Transportation

Investors remain cautious about the US economy and still have significant cash that needs to be put to work which could extend the rally further. Earnings rebound later in the year will be supported by rising sales growth and surging earnings of the Magnificent Seven. A restocking cycle, and a pickup in freight activity support transports. Upgrade Transports to an overweight.

US domestic politics, hypo-globalization, and Great Power Competition favor a revival of US manufacturing capacity. The industrial sector will benefit from the attempt to rebuild US manufacturing. Go long physical infrastructure and defense stocks. Find opportunities to take a long position on the universe versus the metaverse.

Airlines have staged an impressive recovery this year, exceeding all expectations. While companies are optimistic, we are cautious. Just as pent-up demand for travel will fade, headwinds from slowing growth and high inflation will intensify. While it is highly likely that Airlines will continue to rally into the yearend, we will stick to our underweight as our three-to-six-month outlook remains negative.

In this week’s report “Adaptive Expectations: Revisiting Our Views”, we concluded that the S&P 500 is unlikely to find a bottom until inflation turns and monetary conditions stabilize, and US equities will follow a “fat and down” trajectory. We recommended that investors should overweight defensives vs. cyclicals. Accordingly, today we downgrade our overweight in Travel complex (Hotels, Cruises, and Airlines) to underweight. As a reminder, we recently moved retailing and durables categories to below benchmark. The key reason for this call is the effect of persistently high inflation on discretionary spending. In the past, we have written about the bifurcation of the US consumer, and that, while lower-income Americans are struggling with soaring prices of food, gas, and shelter, wealthier Americans are more comfortable and just shift their spending away from goods to services, such as eating out and travel. We expect strong profits for the travel sector this summer on the back of strong consumer demand and return of the business and international travel. We have discussed the drivers of the industry in these reports (here and here). Yet, markets are forward-looking, and the outlook for the industry beyond the summer months is dimming. With inflation entrenched, now even middle- and upper-class Americans as well as retirees are also starting to feel the pain. The US equity and bond market selloffs of the past 12 months have wiped out about $12 trillion and $3.5 trillion off their respective market value. This adds up to a combined $15.5 trillion or about 60% of US GDP (Chart 1). These are nest eggs and pensions shrinking by the day, diminishing future spending, and causing anxiety about the future. And while the S&P 500 is still at a level above the pandemic lows, adjusted for inflation, most of the gains are gone. On top of the reduced value of investments, negative real wage growth dampens consumer confidence (Chart 2). To make things worse, fears of recession and impending layoffs are pervasive in media stories, stoking fear of the future, and perhaps, making an economic downturn a self-fulfilling prophecy. Therefore, even wealthier Americans may have to tighten their belts and reduce their discretionary spending, with travel and leisure categories being on top of their list. Chart 1 CHART 1 CHART 1 Chart 2 CHART 2 CHART 2 Therefore, after the summer vacation surge is over, hotels and airlines are likely to experience slower demand which will weigh on their sales and pricing power. At the same time, these are industries most affected by the rising cost of fuel (airlines and cruise lines) and rising wages (hotels). As a result, we expect profitability to diminish and earnings growth recovery to stall. We have a negative outlook on the travel industry on a tactical time horizon. Bottom Line: Entrenched inflation is weighing on discretionary spending, and travel is likely to be the next victim of curtailed spending. We downgrade the S&P Hotels and the S&P Airlines indexes from overweight to underweight.  

