United States

We first highlighted that investors were turning a blind eye to (geo)political risks on June 8, and failure to pass a new fiscal package before the election will continue to weigh on the economy and on stocks risking a further 10% drawdown near the SPX 3000 level. Figure 1The Fiscal Policy Loop Dark (Fiscal) Clouds Gathering Dark (Fiscal) Clouds Gathering The Fed is now “out of the loop” i.e. a bystander on the sidelines, gently moving the foot off the accelerator as we illustrated on Monday. The FOMC’s, at the margin, less dovish monetary policy setting exerts enormous pressure on fiscal authorities to act as fiscal policy takes center stage. Our sense is that we have entered a Fiscal Policy Loop (FPL) where stalemate in Congress will cause a classic BCA riot point that in turn will force politicians’ hand to act in order to avoid a meltdown, and set in motion the next stage of the FPL (Figure 1). Keep in mind that the 2020s have ignited a paradigm shift from the Washington Consensus to the Buenos Aires Consensus1 and this is episode one of the FPL, more are sure to follow.    This is eerily reminiscent of the October 2008 and October 2018 fiscal policy and monetary policy mistakes, respectively, that resulted in a market riot. Similar to today, markets were down 10% and on a precipice and the policy errors pushed them off the cliff leading to another 10% gap down in a heartbeat. Bottom Line: The odds of a fiscal policy mistake are rising quickly and risk an equity market riot point. We remain cautious on the short-term prospects of the equity market and recommend investors keep their powder dry as a better entry point will likely materialize in the coming months. Footnotes 1  The Washington Consensus – a catchall term for fiscal prudence, laissez-faire economics, free trade, and unfettered capital flows – is being replaced by economic populism, by a Buenos Aires Consensus. Buenos Aires Consensus is our catchall term for everything that is opposite of the Washington Consensus: less globalization, fiscal stimulus as far as the eyes can see, erosion of central bank independence, and a dirigiste (as opposed to laissez-faire) approach to economics that seeks to protect “state champions,” stifles innovation, and ultimately curbs productivity growth.  

Highlights Senate Republicans would be suicidal not to agree to a fiscal relief bill before the election. Democrats are still offering a $2.2 trillion package. Grassroots Republican voters will forgive Republicans for blowing out the budget deficit but they will never forgive them for throwing away control of the White House and Senate. Nevertheless financial markets face more downside until a deal is reached. We are booking gains on several of our tactical risk-off trades but will hold our strategic risk-on trades, as we are still constructive over a 12-month period. Turkey is stepping back from its foreign adventurism in the face of constraints. Our GeoRisk Indicator for Turkey has rolled over. Feature Financial markets continue to sell off in the face of a range of risks, including new threats of COVID-19 restrictions in Europe, an increase in daily new cases of the disease in the United States (Chart 1), and the US Congress’s problems passing a new round of fiscal relief. Chart 1Increase In COVID-19 Cases Among Factors Weighing On Markets Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Chart 2Congress Will Pass Stimulus ~$2-$2.5 Trillion Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Since May, when the Democrats passed the $3.4 trillion HEROES Act, we have maintained that “stimulus hiccups” would roil the market. However, we also argued that Congress would eventually pass a new package – probably in the range of $2-$2.5 trillion (Chart 2).1 The latter part of this view remains to be seen and has come under pressure from investors who fear that Congress could fail to produce a bill entirely. We are sticking with our guns. GOP senators will recognize that they face sweeping election losses; House Democrats will not be able to reverse course and deprive households of badly needed assistance. However, stock investors might sell more between now and the final deal, which must be done by around October 9 so that lawmakers can go back to their home states to campaign for the November 3 election. Moreover the fiscal deal might not come in time to save the Republicans’ re-election bid in the White House and Senate, which raises further downside risk due to the Democratic agenda of re-regulation and tax hikes. And the election’s aftershocks could also be market-negative. For example, President Trump could also escalate the conflict with China, whether as the “comeback kid” or as a lame duck. Therefore this week we are booking some gains. We will not recommend a tactical risk-on position until our fiscal view is confirmed and we can reassess. US Fiscal Stimulus Is Coming Chart 3Republicans Highly Unlikely To Win House Of Representatives Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Why would Democrats agree to a stimulus bill given that it could help President Trump and the Republicans get re-elected? Democrats are afraid to deprive households of relief amid a crisis merely to spite the president and score election points. Around 28-43 of Democrats in the House of Representatives face re-election in districts that are competitive or could become competitive. Republicans need a net gain of 20 seats to retake the House (Chart 3). If Democrats offer to cooperate yet Republican senators balk, then the latter will take the blame for any failed deal and ensuing financial turmoil. The experience of other fiscal cliffs bears this out. The debt ceiling crises of 2011 and 2013 and the government shutdowns of 2013 and 2018-19 all suggest that net presidential and congressional approval ratings suffer when partisanship prevents compromise on major fiscal issues (Charts 4A and 4B). This is a risk for the ruling GOP. All Democrats have to do is remain open to compromise. Net presidential and congressional approval ratings suffer when partisanship prevents compromise on major fiscal issues – a risk for the ruling GOP. Chart 4AFiscal Failures Pose A Risk To Ruling GOP Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Chart 4BFiscal Failures Pose A Risk To Ruling GOP Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Confirming this reasoning, Democrats joined with Republicans this week to pass a continuing resolution to maintain government spending levels through December 11, thus avoiding a government shutdown. Clearly the two parties can still cooperate despite record levels of partisanship. House Speaker Nancy Pelosi ruled out using government shutdown as a weapon to hurt the Republicans, fearing it would backfire. And just last week vulnerable House members pressured Pelosi into stating that the House will remain in session in October until a fiscal relief bill is passed. Democrats remain committed to their current plan – solidifying their grip on the House and demonstrating that they can govern, and that government can do more for households, by passing bills. This is still the strategy even if the risk is that these bills give Trump a marginal benefit. The Democratic demand is for a very large fiscal package – House Speaker Nancy Pelosi is today offering $2.2 trillion, a compromise from the initial $3.4 trillion bill (Table 1). A smaller bill is harder to negotiate because it would cut the House Democrats’ spending priorities for their constituents, including around $1 trillion in state and local government aid, while still giving Trump a bounce in opinion polls for boosting pandemic relief. This is unacceptable – and this is how a policy mistake could happen. Table 1What A Fiscal Compromise Will Look Like Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Chart 5Senate Republicans Face A Hotly Contested Election Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Chart 6Republican Senators' Hung Up On Future Deficit Concerns Republican Senators' Hung Up On Future Deficit Concerns Republican Senators' Hung Up On Future Deficit Concerns Senate Republicans face a hotly contested election – with 23 of them up for re-election versus only 12 Democrats. However, 30 of them are not up for re-election this year (Chart 5). These senators fear the eventual return of deficit concerns among the Republican base so they are bargaining to limit emergency spending (Chart 6). Until they can be cajoled by their fellow senators and the White House, they pose a risk to the passage of new stimulus. But this risk is overrated. Ultimately Senate Majority Leader Mitch McConnell and the Senate Republicans will capitulate. It is political suicide if they do not. The GOP will lose control of the Senate and the White House if premature fiscal tightening sparks a bloody September-October selloff just ahead of the election (Charts 7Aand 7B). Chart 7AStocks Sell, Bonds Rally … When Congress Goes Off Fiscal Cliff Stocks Sell, Bonds Rally... When Congress Goes Off Fiscal Cliff Stocks Sell, Bonds Rally... When Congress Goes Off Fiscal Cliff Chart 7BStocks Sell, Bonds Rally … When Congress Goes Off Fiscal Cliff Stocks Sell, Bonds Rally... When Congress Goes Off Fiscal Cliff Stocks Sell, Bonds Rally... When Congress Goes Off Fiscal Cliff Chart 8Trump Compares Poorly To Other Presidents Re-Elected Amid Recession Trump Compares Poorly To Other Presidents Re-Elected Amid Recession Trump Compares Poorly To Other Presidents Re-Elected Amid Recession Only three out of six presidents in modern times have been re-elected when a recession struck during the election year yet ended prior to the fall campaign. These were William McKinley in 1900, Teddy Roosevelt in 1904, and Calvin Coolidge in 1924.2 Trump faces the same scenario, but financial markets are signaling that Trump is not faring as well as these three predecessors (Chart 8). The Senate races are all on a knife’s edge (Chart 9). American politics are highly nationalized – partisan identification overrides regional concerns. President Trump has also personalized his political party, making the election a referendum on himself (Chart 10). These trends suggest the Senate will fall to the party that wins the White House. Chart 9The Senate Races Are All On A Knife’s Edge Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Consumer confidence is weak and bodes ill for the incumbent president and party (Chart 11). Chart 10Trump Has Personalized Partisan Politics Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Chart 11Consumer Confidence Bodes Ill For Trump And GOP Consumer Confidence Bodes Ill For Trump And GOP Consumer Confidence Bodes Ill For Trump And GOP A failure to provide stimulus will ensure that sentiment worsens for the rest of the campaign and overshadows some underlying material improvements that are the Republicans’ only saving grace. Wage growth is recovering in line with the V-shape recovery in blue and purple states, including purple states that voted for Trump (Chart 12). The manufacturing rebound – and a surge in loans – is creating the conditions for the “Blue Wall” of Pennsylvania, Michigan, and Wisconsin to re-elect President Trump (Chart 13). A fiscal failure will blot out this positive news. Chart 12Fiscal Failure Would Blot Out Economic Improvements Fiscal Failure Would Blot Out Economic Improvements Fiscal Failure Would Blot Out Economic Improvements Chart 13Blue Wall' Could Re-Elect Trump On Economic Improvement Blue Wall' Could Re-Elect Trump On Economic Improvement Blue Wall' Could Re-Elect Trump On Economic Improvement Republicans’ standing offer is for a $1.3 trillion bill. The bipartisan “Problem Solver’s Caucus” has separately proposed a $1.5 trillion package that could be converted. McConnell has shown he can muster his troops by producing 52 Republican votes on a skinny relief bill on September 10. The Senate will go on recess on Friday, October 9 and the House is committed to staying until a bill is done. Negotiations cannot drag on much longer than that, however, because lawmakers need to go back to their home states and districts to campaign for the election. The equity selloff suggests policymakers will need to respond sooner anyway. Is there a way for Trump to bypass Congress and provide stimulus unilaterally? Chart 14Gridlock In 2020-22 Is Possible Under Trump Or Biden Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Trump is only too happy to run against a “do-nothing Congress,” which is how Harry Truman pulled off his surprise victory in 1948. He could use executive orders to redirect federal funds that have already been appropriated. However, he has already provided stimulus by decree – delaying payroll tax collections and calling on states to provide unemployment insurance – and yet the market has sold off anyway. That is because these measures are half-baked – they lack the size and the force of an act of Congress. They require coordination with states and firms, which face uncertainty over the legality of the measures and have little incentive to make sacrifices for an administration that may not last more than a few months. In short, if Trump tries to stimulate by decree, it is an election gimmick that will not satisfy market participants who need to look beyond the next 39 days to the critical question of whether US fiscal authorities understand the needs of the economy and can coordinate effectively. Congressional failure