Equities

The yields continue being range bound, creating an environment more favorable for companies which derive majority of their earnings further in the future. In addition, earnings growth has peaked and is slowing down, making growth stocks more attractive at times when earnings growth is becoming a little harder to find. These two factors support our thesis that it’s time to revisit growth stocks. Looking at growth names in the context of the business cycle is also instructive. The chart below shows relative performance of different S&P 500 styles during various stages of the business cycle. Historically, growth shines best during periods of slowdown, as it is one of the safer styles. Bottom Line: Investors should add growth exposure to their portfolio.

Highlights In the near term, the RMB against the US dollar has ceased to be a one-way bet. Market sentiment will re-focus on economic fundamentals, which are less supportive of further RMB appreciation.  In the longer term, the RMB still has some upside potential, but the pace of its growth should be much slower than in the past 12 months. The sharp rise in the trade-weighted RMB index is starting to threaten China’s export sector and has exacerbated the tightening of domestic monetary conditions. Barring a monetary policy reset by Chinese authorities, even a small increase in the broad-RMB index would heighten the risk of a contraction in corporate profit growth in the coming 12 months. We remain risk adverse to Chinese stocks for the next 6 months. Feature Chart 1The RMB Back On A Fast Ascending Path After a brief pause in March, China’s currency versus the US dollar extended its steep upward trend began in mid-2020 (Chart 1). Chinese policymakers recently ramped up their strong-worded statements warning against speculating on the RMB. Regulators have also taken steps to stem the rise. Questions we have recently been getting from our clients about the RMB can be summarized as follows: After a 10% appreciation since its trough a year ago, does the RMB have more upside in 2021 and beyond? If the RMB continues to appreciate, what would be the impact on China’s economy and corporate sector? What can the PBoC do to slow the pace of the currency’s appreciation? One could argue that the US dollar will continue to weaken, but we see substantial headwinds to the RMB within the year. A weaker US dollar would support global stock prices outside of the US and foreign inflows have driven the recent rally in China’s onshore stocks. However, we think China’s domestic macro policy and economic conditions pose more downside risks on a cyclical basis. How Far Can The RMB Go? A continued upswing in the CNY relative to the USD can no longer be taken for granted. In the coming months, there is a strengthening case for the RMB to fall against the greenback as factors supporting a strong RMB in the past year start to abate. Economic fundamentals will no longer prop up the RMB’s rise going into 2H21. China’s growth momentum is softening due to significant tightening in the monetary environment in the second half of last year and a rapid deceleration in credit growth this year (Chart 2). Meanwhile, the massive rollouts of COVID-19 vaccines in North America and Europe have successfully reduced new infections and hospitalization rates, allowing these countries to reopen their economies. The economic growth gaps between China and the developed markets (DMs) will narrow more significantly in the coming months (Chart 3). Chart 2Chinese Economic Fundamentals Will Start To Weaken Chart 3China's Growth Gap Relative To DMs Will Narrow Chart 4Global Consumption Recovery In Services Will Likely Outpace Goods China’s large current account surplus will likely start narrowing. It has been driven by strong global demand for goods, which is unlikely to be sustained as the pent-up demand for services in DMs will outpace the consumption for goods (Chart 4). Emerging countries (EMs), many of which are China’s export competitors, lag far behind DMs and China on inoculation rates and some have resurging COVID cases (Chart 5). However, EMs will likely benefit from meaningful expansions in global vaccine production in the second half of the year.1 A catchup in vaccinations in these countries will reduce China’s export-sector advantage, reversing the RMB’s gains over other Asian currencies in the past month. Chart 5China's Asian Neighbors Have Been Hit By Resurging COVID Cases The future trend of the USD also matters to the USD/CNY exchange rate. The recent strength of the CNY vis-à-vis the dollar was the mirror image of USD weakness, which has been due to low real rates in the US and recovering economic momentum outside the US (Chart 6). However, the broad dollar index is sitting at a critical technical level that could either breakout or breakdown (Chart 7). When the Fed announces the slowing of asset purchases, which our BCA US Bond Strategy expects before the end of 2021, it could lead to higher US real yields and reverse the trend of hot money flows into China. Chart 6The Sharp Rise In The RMB In The Past Two Months Has Been Dollar-Driven Chart 7The Dollar Index: Breakout or Breakdown? Furthermore, the financial market does not seem to have priced in unstable