The US economy is in the midst of an economic growth slowdown, exacerbated by the nascent monetary tightening cycle, a war in Ukraine, and COVID-19 lockdowns in China. To protect our portfolio against the negative economic backdrop, we have been gradually shifting exposure away from cyclicals and towards more defensive allocations. Recent downgrades of the Consumer Durables and Retail, and upgrades of the S&P Consumer Staples sector, are a case in point. Today, we downgrade the S&P Transportation industry group from overweight to underweight. As the Fed proceeds with an aggressive tightening cycle to combat inflation, and China's and Ukraine's human tragedy continues to unfold, economic growth is likely to disappoint while supply disruptions become entrenched, making transportation of goods one of the early casualties. Already, intermodal rail freight, which is a major rail traffic category, is showing major signs of weakness (Chart 1). Finally, Chart 2 illustrates the tight relationship between the broad economic activity and the performance of the overall transportation industry we are alluding to. Given that ISM Manufacturing PMI is likely headed to the low 50s, it will continue weighing on transportation stocks. When it comes to valuations, there is only a marginal discount for the industry group that is currently trading at 17.4x compared to the 19.3x forward P/E multiple for the S&P 500: Risk premium does not justify owning the sector, and further multiple contraction is likely. Bottom Line: Today we downgrade the S&P Transportation index from overweight to underweight on the back of the economic slowdown and relentless supply chain disruptions. Chart 1 CHART 1 CHART 1 Chart 2 CHART 2 CHART 2  

Executive Summary Shanghai Is Extending Lockdowns Due To Exponentially Rising COVID Cases Shanghai Is Extending Lockdowns Due To Exponentially Rising COVID Cases Shanghai Is Extending Lockdowns Due To Exponentially Rising COVID Cases The economic impact of China’s struggle with another wave of COVID outbreaks is showing up in March’s PMI and high-frequency data. The highly contagious nature of the Omicron variant suggests that Shanghai’s battle against the virus spread may last longer than the market has priced in. Chinese authorities will continue playing whack-a-mole in efforts to eliminate the country’s COVID cases. The zero-COVID approach and the virus’ mutating to more contagious variants mean that the country may have to impose more frequent mobility restrictions going forward than in the past two years. Although Chinese policymakers are determined to stabilize the economy, the ongoing combat with COVID will weigh down the effectiveness of the stimulus. In relative terms, we maintain a neutral position on Chinese onshore stocks. However, downshifting corporate profits and the economic shock from lockdowns remain significant risks to the absolute performance of Chinese stocks. Bottom Line: China’s combat against the current COVID-19 outbreaks may last longer than the market has priced in. In the near term, the lockdowns will weigh down the effectiveness of the stimulus. In the second half of the year, the more contagious virus mutations and China’s sticking to zero-COVID strategy may lead to more frequent disruptions to business activity.     Chart 1China Is Bracing For The Worst COVID Outbreak Since Early 2020 China Is Bracing For The Worst COVID Outbreak Since Early 2020 China Is Bracing For The Worst COVID Outbreak Since Early 2020 China’s efforts to stabilize economic growth are facing new challenges, dampening an already fragile recovery. The current wave of COVID-19 outbreaks — the worst since early 2020 — has infected more than 100,000 (TK) people across the country, and the number of new cases is still rising at an exponential rate (Chart 1). Measures to contain the spread of the virus have led to city lockdowns, halted factory production and have dragged down the tourism and catering industries. In previous reports, we noted that it is challenging for China to reach this year’s 5.5% growth target due to downbeat private-sector sentiment and subdued demand for housing. The outlook for China’s economy is grimmer now. The highly contagious COVID virus mutations, including the emerging Omicron BA.2 variant, will make it more difficult for China to control its domestic outbreaks going forward. We do not expect that China will fundamentally change its zero-COVID policy throughout the rest of this year. Therefore, the country will probably see more frequent regional and city lockdowns this year than in the past two years.  