will cast a pall over the outlook given that there is still a fair chance the election could produce gridlock for the 2020-22 period, under Trump or Biden (Chart 14). Bottom Line: Financial markets face more downside until Senate Republicans capitulate to Pelosi’s demand of a bill around $2-$2.5 trillion. We think they will, but that is not an argument for getting long now – Republicans could capitulate too late to save the market from a deeper selloff. Investors should book profits now and buy when the deal is clinched. What About The Supreme Court? The Supreme Court battle over the death of Justice Ruth Bader Ginsburg may increase the risk of miscalculation in the stimulus negotiations, but not by much. Subjectively we would upgrade that risk from 25% to 33%. Republicans will fill the vacant seat before the election. So far they have the votes – even if Senator Mitt Romney changes his mind, there is still a one-seat buffer. However, a win on the high court has a mixed impact on financial markets. It may increase the odds of a Democratic Party sweep, which is initially a net negative for equities. But House Democrats will become less inclined to compromise on the size of the fiscal bill that we expect. They will say “take it or leave it” on the $2.2 trillion offer. The lowest we can see Democrats passing is $1.9 trillion. If the GOP fails to budge, the equity selloff will be aggravated by the implication that Democrats will win a clean sweep and thus gain the power to raise corporate and capital gains taxes next year. We have put 55%-60% odds on a clean sweep, but the market stands at 49%, so there is room for the market to adjust (Chart 15). As for the Supreme Court itself, a Republican nomination is legitimate regardless of the election timing, though the decision to go forward this close to the election reveals extreme levels of polarization. The Republican pick could energize the Democrats in the election, as occurred with the nomination of Justice Brett Kavanaugh just ahead of the 2018 midterms. A Democratic overreaction could mobilize conservatives, but this will be moot if the stock market collapses. If the presidential election is contested or disputed, Trump’s court nominee pick could cast the decisive vote, although, once nominated, a justice may not rule in accordance with his or her nominator’s wishes. The Supreme Court battle raises the risk of stimulus miscalculation to 33%. In a period of “peak polarization,” one should expect the Supreme Court battle to escalate further from here (Chart 16). Democrats are likely to remove the filibuster if they win the Senate. This would theoretically enable them to create four new seats on the court, which they could then fill with liberal judges. Franklin Roosevelt attempted to pack the court in 1937 when it got in the way of the New Deal and his plan only narrowly failed due to the unexpected death of a key ally in the Senate. Chart 15A Democratic Sweep Would Aggravate The Equity Selloff A Democratic Sweep Would Aggravate The Equity Selloff A Democratic Sweep Would Aggravate The Equity Selloff Chart 16Supreme Court Battle Will Escalate Amid Extreme Polarization Supreme Court Battle Will Escalate Amid Extreme Polarization Supreme Court Battle Will Escalate Amid Extreme Polarization Not only might the court decide the election outcome, but future controversial legislation could live or die by the court’s vote, as occurred with Obamacare in 2012 (Chart 17). In the event that Democrats achieve a clean sweep, the conservative court will be their only obstacle and they will possess the means to remove it. Chart 17Supreme Court Battle Will Prove Market Relevant In Event Of Democratic Sweep Supreme Court Battle Will Prove Market Relevant In Event Of Democratic Sweep Supreme Court Battle Will Prove Market Relevant In Event Of Democratic Sweep Bottom Line: Earlier we saw a 25% chance that stimulus would fail – now we give it a 33% chance. However, the size of the stimulus is now even more likely to fall within the $2-$2.5 trillion range we have signaled in previous reports. The Supreme Court will become a major factor in domestic economic policy uncertainty if Democrats win a clean sweep of government. Turkey Hits Constraints In East Med – For Now … Turkish President Recep Tayyip Erdogan’s foreign policy assertiveness has once again put Turkey in conflict with NATO allies. Tensions escalated last month after Greece signed a maritime boundary deal with Egypt that Athens said nullified last November’s Libya-Turkey agreement (Map 1). Map 1Turkey Testing Maritime Borders In the East Med Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) In response, Turkey issued a navigational warning (which was renewed thrice) and dispatched its seismic research vessel, the Oruc Reis, to explore for hydrocarbons in disputed areas of the Eastern Mediterranean between Greece and Cyprus. In shows of force, Turkey and Greece both deployed their navies to the area last month, raising the risk of an armed confrontation.3 The motivation for Erdogan’s hard power tactics is multi-pronged. Chart 18Erdogan’s Foreign Adventurism Reflects Domestic Weakness Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) On a domestic level, Erdogan’s East Med excursions are an attempt to rally domestic support, where he and his party have lost ground (Chart 18). Given that popular opinion in Turkey indicates that the majority see the self-declared Turkish Republic of Northern Cyprus as a “kin country” and that they do not expect Turkey to be accepted into the EU, Ankara’s East Med strategy is likely to find support. On an international level, Turkey is flexing its muscles against the West. Erdogan has inserted Turkish forces into conflicts in Syria and Libya, confronting NATO allies there, and authorized the provocative purchase of the Russian S400 missile defense system at the expense of membership in the US F-35 program. The East Med gambit is another challenge to the West by testing EU unity. Specifically Erdogan is demonstrating that Turkey is willing to use military force to reject any unilateral attempts by foreign powers to impose maritime borders on Turkey – for instance through the EU’s Seville map.4 By demonstrating maritime strength, Turkey hopes to twist the EU’s arm into agreeing to a more favorable maritime partition plan in the East Med. As such the conflict is part of Turkey’s “Blue Homeland” strategy to expand its sphere of influence and secure energy supplies.5 Turkey is extremely vulnerable as a geopolitical actor because it depends on imports for three-quarters of its energy needs.6 With energy accounting for 20% of its import bill, these imports are weighing on the current account balance (Chart 19). Turkey’s exclusion from regional gas agreements has thus been a blow to its self-sufficiency goals. Meanwhile Greece, Italy, Egypt, Israel, Cyprus, and Jordan have recently formalized their cooperation through the Cairo-based East Mediterranean Gas Organization. Turkish agitation in the East Mediterranean is an attempt to prevent others from exploiting gas resources there so long as its demands remain unmet. Erdogan’s retreat demonstrates Turkey’s constraints in its challenge to the EU. While the EU has yet to impose sanctions or penalties, Erdogan has now backtracked. Oruc Reis returned to Antalya on September 13, despite official statements that it would continue its mission. Turkish and Greek military officials have been meeting at NATO headquarters. And following talks with French President Emmanuel Macron, German Chancellor Angela Merkel, and EU President Charles Michel, Erdogan’s office announced on September 22 that Turkey and Greece were prepared to resume talks. The postponement of the European Council’s special meeting to discuss Turkish sanctions to October 1-2 plays to Turkey’s favor by giving more time for talks. Chart 19Turkey's Energy Dependence A Geopolitical Vulnerability Turkey's Energy Dependence A Geopolitical Vulnerability Turkey's Energy Dependence A Geopolitical Vulnerability Erdogan’s retreat demonstrates Turkey’s constraints in its challenge to the EU. The possibility of damaging sanctions was too much at a time of economic vulnerability. Given Turkey’s dependence on the EU for export earnings and FDI inflows, the impact of sanctions on Turkey’s economy cannot be overstated (Chart 20). Chart 20EU Sanctions Could Destroy Turkey's Economy EU Sanctions Could Destroy Turkey's Economy EU Sanctions Could Destroy Turkey's Economy Turkey is also facing constraints diplomatically as two of its regional rivals – the United Arab Emirates (UAE) and Israel – have agreed to normalize relations and strengthen ties under the US-mediated Abraham Accords (Table 2). The UAE already dispatched F-16s to Crete to participate in joint training exercises in a show of support to Greece. Table 2The Abraham Accords Unify Turkey’s Regional Rivals Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Details about the potential sanctions have not been released. However, EU Minister of Foreign Affairs Josep Borrell has indicated that penalties could be levied not only on individuals, but also on assets, ships, and Turkish access to European ports and supplies. This could include banks financing energy exploration or even entire business sectors, such as the energy industry. Moreover, the EU could play other damaging cards such as halting EU accession talks, or limiting its customs union with Turkey, which Ankara hopes to modernize. Chart 21EU Needs Turkey’s Cooperation To Stem Flow Of Migrants Stimulus Will Come … But May Not Save Trump (GeoRisk Update) Stimulus Will Come … But May Not Save Trump (GeoRisk Update) It is also in Europe’s interest to de-escalate the conflict. Sanctions on Turkey could accelerate Ankara’s re-orientation towards Russia and possibly China, expediting its transition to a hostile regional actor. In addition, Turkey has not shied away from using the 2016 migration deal, whereby Turkey has become the gatekeeper of Middle Eastern migrants fleeing to Europe, as a bargaining chip (Chart 21). Foreign Minister Mevlut Cavusoglu outright stated that Turkey will respond to EU sanctions by reneging on the deal, which could result in an influx of refugees into the EU and new challenges for Europe’s political establishment. Erdogan’s retreat is also likely a response to pressure from Washington. Secretary of State Mike Pompeo lent some support to Greece and Cyprus during his September 12 visit to Cyprus. While the US has distanced itself from recent developments in the East Med, leaving German Chancellor Angela Merkel to play the role of mediator, a deterioration in Ankara’s relations with NATO allies could accelerate Turkey’s de-coupling from the West. Some within Washington are already calling for a relocation of the US strategic Incirlik air base to Greek islands. Erdogan’s retreat from a hawkish stance is in line with similar behavior elsewhere. For instance, despite having taken delivery of all parts and completed all necessary tests, Turkey has yet to activate its Russian S-400 missile defense system. It is wary of US sanctions. Similarly, Ankara has paused its Libyan offensive toward the eastern oil crescent in face of the risk of an outright military confrontation with Egypt. In each case, Erdogan appears to be at least temporarily recognizing the limits to his foreign adventurism. Nevertheless, the recent de-escalation does not mark the end of the conflict. Rather it demonstrates that both sides have hit constraints and are pausing for a breather. Chart 22Erdogan's Tactical Retreat Will Pull Down Turkish Risk Erdogan's Tactical Retreat Will Pull Down Turkish Risk Erdogan's Tactical Retreat Will Pull Down Turkish Risk The tactical retreat will provide some relief for the lira, which hit all-time lows against the dollar and euro, and thus pull down our Turkey GeoRisk indicator (Chart 22). But it does not guarantee that the Turkish risk premium will stay low. Talks between Greece and Turkey are unlikely to result in substantial breakthroughs. Instead the conflict will resurface – perhaps when Turkey is in a stronger economic position at home and the EU is distracted elsewhere, whether with internal political issues or conflicts with Russia, the UK, or any second-term Trump administration. Bottom Line: The recent de-escalation of East Med tensions does not mark the end of a bull market in Turkey-EU tensions. These tensions arise from geopolitical multipolarity – Turkey’s ability to act independently in foreign policy without facing an overwhelming, unified US-EU response. However, Turkey’s vulnerability to European economic sanctions shows that it faces real constraints. A major attempt to flout these constraints is a sell signal for the lira, as European sanctions could then become a reality. We remain negative on the lira, but will book gains on our short trade. Investment Takeaways We are booking gains on some of our tactical risk-off trades, given that we ultimately expect the US Congress to approve a new fiscal package. We are closing our long VIX December 2020 / short VIX January 2021 trade, which captured concerns about a contested election in the United States, for a gain of 4%. Volatility will still rise and a contested election is still possible, but the fiscal risk has gone up, COVID-19 cases have gone up, and Trump’s polling comeback has softened. The 4% gain does not include leverage or contract size. We