United States

Dear client, It was my pleasure to join Dhaval Joshi, BCA’s Chief European Investment Strategist, this past Friday June 12, 2020 on a webcast he hosted titled: “Sectors To Own, And Sectors To Avoid In The Post-Covid World”. You can access the replay of the lively webcast here, where Dhaval and I debate how investors should be positioned in different time horizons. I hope you will find it both insightful and informative. Kind Regards, Anastasios Highlights Portfolio Strategy While we cannot time the exact equity market top, our sense is that we are more than fairly valued at the current juncture and the equity market has entered a speculative phase; thus the risk/reward tradeoff is poor in the near-term. We are compelled to put the S&P home improvement retailers index (HIR) on our downgrade watch list and institute a stop at the 10% return mark in order to reflect softness in our HIR macro model, a hook down in existing home sales and a high profit growth bar that sell-side analysts have set for the coming year. Recent Changes Our rolling 10% stop got hit last Tuesday and we monetized 32% gains since the reinstatement of the long S&P oil & gas exploration & production / short global gold miners pair trade.1 Feature Equities briefly erased all losses for the year early last week, but the Fed’s June meeting lacked any additional easing measures and served as a catalyst for a much needed breather – the fifth 5.3-7.3% pullback since the March 23 bottom – as the week drew to a close. While extremely easy monetary and fiscal policies remain the key macro drivers for the SPX, any hiccups in passing a new fiscal spending bill once the money runs out on July 31, carry enough risk to short circuit the equity market’s momentum and result in a shakeout phase. Importantly, given the recent speculative overshoot in equities, the cyclical return potential has diminished, and that is cause for concern. The ongoing COVID-19 catalyzed recession that the NBER last week confirmed commenced in February, the “second wave” risk, a flare up in the US/Sino trade war and more recently, civil unrest have dominated the news flow. However in all this chaos, the November election has slowly moved into the background, especially the SPX return implications during the 4th year of a Presidency. Chart 1 shows the profile of the S&P 500 during Presidential Election calendar years, going back to the 1950s. The solid green line shows the historical mean, and shaded areas denote the 10th and 90th percentiles of SPX performance. If history rhymes, the average profile of these 17 iterations suggests that more cyclical gains are in store for the S&P 500. Chart 1Do Not Ignore… Nevertheless, before getting carried away, a word of caution is in order. As we highlighted last week, a Biden win represents a risk to the SPX’s euphoric rise from the March lows, and could serve as a catalyst for a much needed pullback (Chart 2).2 Thus, according to our analysis if the 90th percentile proves accurate, then the SPX could trace this lower bound and fall 640 points or 20% (Chart 1). This is a key tail risk to our cyclically sanguine equity market view. Chart 2…(Geo)Political Risks Turning over to the reopening of the economy, while the SPX has now discounted a near fully functioning economy for the rest of the year and beyond (bottom panel, Chart 3), fixed income investors are not in total agreement. In fact, the missing ingredient in giving the green light for equities is a selloff in the bond market, which financials/banks are currently sniffing out on the back of the reopening of the economy. Until fixed income investors get on the same page as equity investors, the SPX will remain on shaky ground (top panel, Chart 3). We first turned positive on the cyclical prospects of the equity market in mid-March3 and cemented our conviction in our March 23 report presenting 20 reasons to buy stocks.4 Since then, the SPX has rocketed higher by 1000 points and overshot our 3,000 SPX target that we recently derived from three methods.5 While we cannot time the exact top and equities may have a bit more upside, our sense is that today, stocks are more than fairly valued and they have entered a speculative phase (Chart 4). Thus the risk/reward tradeoff in the near-term has shifted to the downside. Once these (geo)political risks get appropriately repriced via a higher risk premium, then the broad equity market will resume its cyclical upside march. Chart 3Bond Market Is Not Buying Stock Market’s Euphoria Chart 4Lots Of Good News Is Priced In This week we update one consumer discretionary subgroup and put it on our downgrade