The leadership will calibrate its handling of these lockdowns to minimize damage to the economy, and Beijing will continue stepping up its growth support policies. However, the whack-a-mole strategy to eliminate domestic COVID cases will be disruptive to business activity and dampen the effectiveness of policy easing. A One-Two Punch… Related Report  China Investment StrategyA Choppy Bottom The downside risks to China’s economy stemming from the ongoing domestic COVID outbreaks are adding to the difficulties the country is already facing due to subdued domestic demand. As we have been highlighting in our previous reports, weak private sector sentiment has been weighing down the effectiveness of authorities’ efforts to stimulate the Chinese economy. The sluggish PMI data released last week in part reflects the impact of restrictions imposed to control the latest wave of COVID-19 infections, but also highlights the bleak domestic demand conditions. Notably, the March PMI survey does not capture the full impact of the Shanghai lockdown as the data collection period ended before the restrictions went into effect on March 28. The official composite PMI fell from 51.2 to 48.8 – below the 50 boom-bust threshold and the lowest reading since February 2020. The drop reflects a slump in the manufacturing and – to a greater extent – the non-manufacturing sectors, which both fell into a contractionary territory. The manufacturing PMI slid 0.7 points to 49.5, while the non-manufacturing PMI dropped 3.2 points to 48.4 (Chart 2). The new orders sub-index of the manufacturing PMI lost nearly two percentage points and deteriorated more sharply than the production index (Chart 3). Moreover, the spread between the new orders component and new export orders – a proxy for domestic demand – ticked down in March (Chart 3, bottom panel). This indicates that weak production does not just stem from COVID-related supply-side issues, but also from poor domestic demand conditions. Chart 2Chinese PMIs Slide Into Contractionary Territory Chinese PMIs Slide Into Contractionary Territory Chinese PMIs Slide Into Contractionary Territory Chart 3Economic Shock From Lockdowns Compounds An Already Weak Domestic Demand Economic Shock From Lockdowns Compounds An Already Weak Domestic Demand Economic Shock From Lockdowns Compounds An Already Weak Domestic Demand Chart 4Auto Inventory Index Jumped To Highest Since Early 2020 Auto Inventory Index Jumped To Highest Since Early 2020 Auto Inventory Index Jumped To Highest Since Early 2020 In addition, high-frequency data from the China Automobile Dealers Association shows that the Vehicle Inventory Alert Index (VIAI) – a survey that measures destocking pressures in the automobile industry – jumped to the highest level since the first wave of COVID-19 hit China in early 2020 (Chart 4). A rising VIAI above the 50-percent threshold indicates that auto inventories are cumulating at a faster pace than demand.  Importantly, the cities and regions that have been worst hit by this round of COVID outbreaks are mostly coastal metropolises and business hubs such as Shanghai, Shenzhen and cities in Jiangsu and Zhejiang provinces. These cities and provinces represent more than 20% of China’s aggregate GDP and almost 30% of the country’s total import and export volume. As such, the negative impact on China’s overall economy from the lockdowns will be more substantive than during the previous waves. Measures to contain Shanghai’s worst-ever COVID outbreak are also disrupting operations at the world’s busiest container port, adding strains to the already overstretched global shipping industry (Chart 5). The supplier delivery times subindex of the manufacturing PMI dropped to 46.5 in March, the lowest reading since March 2020 (Chart 6). This suggests that suppliers’ delivery times have lengthened with near-term supply chain pressure, since lower readings reflect longer delivery times. Chart 5Shanghai Lockdowns Will Disrupt The Already Overstretched Global Shipping Industry Shanghai Lockdowns Will Disrupt The Already Overstretched Global Shipping Industry Shanghai Lockdowns Will Disrupt The Already Overstretched Global Shipping Industry Chart 6Chinese Suppliers' Delivery Times Have Lengthened Chinese Suppliers' Delivery Times Have Lengthened Chinese Suppliers' Delivery Times Have Lengthened Bottom Line: The economic shock from the current COVID outbreaks is compounding an already weak domestic demand in China. Since the cities and regions that are affected by this round of lockdowns are some of China’s most developed metropolitan areas, the negative impact will likely be larger than during the past two years. How Long Will The Battle Last? China’s struggle to contain the current round of domestic COVID outbreaks will likely last longer than the market has priced in. There is also a non-trivial risk that during the rest of the year, the country will need to shutter large parts of its economy more frequently to combat the spread of COVID variants, which appear to become more contagious as the mutation continues. The lockdowns in Shanghai have already been extended beyond the originally announced two-phased, eight-day restriction plan (Chart 7). The first phase of the lockdown, for which restrictions were due to be lifted on the morning of April 1, has now been extended to anywhere between 3 to 10 days. It may take Shanghai, a city of 25 million residents, between four to six weeks to bring the number of new cases down to a level that is acceptable to the authorities. Chart 7Shanghai Is Extending Its Two-Phased, Eight-Day Lockdowns Bracing For More Turbulence Bracing For More Turbulence Shenzhen, a dynamic metropolitan city bordering Hong Kong, seems to have successfully contained its COVID outbreaks after only one week of a city-wide lockdown. However, Shenzhen imposed lockdowns at an early stage of the outbreak, when both confirmed and asymptomatic case numbers in the city were in the low double digits. Shanghai, on the other hand, took more stringent measures when the number of asymptomatic cases had already reached nearly a