sales in China are still a fraction of what they are in most other economies, suggesting further upside for sales (Chart 5). Chart 4The Auto Sector Is Showing Signs Of Life (II) The Auto Sector Is Showing Signs Of Life (II) The Auto Sector Is Showing Signs Of Life (II) Chart 5China: Structural Outlook For Autos Is Bright China: Structural Outlook For Autos Is Bright China: Structural Outlook For Autos Is Bright     Trade War Uncertainty The trade war remains the biggest risk to our sanguine view on global growth. As we go to press, rumors are swirling that the US and China have reached a “Phase One” trade deal that would cancel the scheduled December 15th tariff hike and roll back as much as half of the existing tariffs. If this were to occur, it would be consistent with our expectation of a trade truce. Nevertheless, it is impossible to be certain about how things will unfold from here. The best we can do is think through the incentives that both sides face and assume they will act in their own self-interest. For President Trump, the key priority is to get re-elected next year. Trump generally gets poor grades from voters on most issues. The one exception is the economy. Rightly or wrongly, the majority of voters approve of his handling of the economy (Chart 6). An escalation of the trade war would hurt the US economy, especially in a number of Midwestern states that Trump needs to win to remain president (Chart 7). Chart 6Trump Gets Reasonably High Marks On His Handling Of The Economy, But Not Much Else Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead Chart 7Economic Health Of The US Midwest Matters For Trump Economic Health Of The US Midwest Matters For Trump Economic Health Of The US Midwest Matters For Trump A resurgence in the trade war would also hurt Trump’s credibility. The point of the tariffs was not simply to raise revenue; it was to get China to the negotiating table. As a self-described master negotiator, President Trump now has to produce a “great” deal for the American people. If he had finalized an agreement with China a year or two ago, he would currently be on the hook for showing that it resulted in a smaller trade deficit. But with the presidential election only a year away, he can semi-credibly claim that the trade balance will only improve after he is re-elected. For their part, the Chinese would rather grapple with Trump now than face him after the election when he will no longer be constrained by re-election pressures. China would also like to avoid facing someone like Elizabeth Warren or Bernie Sanders, who may insist on including stringent environmental and human rights provisions in any trade deal. At least with Trump, the Chinese know that they are getting someone who is focused on commercial issues. Contrary to most media reports, there is a fair amount of overlap between what Trump wants and what the Chinese themselves would like to achieve. For example, as China has moved up the technological ladder, many Chinese companies have begun to complain about intellectual theft by their domestic rivals. Thus, strengthening intellectual property protection has become a priority for Chinese officials. Along the same vein, China aspires to transform the RMB into a reserve currency. A country cannot have a reserve currency unless it also has an open capital account. Hence, financial market liberalization must be part of China’s long-term reform strategy. These mutual interests between the US and China could provide the basis for a trade truce. The Changing Nature Of Chinese Stimulus Chart 8China: Credit Growth Is Only A Few Percentage Points Above Nominal GDP Growth China: Credit Growth Is Only A Few Percentage Points Above Nominal GDP Growth China: Credit Growth Is Only A Few Percentage Points Above Nominal GDP Growth If a détente in the trade war is reached, will this prompt China to go back to its deleveraging campaign? We do not think so. For one thing, there can be no assurance that a trade truce will last. Thus, China will want to maintain enough stimulus as an insurance policy. In addition, credit growth is currently running only a few percentage points above nominal GDP growth (Chart 8). With the ratio of credit-to-GDP barely rising, there is little need to bring credit growth down much from current levels. This does not mean that the Chinese authorities will allow credit growth to increase significantly further. Instead, the authorities will continue shifting the composition of credit growth from the riskier shadow banking sector to the safer formal banking sector, while increasingly leaning on fiscal policy to buttress growth. One of the developments that has gone largely unnoticed by investors this year is that China’s general government deficit has climbed from around 3% of GDP in mid-2018 to 6.5% of GDP at present (Chart 9). Some of this stimulus has been used to finance tax cuts for households. Some of it has also been used to finance infrastructure spending, which requires imports of raw materials and capital goods. As a result of this fiscal easing, the combined Chinese credit/fiscal impulse has risen to a two-year high. It leads global growth by about nine months (Chart 10). Chart 9China Has Been Stimulating, Fiscally China Has Been Stimulating, Fiscally China Has Been Stimulating, Fiscally Chart 10Chinese Stimulus Should Boost Global Growth Chinese Stimulus Should Boost Global Growth Chinese Stimulus Should Boost Global Growth   Europe On The Upswing Chart 11Euro Area Growth: The Good, The Bad, And The Ugly Euro Area Growth: The Good, The Bad, And The Ugly Euro Area Growth: The Good, The Bad, And The Ugly Chart 12German Economy: Some Green Shoots German Economy: Some Green Shoots German Economy: Some Green Shoots The weakness in euro area growth this year has been concentrated in Germany and Italy. France and Spain have actually grown at a trend-like pace (Chart 11). Germany should benefit from stronger global growth and a recovery in automobile production next year. The recent rebound in the German PMI, as well as improvements in the expectations components of the IFO, ZEW, and Sentix surveys are all encouraging in this regard (Chart 12). Italy should also gain from an easing in financial conditions and receding political risks (Chart 13). The Italian 10-year government bond yield has fallen from a high of 3.69% in October 2018 to 1.23% at present. Chart 13Easing Financial Conditions And Less Political Uncertainty Will Help Italy Easing Financial Conditions And Less Political Uncertainty Will Help Italy Easing Financial Conditions And Less Political Uncertainty Will Help Italy Chart 14Euro Area Fiscal Thrust Euro Area Fiscal Thrust Euro Area Fiscal Thrust   Fiscal policy across the euro area is also turning more stimulative. The fiscal thrust in the euro area rose to 0.4% of GDP this year mainly due to a somewhat larger budget deficit in France (Chart 14). The thrust should remain positive in 2020. Even in Germany, fiscal policy should loosen. Faster wage growth in Germany is eroding competitiveness relative to the rest of the euro area (Chart 15). That could force German policymakers to ratchet up fiscal stimulus in order to support demand. Already, the Social Democrats are responding to poor electoral performance by adopting a more proactive fiscal policy, hoping to stop the loss of votes to the big spending Greens. Chart 15Germany: Faster Wage Growth Eroding Competitiveness Relative To The Rest Of The Euro Area Germany: Faster Wage Growth Eroding Competitiveness Relative To The Rest Of The Euro Area Germany: Faster Wage Growth Eroding Competitiveness Relative To The Rest Of The Euro Area Chart 16Boris Johnson Won't Pursue A No-Deal Brexit Boris Johnson Won't Pursue A No-Deal Brexit Boris Johnson Won't Pursue A No-Deal Brexit   The UK economy should start to recover next year as Brexit uncertainty fades and fiscal policy turns more stimulative. Exit polls suggest that the Conservatives will command a majority government following today's election. There is not enough appetite within the Conservative party for a no-deal Brexit (Chart 16). As such, today's victory will allow Prime Minister Boris Johnson to push his proposed deal through Parliament. It will also allow him to fulfill his pledge to pass a budget that boosts spending.   Japan: Own Goal Japan has been hard hit by the global growth slowdown, given its close ties to its Asian neighbors, namely China. Add on a completely unnecessary consumption tax hike, and it is no wonder the economy has been faltering. Despite widespread weakness, there have been some very preliminary signs of improvement of late: The manufacturing PMI ticked up in November, while the services PMI rose back above 50. Consumer confidence also moved up to the highest level since June. Furthermore, Prime Minister Abe announced a multi-year fiscal package worth approximately 26 trillion yen. The headline number grossly overstates the size of the stimulus because it includes previously announced measures as well as items such as land acquisition costs that will not directly benefit GDP. Nevertheless, the package should still boost growth by about 0.5% next year, offsetting part of the drag from higher consumption taxes.  