were paid to put on the trade and now will be paid to exit it, so we are booking gains (Chart 23). Chart 23Book Gains On Bet On Near Term Volatility Book Gains On Bet On Near Term Volatility Book Gains On Bet On Near Term Volatility We are closing our short “EM Strongman Basket” of Turkish, Brazilian, and Philippine currencies for a gain of 4.5%. The trade has performed well but Turkey is not only recognizing its constraints abroad but also recognizing constraints at home by raising interest rates to defend the lira. In Brazil, Jair Bolsonaro’s approval rating has surged and our GeoRisk indicator has topped out. The latest readings on our GeoRisk Indicators provide confirmation of our major themes, views, and trades. The charts of each country’s indicator can be found in the Appendix. Short China, Long China Plays: Geopolitical risk continues on the uptrend that began with Xi Jinping’s consolidation of power and has not abated with the Phase One trade deal. Policymakers will remain entirely accommodative on fiscal and quasi-fiscal (credit) policy in the wake of this year’s recession. New financial regulations do not herald a return of the deleveraging campaign in any way comparable to 2017-18. The October Politburo meeting on the economy could conceivably sound a hawkish note, which could conveniently undermine sentiment ahead of the US election, but if this occurs then we would not expect follow-through. China plays and commodity plays should benefit, such as the Australian dollar, iron ore prices, and Brazilian and Swedish equities. Yet we remain short the renminbi, which has recently flagged after a fierce rally. Trump is negative for the RMB and Biden will ultimately be tough on China, contrary to the market consensus. Short Taiwan: US-China strategic relations have collapsed over the course of the year but financial markets have ignored it due to COVID-19 and stimulus. The only thing keeping US-China relations on an even keel is the Trump-Xi gentleman’s agreement, which expires on November 3 regardless of the election outcome. While outright military conflict over Taiwan cannot be ruled out, Beijing is much more likely to impose economic sanctions prior to any attempt to take the island by force. This has been our base case since 2016. Our GeoRisk indicator is just starting to price this risk so it remains highly underrated from the perspective of the Taiwanese dollar and equities. We are short and there is still time to put on shorts. Long South Korea: The rise in Korean geopolitical risk since the faltering of US-North Korean diplomacy in 2019 has peaked and fallen back, as expected. Pyongyang has not substantively tested President Trump during the election year and we still do not think he will – though a showdown would mark an October surprise that could boost Trump’s approval rating. South Korean political risk should continue falling and we are long Korean equities. Short Russia: Russian geopolitical risk has exploded upward, as we expected. We have been bearish on the Russian ruble and local currency bonds, though we should note that this differs from our Emerging Markets Strategy view based on macro fundamentals. Our reasoning predates the escalation of tensions with the EU over Belarus, but Belarus highlights the negative dynamic: Vladimir Putin in his fourth term is concerned about domestic social and political stability, and this concern is especially heightened after the global pandemic and recession. Therefore he has little ability to tolerate unrest in the former Soviet sphere. Moreover, he has a window of opportunity when the US administration is distracted, and not unfriendly, whereas that will change if the Democrats take over. If Democrats win, they will not try another diplomatic “reset” with Russia; they believe engagement has failed and want revenge for Putin’s undermining the Obama administration and 2016 election interference. The Nordstream 2 pipeline and Russian local currency bonds are at risk of new sanctions. The Democrats will also increase their efforts at cyber warfare and psychological warfare to counter Russia’s use of such measures. If Trump wins, the upside for Russia is limited as Trump’s personal preferences have repeatedly lost to the US political and military establishment when it comes to Russia. The US has remained vigilant against Russian threats and has increased support for countering Russia in eastern Europe and Ukraine. Chart 24Russia Is At Risk of US Sanctions Russia Is At Risk of US Sanctions Russia Is At Risk of US Sanctions In Belarus, President Lukashenko has been sworn in as president again, and he will not step down unless Russia and its allies orchestrate a replacement who is friendly toward Russian interests. Russia will not allow a pro-EU, pro-NATO government by any stretch of the imagination. The likeliest outcome is that Russia demonstrates its security and military superiority in a limited way, while the US and Europe respond with sanctions but not with military force. There is no appetite for the US or EU to engage in hot war with Russia over Belarus, which they have little hope of re-engineering in the Western image. We are short Russian currency and local bonds on the risk of sanctions stemming from either the US election cycle or the Belarus confrontation or both. We note that local currency bonds are not pricing in the risks that our geopolitical risk indicators are pricing (Chart 24). Long Europe: Our European geopolitical risk indicators show that the EU remains a haven of political stability in an unstable time. European integration is accelerating in the context of security threats from Russia, the potential for sustained economic conflict with the US (if Trump is re-elected), and economic competition with an increasingly authoritarian and mercantilist China. Europe’s latent strengths, when acting in unison, are brought out by the report on Turkey above. However, the 35% chance that the UK fails to reach a trade deal at the end of this year will still push our European risk indicators up in the near term.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Roukaya Ibrahim Editor/Strategist Geopolitical Strategy RoukayaI@bcaresearch.com   We Read (And Liked) … Geopolitical Alpha: An Investment Framework For Predicting The Future What better way to revive the hallowed tradition of BCA Geopolitical Strategy book reviews than to give clients a sneak preview of our founder Marko Papic’s literary debut, Geopolitical Alpha: An Investment Framework for Predicting the Future?7 Long-time readers will know much of this book – it is the distillation of a decade of Marko’s work at BCA Research and, more recently, Clocktower Group. Here is the story of European integration – perhaps Marko’s greatest call, from back in 2011. Here is the story of multipolarity and investing. Here is the apex of globalization. Here is the decline of laissez-faire and the rise of dirigisme. Here is the end of Chimerica. Attendees of the BCA Research Academy will also recognize much in Marko’s formal exposition of his method. The categories of material constraints that bind policymakers. The practical application of the median voter theorem. The psychological lessons from Richards Heuer and Lee Ross. The occasional dash of game theory – and the workingman’s critique of it. The core teaching is the same: “Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.” There is also much that is new, notably Marko’s analysis of the COVID-19 pandemic, which is bound to generate controversy for classifying the whole episode as an example of mass hysteria comparable to the Salem witch trials, but which is as well-researched and well-argued as any section in the book. I was fortunate to learn the geopolitical method with Marko under the guidance of George Friedman, Peter Zeihan, Roger Baker, Fred Burton, Scott Stewart, and other colleagues at Stratfor (Strategic Forecasting, Inc.) in Austin, Texas from the era of the Iraq troop surge, the Russian invasion of Georgia, and the Lehman Brothers collapse. We both owe a lot to these teachers: the history of geopolitics, intelligence analysis, open source monitoring, net assessments, and, of course, forecasting. What Marko did was to take this armory of geopolitical analysis – which we both can testify is best taught in practice, not universities – and to put it to use in the financial context, where political analysis was long treated as optional and anecdotal despite the manifest and growing need for a rigorous framework. A hard-nosed analyst will never cease to be amazed by the gaps that emerge between the consensus view on Wall Street and a careful, disciplined net assessment of a nation or political movement. By the same token, the investor, trader, or economist will never cease to be amazed by the political analyst’s inability to grasp the concept of “already priced in” or “the second derivative.” What needed to be done was to master the art of macro investing and geopolitics. Marko took this upon himself. It was audacious and it provoked a lot of skepticism from the dismal scientists and the political scientists alike. But Geopolitical Alpha, the concept and the book, is the consequence – and we are now all the better for it. Marko is fundamentally a post-modern thinker. His methodological hero is Karl Marx for the development of materialist dialectic, the back-and-forth debate between economic forces that humans internalize in the form of competing ideologies. His foil is the humanist and republican, Niccolo Machiavelli – not for his amoral approach, but for prizing the virtue of the prince in the face of outrageous fortune. Human agency is Marko’s favorite punching bag – he excels at identifying the ways in which individuals will be frustrated despite their best efforts by the cold, insensitive walls of reality around them. If there is a critique of Marko’s book, then, it is that he gives short shrift to the classical liberal tradition – or as I like to think of it, the balance-of-power tradition. The idea that hegemony, or unipolarity, leads to a stable social and political environment conducive to peace and prosperity has a lot going for it. But it also partakes of an older tradition of thought that envisions a single, central political order as necessarily the most stable and predictable – a tradition that can be ascribed to Plato as well as Marx. You can see the positive implication for financial markets. But what if this tradition is only occasionally right – what if it too is subject to historical cycles? If that is the case, then the Beijing consensus is a mirage – and the US’s reversion to a blue-water strategy (not only under President Trump, but also under a future President Biden, according to his campaign agenda) does not necessarily herald the “end [of] American dominance on the world stage.” The classical tradition behind the Greco-Roman, British, and American constitutional systems, including their naval strategies, envisioned a multipolar order that was somewhat less stable but more durable, and this tradition has proven immensely beneficial for the creation of technology and wealth. Of course, Marko is very much alive to this tradition and, despite his critique of the ancients, shows himself to be highly sensitive to the interplay of virtue and fortune. Throughout the work, the analytical style can be characterized as restless energy in the service of cool, chess-playing logic. Marko is generous with his knowledge, merciless in drawing conclusions, and outrageously funny in delivery. He attacks the questions that matter most to investors and that experts too often leave shrouded in finely wrought uncertainty. He also shows himself to be a superb writer as well as strategist, interspersing his methodological training sessions with vivid anecdotes of a lifelong intellectual journey from a shattered Yugoslavia to the heights of finance. The bits of memoir are often the best, such as the intro to Chapter Six on geopolitics. To paraphrase a great author, Marko writes because he has a story to tell, not because he has to tell a story. The tale of the mysterious consulting firm Papic and Parsley will do a great public service by teaching readers precisely how skeptical of mainstream news journalism they should be. It isn’t enough to say that we read Geopolitical Alpha and liked it – the sole criterion for a review in this column. Rather, the book and its author are the reason this column exists. And Geopolitical Alpha is now the locus classicus of market-relevant geopolitical analysis.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Footnotes 1 We favored the upper side of the range, first $2.5 trillion, and subsequently something closer to House Speaker Nancy Pelosi’s demand of $2.2 trillion. We have speculated that Republicans may get her to settle at $1.9 trillion. 2 Two of these cases were unique in that a vice president took over from a president who died and then won re-election – unlike Trump’s scenario. 3 On August 12 a Greek Navy frigate collided with a Turkish vessel guiding the Oruc Reis. Athens called the incident an accident while Ankara referred to it as a provocation. 4 The so-called Seville Map was prepared at the request of the European Union by researchers at the University of Seville, attempts to clarify the exclusive economic zones of Turkey and Greece in the Aegean Sea. The US announced on September 21 that it does not consider the Seville map to have any legal significance. 5 The Blue Homeland or Mavi Vatan doctrine announced in 2006 intends to secure Turkish control of maritime areas surrounding its coast (Mediterranean Sea, Aegean Sea, and Black Sea) in order to secure energy supplies and support Turkey’s economic growth. 6 Erdogan’s claim that gas from the recently discovered Sakarya gas field would reach consumers by 2023 is likely overly optimistic and unrealistic. The drilling costs and commercial viability of the field are yet to be determined. Thus, the find does not impact dynamics in the East Med. 7 New Jersey: Wiley, 2021. 286 pages. Section II: GeoRisk Indicators China China: GeoRisk Indicator China: GeoRisk Indicator Russia Russia: GeoRisk Indicator Russia: GeoRisk Indicator UK UK: GeoRisk Indicator UK: GeoRisk Indicator Germany Germany: GeoRisk Indicator Germany: GeoRisk Indicator France France: GeoRisk Indicator France: GeoRisk Indicator Italy Italy: GeoRisk Indicator Italy: GeoRisk Indicator Canada Canada: GeoRisk Indicator Canada: GeoRisk Indicator Spain Spain: GeoRisk Indicator Spain: GeoRisk Indicator Taiwan Taiwan: GeoRisk Indicator Taiwan: GeoRisk Indicator Korea Korea: GeoRisk Indicator Korea: GeoRisk Indicator Turkey Turkey: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil Brazil: GeoRisk Indicator Brazil: GeoRisk Indicator Section III: Geopolitical Calendar