watch list. Put Home Improvement Retailers On Downgrade Alert We are putting the S&P home improvement retailers index (HIR) on downgrade alert and setting a stop at the 10% return mark in order to protect handsome gains for our portfolio since the mid-April overweight inception. HIR have catapulted to all-time highs both in absolute terms and relative to the broad market. Granted, this has been an earnings-led propulsion (top panel, Chart 5), however, we are uneasy that HD is a top ten holding in the S&P growth index (middle panel, Chart 5).6 Importantly, the first print in the real GDP release for Q1/2020 in late-April made for grim reading, with one notable exception: real residential investment. Business capex took it to the chin, but housing related outlays spiked over 20% on a quarter-over-quarter annualized basis, and signal that DIY same-store retail sales will likely prove resilient this summer (bottom panel, Chart 6). Chart 5An Earnings-Led Advance… Chart 6…Buttressed By Resilient Residential Investment… As a reminder, these Big Box retailers are highly levered to the ebbs and flows of residential investment and the latest GDP print should sustain the recent bid under S&P HIR prices (top & middle panels, Chart 6). Tack on the roughly $75/tbf jump in lumber prices since the early-April trough (not shown), and profits benefit from a dual lift: rising volumes and firming selling prices. The DIY avalanche is real and not likely to dissipate any time soon as a consequence of the coronavirus-induced working from home pervasiveness. Yet, HIR has run too far too fast and is due for a consolidation phase. One yellow flag is the recent fall in existing home sales, despite the all-time lows in mortgage rates brought back by the Fed’s ZIRP. The middle panel of Chart 7 shows that if the home sales decline continues in the summer months, then HIR sales will face stiff headwinds as remodeling activity suffers a setback. In addition, in previous recessions the inventory of homes for sale has surged, but at the current juncture only a small jump in inventories is visible (inventories shown inverted, top panel, Chart 7). Were that trend to gain steam, it could put downward pressure to high-flying HIR equities. Chart 7…But Soft Home Sales Are An Issue… Chart 8…And The Tick Down In Our HIR Model Is A Yellow Flag The industry’s net earnings revision ratio has climbed to multi-year highs and warns that analyst optimism is excessive, which is contrarily negative (bottom panel, Chart 7). Our macro driven HIR model does an excellent job in encapsulating all the moving parts and its recent tick down is worrisome (Chart 8). Nevertheless, given that this has been a profit-led advance, HIR have a large valuation cushion. The relative forward P/E is trading near a market multiple and below the historical mean (bottom panel, Chart 5). Netting it all out, we are compelled to put the S&P HIR index on our downgrade watch list and institute a stop at the 10% return mark in order to reflect softness in our HIR macro model, a hook down in existing home sales and a high profit growth bar that sell-side analysts have set for the coming year (middle panel, Chart 5). Bottom Line: While we remain overweight the S&P HIR index it is now on downgrade alert. We also set a stop at the 10% return mark in order to protect profits for our portfolio. Stay tuned. The ticker symbols for the stocks in this index are: BLBG: S5HOMI – HD, LOW.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com     Footnotes 1     Please see BCA US Equity Strategy Insight Report, “Pocketing Gains In Oil/Gold Pair Trade” dated June 10, 2020, available at uses.bcaresearch.com. 2     Please see BCA US Equity Strategy Weekly Report, “Don’t Turn A Blind Eye To Geopolitical Risks” dated June 8, 2020, available at uses.bcaresearch.com. 3    Please see BCA US Equity Strategy Weekly Report, “Inflection Point” dated March 16, 2020, available at uses.bcaresearch.com. 4    Please see BCA US Equity Strategy Weekly Report, “The Darkest Hour Is Just Before The Dawn” dated March 23, 2020, available at uses.bcaresearch.com 5    Please see BCA US Equity Strategy Weekly Report, “New SPX Target” dated April 20, 2020, and “Gauging Fair Value” dated April 27, 2020, available at uses.bcaresearch.com. 6    https://us.spindices.com/indices/equity/sp-500-growth#data-constituents   Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views June 3, 2019 Stay neutral cyclicals over defensives (downgrade alert)  January 22, 2018 Favor value over growth April 28, 2020  Stay neutral large over small caps  June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V).