US: Chugging Along Despite the slowdown in global growth, a stronger dollar, and the trade war, US real final demand is on track to grow by 2.5% this year (Chart 17). This is above the pace of potential GDP growth of 1.7%-to-2%. Chart 17Underlying US Growth Remains Above Trend Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead The Fed’s 75 basis points of rate cuts has moved monetary policy even further into accommodative territory. Not surprisingly, residential housing – the most interest rate-sensitive part of the economy – has responded favorably (Chart 18). While the tailwind from lower mortgage rates will dissipate by next summer, we do not anticipate much weakness in the housing market. This is because the inventory levels and vacancy rates remain near record-low levels (Chart 19). The shortage of homes should buttress both construction and prices. Chart 18US Housing: On Solid Ground (I) US Housing: On Solid Ground (I) US Housing: On Solid Ground (I) Chart 19US Housing: On Solid Ground (II) US Housing: On Solid Ground (II) US Housing: On Solid Ground (II)   Strong labor and housing markets will support consumer spending, which represents nearly 70% of the economy. Business capital spending should also benefit from lower rates, receding trade tensions, and rising wages which are making firms increasingly eager to automate. II. Financial Markets Global Asset Allocation We argued in the section above that global growth should rebound next year thanks to easier financial conditions, an upturn in the global manufacturing cycle, a detente in the trade war, and modest Chinese stimulus. Chart 20 shows that stocks usually outperform bonds when global growth is accelerating. This occurs partly because corporate earnings tend to rise when growth picks up. BCA’s US equity strategy team expects S&P 500 EPS to increase by 5% next year if global growth merely stabilizes. An acceleration in global growth would surely lead to even stronger earnings growth. On the flipside, investors also tend to price out rate cuts (or price in rate hikes) when growth is on the upswing, resulting in lower bond prices (Chart 21). Chart 20Stocks Usually Outperform Bonds When Global Growth Is Accelerating Stocks Usually Outperform Bonds When Global Growth Is Accelerating Stocks Usually Outperform Bonds When Global Growth Is Accelerating Chart 21Improving Global Growth Boosts Earnings Growth...And Expectations Of Rate Hikes Improving Global Growth Boosts Earnings Growth...And Expectations Of Rate Hikes Improving Global Growth Boosts Earnings Growth...And Expectations Of Rate Hikes Relative valuations also favor stocks over bonds. Despite the stock market rally this year, the MSCI All-Country World Index currently trades at a reasonable 15.8-times forward earnings. This is below the forward PE ratio of 16.7 reached in January 2018 and even below the forward PE ratio of 16.4 hit in May 2015. Analysts expect global EPS to increase by 10% next year, below the historic 12-month expectation of 15% (Chart 22). In contrast to most years when analyst forecasts prove to be wildly overoptimistic, the current EPS forecast is likely to be met. Chart 22Analyst Expectations Are Not Wildly Optimistic Analyst Expectations Are Not Wildly Optimistic Analyst Expectations Are Not Wildly Optimistic Chart 23Equity Risk Premium Remains Quite Elevated Equity Risk Premium Remains Quite Elevated Equity Risk Premium Remains Quite Elevated   If one inverts the PE ratio, one can calculate an earnings yield for global equities of 6.3%. One can then calculate the implied equity risk premium (ERP) by subtracting the real long-term bond yield from the earnings yield. As Chart 23 illustrates, the ERP remains quite elevated by historic standards. Some observers might protest that the ERP is elevated mainly because bond yields are so low. If low bond yields are discounting very poor economic growth prospects, perhaps today’s PE ratio should be lower than it actually is? The problem with this argument is that growth prospects are not so bad. The IMF estimates that global growth will be slightly above its post-1980 average over the next five years (Chart 24). While trend growth is falling in both developed and emerging economies, the rising share of faster-growing emerging markets in global GDP is helping to prop up overall growth. Chart 24The Trend In Global Growth Has Remained Steady Thanks To Faster-Growing EM The Trend In Global Growth Has Remained Steady Thanks To Faster-Growing EM The Trend In Global Growth Has Remained Steady Thanks To Faster-Growing EM Sector And Regional Equity Allocation US stocks have outperformed their overseas peers by 10% year-to-date and by 137% since 2008. About half of the outperformance of US equities since the Great Recession was due to faster sales-per-share growth, a third was due to stronger margin growth, and the rest was due to relative PE expansion (Chart 25). Chart 25Faster Sales Growth, Rising Margins, And Relative PE Expansion Helped Drive US Outperformance Over The Past Decade Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead It is worth noting that the outperformance of US stocks is a fairly recent phenomenon. Between 1970 and 2008, European equity prices and EPS actually rose slightly faster than in the US (Chart 26). EM stocks also outperformed the US in the decade leading up to the Global Financial Crisis. Chart 26US Earnings Have Not Always Outpaced Their Peers US Earnings Have Not Always Outpaced Their Peers US Earnings Have Not Always Outpaced Their Peers We expect US stocks to rise in 2020 by about 5%-to-10%, but to lag their foreign peers in common-currency terms. There are four reasons for this: Sector skews favor non-US equities. Cyclical stocks tend to outperform defensives when global growth is strengthening and the US dollar is weakening (Chart 27). Cyclical sectors are overrepresented outside the US. We would include financials in our definition of cyclicals. Faster global growth next year will lift long-term bond yields. Since central banks are unlikely to raise rates, yield curves will steepen. Steeper yield curves will boost net interest margins, thus helping bank shares (Chart 28). European banks are more dependent on the spread between lending and borrowing rates than US banks, since the latter derive more of their profits from fees. Non-US stocks are quite a bit cheaper than their US peers. The forward PE for US equities currently stands at 18.1, well above the forward PE of 13.6 for non-US equities. Other valuation measures reveal an even bigger premium on US stocks (Chart 29). Differences in sector weights account for about a quarter of the valuation gap between the US and the rest of the world. The rest of the gap is due to cheaper valuations within sectors. Financials, for example, are notably less expensive in the rest of the world, particularly in Europe (Chart 30). The valuation gap between the US and the rest of the world is even starker if we compare earnings yields with bond yields. Since bond yields are lower outside the US, the implied equity risk premium is significantly higher for non-US stocks. Profit margins have less scope to rise in the US than in the rest of the world. According to MSCI data, net operating margins currently stand at 10.3% in the US compared to 7.9% abroad. Unlike in the US, margins in Europe and EM are still well below their pre-recession peaks (Chart 31). While US margins are unlikely to fall next year thanks to stronger global growth, rising wage growth will negatively impact profits in some labor-intensive industries. Labor slack is generally greater abroad, which should limit cost pressures. Uncertainty over the US election is likely to limit the gains to US equities. All of the Democratic frontrunners have pledged to roll back the 2017 Tax Cuts and Jobs Act to one degree or another. A full repeal of the Act would reduce S&P 500 EPS by about 10%. While such a dramatic move is far from guaranteed – for starters, it would require that the Democrats gain control of both the White House and the Senate – it does pose a risk to investors. The same goes for increased regulatory actions, which Senators Sanders and Warren have both vocally championed. Chart 27Cyclicals Do Well Versus Defensives When Global Growth Is Strengthening And The US Dollar Is Weakening Cyclicals Do Well Versus Defensives When Global Growth Is Strengthening And The US Dollar Is Weakening Cyclicals Do Well Versus Defensives When Global Growth Is Strengthening And The US Dollar