Highlights While we are bearish on the US dollar in the long run, the greenback is primed for a rebound in the near term. Consistently, commodities prices will relapse and EM currencies will depreciate versus the US dollar. Global growth stocks will correct further because they are overbought/over-owned and expensive. The rest of the equity market will relapse because its fundamentals are poor, especially given the renewed rise in new infection cases across Europe and the US. Feature Global financial markets are in the process of a reset. Several segments have been through very sharp and considerable movements in recent months, and these movements are starting to partially unwind. The US dollar will rebound, commodities prices will correct and global equities will continue selling off. In brief, EM risk assets and currencies are entering a period of weakness, which will eventually lead to buying opportunities. Inter-Linkages Between Fixed-Income, Currencies And Commodities Chart I-1A Reset In US Inflation Expectations And Real Rates Is Overdue A Reset In US Inflation Expectations And Real Rates Is Overdue A Reset In US Inflation Expectations And Real Rates Is Overdue US inflation expectations have risen meaningfully, and US TIPS (real) yields have plummeted since April (Chart I-1). Consistent with plunging US real rates, the US dollar has sold off sharply (Chart I-1, bottom panel). Although our bias is that US inflation will rise in the coming years, for now, the rise in inflation expectations seems excessive. Given the tight correlation between oil prices and US breakeven inflation, as illustrated in the top panel of Chart I-1, lower crude prices will cause a drop in inflation expectations. Moreover, the absence of another large US fiscal stimulus will also lead to a downgrade in growth and inflation expectations. US nominal bond yields will likely remain largely range bound, and a drop in breakeven inflation will lead to higher real yields. The latter will help the US dollar to rebound from oversold levels, and EM currencies will depreciate against the dollar. In turn, a rebound in the greenback will be associated with lower commodities prices. Notably, investors’ net long positions in copper have become very elevated (Chart I-2). Investor sentiment on commodities in general is quite positive. Hence, from a contrarian perspective, commodities prices are primed for a pullback. In addition, Chinese imports of commodities will slow in the near term, reinforcing the correction in resources prices. China has evidently been stockpiling commodities, as its commodities imports have been considerably stronger than its underlying final demand. In particular, Chart I-3 demonstrates that mainland imports of copper, crude oil, steel and iron ore have been surging. Chinese imports of crude and industrial metals are likely to drop temporarily. Chart I-2Long Copper Is A Crowded Trade Long Copper Is A Crowded Trade Long Copper Is A Crowded Trade Chart I-3China Has Been Stockpiling Commodities China Has Been Stockpiling Commodities China Has Been Stockpiling Commodities   China’s booming intake of commodities in recent months was stipulated by the country’s previously depleted commodity inventories, low prices and the availability of cheap bank financing. Granted commodity inventories have been replenished and resource prices are no longer low, Chinese imports of crude and industrial metals are likely to drop temporarily.    That said, from a cyclical perspective, China’s economic recovery will continue, and final demand for resources will expand. Thus, we will see a material correction, not a crash, in commodities prices. EM credit spreads inversely correlate with commodities prices and currencies – EM sovereign and corporate credit spreads are shown as inverted on both panels of Chart I-4. As commodities prices retreat and the US dollar rebounds, EM credit markets will sell off. Chart I-4EM Credit Markets Will Weaken As EM Currencies And Commodities Sell Off EM Credit Markets Will Weaken As EM Currencies And Commodities Sell Off EM Credit Markets Will Weaken As EM Currencies And Commodities Sell Off EM local currency bond yields might slightly back up as EM currencies depreciate and US real yields rebound. However, economic conditions in many EM countries outside China remain extremely weak, and inflation is very subdued. Hence, any back up in EM domestic bond yields will be limited. Bottom Line: While we are bearish on the US dollar in the long run, the greenback is primed for a rebound in the near term. Consistently, commodities prices will relapse and EM currencies will sell off versus the US dollar. Notably, oil prices, as well as several EM and DM currencies, have rolled over at technical levels which typically herald a major reversal (Chart I-5A and I-5B). Chart I-5AFacing A Major Resistance Facing A Major Resistance Facing A Major Resistance Chart I-5BFacing A Major Resistance Facing A Major Resistance Facing A Major Resistance Finally, EM fixed-income markets will experience a correction that will provide a buying opportunity. The Equity Correction: More To Go The correction in global share prices has further to run. Market leaders – growth stocks – remain overbought, and it is reasonable to expect that they will at least retest their 200-day moving averages. Meanwhile, the parts of the global equity universe hardest-hit during March have failed to break above their 200-day moving average. This can be interpreted as an indication that they have not yet entered a bull market. These include: EM ex-TMT1 and global value stocks as well as the US Value Line Geometric Composite Index (Chart I-6). In short, growth stocks will correct further because they are overbought/over-owned and expensive; the rest of the equity market will relapse because its fundamentals are poor, especially given the renewed rise in new infection cases across Europe and the US. Chart I-6These Stocks Have Not Entered A Bull Market Yet These Stocks Have Not Entered A Bull Market Yet These Stocks Have Not Entered A Bull Market Yet Chart I-7Downside Risks To EM Equities Downside Risks To EM Equities Downside Risks To EM Equities In addition, the following indicators also point to further selloff in EM and DM share prices. Our Risk-On / Safe-Haven currency ratio2 has been falling since June and continues pointing to lower EM share prices (Chart I-7). The EM and DM advance-decline lines have relapsed below zero indicating a deteriorating equity market breadth (Chart I-8). This heralds lower stock prices. As EM corporate bond yields rise due to either weaker EM currencies or lower commodities prices, as we argued above, EM share prices will tumble (Chart I-9).      Chart I-8Deteriorating Breadth Points To Lower Share Prices Deteriorating Breadth Points To Lower Share Prices Deteriorating Breadth Points To Lower Share Prices Chart I-9Rising EM Corporate Bond Yields Will Reinforce EM Equity Selloff Rising EM Corporate Bond Yields Will Reinforce EM Equity Selloff Rising EM Corporate Bond Yields Will Reinforce EM Equity Selloff Bottom Line: Global and EM share prices are in a correction that has not run its course. Investment Strategy A meaningful setback in their EM currencies will lead us to recommend switching from receiving long-term rates to buying their cash local currency bonds (taking currency risks as well). EM Domestic Bonds: We continue recommending receiving 10-year swap rates in Mexico, Colombia, Russia, India, China, Korea and Malaysia. A meaningful setback in their EM currencies will lead us to recommend switching from receiving long-term rates to buying their cash local currency bonds (taking currency risks as well). EM Equities: Absolute-return investors should be cautious at the moment as EM share prices are set to deflate further. Within a global equity portfolio, we continue recommending a neutral allocation to EM. Better equity valuations in EM than in the US will be offset by a rebound in the US dollar, warranting a trading range in EM versus DM relative equity performance. Our country equity allocation within the EM universe is always presented at the end of our report (please refer to page 10).   EM Exchange Rates: Even though we expect a meaningful rebound in the nominal broad trade-weighted US dollar, we believe the safe-haven currencies – such as the JPY, CHF and the euro – will outperform EM currencies.  As such, we reiterate our strategy of shorting a basket of EM currencies versus an equally-weighted basket of JPY, CHF and the euro. Our short EM currency basket consists of BRL, CLP, ZAR, TRY, PHP, KRW and IDR. Finally, we recommend a neutral allocation to EM credit markets (US dollar bonds) versus US corporate credit. Absolute-return investors should accumulate this asset class on a weakness.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes 1Technology, media and telecom stocks excluding information technology (IT) sector before December 2018 and excluding IT, media & entertainment and internet & direct marketing retail as of December 2018 2Average of CAD, AUD, NZD, BRL, IDR, MXN, RUB, CLP & ZAR total return indices relative to average of JPY & CHF; rebased to 100 at January 2000 Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Yellow Flags Waving Yellow Flags Waving The market bounced off the 3233 support level this week and while volatility has retrenched, we continue to caution investors not to deploy fresh capital just yet as a better entry point will likely materialize in the coming months. Looking across three key asset classes – fixed income, commodities, and currencies – reveals that equities will have a hard time breaking out of their recent funk. First, and most importantly, the corporate bond market has been discontent with equities’ behavior since early-August, warning that investors have to allow ample time for this drawdown to fully play out (top panel). Second, in the commodity universe, silver had been diverging from equities as it topped out in early-August and led the broad equity market peak. Now “poor man’s gold” – that fell another 5% yesterday alone – is weighing heavily on the SPX (middle panel). Finally, the ultimate risk-on/off currency cross AUD/CHF peaked in early June alongside a slew of other hypersensitive sectors like banks/financials, representing yet another yellow flag for the near-term prospects of the overall equity market (bottom panel). Bottom Line: Stay patient and refrain from deploying fresh capital in the broad equity market. A better entry point will likely materialize between now and the end of the year. ​​​​​​​