thousand. The Omicron variant is four times more transmissible than the earlier Delta mutation, which means it will generate an explosive rise in cases and make containing the virus spread much more difficult than with Delta. In a fully susceptible (unvaccinated and uninfected) population, one person with Delta would on average infect five other people, while one person with Omicron could transmit the virus to about 20 others. As a result, despite a relatively low number of newly confirmed cases, the surging asymptomatic cases in Shanghai imply that a larger population in the city might have already been infected (Chart 8). China’s struggle with the current wave of COVID outbreaks may be an example of what lies ahead, as continuously mutating variants become more contagious and will pose fresh new challenges to China’s zero-COVID approach. The latest strain of Omicron BA.2 appears to be 40% more contagious than the original Omicron strain and is quickly spreading around the world. The number of cases has spiked across much of Europe, parts of Asia, and has begun to rise in North America (Chart 9). It took only two months from when China reported its first local Omicron BA.1 case in early January to the outbreaks of Omicron BA.2 in March. Chart 8Surging Asymptomatic Patients In Shanghai Imply More Confirmed Cases Still To Come Surging Asymptomatic Patients In Shanghai Imply More Confirmed Cases Still To Come Surging Asymptomatic Patients In Shanghai Imply More Confirmed Cases Still To Come Chart 9Covid Cases Are On The Rise Again Globally Bracing For More Turbulence Bracing For More Turbulence This presents the Chinese authorities with a difficult dilemma: impose severe mobility restrictions when domestic cases pop up, or let the virus run rampant and develop a herd immunity among much of its population. China’s leadership has recently reiterated that the country will stick to its zero-COVID strategy. The success that China has had in suppressing the virus in the past two years has left its population with little natural immunity. Moreover, while China’s overall vaccination rate is high at 85%, less than 50% of people over the age of 80 in the country are fully vaccinated. The authorities have been fine tuning their measures to control the virus spread while sticking to a zero-COVID approach. The recently calibrated measures include allowing residents to take rapid antigen tests at home, quarantining people with asymptomatic COVID cases at dedicated isolation centers rather than hospitals, and monitoring patients for shorter periods than previously required. China has also fast-tracked the approval for the importing and domestic manufacturing of Paxlovid, which is highly effective at preventing hospitalization if taken within five days of the onset of symptoms. In addition, the global production of antiviral drugs is starting to ramp up (Chart 10). Nonetheless, China will probably wait until the antiviral drugs are in sufficient supply before fundamentally relaxing its zero-COVID policy. In the meantime, while the country’s economic growth will rebound when the current wave of COVID cases subsides, disruptive outbreaks and lockdowns may become more frequent as the authorities continue to play whack-a-mole with COVID (Chart 11). As a result, business activity in China will suffer. Chart 10Production Of New COVID Drugs Is Picking Up Production Of New COVID Drugs Is Picking Up Production Of New COVID Drugs Is Picking Up Chart 11China Has The Most Stringent COVID-Control Measures Among Large Economies China Has The Most Stringent COVID-Control Measures Among Large Economies China Has The Most Stringent COVID-Control Measures Among Large Economies Bottom Line: Shanghai’s current battle with COVID outbreaks will likely continue in the coming weeks. Before China can relax its zero-COVID policy, the more contagious COVID virus mutations in the future will see Chinese authorities adopt even harsher quarantine and control measures, which will disrupt economic activity further. Investment Conclusion  Chinese stocks in both onshore and offshore markets have recovered some ground from their deeply oversold conditions in mid-March (Chart 12A). While the risk-reward profile for the A-share market warrants a neutral position in a global portfolio, in absolute terms both on- and offshore Chinese stock prices have probably not reached their bottom (Chart 12B). Chart 12AChinese Stocks Will Likely Fall Further In Q2 Chinese Stocks Will Likely Fall Further In Q2 Chinese Stocks Will Likely Fall Further In Q2 Chart 12BIn Relative Terms, Stay Neutral On Chinese Onshore Stocks In Relative Terms, Stay Neutral On Chinese Onshore Stocks In Relative Terms, Stay Neutral On Chinese Onshore Stocks The private sector’s downbeat sentiment, households’ subdued demand for housing, and the ongoing COVID-19 lockdowns pose significant near-term downside risks to China’s economy and corporate profits. February’s credit impulse shows that corporate and household demand for credit has been weakening. Without a major reversal in corporate credit and the property market, a strong business cycle recovery is unlikely in China. Moreover, the March PMI readings suggest that the lockdowns in China’s business and manufacturing hubs will have substantial negative impacts on the economy. As such, we maintain our neutral stance on Chinese onshore stocks and continue to recommend underweight Chinese offshore stocks in a global portfolio.   Jing Sima China Strategist jings@bcaresearch.com   Strategic Themes Cyclical Recommendations