Is Weakening Chart 28Steeper Yield Curves Help Financials Steeper Yield Curves Help Financials Steeper Yield Curves Help Financials   Chart 29US Equities Are More Expensive Than Stocks Abroad US Equities Are More Expensive Than Stocks Abroad US Equities Are More Expensive Than Stocks Abroad Chart 30European Financials Trade At A Substantial Discount To Their US Peers European Financials Trade At A Substantial Discount To Their US Peers European Financials Trade At A Substantial Discount To Their US Peers     Chart 31Profit Margins Have Less Scope To Rise In The US Than In The Rest Of The World Profit Margins Have Less Scope To Rise In The US Than In The Rest Of The World Profit Margins Have Less Scope To Rise In The US Than In The Rest Of The World Within the non-US universe, euro area stocks have the most upside potential. In contrast, we see less scope for Japanese stocks to outperform the global benchmark because of uncertainties over the impact of the consumption tax hike on domestic demand. In addition, a weaker trade-weighted yen next year will annul the currency translation gains that unhedged equity investors can expect to receive from other non-US stock markets. Lastly, the passage of a new investment law that requires investors wishing to “influence management” to receive prior government approval could cast a pall over recent efforts to improve corporate governance in Japan. Fixed Income Chart 32Inflation Excluding Shelter Has Been Muted Inflation Excluding Shelter Has Been Muted Inflation Excluding Shelter Has Been Muted Chart 33Long-Term Bond Yields Will Move Higher As Faster Growth Pushes Up Estimates Of The Neutral Rate Long-Term Bond Yields Will Move Higher As Faster Growth Pushes Up Estimates Of The Neutral Rate Long-Term Bond Yields Will Move Higher As Faster Growth Pushes Up Estimates Of The Neutral Rate Central banks will remain on the sidelines next year. Inflation is still running well below target in most economies. Even in the US, where slack has largely been absorbed and wage growth has risen, core inflation excluding housing has averaged only 1.2% over the past five years (Chart 32). Nevertheless, long-term bond yields will still move higher next year as investors revise up their estimate of the neutral rate in response to faster growth (Chart 33). On a regional basis, BCA’s fixed-income experts favor low-beta bond markets (Chart 34). Japanese bonds have a very low beta to the overall Barclays Global Treasury index because inflation expectations are quite depressed and the Bank of Japan will actively intervene to prevent yields from rising. On a USD currency-hedged basis, the Japanese 10-year yield stands at a relatively decent 2.38%, above the yield of 1.79% on comparable maturity US Treasurys (Table 1). Chart 34Favor Lower-Beta Government Bond Markets In 2020 Favor Lower-Beta Government Bond Markets In 2020 Favor Lower-Beta Government Bond Markets In 2020 Table 1Bond Markets Across The Developed World Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead In contrast to Japan, the beta of US Treasurys to the overall global bond index is relatively high, implying that Treasurys will underperform other sovereign bond markets in a rising yield environment. The beta for Germany, UK, Australia, and Canada lie somewhere between Japan and the US. Consistent with our bullish view on global equities, we expect corporate bonds to outperform sovereign debt in 2020 (Chart 35). Despite the weakness in manufacturing, US banks further eased terms on commercial and industrial loans in Q3, according to the Fed’s Senior Loan Officer Survey. Chart 35Stronger Growth Causes Corporate Spreads To Tighten Stronger Growth Causes Corporate Spreads To Tighten Stronger Growth Causes Corporate Spreads To Tighten At the US economy-wide level, neither interest coverage nor debt-to-asset ratios are particularly stretched (Chart 36). Admittedly, the picture looks less flattering if we focus solely on high-yield issuers (Chart 37). That said, a wave of defaults is very unlikely to occur in 2020, so long as the Fed is on hold and economic growth is on the upswing. Chart 36Corporate Debt: A Benign Top-Down View Corporate Debt: A Benign Top-Down View Corporate Debt: A Benign Top-Down View Chart 37Corporate Debt: More Concerning Picture Among High-Yield Issuers Corporate Debt: More Concerning Picture Among High-Yield Issuers Corporate Debt: More Concerning Picture Among High-Yield Issuers Chart 38US Corporates: Focus On High-Yield Credit HY Spread Targets US Corporates: Focus On High-Yield Credit HY Spread Targets US Corporates: Focus On High-Yield Credit Moreover, despite narrowing this year, high-yield spreads still remain above our fixed-income team’s estimate of fair value (Chart 38). They recommend moving down the credit curve and increasing the weight in Caa-rated bonds. These have underperformed this year largely because of technical factors such as their large exposure to the energy sector and relatively short duration. As oil prices rise next year, energy sector issuers will feel some relief. Moreover, unlike this year, rising long-term government bond yields in 2020 should also make shorter-duration credit more attractive. In contrast to high-yield spreads, investment-grade spreads have gotten quite tight. Investors seeking high-quality bond exposure should shift towards Agency MBS, which still carry an attractive spread relative to Aa- and A-rated corporate bonds. European IG bonds should also outperform their US peers thanks to faster growth in Europe next year and ongoing support from the ECB’s asset purchase program. Looking beyond the next 12-to-18 months, there is a strong chance that inflation will increase materially from current levels. The unemployment rate across the G7 has fallen to a multi-decade low, while the share of developed economies reaching full employment has hit a new cycle high (Chart 39). Chart 39ADeveloped Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Developed Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Developed Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Chart 39BDeveloped Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Developed Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Developed Markets: Unemployment Rates Keep Trending Lower... And Full Employment Reaching New Cycle Highs Chart 40The Phillips Curve Is Alive And Well The Phillips Curve Is Alive And Well The Phillips Curve Is Alive And Well   For all the talk about how the Phillips curve is dead, wage growth remains well correlated with labor market slack (Chart 40). Rising wages will boost real disposable incomes, leading to more spending. If economies cannot increase supply to meet higher demand, prices will rise. It simply does not make sense to argue that the price of apples will increase if the demand for apples exceeds the supply of apples, but that overall prices will not increase if the demand for all goods and services exceeds the supply of all goods and services. It will take at least until mid-2021 for inflation to rise above the Fed’s comfort zone. It will take even longer for rates to reach restrictive territory, and longer still for tighter monetary policy to make its way through the economy. However, at some point in 2022, the interest-rate sensitive sectors of the US economy will buckle, setting off a global economic downturn and a deep bear market in equities and credit. Enjoy it while it lasts. Currencies And Commodities The US dollar is a countercyclical currency, meaning that it usually moves in the opposite direction of the global business cycle (Chart 41). This countercyclicality stems from the fact that the US, with its large service sector and relatively small manufacturing base, is a “low beta economy.” Strong global growth does help the US, but it benefits the rest of the world even more. Thus, capital tends to flow out of the US when global growth strengthens, which puts downward pressure on the dollar. As global growth picks up in 2020, the dollar will weaken. EUR/USD should increase to around 1.15 by end-2020. GBP/USD will rise to 1.40. USD/CNY will move to 6.8. The Australian and Canadian dollars, along with most EM currencies, will strengthen as well. However, the Japanese yen and Swiss franc are likely to be flat-to-down against the dollar, reflecting the defensive nature of both currencies. Today's rally in the pound has raised the return on our short EUR/GBP trade to 10.5%. For now, we would stick with this position. Chart 42 shows that the pound should be trading near 1.30 against the euro based on real interest rate differentials, which is still well above the current level of 1.20. Chart 41The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency The Dollar Is A Countercyclical Currency Chart 42Interest Rate Differentials Suggest More Upside For The Pound Interest Rate Differentials