Highlights We present a thought experiment for the next eight years. 7000 constitutes a reasonable long-term target for the S&P 500. A doubling of the S&P 500 over the coming eight years is in line with the historical experience. Monetary policy is unlikely to tighten meaningfully, which will allow multiples to remain elevated Earnings per share can rise to $310 by 2028. Market technicals are also consistent with significant long-term gains for stocks. Feature Chart II-1Prolonged ZIRP Neither Eliminates Corrections... Prolonged ZIRP Neither Eliminates Corrections... Prolonged ZIRP Neither Eliminates Corrections... Our structural target is neither a joke nor a marketing ploy. And yes, it really does read SPX 7000! This is our S&P 500 target for the year 2028. A new business cycle has commenced and with it a fresh bull market. Our secular US equity market view is bullish. Our readers can fault us for our optimistic view on the world. But we live by the Buffett maxim that “there are no short sellers in the Forbes Billionaires list.” What gives us confidence in this prima facie hyperbolic market view? The Fed’s explicit acceptance that it is ready to incur inflation risk, cementing the fed funds rate near the zero-lower bound for as long as the eye see. In the last cycle, it took the Fed seven years to lift the fed funds rate from zero, a move that ended being judged as premature and forced the Yellen-led Fed to pause for another year (bottom panel, Chart II-1). Seven years. As such, there is a good chance the Fed will stay put until the year 2028, another election year. Even if it ultimately raises interest rates faster due to an overheated economy goosed up on the sweet nectar of fiscal largesse, it is highly likely to be behind the curve. Before we move on to justifying our target, some observations on ZIRP are in order. First, the Fed’s unorthodox monetary policy (QE and ZIRP) in the last cycle did not prevent stock market corrections, including a near 20% fall in 2011 (top panel, Chart II-1). In other words, we do not expect smooth sailing or a 45-degree angle line in the SPX heading to 2028. Rather, an era of volatility with a plethora of sizable corrections is upon us, but the path of least resistance will be higher. Make no mistake, we are in a “buy the dip” market now. Similar to 2008-2015, there will be a lot of fits and starts and a number of mini economic cycles will develop. Chart II-2 highlights that the ISM oscillated violently during the ZIRP years and so did equity momentum and the 10-year Treasury yield. Granted, the Fed managed to suppress economic volatility as real GDP averaged ~2%/annum in the aftermath of the GFC, but mini economic cycles and profit growth scares did not disappear (top panel, Chart II-3). Chart II-2...Nor Mini Economic Cycles ...Nor Mini Economic Cycles ...Nor Mini Economic Cycles Chart II-3"Lowflation"/Disinflation Has Been The Story Of The Past 30 Years "Lowflation"/Disinflation Has Been The Story Of The Past 30 Years "Lowflation"/Disinflation Has Been The Story Of The Past 30 Years   Importantly, while the 10-year Treasury yield moved with the ebbs and flows of the ISM manufacturing survey’s readings, it remained in a downtrend and every bond market selloff proved a buying opportunity in the era of ZIRP (third panel, Chart II-2). What the Fed failed to generate was inflation – of either the CPI or PCE deflator variety. In fact, the Fed has not seen core PCE price inflation overshoot 2.5% since the early 1990s (bottom panel, Chart II-3). Another feature of the ZIRP years in the last cycle was that early on easy monetary policy coincided with easy fiscal policy, as was warranted for the first few years post the GFC. Subsequently, fiscal thrust increased starting in 2016 counterbalancing the Fed’s interest rate hikes. Despite all that fiscal easing, real GDP growth peaked at 3% in 2018 before decelerating last year, raising a question mark about the long-term health of the US economy, a question to be answered in a future Special Report. Frequent readers of US Equity Strategy know our long-held view that the two primary equity market drivers have been easy fiscal and monetary policies since the March carnage. Looking ahead, the Fed has cemented the view that easy monetary policy will stay with us for quite some time. While the jury is still out on fiscal policy, it appears at the moment that profligacy has staying power as no party in Washington is campaigning on austerity or worrying about paying down the debt (save for the lone voice of the Kentucky Senator Rand Paul). The Buenos Aires Consensus is a paradigm shift, and the most important long-term consequence will be higher inflation. The US has abandoned the guardrails on populism established by the Washington Consensus – countercyclical fiscal policy, independent central banking, free trade, laissez-faire economic policy – and has adopted something… different. A new Consensus. These are extremely potent macro forces and given that there is a lag between the time both easy monetary and loose fiscal policies hit the economy, their effects will be long lasting. Especially given that they are now synchronized – unlike for large periods of the previous cycle – and undertaken at a much greater order of magnitude than after the GFC. Table II-1 October 2020 October 2020 With that macro backdrop in mind, let us circle back to our 7000 SPX target. A fresh bull market has commenced and we consider the breakout above the previous cycle’s highs as its starting point. In August, the SPX surpassed the February 19, 2020 highs, giving birth to the new bull market. Using empirical evidence since the late-1950s we conclude that, on average, the SPX doubles from its breakout point (Table II-1). This gives us the SPX 7000 reading before the new bull is slayed in the plaza de toros of economic cycles. While this qualitative analysis is enticing, ultimately earnings have to deliver in order to justify the equity market’s appreciation. Put differently, easy fiscal and monetary policies the world over will deliver EPS inflation. On the quantitative EPS front, we first turn to the reconstructed S&P 500 earnings back to the late-1920s. On average, EPS have grown by 7.5%/annum, effectively doubling every decade (Chart II-4). Chart II-4Average Annual EPS Growth Since 1920s = 7.5% Average Annual EPS Growth Since 1920s = 7.5% Average Annual EPS Growth Since 1920s = 7.5% More recently, using I/B/E/S data, there have been four distinct EPS growth periods over the past four decades with different durations. From trough-to-peak, EPS have enjoyed an average CAGR of over 10% (top panel, Chart II-5). Chart II-5EPS Can Double In Next Eight Years EPS Can Double In Next Eight Years EPS Can Double In Next Eight Years The current trough in forward EPS stands just shy of $140. Applying the average CAGR until 2028 results in a $310 EPS figure. This is our starting point of our EPS sensitivity analysis. Assigning the current forward multiple equates to an SPX terminal value of over 7000. Table II-2 showcases different EPS and forward P/E multiple permutations with the grey shaded area representing our tight range of peak cycle multiples and peak EPS estimates. Table II-2SPX EPS & Multiple Sensitivity October 2020 October 2020 With regard to what is currently priced in by sell side analysts, the 5-year forward EPS growth rate – the longest duration estimate available – is near a trough reading of 10%. The historical mean is 12% since 1985, with a range of 19% near the dotcom bubble peak and a trough of 9% at the depths of the 2016 manufacturing recession (bottom panel, Chart II-5). A few words on presidential cycles are relevant given our structural bullish equity market view. We first noticed Tables II-3 & II-4 in the WSJ in late-2016 and we have corrected some minor mistakes and updated them filling in the gaps. Drawdowns are frequent during term presidencies1 dating back to Hoover. Table II-3Every Presidency Experiences Drawdowns October 2020 October 2020 Table II-4S&P 500 Returns During Presidential Terms October 2020 October 2020 What is truly remarkable, however, is that since the late-1920s only three term presidencies ended up in the red. What the WSJ article did not mention was that in all three market declines GOP presidents were at the helm and had taken over at/or near all-time highs in the SPX! This represents a risk to our SPX 7000 view. If President Trump wins the upcoming election, given the recent modest recovery in the polling, he could meet the same fate as his Republican predecessors. Our sister Geopolitical Strategy service still assigns 35% probability for the incumbent to remain in office, a solid figure that suggests the race remains close. Importantly, while we believe a transition to a Democratic president will be tumultuous as we have been cautioning investors recently, a Biden presidency along with the possibility of a “Blue Wave” will bode well for the long-term prospects of the US equity market, if history at least rhymes. BCA’s Geopolitical strategist Matt Gertken assigns 65% odds to a Biden win and 55% to a Blue trifecta. Finally, on a technical note, the recent megaphone formation has stirred a lot of debate among technical analysts in the blogosphere and is eerily reminiscent of a similar formation that lasted from 1965 until 1975. Typically, these megaphone formations get resolved/completed by a diamond formation (Chart II-6). Chart II-6Of Megaphones And Diamonds Of Megaphones And Diamonds Of Megaphones And Diamonds Chart II-7Diamond Base Is Long Term Bullish Diamond Base Is Long Term Bullish Diamond Base Is Long Term Bullish While this points to a selloff in the broad equity market in the near-term, which is in accordance with our tactically cautious view (please see the last section of this Weekly Report), it is very bullish for the long-term, as equities catapult higher from such a diamond base formation (Chart II-7). In other words, odds are much higher that the SPX will hit 7000 first, before it ever revisits 2200. Adding it all up, we are introducing a structurally constructive US equity market view with an SPX 7000 target for year 2028 on the back of peak cycle EPS of $310 and peak cycle P/E multiple of 23. Anastasios Avgeriou US Equity Strategist Footnotes 1 By term presidencies we are referring to the different duration of Presidents staying in office.

Highlights The global recovery has legs, but it will follow a stop-and-go pattern. Global fiscal policy will ultimately remain loose enough to create an appropriate counterweight to three major risks. Risk assets are still attractive on a 12-month investment horizon despite short-term dangers. The dollar cyclical downtrend will be tested, but it will prevail. 10-year Treasury yields will be range bound between 0.5% and 1%. Industrials, materials, gold and Japanese equities are attractive. Feature Chart I-1Ebbing Surprises Ebbing Surprises Ebbing Surprises The S&P 500 correction remains minimal in the face of Washington’s inability to reach a much-needed fiscal compromise. This resilience reflects that economies in the G-10 and China have pleasantly surprised investors despite rolling second waves of infections across the world, fiscal policy paralysis and generalized unease (Chart I-1). Strong growth has fueled higher earnings expectations. Meanwhile, global central banks are promising to keep accommodative monetary conditions in place indefinitely, which has allowed valuations to balloon. The cyclical outlook for stocks remains attractive. Nonetheless, global equities have entered a period of heightened volatility and downside risk until year-end. The S&P 500 had overshot its fundamentals, but now the momentum of the economic surprise index is deteriorating and central banks have deployed their full arsenal. Investors are concerned by a lack of fiscal support and rising policy uncertainty created by the approaching US election in November. This nervousness will spark powerful fluctuations in stock prices.  Avoid Binary Judgments The global economy is at a complex juncture, buffeted between forces that will either propel its recovery or sink it. The positives will predominate in this contest, which suggests that the business cycle remains in an upswing, albeit, a volatile one. The Good… Five main positive forces underpin the nascent economic bounce and thus, the profit outlook. Pent-up demand and the inventory cycle: The economy is making up for the collapse of both cyclical spending and production at the end of Q1 and into Q2. Inventories of finished products have sharply declined in the past six months. In the US, rapidly shrinking inventories are supercharging the uptick in the new-orders-to inventories ratio. Similar dynamics are occurring in China, Europe and Japan (Chart I-2). China’s stimulus-driven recovery will provide a crucial boost to the global business cycle. The Chinese engine is revving: An aggressive stimulus campaign followed Beijing’s swift actions to contain the domestic spread of COVID-19. China’s policies are generating economic dividends that will percolate through the global industrial and commodity sectors. Sales of floor space are already expanding by 40% annually, driven by a 60% jump in Tier-1 cities. In response, construction is forming a trough. Moreover, the large issuance of local government bonds is financing an increase in infrastructure spending. Thanks to an upturn in building activity, the equipment purchases, construction and installation components of China’s real estate investment are all bottoming (Chart I-3). Chart I-2The Inventory Adjustment Is Advanced The Inventory Adjustment Is Advanced The Inventory Adjustment Is Advanced Chart I-3China: A Policy-Driven Recovery China: A Policy-Driven Recovery China: A Policy-Driven Recovery   BCA Research’s Emerging Markets team recently showed that the expenditure rebound is not limited to the real estate sector.1 Vehicle sales are healthier and tech infrastructure outlays are reaccelerating (Chart I-4). Retail sales also moved back into positive territory in August. Thus, China’s cyclical spending has regained its footing. China’s stimulus-driven recovery will provide a crucial boost to the global business cycle. Beijing’s unconstrained credit easing is the source for the turnaround in China’s cyclical and capital expenditures outlook. Hence, the sharp increase in China’s credit and fiscal impulse foreshadows a powerful rebound in imports and in global industrial production because Chinese capex demands plentiful commodities, industrial goods and capital goods (Chart I-5).  