Upgrading Airlines Upgrading Airlines Following another sell-off, S&P airlines have been regaining some altitude of late despite US Covid cases and hospitalizations rising. The surge in Omicron infections appears to be priced in. Airlines have underperformed S&P 500 by about 20% over the past 13 weeks. The market is expecting the virus story to be over soon and is slowly rotating into the beaten down industries. One of the reasons for the optimistic outlook is likely due to the fact that the Omicron variant is milder. At the same time, there are no lockdowns in the US, and Americans are learning how to live with Covid on a permanent basis. Case in point, holiday travel has exceeded the pre-pandemic peak. We are also getting closer to the point of the white-collar workers returning to the office – hope is that business travel will pick up shortly after – which will benefit airlines stocks. True, international travel still weighs on the industry as quite a few European and Asian countries have reinstituted the lockdowns, but those headwinds are likely to dissipate over the course of 2022. Bottom Line: The time is ripe to start nibbling at the S&P airlines index. ​​​​​​​

Highlights Asian and European natural gas prices will remain well bid as the Northern Hemisphere winter approaches. An upgraded probability of a second La Niña event this winter will keep gas buyers scouring markets for supplies (Chart of the Week). The IEA is pressing Russia to make more gas available to European consumers going into winter. While Russia is meeting contractual commitments, it is also trying to rebuild its inventories. Gas from the now-complete Nord Stream 2 pipeline might not flow at all this year. High natgas prices will incentivize electric generators to switch to coal and oil. This will push the level and costs of CO2 emissions permits higher, including coal and oil prices. Supply pressures in fossil-fuel energy markets are spilling into other commodity markets, raising the cost of producing and shipping commodities and manufactures. Consumers – i.e., voters – experiencing these effects might be disinclined to support and fund the energy transition to a low-carbon economy. We were stopped out of our long Henry Hub natural gas call spread in 1Q22 – long $5.00/MMBtu calls vs short $5.50/MMBtu calls in Jan-Feb-Mar 2022 – and our long PICK ETF positions with returns of 4.58% and -10.61%. We will be getting long these positions again at tonight's close. Feature European natural gas inventories remain below their five-year average, which, in the event of another colder-than-normal winter in the Northern Hemisphere, will leave these markets ill-equipped to handle a back-to-back season of high prices and limited supply (Chart 2).1 The probability of a second La Niña event this winter was increased to 70-80% by the US Climate Prediction Center earlier this week.2 This raises the odds of another colder-than-average winter. As a result, markets will remain focused on inventories and flowing natgas supplies from the US, in the form of Liquified Natural Gas (LNG) cargoes, and Russian pipeline shipments to Europe as winter approaches. Chart of the WeekSurging Natural Gas Prices Intensify Competition For Supplies Natgas Markets Continue To Tighten Natgas Markets Continue To Tighten Chart 2Natgas Storage Remains Tight Natgas Markets Continue To Tighten Natgas Markets Continue To Tighten US LNG supplies are being contested by Asian buyers, where gas storage facilities are sparse, and European buyers looking for gas to inject into storage as they prepare for winter. US LNG suppliers also are finding ready bids in Brazil, where droughts are reducing hydropower availability. In the first six months of this year, US natgas exports averaged 9.5 bcf/d, a y/y increase of more than 40%. Although Russia's Nord Stream 2 pipeline has been completed, it still must be certified to carry natgas into Germany. This process could take months to finish, unless there is an exemption granted by EU officials. Like the US and Europe, Russia is in the process of rebuilding its natgas inventories, following a colder-than-normal La Niña winter last year.3 Earlier this week, the IEA called on Russia to increase natgas exports to Europe as winter approaches. The risk remains no gas will flow through Nord Stream 2 this year.4 Expect Higher Coal, Oil Consumption As other sources of energy become constrained – particularly UK wind power in the North Sea, where supplies went from 25% of UK power in 2020 to 7% in 2021 – natgas and coal-fired generation have to make up for the shortfall.5 Electricity producers are turning more towards coal as they face rising natural gas prices.6 Increasing coal-fired electric generation produces more CO2 and raises the cost of emission permits, particularly in the EU's Emissions Trading System (ETS), which is the largest such market in the world (Chart 3). Prices of December 2021 ETS permits, which represent the cost of CO2 emissions in the EU, hit an all-time high of €62.75/MT earlier this month and were trading just above €60.00/MT as we went to press. Chart 3Higher CO2 Emissions Follow Lower Renewables