Highlights Equities hit an air pocket last week after making another recovery high: Investors seemed to reassess the economy’s direction following official forecasts that ranged from sober to grim. “Whatever we can, and for as long as it takes”: The FOMC’s outlook may have dampened investors’ mood now, but it contained the promise of an extended period of easy policy. Further fiscal help is on the way: The White House supports additional spending and some new Republican proposals offered a hint of what the next phase of fiscal relief might look like. Bank stocks quailed at the prospect of lower rates: The SIFI banks sold off sharply as investors feared that falling rates and a flatter yield curve would crimp net interest margins. We are undeterred from our bullish stance on the group. Feature Coming into last week, the gap between the effervescence of the stock market and the gloom of the pandemic-stricken economy was Topic A for investors and the financial media. We have interpreted the gap as a vote of confidence for policymakers. The Fed and Congress have thrown nearly everything they have at shielding the economy from the virus’ depredations and investors have concluded that they’ll succeed, bidding equities higher and corporate bond spreads tighter (Chart 1). Chart 1Spreads Are Back To The Middle Of Their Post-GFC Range ... Through last Monday, the benchmark Bloomberg Barclays Investment Grade and High Yield Corporate Bond Indexes had generated total returns of 17% and 24%, respectively, since their March 20-23 lows, while the S&P 500 was up 45% peak-to-trough on a total return basis. Equities’ torrid run had the S&P in the black year-to-date and within just 5% of its mid-February peak (Chart 2). Given that the economic projections have only worsened since late March, and the virus toll has been worse than the consensus expected, policy has had to shoulder the entire load. Chart 2... And Equities Made It All The Way Back To Their 2019 Close In the monetary sphere, the Fed swiftly cut the fed funds rate to zero, purchased Treasuries and agency MBS at a faster rate than it did during the global financial crisis, revived several GFC initiatives and announced it would lend money directly to investment-grade-rated corporations1 for the first time. The medley of measures quickly gained traction. Though the new issuance market initially seized up upon the arrival of the pandemic, record amounts of corporate bonds were issued in both March and April. All-out stimulus efforts from Congress and the Fed have produced a remarkable market turnaround. From the fiscal side, Congress passed several measures to speed aid to vulnerable parts of the economy, crowned by the CARES Act. As we detailed last week,2 its expansion of state unemployment insurance benefits has made two-thirds of the unemployed eligible to earn more than they did at their jobs. Bolstering unemployment insurance and sending direct $1,200 payments to nearly two-thirds of taxpayers has allowed households to service their debt and pay their rent, preventing wider contagion. Although several fiscal hawks cited May’s way-better-than-expected employment situation report as evidence that Congress can relax its fiscal efforts, we expect that another phase of assistance will follow by the end of July. The potential vulnerability in financial markets stems from the prevailing certainty that policymakers have already won. But things could still go wrong, as highlighted by last week’s bracing economic projections from the OECD and the Fed. US financial markets are generally unaware of the OECD’s semi-annual outlooks, but this one’s probability assessments were striking: it sees a 50-50 chance that an infection second wave will require new lockdowns before the end of the year. The Fed Has The Economy’s Back … Chart 3Take All This ZIRP And Call Me In 2023 “At the Federal Reserve, we are strongly committed to using our tools to do whatever we can, and for as long as it takes, to provide some relief and stability, to ensure that the recovery will be as strong as possible, and to limit lasting damage to the economy.” As Chair Powell stated at the beginning of his prepared remarks, whatever it takes was the theme of last week’s FOMC meeting press conference. He made it very clear that the Fed intends to err to the side of providing too much accommodation as it confronts the highly uncertain environment. Asked how long the Fed would stick with zero interest rates if the economy surprises to the upside, he said, “we’re not even thinking about thinking about raising rates.” The first Summary of Economic Projections (SEP) since December validated his statement. Every voter projected that the fed funds rate will remain at its current near-zero level for all of 2020 and 2021, and only two voters foresaw rate hikes in 2022 (Chart 3). After Powell described the new round of QE purchases as a necessary measure to support the smooth functioning of financial markets and ensure credit access, a reporter asked if they were still needed, given how market disruptions have dissipated amidst the recovery rally. He replied that the FOMC did not want to take anything for granted and risk prematurely withdrawing its support. As he said in his prepared remarks, “We will continue to use [our emergency lending] powers forcefully, proactively, and aggressively until we are confident that we are solidly on the road to recovery.” The Fed is not even thinking about thinking about raising rates. Powell’s pledges to keep applying the Fed’s full range of tools to support the economy went to the heart of our rationale for overweighting equities over the cyclical timeframe: the Fed will maintain hyper-accommodative policy settings even after they’re no longer necessary. Every rose has its thorn, however, and the Fed would not be on an emergency footing if conditions weren’t dire. Though Powell and the