Chart I-4More Chinese Recovery More Chinese Recovery More Chinese Recovery Chart I-5Chinese Stimulus Matters Globally Chinese Stimulus Matters Globally Chinese Stimulus Matters Globally   Chart I-6Robust American Households Robust American Households Robust American Households Consumer balance sheets are robust: Unlike the aftermath of the Great Financial Crisis (GFC), US households do not need to rebuild destroyed balance sheets. This time around, the low level of household debt and the limited hit to net worth has allowed consumers to withstand an even greater income shock than during the GFC (Chart I-6). As a result, expenditures are rebounding much quicker than most investors anticipated six months ago. An extremely vigorous policy response: Policymakers in the G-10 did not wait to deploy their economic arsenal when the economic crisis erupted. Governments have racked up their largest budget deficits since World War II (Chart I-7). Monetary authorities also moved quickly to ease financial conditions. Broad money supply growth among advanced economies has skyrocketed, global corporate bond issuance stands at a record $2.6 trillion, and excess liquidity points to continued industrial production strength. In the US, our Financial Liquidity Index is climbing higher alongside the ISM Manufacturing Index. Even the performance of EM carry trades (a financial variable that shows whether funds are flowing into EM economies) is consistent with a stabilization in global IP (Chart I-8). Chart I-7Exceptional Fiscal Stimulus October 2020 October 2020 Chart I-8Liquidity Helps Growth Liquidity Helps Growth Liquidity Helps Growth     Stronger industrial production models: Our industrial production models for the major advanced economies are all moving up after experiencing massive collapses this past spring. These models encapsulate many influences and their uniformly positive message is very encouraging. In all likelihood, a virtuous cycle has been unleashed. As IP recovers, then so will income, which will fuel the demand expansion and thus, more production. We expect the models to rise even more in the coming quarters. … And The Bad Three near-term concerns still hang over the global economy. Hence, while Q3 is set to deliver stunningly strong numbers boosted by advantageous base effects, growth will recede in Q4.2  While fiscal policy was on point in late Q1 and Q2, Washington’s performance in the past three months has been questionable. Fiscal stimulus hiccups in the US: While fiscal policy was on point in late Q1 and Q2, Washington’s performance in the past three months has been questionable. The CARES Act’s expanded $600 per week unemployment benefit lapsed at the end of July. This benefit, along with one-time $1200 stimulus checks, pushed disposable income higher by 7.5% during the past five months. Thankfully, households managed to save a large proportion of the government support. Consequently, consumption remained strong in August, despite limited help from the federal government. The short-term outlook for consumption is fragile because households cannot continue to tap into their savings. In August, US retail sales disappointed. Calculations by our US fixed-income strategist show that in the coming months, Washington must spend almost $800 billion just for consumer expenditures to match its growth rate of -3% recorded at the depth of the last recession.3 Moreover, a potential wave of eviction of renters looms. Thus, the economy could relapse violently as long as Democrats and Republicans remain apart on a compromise for a new stimulus bill. The upcoming Senate confirmation process to fill the Supreme Court seat left vacant by Ruth Bader-Ginsburg’s passing only complicates the passage of these needed spending measures. Chart I-9Permanent Joblessness Is A Threat Permanent Joblessness Is A Threat Permanent Joblessness Is A Threat Rising permanent job losses: The US unemployment rate has fallen from a high of 14.7% in April to 8.4% in August. This bright picture hides a negative development. The number of permanent job losses has quickly escalated, reaching 4.1 million last month (Chart I-9). Moreover, continuing unemployment insurance claims are barely declining. Mounting long-term unemployment is not associated with an economic recovery. Furthermore, permanent joblessness could easily push down consumer confidence, which would lift the household savings rate and hurt consumption. This problem is not unique to the US. In the UK, an unemployment cliff looms on October 31 when there will be an end to government schemes allowing firms to receive funds as long as they do not permanently severe their links with furloughed workers. The UK’s unemployment rate of only 4.1% is bound to surge when these support measures disappear. In continental Europe, similar stimulus programs could also be rescinded this fall. The weak health of small businesses accentuates risks to the labor market. In the US, 21% of very small firms will run out of money by the end of the year if the government does not dispense supplemental help. Closing these businesses will push up permanent joblessness even more and thus, further weaken consumption. Either weaker stock prices or a deterioration in the economy will be the catalyst for Washington to strike a deal. COVID-19 and the service sector: Many major countries are now fighting a second wave of infections, which may surpass the first wave. Many schools have re-opened and winter in the Northern Hemisphere is approaching (which will force people to congregate inside), bringing with it the regular flu season. Chart I-10The Service Sector Is The Weakest Link The Service Sector Is The Weakest Link The Service Sector Is The Weakest Link This epidemiological backdrop still represents an elevated hurdle to overcome for large swaths of the service sector, especially leisure, food, hospitality and travel. While these industries account for only 10% of GDP in the US, they contribute roughly 25% of employment. If governments toughen social distancing rules and implement localized lockdowns, then the service sector will act as a drag on GDP and employment (Chart I-10). Which Side Will Win? Ultimately, we anticipate that the tailwinds supporting the economy will overcome the headwinds. On the policy front, governments will pass more stimulus. Our Geopolitical strategists believe that the following constraints will force greater spending in the US by mid-October: The Democrats face an election and they want to deliver benefits to their voters.  The White House needs to prevent financial turmoil in the final month of the campaign. If the Republicans fail to agree on a second stimulus bill, there is a significant risk they will lose the White House and their majority in the Senate. Chart I-11No Constraints There No Constraints There No Constraints There The package should total nearly $2 trillion. The Democrats have reduced their demands to $2.3 trillion, while the GOP has moved up its offer to $1.3 trillion. Moreover, a bi-partisan “Problem Solvers Caucus” has emerged in Congress with a $1.5 trillion bill proposal that the White House is considering. Either weaker stock prices or a deterioration in the economy will be the catalyst for Washington to strike a deal. Fiscal stimulus will also remain generous outside the US. In Europe, France is providing an attractive template. On September 3, the Macron government announced an additional EUR100 billion stimulus package, whereby 40% of the funds would come from the common bond issuance recently announced by the EU. In Japan, Prime Minister Yoshihide Suga will continue the policies of his predecessor. Finally, in emerging economies, the absence of inflation and well-behaved sovereign yields and spreads have provided room for local authorities to alleviate any economic pain created by COVID-19 (Chart I-11). Monetary policy will remain extremely stimulative. Central banks will not meaningfully ease policy further, but our monetary indicators are already at their most accommodative levels on record (see Section III). Plus, the US Federal Reserve’s switch to an average-inflation target last month raised the bar that inflation must reach before the FOMC tightens policy. The European Central Bank is contemplating a similar change. Furthermore, the continued woes of service-sector employment constitute another hurdle to clear before central banks can remove accommodation. Chart I-12US Housing Is The New Locomotive US Housing Is The New Locomotive US Housing Is The New Locomotive Finally, COVID-19 currently has a limited impact on the lion’s share of cyclical spending, which will continue to recover. Cyclical sectors include residential investment, business capex and spending on consumer durable goods. In the US, they account for only 20% GDP, but they generate 70% of the variance in its fluctuations. These sectors are heavily geared toward manufacturing, which is crucial for cyclical spending. Importantly, the robustness of household balance sheets and record low borrowing costs have allowed mortgage applications for purchases to rise sharply, home sales to recover and homebuilder confidence to surge to an all-time high (Chart I-12). Hence, residential activity will remain an important driver of domestic demand, especially because residential investment also often galvanizes other forms of cyclical spending. Bottom Line: The global economy remains buffeted between five positive forces that bolster the recovery and three negatives that hamper it. Ultimately, the authorities will have no choice but to add supplementary fiscal stimulus and monetary conditions will remain extremely accommodative. The recovery will then slow from its heady Q3 pace, but cyclical spending will still power ahead next year. In a nutshell, the economy will not be weaker nor much stronger than the base case presented by the IMF. Investment Implications Our somewhat upbeat position on the global economic outlook remains consistent with a favorable stance toward risk assets in the next 12 to 18 months, because adverse economic outcomes are unlikely to materialize, not because growth will be stronger than expected. Nonetheless, we are conscious that the market place remains fraught with many risks and that growth will stay volatile. As a result, episodic violent corrections will punctuate the upward path in risk asset. We are currently in the midst of such a correction. Chart I-13The Dollar Remains Expensive The Dollar Remains Expensive The Dollar Remains Expensive The Dollar We are still bearish on the dollar on a cyclical investment horizon. The USD remains expensive despite its recent weakness. Against major currencies, the dollar has climbed by 30% since 2008. On a broad, trade-weighted basis, it is up 36% in the same period. Therefore, the US currency trades 15% above its Purchasing Power Parity equilibrium, the most among the major currencies (Chart I-13).4  The US balance of payments picture is becoming increasingly problematic for the dollar. After a surge this spring, US private-sector savings are set to decline. Low interest rates and asset bubbles will increasingly incentivize consumption, while rising capex intentions point to a drop in the corporate sector’s savings. Given that we anticipate the fiscal balance to remain negative in the coming years, the national savings rate will sag, which will worsen the US current account (Chart I-14).5 In other words, the US twin deficits will balloon as the recovery progresses. Despite our bearish view on the dollar, our base case still anticipates a short-term bounce in the USD. The US capital account will not offset the impact on the dollar of a wider current account deficit. US real interest rate differentials have collapsed and foreigners have shunned the Treasury market (Chart I-15, top panel). The Fed conducts the loosest monetary policy among the major economies, which is pushing the US shadow rate lower versus the euro area. Such a trend is euro bullish (dollar bearish) because it draws capital outside of the US economy (Chart I-15, middle panel). Additionally, the USD’s counter cyclicality will be its final undoing during the global economic recovery and will create another hurdle for the US capital account. Chart I-14A Dollar-Bearish Savings Backdrop A Dollar-Bearish Savings Backdrop A Dollar-Bearish Savings Backdrop Chart I-15No Love For The Greenback No Love For The Greenback No Love For The Greenback Chart I-16The Dollar Is Ripe For A Rebound The Dollar Is Ripe For A Rebound The Dollar Is Ripe For A Rebound Despite our bearish view on the dollar, our base case still anticipates a short-term bounce in the USD. Our dollar capitulation index is overextended and if stocks experience heightened volatility (see equities on page 32), then a safe-haven asset such as the greenback will catch a temporary bid (Chart I-16). A correction in the euro to 1.15-1.14 is a reasonable target. Government Bonds Our reluctance to overweight bonds or duration is intact. The BCA US 10-Year Government Bond Valuation index is consistent with higher yields in the next 12 months (Chart I-17). Moreover, bond prices are losing momentum, which creates a technical vulnerability for this asset class. The economy is the potential catalyst to expose the underlying valuation and technical risks of government bonds. Inflation is still a distant danger, but our BCA Pipeline Inflation indicator highlights that deflationary pressures are receding (Chart I-18, top panel). Likewise, our Nominal Cyclical Spending proxy already warns that yields have upside; and an expanding recovery implies that bond-bearish pressures will progress (Chart I-18, bottom panel). Chart I-17The Traitorous Treasury Market The Traitorous