Output Higher CO2 Emissions Follow Lower Renewables Output Higher CO2 Emissions Follow Lower Renewables Output Going into winter, the likelihood of higher ETS permit prices increases if renewables output remains constrained and natgas inventories are pulled lower to meet space-heating needs in the EU. This will increase the price of power in the EU, where consumers are being particularly hard hit by higher prices (Chart 4). The European think tank Bruegel notes that even though natgas provides about 20% of Europe's electricity supply, it now is setting power prices on the margin.7 Chart 4EU Power Price Surge Is Inflationary Natgas Markets Continue To Tighten Natgas Markets Continue To Tighten Elevated natgas prices are inflationary, according to Bruegel: "On an annual basis, a doubling of wholesale electricity prices from about €50/megawatt hour to €100/MWh would imply that EU consumers pay up to €150 billion (€50/MWh*3bn MWh) more for their electricity. … Drastic increases in energy spending will shrink the disposable income of the poorest households with their high propensity to consume." This is true in other regions and states, as well. Is the Natgas Price Surge Transitory? The odds of higher natgas and CO2 permit prices increase as the likelihood of a colder-than-normal winter increases. Even a normal winter likely would tax Europe's gas supplies, given the level of inventories, and the need for Russia to replenish its stocks. However, at present, even with the odds of a second La Niña event this winter increasing, this is a probable event, not a certainty. The global natgas market is evolving along lines similar to the crude oil market. Fungible cargoes can be traded and moved to the market with the highest netback realization, after accounting for transportation. High prices now will incentivize higher production and a stronger inventory-injection season next year. That said, prices could stay elevated relative to historical levels as this is occurring. Europe is embarked on a planned phase-out of coal- and nuclear-powered electricity generation over the next couple of years, which highlights the risks associated with the energy transition to a low-carbon future. China also is attempting to phase out coal-fired generation in favor of natgas turbines, and also is pursuing a buildout of renewables and nuclear power. Given the extreme weather dependence on prices for power generated from whatever source, renewables will remain risky bets for modern economies as primary energy sources in the early stages of the energy transition. When the loss of wind, for example, must be made up with natgas generation and that market is tight owing to its own fundamental supply-demand imbalance, volatile price excursions to high levels could be required to destroy enough demand to provide heat in a cold winter. This would reduce support for renewables if it became too-frequent an event. This past summer and coming winter illustrate the risk of too-rapid a phase out of fossil-fueled power generation and space-heating fuels (i.e., gas and coal). Frequent volatile energy-price excursions, which put firms and households at risk of price spikes over an extended period of time, are, for many households, material events. We have little doubt the commodity-market effects will be dealt with in the most efficient manner. As the old commodity-market saw goes, "High prices are the best cure for high prices, and vice versa." All the same, the political effects of another very cold winter and high energy prices are not solely the result of economic forces. Inflation concerns aside, consumers – i.e., voters – may be disinclined to support a renewable-energy buildout if the hits to their wallets and lifestyles become higher than they have been led to expect. Investment Implications The price spike in natgas is highly likely to be a transitory event. Another surge in natgas prices likely would be inflationary while supplies are rebuilding – so, transitory.  Practically, this could stoke dissatisfaction among consumers, and add a political element to the transition to a low-carbon energy future. This would complicate capex decision-making for incumbent energy suppliers – i.e., the fossil-fuels industries – and for the metals suppliers, which will be relied upon to provide the literal building blocks for the renewables buildout.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Commodities Round-Up Energy: Bullish US crude oil inventories fell 3.5mm barrels in the week ended 17 September 2021, according to the US EIA. Product inventories built slightly, led by a 3.5mm-build in gasoline stocks, which was offset by a 2.6mm barrel draw in distillates (e.g., diesel fuel). Cumulative average daily crude oil production in the US was down 7% y/y, and stood at 10.9mm b/d. Cumulative average daily refined-product demand – what the EIA terms "Product Supplied" – was estimated at 19.92mm b/d, up almost 10% y/y. Brent prices recovered from an earlier sell-off this week and were supported by the latest inventory data (Chart 5). Base Metals: Bullish Iron ore prices have fallen -55.68% since hitting an all-time high of $230.58/MT in May 12, 2021 (Chart 6). This is due to sharply reduced steel output in China, as authorities push output lower to meet policy-mandated production goals and to conserve power. Even with