Developed Countries

Overweight General Electric, the former heavyweight of the S&P industrial conglomerates index, found some reprieve Tuesday on the news that they had agreed to divest part of their investment in Baker Hughes as part of an overall asset sale effort to shore up the company's weak balance sheet. Credit crunch fears had been weighing heavily on the stock in the week prior, taking the industrial conglomerates index down, despite strength from the other constituent members (top panel). We have previously focused heavily on GE with respect to our positioning on the S&P industrial conglomerates index. However, as shown in the second and third panels of the chart, such focus is no longer warranted as the stock represents a very much diminished share of both the S&P industrial conglomerates index and the greater S&P industrials index. We recently upgraded the S&P industrial conglomerates index to overweight on the basis that valuations had become enticing as most of the GE negativity had been priced in (bottom panel). Tack on GE's vastly lower share of the S&P industrial conglomerates index and the discounted valuation is even more compelling; we reiterate our overweight recommendation. The ticker symbols for the stocks in this index are: BLBG: S5INDCX - GE, MMM, HON, ROP.

Highlights When we flagged the increasing likelihood of higher volatility a few weeks ago, we did not expect the Trump Administration's granting of waivers on sanctions against Iranian oil exports, which ultimately led to the oil-price meltdown.1 Neither, it seems, did the market, as the surge in Brent and WTI implied volatilities attests (Chart of the Week). Chart of the WeekOil-Price Volatility Surges As Markets Process Conflicting News In one fell swoop, the Trump Administration's volte-face on Iran oil-export sanctions transformed the threat of an oil-price spike to $100/bbl in 1Q19 into a price rout. Whether that persists depends on how OPEC 2.0 responds to sharply higher short-term supply. Our updated supply - demand balances and price forecast are highly conditional on our expectation OPEC 2.0 will reduce output in response to the 1mm+ b/d or so of oil put back into the market early next year because of waivers. Inventories globally are at risk of swelling once again, if OPEC 2.0 does not cut output. OPEC 2.0's interests will conflict with the Trump Administration's agenda. Going into OPEC 2.0's December 6 meeting in Vienna, we lowered our 2019 Brent expectation $82/bbl, and continue to expect WTI to trade $6/bbl below that. We expect volatility to persist. Energy: Overweight. Natgas futures raced above $4.00/MMBtu on the NYMEX as the U.S. heating season kicked off with inventories of 3.2 TCF - 16% below their five-year average, and the lowest since 2005, according to EIA data. Base Metals: Neutral. China's benchmark copper treatment and refining charges are expected to remain on either side of $82.25/MT next year, as concentrate supply tightens slightly, Metal Bulletin's Fastmarkets reported. Precious Metals: Neutral. The Fed is on course to lift the fed funds range 25bp to 2.25% - 2.50% at its December meeting, which will keep gold under pressure. Ags/Softs: Underweight. The USDA's latest ending stocks estimates for the 2018/19 crop year came in below trade expectations for corn and wheat - at 1.74 billion and 949mm bushels, respectively, vs. expectations of 1.78 billion and 969mm, according to agriculture.com. Soybean estimates came in at 955mm vs. an expected 906mm bushels. Feature Brent and WTI crude oil prices air-dropped from a high of $86.10/bbl in early October to a Wednesday low of $65.01/bbl as we went to press. This was a 24% drop in a little more than a month, reflecting the difficulty markets experienced recalibrating supply - demand balances in the wake of the Trump Administration's volte-face on Iranian export sanctions, which took effect last week. Over the past weeks, markets appear to be pricing the return of more than 1mm b/d of Iranian exports in 1Q19, on the back of these waivers for importers of Iranian crude. The full extent of the additional volumes that will be allowed back on the market still is unknown. Lacking certain information, market participants have to assume the waivers will dramatically expand short-term supplies, which already had been boosted by OPEC 2.0 and U.S. producers, in the lead-up to sanctions (Table 1).2 The sell-off on the back of the waivers did, however, dissipate some of the risk premium we identified in prices in October, and brought price more in line with actual balances (Chart 2).3 Table 1BCA Global Oil Supply - Demand Balances (MMb/d) (Base Case Balances) Chart 2Oil Risk Premium Dissipates Prior to the granting of waivers, markets were girding for sanctions-induced losses of as much as 1.7mm b/d. Now markets could see a far lower supply loss of 500k b/d in Iranian exports. This lower loss of exports from Iran reduced expected prices by $10/bbl in 