Treasury Market The Traitorous Treasury Market Chart I-18Problems For Treasurys Problems For Treasurys Problems For Treasurys   The Fed’s switch to an average inflation target is also consistent with higher long bond yields. The Fed’s newfound tolerance for loftier inflation should lift long-term inflation expectations and medium-term inflation uncertainty, especially given current fiscal trends. Higher long-term inflation expectations and inflation uncertainty have the potential to generate a broader range of policy-rate outcomes, therefore they will also normalize the extraordinarily depressed term premium and lead to a steeper yield curve (Chart I-19). Thus, 10- and 30-year yields have room to increase even if current short rates remain anchored near their lower bounds for the next three years. Over the next 12 months, 10- and 30-year Treasury yields will be capped at 1% and 2%, respectively. The expected yield upside will be limited in the next year. While investors should anticipate some curve steepening, the most violent selloffs only take hold of the Treasury market when the Fed generates hawkish surprises, which is very unlikely in 2021 (Chart I-20). Moreover, the stock market creates its own constraints. As our European Investment strategist has reasoned, higher yields will hurt growth stocks that derive a disproportionate share of their intrinsic value from long-term cash flows.6 If bond prices fall too quickly, then these growth stocks would plunge and drag down the equity market. In essence, elevated bond yields can generate a deflationary shock that undoes the primary reason why yields would rise. Therefore, over the next 12 months, 10- and 30-year Treasury yields will be capped at 1% and 2%, respectively. Chart I-19Average-Inflation Targeting Hurts Long-Dated Bonds Average-Inflation Targeting Hurts Long-Dated Bonds Average-Inflation Targeting Hurts Long-Dated Bonds Chart I-20Limited Upside For Yields Limited Upside For Yields Limited Upside For Yields   Equities Several factors underpin our positive stance on global equities in the next 12 months. The lack of investment alternatives or TINA (There Is No Alternative) is a crucial support under stock prices. As BCA Research’s Global Investment Strategy service recently discussed, the S&P 500’s dividend yield stands at around 100 basis points above 10-year Treasury yields.7 Conservatively assuming that dividends per share remain constant in the next 10 years and inflation averages 2%, the real value of the US equity benchmark must decline by 25% during that period before it underperforms Treasurys. Given that gaps between dividend yields and bond yields are even larger outside the US, many foreign bourses must experience deeper real depreciation before they underperform their respective bond markets (Chart I-21). Corporate pricing power is returning, which is positive for the earnings outlook. The ability of firms to boost prices will be enhanced by the combination of a weak dollar, declining deflationary forces, rebounding commodity prices and a surge in the sales-to-inventory ratio. The pickup in pricing power is broadly based; 59% of the S&P 500 groups analyzed by our US equity strategist are experiencing mounting prices.8 When higher pricing power meets mending sales volumes, operating leverage allows profit margins to expand, which lifts earnings per share and stock prices (Chart I-22). Chart I-21TINA Flatters Stocks TINA Flatters Stocks TINA Flatters Stocks Chart I-22Corporate Pricing Power Is Coming Back Corporate Pricing Power Is Coming Back Corporate Pricing Power Is Coming Back Chart I-23Liquidity Underpins This Rally Liquidity Underpins This Rally Liquidity Underpins This Rally The global monetary environment also supports stocks. The swell in our US Financial Liquidity index is consistent with additional equity gains because it forecasts stronger economic activity (Chart I-23). Expectations of an upswing in the business cycle let earnings forecasts climb and can also improve the anticipated growth rate of long-term earnings while encouraging risk-taking, which compresses the equity risk premium. Moreover, generous liquidity limits the upside to real yields, which further boosts equity multiples. Another consequence of ample liquidity is a marked increase in corporate actions. Firms engage in greater M&A activity, which can generate gains in accounting earnings while withdrawing equity from the market. Businesses around the world have tapped the corporate bond market at a record pace this year, creating both large war chests and the capacity to deploy funds for capex. Higher capex boosts demand and cyclical spending, which creates a positive environment for earnings. Our positive cyclical view on stocks does not preclude a period of heightened volatility and further downside risk in the coming three months. The US and G-10 economic surprise indices are elevated, but they are losing momentum. This deterioration in the second derivative of activity is problematic when there is a non-trivial chance of a policy error in Washington. Importantly, the upcoming US election will raise questions about the regulatory environment for the two market heavyweights: technology and healthcare stocks. As we wrote last month, a shift of leadership away from these sectors will translate into episodic corrections for stocks at large.9 Additionally, investors must price in the risk of gridlock in Washington. If Senate Republicans are reluctant to write a check while an unpopular President Trump faces an imminent election, then their willingness to expand spending if Biden clinches the White House will be nonexistent. A complete refusal to add fiscal stimulus would nearly guarantee a double-dip recession. Equities must embed a risk premium against this scenario ahead of the election. Therefore, the S&P 500 is likely to test 3000 in the coming weeks before rebounding. Our positive cyclical view on stocks does not preclude a period of heightened volatility and further downside risk in the coming three months. Sector Considerations We are positive on the medium-term outlook for value versus growth stocks. The cheapness of value versus growth makes the former attractive, but is not enough to allocate funds to it aggressively. Instead, our bias takes root in our economic view. The forward earnings of global value stocks are very depressed relative to growth stocks. However, the ratio of value EPS to growth EPS is extremely pro-cyclical. Thus, our positive stance on global growth is consistent with a rebound in relative profits that will help value equities (Chart I-24, top panel). Moreover, higher yields correlate with a re-rating of relative equity multiples in favor of value stocks, which are less sensitive to rising discount rates than their growth counterparts (Chart I-24, bottom panel). In this context, we continue to favor industrials and materials; consumer discretionary stocks are also appealing.10 Investors should underweight the US, especially in common currency terms. Gold mining equities remain attractive long-term investments. In the near term, as long as the dollar counter-trend bounce continues, gold will purge its excess froth (Chart I-25, top panel). Nonetheless, our trend indicator remains positive for gold (Chart I-25, bottom panel). Moreover, if real yields start to stagnate at their current low levels, then gold will lose a tailwind but it will not develop a new handicap. In this context, an increase in inflation expectations will elevate gold prices (Table I-1). Other bullish cyclical forces underpinning gold include the dollar’s long-term bear market, limited supply expansion and the diversification of EM central banks away from Treasurys into gold. This positive backdrop should allow the attractive relative valuation of global gold mining firms and their improving operating metric (courtesy of rigorous cash flow management and limited expansion plans) to blossom into more equity price outperformance over the next year or so. Chart I-24Long Growth vs Value: A Cyclical Trade Long Growth vs Value: A Cyclical Trade Long Growth vs Value: A Cyclical Trade Chart I-25A Shakeout For The Gold Bull Market A Shakeout For The Gold Bull Market A Shakeout For The Gold Bull Market Table I-1Gold's Response To Yields October 2020 October 2020 Finally, Japan has become our favorite equity market for the next 9 to 12 months. Japanese stocks possess the perfect equity exposure to play the themes we espouse because they greatly overweight industrials and traditional consumer discretionary stocks at the expense of tech and healthcare (Table I-2). Moreover, we like auto stocks, an industry well represented in the Japanese bourse, which will benefit from a weak trade-weighted yen.11 Lastly, Japanese stock prices incorporate a large margin of safety. Most sectors in Japan trade at a significant discount to their European and US counterparts (Chart I-26). Nevertheless, it is too early to make a structural bet on Japan because its productivity problems and persistent deflation generate a long-lasting drag on corporate profitability. Table I-2Japan Possesses An Attractive Sector Composition October 2020 October 2020 Chart I-26Japan Is A Cheap Recovery Bet October 2020 October 2020 Section II presents a thought experiment by our Chief US Equity Strategist, Anastasios Avgeriou, which details the feasibility of a doubling of the S&P 500 over the coming 8 years. I trust you will find this report based on historical evidences thought-provoking.   Mathieu Savary Vice President The Bank Credit Analyst September 24, 2020 Next Report: October 29, 2020   II. SPX 7000 We present a thought experiment for the next eight years. 7000 constitutes a reasonable long-term target for the S&P 500. A doubling of the S&P 500 over the coming eight years is in line with the historical experience. Monetary policy is unlikely to tighten meaningfully, which will allow multiples to remain elevated Earnings per share can rise to $310 by 2028. Market technicals are also consistent with significant long-term gains for stocks. Chart II-1Prolonged ZIRP Neither Eliminates Corrections... Prolonged ZIRP Neither Eliminates Corrections... Prolonged ZIRP Neither Eliminates Corrections... Our structural target is neither a joke nor a marketing ploy. And yes, it really does read SPX 7000! This is our S&P 500 target for the year 2028. A new business cycle has commenced and with it a fresh bull market. Our secular US equity market view is bullish. Our readers can fault us for our optimistic view on the world. But we live by the Buffett maxim that “there are no short sellers in the Forbes Billionaires list.” What gives us confidence in this prima facie hyperbolic market view? The Fed’s explicit acceptance that it is ready to incur inflation risk, cementing the fed funds rate near the zero-lower bound for as long as the eye see. In the last cycle, it took the Fed seven years to lift the fed funds rate from zero, a move that ended being judged as premature and forced the Yellen-led Fed to pause for another year (bottom panel, Chart II-1). Seven years. As such, there is a good chance the Fed will stay put until the year 2028, another election year. Even if it ultimately raises interest rates faster due to an overheated economy goosed up on the sweet nectar of fiscal largesse, it is highly likely to be behind the curve. Before we move on to justifying our target, some observations on ZIRP are in order. First, the Fed’s unorthodox monetary policy (QE and ZIRP) in the last cycle did not prevent stock market corrections, including a near 20% fall in 2011 (top panel, Chart II-1). In other words, we do not expect smooth sailing or a 45-degree angle line in the SPX heading to 2028. Rather, an era of volatility with a plethora of sizable corrections is upon us, but the path of least resistance will be higher. Make no mistake, we are in a “buy the dip” market now. Similar to 2008-2015, there will be a lot of fits and starts and a number of mini economic cycles will develop. Chart II-2 highlights that the ISM oscillated violently during the ZIRP years and so did equity momentum and the 10-year Treasury yield. Granted, the Fed managed to suppress economic volatility as real GDP averaged ~2%/annum in the aftermath of the GFC, but mini economic cycles and profit growth scares did not disappear (top panel, Chart II-3). Chart II-2...Nor Mini Economic Cycles ...Nor Mini Economic Cycles ...Nor Mini Economic Cycles Chart II-3"Lowflation"/Disinflation Has Been The Story Of The Past 30 Years "Lowflation"/Disinflation Has Been The Story Of The Past 30 Years "Lowflation"/Disinflation Has Been The Story Of The Past 30 Years   Importantly, while the 10-year Treasury yield moved with the ebbs and flows of the ISM manufacturing survey’s readings, it remained in a downtrend and every bond market selloff proved a buying opportunity in the era of ZIRP (third panel, Chart II-2). What the Fed failed to generate was inflation – of either the CPI or PCE deflator variety. In fact, the Fed has not seen core PCE price inflation overshoot 2.5% since the early 1990s (bottom panel, Chart II-3). Another feature of the ZIRP years in the last cycle was that early on easy monetary policy coincided with easy fiscal policy, as was warranted for the first few years post the GFC. Subsequently, fiscal thrust increased starting in 2016 counterbalancing the Fed’s interest rate hikes. Despite all that