Suggest More Upside For The Pound Interest Rate Differentials Suggest More Upside For The Pound   The trade-weighted dollar will continue to depreciate until late-2021, and then begin to strengthen again as the Fed turns more hawkish and global growth starts to falter. Commodity prices tend to closely track the global growth/dollar cycle (Chart 43). Industrial metal prices will fare well next year. Oil prices will also move up. Globally, the last of the big projects sanctioned prior to the oil-price collapse in late 2014 are coming online in Norway, Brazil, Guyana, and the US Gulf. Our commodity strategists expect incremental oil supply growth to slow in 2020, just as demand reaccelerates. Gold is likely to be range-bound for most of next year reflecting the crosswinds from a weaker dollar on the one hand (bullish for bullion), and receding trade war risks and rising bond yields on the other hand. Gold will have its day in the sun starting in 2021 when inflation finally breaks out. Our key market charts are shown on the following page. Peter Berezin Chief Global Strategist peterb@bcaresearch.com Chart 43Dollar Weakness Is A Boon For Commodities Dollar Weakness Is A Boon For Commodities Dollar Weakness Is A Boon For Commodities   Key Financial Market Forecasts Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead   MacroQuant Model And Current Subjective Scores Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategy Outlook – 2020 Key Views: Full Speed Ahead Strategic Recommendations Closed Trades

Highlights We are upgrading Pakistani equities to overweight within an EM equity portfolio. Fixed-income investors should consider purchasing 5-year local currency government bonds. The balance-of-payments adjustment is probably over. Hence, the currency will be stable, allowing inflation and interest rates to drop. Feature The country’s macro dynamics have shown signs of stabilization. This has begun benefiting share prices in both absolute terms and relative to the EM equity benchmark. Chart I-1Pakistani Stocks: The Worst Is Over Pakistani Stocks: The Worst Is Over Pakistani Stocks: The Worst Is Over We downgraded Pakistani equities in March 2017  and put this bourse on our upgrade watch list this past May (Chart I-1). In the past two years, the country has been going through a severe balance-of-payments crisis and a correspondingly painful adjustment. In recent months, the country’s macro dynamics have shown signs of stabilization. This has begun benefiting share prices in both absolute terms and relative to the EM equity benchmark. Today we are upgrading Pakistani stocks to overweight within an EM equity portfolio and recommend buying 5-year local currency government bonds. The worst is over for the economy and its financial markets for the following reasons. First, the country’s balance-of-payments position will improve. In real effective exchange rate (REER) terms, the Pakistani rupee has depreciated 15% over the past two years (Chart I-2). This will boost exports and cap imports, narrowing both trade and current account deficits further (Chart I-3).   Chart I-2Considerable Depreciation In Pakistani Rupee… Considerable Depreciation In Pakistani Rupee... Considerable Depreciation In Pakistani Rupee... Chart I-3…Will Boost Exports And Cap Imports ...Will Boost Exports And Cap Imports ...Will Boost Exports And Cap Imports We expect exports to grow 5-10% next year. The country’s competitiveness has improved considerably, with its top commodities exports all having shown impressive growth in volume terms, despite weakening global growth (Chart I-4). Besides, in order to boost exports, the government has reduced the cost of raw materials and semi-finished products used in exportable products by exempting them from all customs duties in fiscal 2020 (July 2019 – June 2020). The government has also promised to provide sales tax refunds to the export sector. Chart I-4Increasing Competitiveness In Pakistan Exports Increasing Competitiveness In Pakistan Exports Increasing Competitiveness In Pakistan Exports In addition, falling oil prices will help reduce the country’s import bill. Remittance inflows – currently equaling 9% of GDP – have become an extremely important source of financing for Pakistan’s trade deficit. In the past 12 months, remittances sent from overseas have risen to US$22 billion, and have covered most of the US$28 billion trade deficit.   Financial inflows are also likely to increase in 2020 and will be sufficient to finance the current account deficit. The IMF will disburse roughly US$2 billion to Pakistan. Other multilateral/bilateral lending/grants and planned issuance of Sukuk or Euro bonds will provide the government with much-needed foreign funding.  As the economy recovers, net foreign direct inflows are also likely to increase. Net foreign direct investment received by Pakistan has grown 24% year-on-year in the past six months, with 56% of the increase coming from China. Overall, the improvement in Pakistan’s balance-of-payments position will continue, resulting in a refill of the country’s foreign currency reserves. Odds are that the central bank will purchase foreign currency from the government as the latter gets foreign funding. This will provide the government with local currency to spend. At the same time, the central bank’s purchases of these foreign exchange inflows will boost the local currency money supply – a positive development for the economy and stock market. Chart I-5 shows that the Pakistani stock market closely correlates with swings in the nation’s narrow money growth. The Pakistani central bank will soon start a rate-cutting cycle as the exchange rate stabilizes. This is a typical recovery process following a balance-of-payments crisis and substantial currency devaluation. Chart I-5Pakistan: Ameliorating Balance-Of-Payments Position Will Benefit Stock Prices Pakistan: Ameliorating Balance-Of-Payments Position Will Benefit Stock Prices Pakistan: Ameliorating Balance-Of-Payments Position Will Benefit Stock Prices Chart I-6Pakistan: Improving Fiscal Balance Pakistan: Improving Fiscal Balance Pakistan: Improving Fiscal Balance Second, Pakistan’s fiscal balance also shows signs of improvement. Pakistan and the IMF have agreed to set the target for the overall budget and primary deficits at 7.2% of GDP and 0.6% of GDP, respectively, for the current fiscal year (Chart I-6). This will be a considerable improvement from the 8.9% of GDP and 3.3% of GDP, respectively, last fiscal year. In early November, the IMF praised Pakistan for having successfully managed to post a primary budget surplus of 0.9% of GDP during the first quarter (July 1, 2019 – September 30, 2019) of its current fiscal year. The authorities are determined to maintain strict fiscal discipline. The country’s tax-to-GDP ratio is at about 12%, one of the lowest in the world, so there is room to expand the tax base. Third, the Pakistani central bank will soon start a rate-cutting cycle as the exchange rate stabilizes. This is a typical recovery process following a balance-of-payments crisis and substantial currency devaluation. Both headline and core inflation seem to have peaked (Chart I-7). Headline inflation fell to 11% in October, which already lies within the central bank’s target range of 11-12% for the current fiscal year. The policy rate is currently 225 basis points higher than headline inflation. As inflation drops and the currency finds support, interest rates will be reduced to facilitate the economic recovery. In addition, there has been much less public debt monetization by the central bank. After borrowing Rs3.16 trillion from the central bank in the previous fiscal year, the federal government has curtailed such borrowing to only Rs122 billion in the first three months of this fiscal year. Diminishing debt monetization will also help ease domestic inflation. Chart I-7Inflation Has Peaked Inflation Has Peaked Inflation Has Peaked Chart I-8Manufacturing Activity Is Likely To Recover Soon Manufacturing Activity Is Likely To Recover Soon Manufacturing Activity Is Likely To Recover Soon Fourth, manufacturing activity in Pakistan has plunged to extremely low levels, comparable to the 2008 Great Recession (Chart I-8). With a more stabilized local currency, easing domestic inflation and interest rate reductions, Pakistan’s economic activity is set to recover soon from a very low base.  