1H19, vs. our previous expectation of $85/bbl for 1H19 using our ensemble forecast (Chart 3). For market participants hedging or trading based on the expectation of higher losses of Iranian exports, the granting of waivers creates even more "new-found" and unanticipated supply. In a simulation with the waivers extended to end-2019, average 2019 Brent prices fall to $75/bbl vs. $82/bbl using our current assumptions. Chart 3OPEC 2.0 Production Hike Pushes Price Spike To 2Q19 In our estimation, "finding" this much supply via waivers amounts to a supply shock. This was compounded by surging U.S. crude and liquids production, which is boosting oil and product exports from America. Uncertain Balances, Volatile Prices Waivers are not the only factor contributing to price volatility. Fears of weaker global demand come up repeatedly - particularly as regards Asia in general, and China in particular.4 Those fears are not showing up in actual demand. In our balances estimates, we expect demand growth of 1.46mm b/d next year, down slightly from our previous estimate, given realized oil consumption remains strong (Chart 4 and Table 1). Supporting data - e.g., EM import volumes - continue to indicate incomes are holding up. Chart 4Demand Expected To Hold; Supply Highly Conditional On OPEC 2.0 On the supply side, references to an apparent disagreement between the Kingdom of Saudi Arabia (KSA) and Russia - the leaders of OPEC 2.0 - over the need to cut 1mm b/d of production next year, to keep inventories from once again swelling as they did in 2014 - 2016, compounding risks.5 While it appears KSA has carried the day on the need to cut production, that could change at OPEC 2.0's December meeting in Vienna. Output from OPEC 2.0's weakest member states - i.e., Libya and Nigeria - remains strong. Even Venezuela's rate of decline slowed some. Therefore, even without the waivers, KSA and its Gulf Arab allies would have had to reduce output to make room for these states, which are desperately trying to rebuild war-torn infrastructure. In addition to the OPEC 2.0 output surge, U.S. production has been unexpectedly strong, as have U.S. crude and refined product exports (Chart 5). The EIA - in an adjustment that surprised its analysts - revised its U.S. production estimate for October by 400k b/d vs. September's estimate to 11.4mm b/d. Production in the Big 4 shale plays - Permian, Eagle Ford, Bakken, Niobrara - is proving to be even stronger as well (Chart 6). U.S. shale output will be just under 8mm b/d by December, months ahead of schedule. The infrastructure buildout in the Permian will no doubt absorb this production and the subsequent growth in shale output by ~1.35mm b/d next year easily. Chart 5U.S. Production, Exports Surge Chart 6U.S. Shale Production Will Surge U.S. producers do not have an interest in managing their production. OPEC 2.0 does, however. We expect KSA and its Gulf Arab allies to reduce production in December and keep it low until the recently formed overhang brought on by the waivers to Iranian sanctions clears. This means OECD inventory levels will once again be a key variable for OPEC 2.0 in its production management decisions (Chart 7). Chart 7Once Again, OECD Stocks Are OPEC 2.0's Policy Variable We assume KSA will mobilize 800k to 1mm b/d of cuts in the coalition's production at least through 1H19. KSA already has said it will reduce exports by 500k b/d in Dec18, and that could be extended to Jun19. We also expect the rest of the Gulf Arab producers to follow suit, and cut back on the production increases they brought on line at President Trump's urging. By 2H19, the waivers will have expired, but U.S. shale output will be surging and newly built pipelines will be filling. We have been carrying lower 2H19 OPEC 2.0, particularly KSA, production estimates in anticipation of this increased production and exports from the U.S. (Table 1). OPEC 2.0 + 1? President Trump apparently wants to continue to have a say in OPEC 2.0's policy deliberations, as he obviously did in the run-up to U.S. mid-term elections earlier this year. In response to persistent messaging from President Trump, KSA, Russia and their allies surged production ~ 750k b/d in July - November over their 1H18 output, in preparation for the U.S. sanctions against Iran. In addition to pushing for higher production, the U.S. has taken a more activist approach to boosting oil production among U.S. allies, possibly ahead of another attempt to impose sanctions on Iran when the current waivers expire next year in June, assuming the 180-day wind-down begins in January. For example, the U.S. has taken a more active role in re-starting exports of oil from Iraq's semi-autonomous Kurdish province - some 400k b/d, which would flow to Turkey and on to Western consumers. Without higher production from Iraq and others in OPEC 2.0, the Iran waivers almost surely will have to be extended when they expire. As we have shown in our research, Brent prices mostly