fiscal easing, real GDP growth peaked at 3% in 2018 before decelerating last year, raising a question mark about the long-term health of the US economy, a question to be answered in a future Special Report. Frequent readers of US Equity Strategy know our long-held view that the two primary equity market drivers have been easy fiscal and monetary policies since the March carnage. Looking ahead, the Fed has cemented the view that easy monetary policy will stay with us for quite some time. While the jury is still out on fiscal policy, it appears at the moment that profligacy has staying power as no party in Washington is campaigning on austerity or worrying about paying down the debt (save for the lone voice of the Kentucky Senator Rand Paul). The Buenos Aires Consensus is a paradigm shift, and the most important long-term consequence will be higher inflation. The US has abandoned the guardrails on populism established by the Washington Consensus – countercyclical fiscal policy, independent central banking, free trade, laissez-faire economic policy – and has adopted something… different. A new Consensus. These are extremely potent macro forces and given that there is a lag between the time both easy monetary and loose fiscal policies hit the economy, their effects will be long lasting. Especially given that they are now synchronized – unlike for large periods of the previous cycle – and undertaken at a much greater order of magnitude than after the GFC. Table II-1 October 2020 October 2020 With that macro backdrop in mind, let us circle back to our 7000 SPX target. A fresh bull market has commenced and we consider the breakout above the previous cycle’s highs as its starting point. In August, the SPX surpassed the February 19, 2020 highs, giving birth to the new bull market. Using empirical evidence since the late-1950s we conclude that, on average, the SPX doubles from its breakout point (Table II-1). This gives us the SPX 7000 reading before the new bull is slayed in the plaza de toros of economic cycles. While this qualitative analysis is enticing, ultimately earnings have to deliver in order to justify the equity market’s appreciation. Put differently, easy fiscal and monetary policies the world over will deliver EPS inflation. On the quantitative EPS front, we first turn to the reconstructed S&P 500 earnings back to the late-1920s. On average, EPS have grown by 7.5%/annum, effectively doubling every decade (Chart II-4). Chart II-4Average Annual EPS Growth Since 1920s = 7.5% Average Annual EPS Growth Since 1920s = 7.5% Average Annual EPS Growth Since 1920s = 7.5% More recently, using I/B/E/S data, there have been four distinct EPS growth periods over the past four decades with different durations. From trough-to-peak, EPS have enjoyed an average CAGR of over 10% (top panel, Chart II-5). Chart II-5EPS Can Double In Next Eight Years EPS Can Double In Next Eight Years EPS Can Double In Next Eight Years The current trough in forward EPS stands just shy of $140. Applying the average CAGR until 2028 results in a $310 EPS figure. This is our starting point of our EPS sensitivity analysis. Assigning the current forward multiple equates to an SPX terminal value of over 7000. Table II-2 showcases different EPS and forward P/E multiple permutations with the grey shaded area representing our tight range of peak cycle multiples and peak EPS estimates. Table II-2SPX EPS & Multiple Sensitivity October 2020 October 2020 With regard to what is currently priced in by sell side analysts, the 5-year forward EPS growth rate – the longest duration estimate available – is near a trough reading of 10%. The historical mean is 12% since 1985, with a range of 19% near the dotcom bubble peak and a trough of 9% at the depths of the 2016 manufacturing recession (bottom panel, Chart II-5). A few words on presidential cycles are relevant given our structural bullish equity market view. We first noticed Tables II-3 & II-4 in the WSJ in late-2016 and we have corrected some minor mistakes and updated them filling in the gaps. Drawdowns are frequent during term presidencies12 dating back to Hoover. Table II-3Every Presidency Experiences Drawdowns October 2020 October 2020 Table II-4S&P 500 Returns During Presidential Terms October 2020 October 2020 What is truly remarkable, however, is that since the late-1920s only three term presidencies ended up in the red. What the WSJ article did not mention was that in all three market declines GOP presidents were at the helm and had taken over at/or near all-time highs in the SPX! This represents a risk to our SPX 7000 view. If President Trump wins the upcoming election, given the recent modest recovery in the polling, he could meet the same fate as his Republican predecessors. Our sister Geopolitical Strategy service still assigns 35% probability for the incumbent to remain in office, a solid figure that suggests the race remains close. Importantly, while we believe a transition to a Democratic president will be tumultuous as we have been cautioning investors recently, a Biden presidency along with the possibility of a “Blue Wave” will bode well for the long-term prospects of the US equity market, if history at least rhymes. BCA’s Geopolitical strategist Matt Gertken assigns 65% odds to a Biden win and 55% to a Blue trifecta. Finally, on a technical note, the recent megaphone formation has stirred a lot of debate among technical analysts in the blogosphere and is eerily reminiscent of a similar formation that lasted from 1965 until 1975. Typically, these megaphone formations get resolved/completed by a diamond formation (Chart II-6). Chart II-6Of Megaphones And Diamonds Of Megaphones And Diamonds Of Megaphones And Diamonds Chart II-7Diamond Base Is Long Term Bullish Diamond Base Is Long Term Bullish Diamond Base Is Long Term Bullish While this points to a selloff in the broad equity market in the near-term, which is in accordance with our tactically cautious view (please see the last section of this Weekly Report), it is very bullish for the long-term, as equities catapult higher from such a diamond base formation (Chart II-7). In other words, odds are much higher that the SPX will hit 7000 first, before it ever revisits 2200. Adding it all up, we are introducing a structurally constructive US equity market view with an SPX 7000 target for year 2028 on the back of peak cycle EPS of $310 and peak cycle P/E multiple of 23. Anastasios Avgeriou US Equity Strategist III. Indicators And Reference Charts The stock market correction has begun in earnest. The S&P 500 is suffering as the economic surprise index deteriorates, the dollar rebounds and uncertainty surrounding fiscal policy takes center stage. The deteriorating performances of silver, investment grade bonds, small-cap stocks, EM currencies and the AUD/CHF cross confirm that the equity market will suffer more downside. Moreover, the number of NYSE stocks trading above their 10-week moving average is in free-fall but remain well above levels consistent with a bottom. Despite these short-term headwinds, the main pillar supporting the rally remains intact: global monetary conditions are highly accommodative. The shift to an average-inflation target by the Fed, which the ECB is also considering, buttresses this dovish stance further as inflation will have to rise even more than normally before the major global central banks tighten policy. Moreover, outside of the US, fiscal policy remains accommodative. Even in the US, we expect more stimulus to come through before the November election. Our cyclical indicators confirm the positive backdrop for stocks. Our Monetary Indicator has softened but it remains at the top of its pre-COVID-19 distribution, which balances the expensiveness of the market flashed by our Valuation Indicator. Putting those forces together, our Intermediate-Term Indicator and our Revealed Preference Indicator strongly argues in favor or staying invested in equities. When weighing the short-term negative forces against the cyclical positives, we expect the S&P 500 to find a floor around 3000. At this level, the froth highlighted by our Speculation Indicator will have dissipated. Despite the equity correction, bonds remain extremely unappealing. Our Bond Valuation Index shows Treasurys as prohibitively expensive and our Composite Technical Indicator continues to lose momentum. Moreover, our Cyclical Bond Indicator has turned higher and is now flashing an outright sell signal. In effect, with rates near their lower bound, the market understands that yields have little room to decline and thus bonds seems to be losing their ability to hedge equity risk. Thus, bonds yields are unlikely to rise as stocks correct, but their lack of downside right now suggests that when equities regain their footing, 10-year Treasury yields could quickly move higher toward 1%. The dollar countertrend rally that we expected last month has begun. So far, the dollar has still not purged its oversold conditions and the deterioration in risk sentiment around the world will likely result in additional upside for the greenback. Ultimately, this rally will be temporary. The global economic recovery has just begun, the US balance of payments picture is deteriorating and the USD trades at a large premium to its purchasing power parity equilibrium. Commodities remain in a bull market, but their current correction has further to run. As investors absorb the deterioration in economic surprises and risk sentiment declines, the overbought commodity complex will remain under downward pressure. The strength in the US dollar is creating an additional powerful headwind against commodities. Gold’s decline has been particularly noteworthy. Gold remains above its short-term fair value, hence its vulnerability to the dollar and to the decline in our Monetary Indicator is particularly pronounced. A stabilization in gold and silver prices is required before the rest of the commodity complex and stocks can find a firmer footing. Stronger precious metals would indicate that the deterioration in liquidity visible at the margin is ending. It is likely to be contemporary with the passage of a new fiscal stimulus bill in the US. 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 III-16US Dollar And PPP US Dollar And PPP US Dollar And PPP Chart III-17US Dollar And Indicator US Dollar And Indicator US Dollar And Indicator Chart III-18US Dollar Fundamentals US Dollar Fundamentals US Dollar Fundamentals Chart III-19Japanese Yen Technicals Japanese Yen Technicals Japanese Yen Technicals Chart III-20Euro Technicals Euro Technicals Euro Technicals Chart III-21Euro/Yen Technicals Euro/Yen Technicals Euro/Yen Technicals Chart III-22Euro/Pound Technicals Euro/Pound Technicals Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Broad Commodity Indicators Broad Commodity Indicators Chart III-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  Emerging Markets Strategy "Charts That Matter," dated September 10, 2020, available at ems.bcaresearch.com 2 The Atlanta Fed GDPNow model already points to an annualized growth rate of 32% in Q3 in the US, but the New York Fed’s model pencils in a much more modest 5.3% expansion rate for Q4. 3 Please see  US Bond Strategy "More Stimulus Needed," dated September 15, 2020, available at usbs.bcaresearch.com 4 Please see Foreign Exchange Strategy "Revisiting Our High-Conviction Trades," dated September 11, 2020, available at fes.bcaresearch.com 5 Please see The Bank Credit Analyst "August 2020," dated July 30, 2020 and The Bank Credit Analyst "July 2020," dated June 25, 2020, available at bca.bcaresearch.com 6 Please see European Investment Strategy "The Puppet Master Is The 30-Year Bond," dated August 6, 2020, available at eis.bcaresearch.com 7 Please see Global Investment Strategy "Stock Prices And Interest Rates: Can We Trust TINA?," dated September 11, 2020, available at gis.bcaresearch.com 8 Please see US Equity Strategy "Pricing Power Update," dated September 14, 2020, available at uses.bcaresearch.com 9 Please see The Bank Credit Analyst "September 2020," dated August 27, 2020, available at bca.bcaresearch.com 10 However, in the US, investors must be careful as the sector is dominated by one firm: Amazon, which trades as a tech stock, not as a traditional consumer discretionary. 11 Please see Daily Insights "More Cars Please!" dated July 20, 2020, available at di.bcaresearch.com 12 By term presidencies we are referring to the different duration of Presidents staying in office.

Continue To Avoid Semi Cap Names Continue To Avoid Semi Cap Names Underweight We are currently underweight the S&P semi equipment index in line with our broader strategy of preferring defensive software & services tech stocks at the expense of the more aggressive hardware & equipment tech stocks. Recent news of the Trump administration’s potential tightening of the noose on Chinese chip company SMIC (the country’s largest foundry) was a net negative for US semi cap names. It also was a wake up call for investors with regard to the sector’s vulnerability to a flare up in the US/China trade tensions, especially given the sell-side’s extremely optimistic sales and earnings projections (see chart).   Bottom Line: Stay underweight the S&P semiconductor equipment index. For more details, please refer to this Monday’s Weekly Report. The ticker symbols for the stocks in this index are: BLBG S5SEEQ – AMAT, KLAC, LRCX. ​​​​​​​