Finally, Phase II of the China-Pakistan Economic Corridor (CPEC) is set to begin this month. Under Phase II of the CPEC, five special economic zones will be established with Chinese industrial relocation. Phase II will also bring forward dividends from Phase I projects. The nation’s infrastructure facilities built by China over the past several years have enhanced the productive capacity of the Pakistani economy. The significant increase in electricity supply and improved railway/highway transportation will promote higher productivity/efficiency gains. Bottom Line: We are upgrading Pakistani equities to overweight within the emerging markets space. Both absolute and relative valuations of Pakistani stocks appear attractive (Charts I-9 and I-10). Chart I-9Pakistani Stocks: Valuations Are Attractive In Absolute Terms... Pakistani Stocks: Valuations Are Attractive In Absolute Terms... Pakistani Stocks: Valuations Are Attractive In Absolute Terms... Chart I-10…And Relative To EM Equities ...And Relative To EM Equities ...And Relative To EM Equities Meanwhile, we recommend going long Pakistani 5-year local currency government bonds currently yielding 11.5%, as we expect interest rates to drop quite a bit (Chart I-11).  Chart I-11Go Long Pakistani 5-Year Local Currency Government Bonds Go Long Pakistani 5-Year Local Currency Government Bonds Go Long Pakistani 5-Year Local Currency Government Bonds   Ellen JingYuan He Associate Vice President ellenj@bcaresearch.com Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights Structurally overweight US T-bonds versus core European bonds. Our preferred expression is long T-bonds versus Swiss bonds. US yields can fall a lot more than European yields, and European yields can rise a lot more than US yields. Structurally underweight the overvalued dollar versus undervalued European currencies. Our preferred expression is long SEK/USD. Structurally underweight price-sensitive European export sectors. Undervalued European currencies cannot fall much further, and those European exporters that depend on price competitiveness will struggle to outperform. But structurally overweight soft luxuries. Despite President Trump’s threat to tariff French products, soft luxuries retain very strong pricing power and sustainable long term demand growth from rising female labour participation rates globally. Fractal trade: The 65-day fractal structure of global equities suggests that they are vulnerable to a near-term countertrend move. Feature Chart of the WeekLike-For-Like, Structural Inflation Is Lower In the US Than In Europe Like-For-Like, Structural Inflation Is Lower In the US Than In Europe Like-For-Like, Structural Inflation Is Lower In the US Than In Europe A seemingly trivial disagreement between Europeans and Americans on how to measure inflation turns out to be the culprit for three major distortions in the world right now: Deeply divergent monetary policies across the developed economies. Huge valuation anomalies in the foreign exchange markets. President Trump’s threat of a trade war to counter the huge trade surpluses that Europe and China are running against the US. The inflation measurement disagreement wouldn’t really matter if inflation were running in the mid-single digits. But when inflation is near zero, the seemingly trivial difference in inflation measurement methodologies has ended up generating massive distortions. European And American Inflation Are Not The Same European inflation excludes the maintenance and upkeep costs associated with owning your home, whereas US inflation includes these costs at a hefty 25 percent weighting, making owner occupied housing by far the largest single item in the US inflation basket. By omitting the largest item in the US inflation basket, European inflation is subtly yet crucially different to American inflation. The European statisticians argue that unlike all the other items in the inflation basket, there is no independent market price for the ongoing cost of home ownership, and therefore this cost should be excluded. The American statisticians argue that the ongoing cost of home ownership is the single largest expense for most people and, as such, it should be ‘imputed’ from a concept known as ‘owner equivalent rent’ – essentially, asking homeowners how much it would cost to rent their own home. Different definitions of inflation will trigger very different policy responses from central banks. Both the European and American approaches have their merits and drawbacks, and it is not our intention to endorse one approach over the other. Our intention is simply to point out that the two approaches can give very different results for inflation – and therefore trigger very different policy responses from inflation-targeting central banks, with their consequent economic and political repercussions. If Americans used the European definition of inflation, then headline inflation in the US today would be running at the same sub-par rate as in the euro area, 1 percent, and well below the Fed’s 2 percent target (Chart I-2 and Chart I-3). More important, the five year annualised rate of inflation – let’s call it US structural inflation – would have been stuck below 1 percent since 2016 (Chart I-1 and Chart I-4). Under these circumstances, it would have been impossible for the Fed to hike the funds rate eight times, as it did through 2017-18. Chart I-2Like-For-Like, Headline Inflation Is Identical In The US And The Euro Area... Like-For-Like, Headline Inflation Is Identical In The US And The Euro Area... Like-For-Like, Headline Inflation Is Identical In The US And The Euro Area... Chart I-3...And Core Inflation Is ##br##Very Similar ...And Core Inflation Is Very Similar ...And Core Inflation Is Very Similar   Chart I-4Using The European Definition Of Inflation, The Fed Couldn't Have Hiked Rates Using The European Definition Of Inflation, The Fed Couldn't Have Hiked Rates Using The European Definition Of Inflation, The Fed Couldn't Have Hiked Rates Instead, what if Europeans used the American definition of inflation? European inflation does not include owner equivalent rent, but it does include housing rent for those that do rent their homes. In the US, these two items tend to move in lockstep (Chart I-5). If we assume the same for Europe, we can deduce that a US type weighting for owner equivalent rent would have boosted the headline inflation rate in the euro area by 0.3-0.4 percent through 2014-16, and by a possible 0.5 percent in Sweden through 2013-15 (Chart I-6 and Chart I-7). Under these circumstances, it would have been very difficult for the ECB and Riksbank to take and maintain policy rates deeply in negative territory, as they did through 2015-19. Chart I-5Owner Equivalent Rent Tracks ##br##Housing Rent Owner Equivalent Rent Tracks Housing Rent Owner Equivalent Rent Tracks Housing Rent Chart I-6Using The American Definition Of inflation, Euro Area Inflation Would Have Been Higher... Using The American Definition Of inflation, Euro Area Inflation Would Have Been Higher... Using The American Definition Of inflation, Euro Area Inflation Would Have Been Higher... Chart I-7...And Swedish Inflation Would Have Been Much Higher ...And Swedish Inflation Would Have Been Much Higher ...And Swedish Inflation Would Have Been Much Higher The Different Definitions Of Inflation Have Created Dangerous Distortions If Europeans and Americans were using the same definition of inflation then, one way or the other, their monetary policies would not be as deeply divergent as they are now. One important implication is that European currencies would not be as undervalued as they are now. If Europeans and Americans were using the same definition of inflation then their monetary policies would not be as deeply divergent as they are now.  Based on the ECB’s own analysis, the euro area is over-competitive versus its top 19 trading partners – meaning the euro is undervalued – by at least 10 percent. Moreover, the ECB admits that this sizable undervaluation only appeared after the ECB and Fed started taking their monetary policies in opposite directions in 2015 (Chart I-8). Chart I-8The Euro Is Undervalued By More Than 10 Percent The Euro Is Undervalued By More Than 10 Percent The Euro Is Undervalued By More Than 10 Percent Put the other way, the dollar would not be as overvalued as it is now. In turn, the stronger dollar has created its own dangerous spill-overs. As we explained last week in The Hidden Sales Recession Of 2015… And Why It Matters Now, the surging dollar in 2015 could not have come at a worse time for China. Given that the Chinese economy was already slowing sharply, and the yuan was pegged to the dollar, the resulting loss of Chinese competitiveness just exacerbated the slump. Forcing China to loosen the dollar peg in August 2015. All of which brings us neatly to the hot topic of 2019, and likely 2020 too – President Trump’s threat of a trade war to counter the huge trade imbalances that Europe and China are running against the US. As it happens, President Trump has a good point. Trade wars almost always stem from trade imbalances; and trade imbalances almost always stem from exchange rate manipulations or, at least, exchange rate distortions that advantage one economy to the detriment of another. The euro's undervaluation only