likely would push toward $100/bbl without a substantial increase in spare capacity within OPEC 2.0.6 President Trump gives every impression he and his administration now share our assessment, as the FT noted: "US president Donald Trump said this week he was 'driving' oil prices down and that he had granted waivers to some of Iran's customers as he did not want to see '$100 a barrel or $150 a barrel' crude."7 BCA's Geopolitical Strategy notes the waivers also send two very important messages to KSA: "First, the U.S. cares about its domestic economic stability. Second, the U.S. does not care about Saudi domestic economic stability. Our commodity strategists believe that Saudi fiscal breakeven oil price is around $85. As such, the U.S. decision to slow-roll the sanctions against Iran will be received with chagrin in Riyadh, especially as the latter will now have to shoulder both lower oil prices and the American request for higher output."8 Forecasting supply-demand fundamentals and, therefore, prices in this environment is extremely difficult, as it involves reconciling conflicting goals between the Trump Administration and OPEC 2.0. If President Trump prevails and KSA increases output - against its own best interests, given it requires higher prices to fund its budget - then prices will be lower for longer, once again. We are inclined to believe President Trump's alarm bells start sounding when oil prices are approaching the $85/bbl level. This also is the price level KSA needs to fund its fiscal obligations. For this reason, we expect KSA and its Gulf allies to reduce output in the near term until the waivers-induced overhang clears. Depending on how quickly they act, this could be done in fairly short order. Bottom Line: Volatility likely will persist as global markets absorb an unexpected supply surge resulting from the Trump Administration's last-minute volte-face on Iranian export sanctions, which is compounded by the supply ramp undertaken by OPEC 2.0 ahead of sanctions being imposed, and surging U.S. production gains. Robert P. Ryan, Senior Vice President Commodity & Energy Strategy rryan@bcaresearch.com Hugo Bélanger, Senior Analyst Commodity & Energy Strategy HugoB@bcaresearch.com 1 Please see BCA Research's Commodity & Energy Strategy Weekly Report "Risk Premium In Oil Prices Rising; KSA Lifts West Coast Export Capacity," published on October 25, 2018. It is available at ces.bcaresearch.com. 2 OPEC 2.0 is the name we coined for the OPEC - non-OPEC producer coalition formed at the end of the price collapse of 2014 - 16 to get control over global output and bring down swollen crude oil and refined product inventories. The coalition meets December 6 in Vienna to consider formalizing the union as a production-management cartel. 3 Our price-decomposition model's residual term is our proxy for the risk premium in oil prices. This is the red bar in Chart 2. Please see discussion in "Risk Premium In Oil Prices rising; KSA Lifts West Coast Export Capacity," which is cited above. 4 Please see "Asia's weakening economies, record supply threaten to create oil glut," published November 14, 2018, by uk.reuters.com. 5 Please see "OPEC and Russia Prepare for Clash Over Oil Output Cuts," published online by the Wall Street Journal November 9, 2018. 6 Please see BCA Research's Commodity & Energy Strategy Weekly Reports "Odds Of Oil-Price Spike In 1H19 Rise; 2019 Brent Forecast Lifted $15 To $95/bbl," published on September 20, 2018, and "Risks From Unplanned Oil-Outage Rising; OPEC 2.0's Spare Capacity Is Suspect," published September 27, 2018. Both are available at ces.bcaresearch.com. 7 Please see "Iraq close to deal to restart oil exports from Kirkuk," published by the Financial Times November 9, 2018. 8 Please see BCA Research's Geopolitical Strategy Weekly Report "Insights From The Road - Constraints And Investing," published on November 14, 2018. It is available at gps.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2018 Summary of Trades Closed in 2017

Highlights Bond yields have trapped equities, and equities have trapped bond yields. The double-digit investment opportunities are within asset-classes. From a tactical perspective: Banks will outperform the broad market. EM will outperform DM. The Eurostoxx50 will briefly outperform the S&P500. Raw industrial commodities will outperform crude oil. Feature What has been the biggest driver of financial markets this year? Trade wars and the emerging market slowdown? The budget spat between Italy and the EU Commission? The U.S. mid-term elections? Or perhaps, central bank policy normalization? These are all sensible answers, and each one has generated endless output of commentary and analysis. But none of these tells the biggest story of 2018. Chart of the WeekIn 2018, Bond Yields Have Trapped Equities, And Equities Have Trapped Bond Yields The Biggest Story Is Not Economics Or Politics... It Is Mathematics This year, the two largest five-day