committee expect a recovery to take hold over the next two quarters, the median SEP participant expects the unemployment rate to exceed 9% at the end of this year and does not see GDP returning to its 2019 level until the second half of 2022. The glum projections dampened investors’ enthusiasm and halted equities’ upward march. … And Congress Eventually Will, Too In testimony before a Senate committee on Wednesday, Treasury Secretary Mnuchin touted the budding recovery but made it clear that the administration wants additional stimulus measures. “I definitely think we are going to need … to put more money into the economy,” he said. He expressed a preference for programs that get people back to work and voiced concern that the first round of enhanced unemployment benefits may encourage people to stay out of work, but left the door open to some form of extension. He also indicated that the administration would consider another round of direct payments to taxpayers. Unemployment benefits well in excess of median wages may not be extended beyond July 31st but Republican senators and representatives have begun to put forth appealing alternative proposals like a temporary $450 weekly bonus or an additional two weeks of the existing $600 supplement for those returning to work. The bottom line is that events are validating our geopolitical strategists’ view that another fiscal stimulus package is inevitable. Senate holdouts caught between the House’s and the White House’s desire for more aid will be unable to thwart another round. Banks And The Yield Curve Just a week ago, when the animal spirits sap was rising and a range of indicators suggested that growth may be bottoming, the 10-year Treasury yield surged 26 basis points (bps) in six sessions, from 0.65% to 0.91%, and the 2s/10s segment of the curve steepened by 20 bps. Bank stocks surged, and the SIFIs gained an average of 22% (Table 1). Then the 10-year yield reversed field, tumbling 25 bps in just three sessions from Tuesday to Thursday, and the curve flattened by 23 bps. The SIFI rally evaporated across the three midweek sessions, and the group fell 18% to end the nine-day round trip 30 bps from where it began. Table 1Back So Soon? The violent back and forth reinforced the conventional wisdom that banks are joined at the hip with long yields and the slope of the curve. If the 10-year doesn’t go anywhere, the thinking goes, and the curve doesn’t steepen, bank stocks can’t make any significant headway. We beg to differ. The link from the curve to bank earnings runs through net interest margin (NIM), the difference between the banks’ weighted-average lending yield and cost of funds. It makes perfect sense that NIM would expand and contract as the yield curve steepens and flattens, and it did into the early nineties. But by then banks had learned the lesson of the savings and loan debacle – borrowing short and lending long can be fatal if inflation and/or the Fed drive short rates much higher – and they became fastidious about matching the duration of their assets and liabilities. In the new duration-matched regime, NIM has become insensitive to the slope of the curve (Chart 4). With the NIM link broken, the yield curve has no influence on bank earnings (Chart 5). There is no doubt that banks regularly trade with long yields, but any link with the yield curve is easily severed (Chart 6) by earnings surprises. If the policy outlook doesn’t change between now and mid-July, we expect the SIFI banks will get a boost from smaller than expected loan-loss reserve builds. Taking our cue from the way monetary and fiscal largess will hold down defaults, we reiterate our overweight on the SIFI banks. Chart 4There's No Empirical Relationship Between Bank NIM And The Yield Curve, ... Chart 5... Or Bank Net Income And The Yield Curve Chart 6Bank Stocks' Relative Performance Is Not A Function Of The Yield Curve Investment Implications A client asked us last week how investors who have built up cash holdings over the last few months should approach re-entering the equity market. Patiently, we replied, in line with the qualms we’ve had about the magnitude and speed of the rally from the March lows. We are only neutral equities over the tactical 0-to-3-month horizon because the S&P 500’s forward P/E multiple is elevated (Chart 7) and investors don’t seem to be assigning a high enough probability to the possibility that the virus, Congress, or geopolitics could create a bump in the road. We are still looking for a double-digit correction. Our SIFI banks thesis doesn't require a steeper curve or higher long yields; it'll work as long as loan-loss reserve builds fall short of investors' fears. Chart 7Stocks Are Expensive Table 2Downside Insurance Is Awfully Expensive We suggested that the client get 15-20% of the desired allocation deployed that day (Thursday, fortuitously) and parcel the rest out at lower limits all the way down to 2,875 (10% below the recent peak around 3,200) or some lower target like 2,700 or 2,800. With the revival in the VIX, we also suggested considering writing out-of-the-money put options on the SPY ETF. As of Thursday’s close, an investor could be compensated handsomely for agreeing to get hit down another 6.7% (280) or 10% (270) any time between now and the third Friday of July (Table 2). Writing puts is a way to get paid to wait to deploy capital, and with the VIX in the 40s, an investor can earn 20-30% annualized on the notional amount of capital s/he is committing by writing the option.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 Corporations downgraded to junk ("fallen angels") after the lending facility was announced subsequently became eligible to participate. 2 Please see the June 8, 2020 US Investment Strategy Weekly Report, "So Far, So Good (How Markets Learned To Stop Worrying And Love Washington, DC)", available at usis.bcaresearch.com.