happened after monetary policies diverged in 2015. Most of the euro area’s €150 billion trade surplus with the US appeared after 2015, so it cannot be a structural issue. In fact, the evolution of the trade imbalance has tracked relative monetary policy between the Fed and ECB almost tick for tick (Chart I-9), via the exchange rate channel and the over-competitiveness of the euro which the ECB fully admits. Chart I-9Excessively Divergent Monetary Policies Caused The Euro Area's Huge Trade Surplus With The US Excessively Divergent Monetary Policies Caused The Euro Area's Huge Trade Surplus With The US Excessively Divergent Monetary Policies Caused The Euro Area's Huge Trade Surplus With The US Of course, neither the ECB nor the Fed are deliberately targeting trade or the exchange rate; they are targeting inflation. But to repeat, they are targeting different definitions of inflation. Crucially, with a backdrop of near zero inflation, small definitional differences in inflation can generate huge economic and financial distortions, with dangerous political consequences. The Compelling Structural Opportunities The definitional difference between European and American inflation explain many of the economic and financial distortions we are witnessing now, as well as the dangerous political consequences. The main counterargument is that the inflation definitions are what they are; neither the ECB nor the Fed are likely to change them anytime soon. Nevertheless, there are compelling structural opportunities. Since 2015, American inflation has outperformed European inflation for one reason and one reason only: owner equivalent rents have surged by almost 20 percent relative to other prices (Chart I-10 and Chart I-11). The historic evidence suggests that such a pace of outperformance is unsustainable structurally and, absent this tailwind, US and European headline inflation rates have to converge, one way or the other. Chart I-10An Unsustainable Surge In US Owner Equivalent Rent... An Unsustainable Surge In US Owner Equivalent Rent... An Unsustainable Surge In US Owner Equivalent Rent... Chart I-11...Has Lifted US Headline ##br##Inflation ...Has Lifted US Headline Inflation ...Has Lifted US Headline Inflation In this inevitable convergence, the asymmetric starting point of bond yields favours a long US T-bonds, short core European bonds structural position. Because, if the inflation convergence is downwards, T-bond yields will fall much further than European yields; whereas if the inflation convergence is upwards, European yields will likely rise more than T-bond yields. Our preferred structural expression is: long US T-bonds, short Swiss bonds. For currencies it is the opposite message. The overvalued dollar is likely to underperform, at least versus other developed market currencies. Given that Swedish inflation has been the most understated by the exclusion of owner equivalent rents, combined with the Riksbank’s intention to exit negative interest rate policy imminently, our preferred structural expression is: long SEK/USD. American inflation has outperformed European inflation for one reason and one reason only: owner equivalent rents have surged by almost 20 percent relative to other prices. Lastly, European export growth – even in Germany – has been heavily reliant on a cheapening euro (Chart I-12). Undervalued European currencies cannot fall much further, and those European exporters that depend on price competitiveness will struggle to outperform. Even those multinationals that sell their products in dollars will lose out in the accounting translation back into a strengthening domestic currency. Hence, structurally underweight price-sensitive European export sectors. Chart I-12Without A Weaker Euro, Most European Exporters Will Struggle To Outperform Without A Weaker Euro, Most European Exporters Will Struggle To Outperform Without A Weaker Euro, Most European Exporters Will Struggle To Outperform The one exception to this is the soft luxuries sector. Despite President Trump’s threat to tariff French products, soft luxuries retain very strong pricing power and sustainable long term demand growth from rising female labour participation rates globally. Stay structurally overweight soft luxuries. Fractal Trading System* The 65-day fractal structure of global equities suggests that they are vulnerable to a near-term countertrend move. Accordingly, this week’s recommended trade is to short the MSCI All Country World versus the global 10-year bond (simple average of US, euro area, and China), setting a profit target and symmetrical stop-loss at 2.5 percent. In other trades, long NZD/JPY and long SEK/JPY both achieved their profit targets of 3 percent and 1.5 percent respectively. Against this, long Poland versus World reached its 4 percent stop-loss. The rolling 1-year win ratio now stands at 65 percent. Chart I-13MSCI All-Country World Vs. Global 10-Year Bond MSCI All-Country World Vs. Global 10-Year Bond MSCI All-Country World Vs. Global 10-Year Bond 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 Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World   Cyclical Recommendations Structural Recommendations How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World How Low Inflation Has Distorted The World 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    

Highlights Economy & Inflation: The macro backdrop in Japan remains bond friendly for JGBs; growth momentum is only starting to bottom out, but will lag the recovery heralded by improving global leading economic indicators, while inflation remains closer to 0% than the BoJ's 2% target. BoJ Options: The BoJ has limited policy choices available to provide more stimulus, with negative policy rates crushing Japanese bank profitability and the central bank already owning massive amounts of JGBs and ETFs. 2020 Japan Bond Strategy: Dedicated bond investors should overweight Japan in global government bond portfolios over the next year, as a complement to an overall below-benchmark duration exposure. Expect some mild yield curve steepening pressure if the BoJ attempts to use its limited remaining policy tools, like targeting shorter maturities for its asset purchases, to try and alleviate the pressure on banks from negative rates and a flat yield curve. Feature Chart 1The Role Of Japan In Global Bond Investing Is Complex The Role Of Japan In Global Bond Investing Is Complex The Role Of Japan In Global Bond Investing Is Complex In a year where the majority of global bond markets have delivered stellar returns, Japanese fixed income performance has predictably languished in 2019 compared to the other developed economies. Despite a cyclically weak economy with very low inflation, Japanese government bond (JGB) yields have been locked in narrow ranges at or below 0% throughout the year. Monetary policy is a big reason for that, as the Bank of Japan (BoJ) has run of out of fresh stimulus options to try and push JGB yields even lower. In this Special Report, we make the case for owning JGBs as a low-beta, defensive asset in global fixed income portfolios over the next 6-12 months – a period when improving growth is expected to exert upward pressure on global bond yields, but where JGB yields are expected to remain anchored with Japan likely to lag the global upturn (Chart 1). The Japanese Growth & Inflation Backdrop Is No Threat To JGBs Japan’s economy has suffered alongside the global industrial downturn in 2019, with the Japanese manufacturing PMI struggling below 50 for seven consecutive months. Both business investment and exports have been contracting, in response to the slump in global and trade and increase in uncertainty related to the US-China tariff war. The underlying trend in consumer spending – the largest component of Japan’s economy – is more difficult to interpret, however, because of the volatility surrounding the October hike in the consumption tax. On October 1st, Japanese Prime Minister Abe’s government finally passed its long-desired hike in the consumption tax rate from 8% to 10%, in a bid to begin chipping away at Japan’s massive fiscal debt burden. The timing of the move, which had been twice delayed previously, appears ill-advised given the overall weakness in the economy. That can be seen in the response of consumer demand to the tax increase. Japanese consumers, quite rationally, front-loaded purchases in September in advance of the tax hike, but that surge was followed by a collapse in nominal retail sales in October of -14% on a month-over-month basis (Chart 2). This was much larger than the decreases seen after the previous consumption tax increases in 1997 and 2014. This may seem surprising given that the Japanese unemployment rate is a stunningly low 2.4%, suggesting a tight labor market that should be boosting wage growth and consumer confidence. Quite the