US-China relations, which could undermine global risk appetite (Chart 8). Recent actions by US President Joe Biden – from expanding the investment ban on 59 blacklisted Chinese tech companies to calling for the US intelligence community to investigate the origins of COVID-19 – point to risks for escalating tensions between the two nations. Longer term, the RMB is at about one standard deviation below its fair value, which suggests that it still has more upside potential (Chart 9). Based on our BCA’s Foreign Exchange Strategist’s real effective exchange rate (REER) model, the RMB’s fair value mostly climbed in the past three decades, driven by higher productivity in China relative to its trading partners. However, part of the RMB’s appreciation since mid-2020 has been a catch up to its pre-trade war value and its valuation gap has rapidly narrowed. From the current valuation levels, the pace of RMB appreciation should be much slower going forward. Chart 8Geopolitical Surprises Could Spook The Market Chart 9Valuation Gap Has Rapidly Narrowed We also expect China’s real interest rates relative to the US to dwindle in the next three to five years. Demographic headwinds in China herald lower real rates while the Fed is primed to start rate liftoffs within the next two years. Bottom Line: The RMB still has some upside potential in the long run, but the pace of its appreciation should be much slower than in the past 12 months. In the near term, odds are high that economic fundamentals will not boost the RMB any further.  How Does A Stronger RMB Affect China’s Economy? Historically, a stronger RMB relative to the dollar has not had a significant impact on China’s economy. However, if the CNY appreciates considerably versus the greenback so that it pushes up the trade-weighted RMB index, then China’s corporate profits will be negatively affected (Chart 10). Chart 10Strengthening Broad-RMB Index Has Historically Led To Weaker Corporate Profit Growth... Chart 11...And Could Significantly Raise Prob Of A Earnings Contraction In 12 Months Our earnings growth recession probability model confirms our view. If all else is equal, a 3% rise in the trade-weighted RMB index from its current level would more than double the probability of a contraction in earnings growth in the coming 12 months (Chart 11, Scenario 1). On the other hand, all else will not be equal if the broad RMB index goes up by 3%. A quick increase in the RMB’s value against the currencies of its trading partners will impede China’s export growth and tighten domestic monetary conditions. Chart 12Moving Into Restrictive Territory For Chinese Exports Chart 12 shows the impact on export growth from the speed of the RMB’s appreciation; we calculate the rise in an export-weighted RMB index relative to its highs and lows in the past few years. The metric implies that the acceleration in the RMB’s value has reached levels that should be restrictive for exports. The nominal export-weighted RMB index has been significantly above the median value since 2015 and it is approaching the peak reached in that year. Clearly, the strong RMB is linked to a recent weakness in the PMI surveys on export orders. A 3% increase in the trade-weighted RMB from the current level, coupled with a drop in export growth and further deceleration in credit impulse would prop up the earnings contraction probability to more than 50% (Scenario 2 in Chart 11 above). Bottom Line: Our metrics suggest that the RMB’s recent sharp rise is starting to threaten the export sector. An additional 3% appreciation in the broad RMB index would cause a meaningful increase in the probability of a corporate earnings growth contraction in the coming 12 months. What Can The PBoC Do To Halt The RMB Rally? We break this question into two parts: the willingness and the capability of the PBoC to intervene in the currency market.  On the first aspect, the PBoC in recent years has largely refrained from draconian intervention measures in the currency market. Allowing a more market-based currency exchange rate regime is a crucial part of China’s RMB internationalization process. The PBoC seems to be mostly sticking to this long-term goal. Chart 13New FX Regime Began In 2015 Has Significantly Lowered USD Weight In The Broad-RMB Index... Importantly, the new exchange rate regime that the PBoC switched to at end-2015 has greatly weakened the link between the USD and the broad RMB trend (Chart 13). Since then China has continuously cut the weighting of the USD in the CFETS currency index basket, which has reduced the impact of dollar moves on the index. Therefore, the PBoC has mostly ignored short-term volatilities in the CNY/USD exchange rate. The central bank tends to intervene only when swings in the CNY/USD exchange rate are large enough and/or the market forms a unilateral view on the Chinese currency to drive sustained movements in the broader RMB index.  