Highlights The relaxation of lockdown measures, along with mass protests over the past two weeks, have made a second wave of the pandemic more likely than not in many countries. Unlike during the first wave, most governments will not shutter their economies in response to a renewed spike in infection rates. For better or for worse, the “Sweden strategy” will become commonplace. As today’s stock market selloff illustrates, a second wave could significantly unnerve investors, especially since it is coming on the heels of a substantial rally in stocks. However, global equity prices will still rise over a 12-month horizon. Easy monetary policy, improving labor market conditions, and significant amounts of cash on the sidelines should allow the equity risk premium to decline, especially outside the US where valuations remain quite cheap. The US dollar has entered a cyclical bear market. This is especially positive for commodities, economically-sensitive equity sectors, and non-US stocks. Opening The Hatch Chart 1Governments Are Lifting Lockdown Restrictions Three months after the virus burst out of China, countries around the world are starting to relax lockdown measures. Our COVID-19 Government Response Stringency Index, created by my colleague Jonathan LaBerge and showcased in last week’s Global Investment Strategy report, has been on an easing course since May. A similar measure developed by Goldman Sachs broadly shows the same loosening pattern. Reflecting these developments, the Dallas Fed’s index of “mobility and engagement” has been slowly returning to normal (Chart 1). The reopening of economies is taking place despite limited success in containing the virus. While some countries have seen a considerable drop off in the number of new cases and deaths, others continue to experience an increase in both metrics (Chart 2). Globally, the number of new cases has begun to trend higher after remaining flat for most of April. The number of deaths — which lags new cases by about three weeks but is less vulnerable to statistical distortions caused by changes in testing prevalence — has also ticked higher after falling for nearly two months. Mass protests starting in Minneapolis and spreading to much of the western world have the potential to further increase the infection rate. As Jonathan noted last week, large gatherings have been an important vector of transmission for the virus. While the protests have occurred outdoors, many protestors did not wear masks while singing and shouting nor practise social distancing. Chart 2Globally, The Number Of New Cases and Deaths Has Started To Trend Higher Again A Risky Gambit How markets react to a second wave of the pandemic will depend a lot on how policymakers and the broader public respond. For better or for worse, the patience for continued lockdowns has waned. The US and a number of other countries appear to be moving towards the “Swedish model” of trying to keep a lid on the virus without imposing draconian lockdown restrictions. It is a risky gambit, especially in light of the jump in infections that Sweden has reported in the past two weeks. While some countries such as China and New Zealand, which have effectively eradicated the virus, can allow most activities – with the exception of international travel – to resume, others should arguably wait longer until they too have defeated the disease. As Professor Peter Doherty, renowned immunologist and co-recipient of the 1996 Nobel Prize for Medicine, discussed in a webcast with my colleague Garry Evans on Monday, significant progress has been made towards developing a vaccine for COVID-19. Opening up economies now could cause a lot of needless death before a vaccine becomes available. Near-Term Risks To Stocks… Chart 3Earnings Estimates Have Taken It On The Chin Even if governments continue opening up their economies despite rising infection rates, some people will increase the amount of social distancing they practise regardless of official recommendations. Airline, cruise ship, and restaurant stocks had rallied mightily off their March lows before giving up some of their gains over the past few days. If a second wave occurs, they will fall further. The rally in stocks linked to the reopening of the economy occurred alongside a retail investor speculative frenzy. In one of the more bizarre episodes in financial history, stocks of bankrupt or soon-to-be-bankrupt companies surged on Monday as novice day traders snapped up shares of companies that most institutional equity investors had left for dead. Meanwhile, earnings estimates have taken it on the chin (Chart 3). Many companies chose not to provide guidance for the second quarter, citing unprecedented uncertainty over the near-term business outlook. Since Q2 will be the worst quarter for economic