opposite is happening, however, as consumer confidence is depressed and wage growth is contracting in real terms (bottom panel). Even more unusual is that real disposable income growth for Japanese households is now up to 5% (year-over-year), after stagnating for much of the previous decade. The acceleration is due to more people, especially women and senior citizens, having joined the labor force and found work – on a “per worker” basis, income growth is much less impressive and is more in line with stagnant wage growth. Therefore, unless there is clear acceleration of wages, a sustainable improvement in aggregate consumption is not expected. In the absence of an unlikely consumer boom, a pickup in global trade and manufacturing activity is a necessary requirement to stabilize the Japanese economy where the manufacturing sector is relatively larger than that of other major developed countries (20% of GDP).1 On that front, the news is getting better with the recent improvement seen in the global manufacturing PMI, global ZEW and our own global leading economic indicator (LEI). Looking at the overall conditions in Japan's manufacturing sector, however, there are still mixed signals indicating that a true bottom has been reached (Chart 3): Chart 2Challenging Times For Japanese Consumers Challenging Times For Japanese Consumers Challenging Times For Japanese Consumers Chart 3A Trough In Japanese Manufacturing A Trough In Japanese Manufacturing A Trough In Japanese Manufacturing the Markit manufacturing PMI did rise modestly in November, but remains at only 48.9 (top panel); the most recent Tankan survey from the BoJ showed that both large and small firms in the manufacturing sector expect business conditions to worsen (second panel); real capital spending growth did perk up in the third quarter in the GDP accounts, but additional gains are unlikely given the still moderate reading on manufacturing business confidence (third panel); machine tool orders continue to contract on a year-over-year basis, although the growth in domestic orders may be stabilizing; foreign orders remain depressed due to weakening Chinese demand for automotive and electronic equipment (bottom panel). Chart 4Japan"s Non-Manufacturing Sector Is Struggling Japan"s Non-Manufacturing Sector Is Struggling Japan"s Non-Manufacturing Sector Is Struggling Turning to the services sector, which accounts for around 80% of the Japanese economy, the data also show only moderate growth. This is mainly because demand for services is less influenced by global economic conditions, and more related to the tight labor market and rising household income growth. Even given that better fundamental backdrop, however, it is still not clear that services can drive growth in the Japanese economy in 2020 (Chart 4): Chart 5Past The Worst For Japanese Exports Past The Worst For Japanese Exports Past The Worst For Japanese Exports while the Tankan survey of large non-manufacturing firms has stayed at the same high level seen since 2014, the data for smaller firms has weakened steadily throughout 2019; the Markit services PMI index has remain solidly above the 50 boom/bust line all year long, yet overall sales for non-manufacturers contracted by -3.1% on a year-over-year basis in the third quarter of the year according to Japan’s Ministry of Finance. One potential ray of hope for Japanese growth comes from exports. While growth in total nominal exports is still contracting by –9.2% on a year-over-year basis, the recent pickup in our global LEI is heralding a potential bottoming in export momentum (Chart 5). In particular, the emerging market sub-component of our global LEI is signaling a potentially sharp pickup in demand for Japanese exports to Asia (middle panel). A similar optimistic message is given regarding Chinese demand, based on the modest improvement in the OECD China LEI (bottom panel). Yet these developments are still in the early stages and could be derailed by a breakdown of the US-China trade negotiations (not the base case scenario of BCA’s geopolitical strategists). Summing it all up, the Japanese economy remains in a fragile state after absorbing multiple blows from trade uncertainty, contracting global manufacturing activity and, more recently, an ill-timed hike in the consumption tax. While some data is showing signs of bottoming, the momentum is unlikely to be strong enough in 2020 to generate much upward pressure on Japanese bond yields. Japanese Inflation Remains A No-Show Japan remains the poster child for the global low inflation backdrop of the post-crisis decade. Even an economy with an unemployment rate near record lows can still not generate inflation sustainably above 0%. Headline CPI inflation is now at only 0.2%, while and core CPI inflation is slightly higher at 0.7% (Chart 6). The former is being dragged down by the lagged impact of lower oil prices and the stubbornly firm Japanese yen. More worrisome, however, is that services CPI inflation dipped slightly below 0% in November (middle panel), in line with the contraction seen in the domestic corporate goods prices and import prices indices (bottom panel). Chart 6Inflation Remains WELL Below The BoJ"s Target Inflation Remains WELL Below The BoJ"s Target Inflation Remains WELL Below The BoJ"s Target Chart 7Not A Consistent Story From Japanese Inflation Expectations Not A Consistent Story From Japanese Inflation Expectations Not A Consistent Story From Japanese Inflation Expectations Market-based inflation expectations, measured using either CPI swap rates or breakevens from inflation-linked bonds, are also hovering close to 0% (Chart 7). In a bit of a surprise, survey-based measures of inflation expectations produced by the BoJ are closer to the 2-3% range, even though realized inflation only reached that range once, on an annual calendar year basis, since 1991 – in 2014, unsurprisingly another year with a consumption tax increase. The market-based inflation indicators are more important for bond investors, however. It will take a sustained increase in realized inflation before the JGB market begins to worry about inflation again. Perhaps that can begin to happen in 2020 if Japanese and global growth improves, coming alongside some yen weakness. More likely, next year will be another year of mushy inflation readings from Japan as the economy tries to emerge from the slowdown seen in 2019 and the unnecessary tightening of fiscal policy coming from the consumption tax hike (which is likely to cause a temporary, but not sustained, blip in realized inflation rates in 2020). Bottom Line: The macro backdrop in Japan remains bond friendly for JGBs; growth momentum is only starting to bottom out, but will lag the recovery heralded by improving global leading economic indicators, while inflation remains closer to 0% than the BoJ's 2% target. There’s Not Much New The BoJ Can Do The BoJ remains in a bind with regards to future monetary policy decisions. Inflation remains far below its target, while the economy is struggling to generate above-potential growth. Yet unemployment remains exceptionally low and, by the BoJ’s own estimates, Japan’s economy is operating with no spare capacity (i.e. the output gap is a positive number). For a traditional central bank that believes in the tradeoff between spare capacity/unemployment and inflation, like the BoJ, the data is sending a very confusing message about the next policy move. Can A Weaker Yen Solve Japan’s Low Inflation Problem? Chart 8The Balance Of Payments Remains Yen-Supportive The Balance Of Payments Remains Yen-Supportive The Balance Of Payments Remains Yen-Supportive The BoJ’s job in setting the right policy to get Japanese inflation higher would be made a lot easier if the yen were not so stubbornly firm. On a trade-weighted basis, the yen is 10.1% above the low seen in 2018 and 22.9% above the 2015 low (Chart 8). This has happened despite the disappointing performance of the Japanese economy and the negative interest rates that have typically made the yen a good funding currency for global carry trades. While there has been likely been some safe-haven demand for the yen given the global growth uncertainties and sharp decline in non-Japanese bond yields in 2019, the root cause for the yen strength is more fundamental. Our colleagues at BCA Research Foreign Exchange Strategy published a Special Report last week, reviewing the balance of payments of the major global currencies.2 Going through the components for Japan, the current account balance remains firmly positive at 3.4% of GDP, despite the fact that the trade balance is now negative. The main reason for that is the steady 4% of GDP in the investment income balance – an inevitable result given Japan’s massive net foreign asset position. On the capital account side, there has been a steady increase in net foreign direct