plunges in the global stock market - 6 percent in February and 7 percent in mid-October - resulted directly from the two largest five-day spikes in the global bond yield (Chart I-2 and Chart I-3). This simple observation reveals the biggest story in the financial markets this year: the hypersensitivity of the stock market to rising bond yields, and especially when the global 10-year yield approaches 2 percent - or equivalently 'the rule of 4': when the sum of the 10-year U.S. T-bond, German bund and Japanese government bond approaches 4 percent (Chart of the Week).1 Chart I-2Equities Plunged In February After A Spike In Bond Yields Chart I-3Equities Plunged In October After A Spike In Bond Yields With the global stock market now flat year-to-date, it follows that excluding these two five-day plunges, global equities would be comfortably higher even with the emerging market slowdown, trade war quarrels, and political spats. Meaning that this year's market action is not explained by economics or by politics. It is explained by mathematics, and specifically the great misunderstanding of investment risk. Previous reports have focused on this great misunderstanding, most recently Risk: The Great Misunderstanding Of Finance, to which we refer our readers. Here, we will just summarize:2 An investment's risk depends on the negative asymmetry of its short-term returns. At very low bond yields, bond returns develop the same negative asymmetry as equity returns. This means that equities lose their excess riskiness versus bonds, requiring equity valuations to experience a phase transition sharply higher. But when bond yields normalize, equities regain their excess riskiness versus bonds - and their valuations must suffer a phase transition sharply lower. This phase transition to sharply lower equity valuations is most pronounced when the global 10-year bond yield rises to 2 percent. This dynamic has proved to be the biggest driver of financial markets in 2018, and is likely to be the biggest driver in 2019 too. Essentially, higher bond yields can suddenly and viciously undermine the valuation support of equities, limiting the upside in the stock market (Chart I-4). In turn, a plunge in the stock market and other risk-assets threatens a disinflationary impulse, limiting the sustainable upside in bond yields. Chart I-4Equities Remain Richly Valued In effect, bond yields have trapped equities, and equities have trapped bond yields (Chart I-5). The result is that in 2018 the global asset-classes: equities, bonds, commodities, and cash have all ended up going nowhere. Indeed, the global 30-year bond yield has been trapped since early 2017!3 Chart I-5The Global 30-Year Bond Yield Has Been Trapped For Two Years The Double-Digit Investment Opportunities Are Within Asset-Classes Although the global asset-classes have ended up going nowhere this year (Chart I-6), 2018 has still provided double-digit investment opportunities. But to find these double-digit opportunities, you have to look below the main asset allocation decision to within the asset-classes, in sector, region and country allocation. Chart I-6In 2018, Global Asset-Classes Have Ended Up Going Nowhere For example, until very recently: banks had underperformed the broad equity market by 10 percent globally and 25 percent in Europe; emerging market equities had underperformed developed market equities by 15 percent; the Eurostoxx50 had underperformed the S&P500 by 13 percent; and raw industrial commodities had underperformed crude oil by 30 percent. But in the last month or so, these strong trends have exhausted and even started to reverse: banks have started to outperform the market; the Eurostoxx50 has eked ahead of the S&P500; emerging market equities have retraced versus developed market equities; and raw industrial commodities have made up much lost ground on crude oil (Charts I-7 - Chart I-10). One important reason is that the sharp down-oscillation in global credit growth which was responsible for many of this year's intra asset-class trends has now clearly rebounded into an up-oscillation. Chart I-7Banks Have Started To Outperform Chart I-8The Eurostoxx50 Is Starting To Outperform The S&P500 Chart I-9EM Has Started To Outperform DM Chart I-10Industrial Commodities Are Starting To Outperform Crude Oil Hence, we expect these trend reversals to continue in the coming months. From a tactical perspective only, this means: 1. Banks will outperform the broad market. 2. EM will outperform DM. 3. The Eurostoxx50 will briefly outperform the S&P500. 