growth, it will probably also be a very bad quarter for earnings. The prospect of a slew of poor earnings reports in July could further dent investor sentiment, exacerbating the stock market correction we have seen over the past few days. All this suggests that global equities could experience some further weakness over the next few months. …But Still Sticking With Our 12-Month Overweight To Equities Chart 4Economic Activity Has Started Rebounding Despite these short-term risks, we are not ready to abandon our cyclical overweight view on stocks. While many people have remarked that the equity market has diverged from the economy, in fact, the rebound in the stock market has tracked the peak in initial unemployment claims and the trough in current activity indicators quite closely (Chart 4). A second wave would certainly slow the economic rebound. However, it would probably not reverse it completely given that the mortality rate from the virus now appears to be somewhat lower than initially feared and an increasing number of medical treatments are becoming available. If output and employment keep rising, stocks are likely to trend higher. A Deep Hole This does not mean that everything will return to normal soon. Even though global growth appears to have bottomed in April, the level of employment remains at depression-like levels (Chart 5). About 12% of US workers are employed in the hospitality, restaurant, and travel sectors. A return to normalcy in those sectors will take several years at best. Nevertheless, the recovery will not be nearly as drawn out as the one following the Global Financial Crisis. The Congressional Budget Office expects that it will take another eight years for the US unemployment rate to fall back to 5% (Chart 6). That seems unduly pessimistic. Chart 5Employment Remains At Depression-Like Levels Chart 6CBO Projects The Unemployment Rate Will Fall Very Slowly Cyclical Versus Structural Unemployment Chart 7Residential Construction Accounted For Less Than 20% Of The Job Losses During The Great Recession Commentators like to talk about structural unemployment, but the truth is that large increases in joblessness usually reflect deficient labor demand rather than insufficient supply. For example, the decline in residential construction employment and related sectors accounted for less than one-fifth of the job losses during the Great Recession (Chart 7). You don’t have to fill a half-empty pool through the same pipe from which the water escaped. As long as there is enough demand throughout the economy, workers who lose their jobs will likely find new jobs elsewhere, whether it be at an Amazon distribution center or any number of manufacturing companies that will benefit from the repatriation of production back onshore. The shift in jobs from one sector to the next is not instantaneous, but it need not drag on for years either. Policy Will Stay Stimulative This is where the role of monetary and fiscal policy takes center stage. Despite the improving economic outlook, government bond yields have barely moved off their lows as investors have become increasingly convinced that central banks will keep rates at rock-bottom levels (Chart 8). This week’s FOMC meeting made it clear that the Fed has no intention of raising rates through 2022. “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” Fed Chairman Jerome Powell declared during his press conference. Granted, the zero lower bound has prevented yields from falling as much as they normally would. Fortunately, fiscal policy has stepped in to fill the void. Chart 9 shows that governments have eased fiscal policy much more this year than they did in 2008-09. If governments tighten fiscal policy prematurely like they did after the Great Recession, the recovery will indeed be sluggish. Such a risk cannot be ignored. BCA’s geopolitical team, led by Matt Gertken, has argued that Republican Senators will initially resist the proposed $3 trillion in new stimulus, until they are forced to act by a major new round of financial or social turmoil. Nevertheless, Matt thinks that the Republican Senate will ultimately buckle under the political pressure, knowing full well that a large dose of fiscal largess could prevent a Democratic sweep in November. Chart 8Yields Remain Close To Recent Lows Chart 9Will It Be Enough? Chart 10China Has Ramped Up Stimulus Outside the US, fiscal support shows little sign of being scaled back. Germany has pushed forward with additional stimulus, going so far as to propose a risk-sharing arrangement via the creation of an EU Recovery Fund. On Wednesday, the Japanese House of Representatives approved a draft supplementary budget of 32 trillion yen ($296 billion) providing additional funding for small businesses and medical workers. Jing Sima, BCA Research's