the cuts in steel production, overall steel output in the first seven months of the year was up 8% on a y/y basis, or 48mm MT, according to S&P Global Platts. Supply constraints likely will be exacerbated as the upcoming Olympic Games hosted by China in early February approach. Authorities will want blue skies to showcase these events. Iron ore prices will remain closer to our earlier forecast of $90-$110/MT than not over this period.8 Precious Metals: Bullish The Federal Open Market Committee is set to publish the results of its meeting on Wednesday. In its last meeting in June, more hawkish than expected forecasts for interest rate hikes caused gold prices to drop and the yellow metal has been trading significantly lower since then. Our US Bond Strategy colleagues expect an announcement on asset purchase tapering in end-2021, and interest rate increases to begin by end-2022.9 Rate hikes are contingent on the Fed’s maximum employment criterion being reached, as expected and actual inflation are above the Fed criteria. Tapering asset purchases and increases in interest rates will be bearish for gold prices. Chart 5 BRENT PRICES BEING VOLATILE BRENT PRICES BEING VOLATILE Chart 6 BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI)RECOVERING BENCHMARK IRON ORE 62% FE, CFR CHINA (TSI)RECOVERING       Footnotes 1     Equinor, the Norwegian state-owned energy-supplier, estimates European natgas inventories will be 70-75% of their five-year average this winter.  Please see IR Gas Market Update, September 16, 2021. 2     Please see "ENSO: Recent Evolution, Current Status and Predictions," published by the US Climate Prediction Center 20 September 2021.  Earlier this month, the Center gave 70% odds to a second La Niña event in the Northern Hemisphere this winter.  Please see our report from September 9, 2021 entitled NatGas: Winter Is Coming for additional background. 3    Please see IEA calls on Russia to send more gas to Europe before winter published by theguardian.com, and Big Bounce: Russian gas amid market tightness.  Both were published on September 21, 2021. 4    Please see Nord Stream Two Construction Completed, but Gas Flows Unlikely in 2021 published 14 September 2021 by Jamestown.org. 5    Please see The U.K. went all in on wind power. Here’s what happens when it stops blowing, published by fortune.com on 16 September 2021.  Argus Media this week reported wind-power output fell 56% y/y in September 2021 to just over 2.5 TWh. 6    Please see UK power firms stop taking new customers amid escalating crisis, published by Aljazeera; Please see UK fires up coal power plant as gas prices soar, published by BBC. 7     Please see Is Europe’s gas and electricity price surge a one-off?, published by Bruegel 13 September 2021. 8    Please see China's Recovery Paces Iron Ore, Steel, which we published on November 5, 2020. 9    Please see 2022 Will Be All About Inflation and Talking About Tapering, published on September 22, 2021 and on August 10, 2021 respectively.     Investment Views and Themes Recommendations Strategic Recommendations Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

KSU's Bidding War KSU's Bidding War Overweight We are currently overweight the S&P railroads index in anticipation of financial sector liquidity morphing into real economic growth and thus propelling domestic oriented railroad stocks. There is also another way easy monetary policy is boosting this transportation sub-industry's already high monopolistic stature: by providing cheap capital incentivizing mergers as is evident in the recent bidding war for KSU that pushed the stock higher by 35% in a month. Switching to macro data, and the message is equally upbeat. Both our macro earnings model and margin proxy – constructed using industry-level data – are sending a bullish message and corroborate that investors should remain overweight rails (see chart). Bottom Line: We reiterate our March 15 boost to overweight in the S&P railroads index. The ticker symbols for the stocks in this index are: BLBG: S5RAIL – CSX, KSU, NSC, UNP.  

Bon Voyage! Bon Voyage! Overweight We have been overweight the niche (0.33% of the S&P 500) airlines sector going into the pandemic, and while it has been slow to recover, there is little doubt that soon airline stocks will reclaim their pre-COVID-19 altitude. The top panel of the chart on the right highlights that travelling is making a comeback as a larger and larger proportion of the world population is becoming inoculated. Consequently, air travel is springing to life. Another services industry that COVID-19 wrecked also confirms that the path of least resistance is higher for airlines: indoor dining is en route to rebound to pre-pandemic levels (middle panel). Finally, business and consumer travelling is slated to make a huge comeback following months of “staycations”. Consumers and businesses alike have amassed significant excess savings and stand ready to draw them down when the opportunity arises, likely some time after Memorial Day. This will further underpin the recovery in airlines and other savaged services stocks. Bottom Line: Stay overweight the S&P airlines index that will be gaining altitude as fiscal checks trickle down through the economy at a time when the US at large reaches herd immunity. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. ​​​​​​​