4. Raw industrial commodities will outperform crude oil. Such an inflection point can leave investors scratching their heads in confusion, because sector performances seem to conflict with the economic data releases. But the conflict is easily resolved. Though we are now in mid-November, the economic data releases - for example, German exports - are a lagging indicator, referring to a time in the past, September, when global credit growth might still have been in a down-oscillation. Whereas the financial markets - for example, bank equities' relative performance - are a contemporaneous indicator, sensing credit growth's switch to an up-oscillation in real-time. Always remember that market prices move on the marginal change in information and expectations. To be absolutely clear, we are not referring to the business cycle. We are referring to predictable oscillations in credit growth that occur within the business cycle, but which nevertheless create double-digit investment opportunities - such as bank equities' relative performance. The Importance Of 6-Month Credit Growth Still, several clients have asked about our choice of 6-month credit growth, as it appears to be an arbitrary period plucked out of thin air or, more cynically, 'data-mined'. In fact, our choice of 6-month growth has a rock-solid foundation in economic theory.4 For any item, if supply lags demand by a period t, then economic theory proves that both the quantity of the item and its price will experience oscillations with half-cycle length t. Clearly, bank credit is such an item whose supply does lag demand. For example, a mortgage is only allocated and released after a time-consuming process of checking collateral and creditworthiness. For bank credit in aggregate, the lag between demand and supply, and specifically final spending of the funds, averages six to eight months. Once you accept this fundamental truth, it follows that credit growth must also experience oscillations whose half-cycles last six to eight months. So we end with a very important investment lesson. If you only look at the conventionally examined year-on-year credit growth data, you will not see the predictable oscillations in 6-month credit growth. And if you do not look at 6-month credit growth, you will miss the double-digit investment opportunities that are always on offer (Chart I-11). Chart I-11A Sharp Down-Oscillation In Global Credit Growth Has Rebounded Into An Up-Oscillation The choice is yours. Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com 1 We use the MSCI All Country World Index in local currency terms to capture the global stock market. 2 Negative asymmetry of returns means the possibility of larger short-term losses than short-term gains. Please see the European Investment Strategy Weekly Report, "Risk: The Great Misunderstanding Of Finance", October 25, 2018 available at eis.bcaresearch.com. 3 Please see the European Investment Strategy Weekly Report, "Trapped: Have Equities Trapped Bonds?", September 13, 2018 available at eis.bcaresearch.com. 4 Please see the European Investment Strategy Special Report, "The Cobweb Theory And Market Cycles", January 11, 2018 available at eis.bcaresearch.com. Fractal Trading Model* Palladium has outperformed nickel by 50% in the past three months, but this strong trend is nearing exhaustion according to its 65-day fractal dimension. Hence, this week's trade recommendation is long nickel/short palladium setting a profit target of 14% with a symmetrical stop-loss. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment's fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-12 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report "Fractals, Liquidity & A Trading Model," dated December 11, 2014, available at eis.bcaresearch.com Fractal Trading Model Recommendations Asset Allocation Equity Regional and Country Allocation Equity Sector Allocation Bond and Interest Rate Allocation Currency and Other Allocation Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations

Neutral When we downgraded the S&P home improvement retail index (HIR) to neutral in September, the core of our thesis was that fixed residential investment as a percentage of GDP appeared to have peaked, up 50% from trough to the recent highs, whereas relative HIR performance is up 170% in the same time frame (top and second panels).1 Such euphoria, both among investors and the sell side community (bottom panel), leaves the index prone to fall, should a disappointment occur. Yesterday's results from index giant Home Depot reinforce this point. The company exceeded earnings expectations and raised their guidance (albeit for only one quarter) and the stock still underperformed the market. Considering the cautious guidance from management on the housing market, cost pressures from tariffs and a much-reduced price of lumber, it is of little wonder the company failed to live up to expectations. Net, while we remain constructive on the overall housing market, we continue to think the positivity is fully baked in to the S&P HIR index; stay neutral. Clients seeking housing exposure should consider the compellingly valued S&P homebuilding index that we are overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOMI - HD, LOW. 1 Please see BCA U.S. Equity Strategy Weekly Report, "Indurated," dated September 24, 2018, available at uses.bcaresearch.com.