chief China strategist, expects Chinese credit formation as a share of GDP to reach the highest level since 2009 and the budget deficit to widen to the largest on record (Chart 10). The upshot is that we may find ourselves in an environment over the next few years where global GDP and corporate profits are moving back to trend, while interest rates (and the implied discount rate used for valuing stocks) stay at very low levels. If profits return back to normal but interest rates do not, the surreal implication is that the pandemic could end up increasing the fair value of the stock market. Ample Cash On The Sidelines Stocks also have another factor working in their favor: huge amounts of cash on the sidelines (Chart 11). The combination of massive fiscal income transfers and low spending has led to a surge in private-sector savings. The US personal savings rate reached 33% in April, the highest on record. Reflecting this increase in savings, private sector bank deposits have ballooned (Chart 12). Chart 11Sizable Amount Of Dry Powder Chart 12Savings Have Spiked Amid Stimulus     Investors often talk about cash “flowing” in and out of the stock market. This is a somewhat misleading characterization. Setting aside the impact of corporate buybacks and public share offerings, the decision by one person to buy shares requires a corresponding decision by someone else to sell shares. The buyer of the shares loses some cash, while the seller gains some cash. On net, there is no inflow of cash into the stock market. Rather, what happens is that the price of shares adjusts to ensure that there is a seller for every buyer. If people feel that they have too much cash relative to the value of their equity holdings, they will bid up the price of stocks until enough sellers come forward. This will cause the amount of cash that people hold as a percentage of their total wealth to shrink, even if the dollar value of that cash remains the same. The process will only stop when the amount of cash that people hold is in line with their preferences. The amount of cash held in US money market funds and personal cash deposits has surged by $2.6 trillion since February. Despite the rally in equities, cash holdings as a percent of stock market capitalization remain near multi-year highs. This suggests that the firepower to fuel further increases in the stock market has not been exhausted. Start Of The Dollar Bear Market After peaking in March, the broad trade-weighted US dollar has weakened by 5.3%. The dollar is a countercyclical currency, meaning that it tends to move in the opposite direction of the global business cycle (Chart 13). While the dollar could strengthen temporarily in response to a second wave of the pandemic, global growth should continue to recover in the second half of the year provided that severe lockdown measures are not reintroduced. Stronger global growth will push the greenback lower. Chart 13The US Dollar Is A Countercyclical Currency Unlike last year, the dollar no longer has support from higher US interest rates. Indeed, US real rates are below those of many partner countries due to the fact that US inflation expectations are generally higher than elsewhere (Chart 14). Chart 14The Dollar Has Been Losing Interest Rate Support A Weaker Dollar Will Support Non-US Stocks The combination of a weaker dollar and stronger global growth should disproportionately help the more cyclical sectors of the stock market, particularly commodity producers. Since cyclical stocks tends to be overrepresented outside the US, non-US equities should outperform their US peers over the next 12 months. A weaker dollar will also reduce the local- currency value of dollar-denominated debt. This will be especially helpful for emerging markets. Despite the recent rally, the cyclically-adjusted PE ratio for EM stocks remains near historic lows (Chart 15). EM equities should fare well over the next 12 months.   Chart 15EM Stocks Are Very Cheap Peter Berezin Chief Global Strategist peterb@bcaresearch.com Global Investment Strategy View Matrix Current MacroQuant Model Scores

Overweight While we are neutral the S&P tech sector, we continue to employ a defensive over aggressive tech strategy and prefer software and services to hardware and equipment. The S&P software index in particular has proven its resilience during the COVID-19 sell-off and recovery and has now broken out to fresh all-time highs both in absolute and relative terms. Upbeat profit fundamentals underpin software buoyancy. Relative capex spending remains in a secular uptrend, spring-boarding the share price ratio. Our relative macro earnings growth model is also gaining steam highlighting that the earnings driven outperformance phase has staying power. Bottom Line: Stay overweight the S&P software index.