investment (FDI) outflows over the past several years, as more Japanese companies have moved productive capacity offshore (and fewer foreign companies invest in Japan). In addition, portfolio outflows have been gaining momentum with Japanese investors ramping up their purchases of foreign long term assets. Add it all up and Japan's basic balance (the current account plus net FDI) is now negative for the first time since 2015 (bottom panel). Thus, Japan’s balance of payments may now finally be in a position to generate some yen weakness that can help boost domestic inflation – if some of the uncertainties over global growth and the US-China trade negotiations begin to dissipate, as we expect in 2020. So what can the BoJ do? The BoJ has maintained a negative policy interest rate for 45 months since cutting rates below zero in February 2016. Yet according to our BoJ Monitor, there is still a need for additional monetary policy easing to combat weak growth and inflation (Chart 9). Chart 9The BoJ"s Policy Options Are Limited The BoJ"s Policy Options Are Limited The BoJ"s Policy Options Are Limited Interest rate markets do not expect the BoJ to do much with short-term interest rates in 2020, with only -5bps of cuts discounted in the Japanese overnight index swap (OIS) curve. BoJ officials have not outright dismissed the possibility that another rate cut could happen, but policymakers have learned that negative rates are lethal for the profits of the banking system. That can be seen in Japan, where bank profits have contracted -19.4% over the past year as negative borrowing rates have become more deeply entrenched. Other parts of the Japanese financial system, like insurance companies and pension funds that need income to meet payouts and liabilities, also suffer from negative interest rates on domestic fixed income assets. Therefore, the BoJ cutting policy rates deeper into negative territory is a very unlikely outcome, even if the economy and inflation continue to struggle, as the risks to the financial system would be worsened. So what else can the BoJ do to provide further monetary stimulus, if necessary? The choices are limited. The BoJ could alter its forward guidance to signal to the market that rates will remain low for a very long time, but that would have a limited effect with rate levels already so low. The central bank could also ramp up its pace of asset purchases, but that will also prove difficult as it owns nearly 50% of outstanding JGBS and nearly 80% of outstanding ETFs. Buying more assets would likely not generate any easier financial conditions, and would simply further disrupt the liquidity of Japan’s financial markets. A March 2019 academic study found that the impact on Nikkei 225 stock returns from the BoJ ETF buying has grown smaller over time despite the increased purchase amounts.3 Chart 10More Room For The BoJ To Buy Shorter Maturity Bonds Japanese Government Bonds In 2020: Boring, But Useful Japanese Government Bonds In 2020: Boring, But Useful The BoJ could lower its “Yield Curve Control” target yield for 10-year JGBs to below 0%, but that would also prove difficult as the BoJ already owns a whopping 75% of all outstanding 10-year JGBs (Chart 10) – a figure that would likely need to increase if global bond yields continue to drift higher in 2020, as we expect, forcing the BoJ to buy more 10-year JGBs to ensure that yields do not rise. A unique option might be for the BoJ to purchase foreign bonds. This would potentially help further weaken the yen, which would help increase exports and inflation. Although given the current global backdrop of populism and trade protectionism, a policy specifically designed to weaken the yen would likely not be greeted warmly by other countries. In our view, there is only one plausible option that the BoJ could consider to ease policy further in 2020 to fight low inflation – choosing a different maturity point for its Yield Curve Target. For example, instead of targeting a 10-year JGB near 0%, the BoJ could target a 5-year JGB near 0%. The BoJ owns a lower share of outstanding bonds in that part of the curve (around 45%, by our calculations). The net result could be a steeper JGB curve, which could help ease the drag on profits of the Japanese banks from negative longer-term yields and a flat curve (Chart 11). One thing is for certain: none of the conditions that we have long believed would be necessary before the BoJ would consider abandoning its yield curve target and letting yields rise – a USD/JPY exchange rate between 115 and 120; core CPI inflation and nominal wage inflation both above 1.5%; and clear signs of JGB overvaluation - are currently in place (Chart 12). The BoJ has to continue to stay accommodative, even if other central banks turn less dovish as global growth improves in 2020. Chart 11Shifting BoJ Purchases Could Generate A Steeper JGB Curve Shifting BoJ Purchases Could Generate A Steeper JGB Curve Shifting BoJ Purchases Could Generate A Steeper JGB Curve Chart 12These Must ALL Happen Before The BoJ Lifts Its JGB Yield Target These Must ALL Happen Before The BoJ Lifts Its JGB Yield Target These Must ALL Happen Before The BoJ Lifts Its JGB Yield Target   Bottom Line: The BoJ has limited policy choices available to provide more stimulus, with negative policy rates crushing Japanese bank profitability and the central bank already owning massive amounts of JGBs and ETFs. Overweight Low-Beta JGBs In Global Bond Portfolios In 2020 Chart 13Overweight Low-Beta JGBs In 2020 Overweight Low-Beta JGBs In 2020 Overweight Low-Beta JGBs In 2020 As we have discussed in previous reports, yield betas of developed market sovereign bonds to changes in the “global” bond yield are a good tool to use when considering fixed income country allocation decisions when yields are rising everywhere.4 We are currently recommending overweight allocations to government bonds in countries with more dovish central banks and/or where yields are low in relative terms – namely, Germany, Japan and Australia. Not by coincidence, those are also countries whose government bonds have the lowest yield betas among the major developed economies. The rolling 52-week yield betas for JGB yields to the “global” yield (defined as the yield-to-maturity of the Bloomberg Barclays Global Treasury index) is shown in Chart 13. We show the betas for different maturity “buckets” across the yield curve, and we also present the same betas for US Treasuries and German government bonds for comparison. The betas for JGBs are consistent but positive across the entire yield curve, around 0.5 or less. German yields have a similar beta at shorter maturities but a beta close to 1.0 at the longer-end of the curve. US Treasuries, to no surprise, are the highest beta market, with yield betas of 1.5 or more across the entire yield curve. The positive low beta for JGBs means that Japanese bond yields will still move in the same direction as global yields, but with far less volatility. Thus, during the period when global government bonds are rallying, low-beta markets like Japan underperform versus global benchmarks. That has been the story in 2019, when much of the world needed to ease monetary policy but Japan was already at very accommodative policy settings. When global yields are rising, however, lower beta markets should see smaller yield increases and better relative performance. That will be the story for JGBs in 2020, given the strong likelihood that Japan will lag the global economic rebound that we expect next year and the BoJ will be forced to, once again, be the most dovish central bank among the major economies. Bottom Line: Dedicated bond investors should overweight Japan in global government bond portfolios over the next year, as a complement to an overall below-benchmark duration exposure. Expect some mild yield curve steepening pressure if the BoJ attempts to use its limited remaining policy tools, like targeting shorter maturities for its asset purchases, to try and alleviate the pressure on banks from negative rates and a flat yield curve.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com   Ray Park, CFA Research Analyst ray@bcaresearch.com Footnotes 1 Based on the value added from manufacturing as % of GDP. Other countries, by comparison: China: 29%; Germany: 21%; World: 16%; US: 11%. Source: United Nations and World Bank. 2 Please see BCA Research Foreign Exchange Strategy Special Report, “Updating Our Balance Of Payments Monitor” dated November 29, 2019, available at fes.bcaresearch.com. 3 Kimie Harada and Tatsuyoshi Okimoto, "The BOJ’s ETF Purchases and Its Effects on Nikkei 225 Stocks", RIETI Discussion Paper Series 19-E-014, March 2019. 4 Please see BCA Research Global Fixed Income Strategy Weekly Report, " Cracks Are Forming In The Bond-Bullish Narrative", dated October 23, 2019, available at gfis.bcaresearch.com.