For example, the RMB value rose at a much faster rate against the USD compared with its other trading partners in the second half of 2020. However, this year, the pace of growth in the broad RMB index has caught up with that of the CNY/USD appreciation. Moreover, even when the RMB depreciated against the USD in March, the CFETS index basket kept rising and is now breaching its previous peak in April 2018 (Chart 14). As discussed in the previous section, a sharp jump in the trade-weighted RMB would be more detrimental to China’s corporate profits than an increase in the CNY/USD. Chart 14...But The Massive Appreciation In The CNY/USD Of Late Has Pushed The RMB Index To A Three-Year High Chart 15The PBoC Has Been Trying To Guide Market Expectations Lower On The RMB On the second aspect, the PBoC is unlikely to alter its monetary policy trajectory to tame the RMB’s appreciation. A looser monetary environment would encourage more asset price bubbles domestically and jeopardize policymakers’ ongoing progress in financial and property-market de-risking. If the CFETS strengthens further, Chinese authorities will probably use tools such as managing market expectations and various capital controls to mop up excess FX liquidity generated from capital inflows. In the near term, the PBoC may set a weaker fixing rate against the dollar to dampen market expectations for more RMB growth (Chart 15). An increase in the FX deposit reserve requirement ratio (RRR) rate, announced by the PBoC last week, is another example of the central bank trying to prevent a one-sided expectation by market participants. However, the previous three FX deposit RRR hikes –all taken place more than a decade ago—did little to alter the path of the CNY exchange rate; the pace of USD/CNY depreciation actually accelerated following the May 2007 RRR hike.  The two-percentage point bump in the FX deposit RRR rate will drain China’s domestic FX liquidity by about US$20 billion. Its effect on domestic FX liquidity and FX loan rates is rather limited – FX inflows to Chinese financial institutions since 2H20 were more than US$20 billion a month –more than offsetting the tightening from a RRR rate hike.  The PBoC can further loosen outward capital controls to release some pressure on the RMB’s increase. In a report from November last year we wrote that Chinese policymakers attempted to slow the pace of appreciation in the RMB through a build-up in strategic FX assets by commercial banks and other financial institutions . Since August last year, China has relaxed outbound investment regulations and increased quotas to help channel domestic money into offshore financial markets. China’s commercial banks significantly ramped up their FX assets last year (Chart 16). In Q1 this year, commercial banks enriched their FX asset holdings by US$518.5 billion, a record high in the past five years.  Bottom Line: The PBoC is willing to allow more volatility in the USD/CNY exchange rate, but a sharp jump in the RMB’s value against a basket of other currencies would warrant further policy actions. Chart 16Chinese Banks Ramped Up FX Asset Holdings Chart 17Chinese Onshore Stocks Propped Up By Foreign Investors Investment Conclusions A tightened monetary and credit environment has created headwinds for Chinese equities since early this year. However, the domestic market appears to have found support at a key technical level of late (Chart 17). The recent rebound in China’s onshore stocks on the back of a sharp CNY appreciation and accelerated foreign capital inflows, in our view, are unsustainable on a cyclical basis. Despite buoyant global economic growth, investors should consider deteriorating cyclical conditions in China when judging the appropriate allocation for Chinese equities. While policy tightening has brought multiples closer to earth than last year, the upside in Chinese stock prices will be capped by subsiding stimulus and slower profit growth ahead. As such, a decisive breakout to the upside in Chinese stock prices will require major reflationary catalysts, and it is the reason we are still risk adverse on Chinese equities (Chart 18). Meanwhile, we continue to favor onshore consumer discretionary stocks relative to the broad A-share market. A strong RMB can be a booster to domestic discretionary spending. We initiated this trade in May last year and it has largely outperformed China’s onshore broad market (Chart 19). We will close the trade when the CNY loses its strength and Chinese domestic demand starts to falter. Chart 18Cyclical Performance In Chinese Stocks Is Still Driven By Economic Fundamentals Chart 19Keep A Long CD Position, But On A Short Leash   Jing Sima China Strategist jings@bcaresearch.com Footnotes 1The UN estimates that as many as 15 billion vaccine doses could be produced by the second half of 2021, enough to inoculate most of the world’s population. Cyclical Investment Stance Equity Sector Recommendations

Our hedging techniques proved profitable this year with the previous long VIX futures trade  bringing in gains just shy of 20%, on top of our two synthetic SPY long options trades that added 676% ($5.41/contract) and 2850% ($8.86/contract) in returns to the portfolio. Our reinstated and currently active June 2021 VIX futures hedge is about to expire for a loss of 27% as the market has proven to be resilient. Alas, wrong and early look the same! Indeed, we had a chance to crystalize some gains on May 12, but we believed, and still do, that a more pronounced correction is imminent, especially given the divergence between high-yield corporate spreads and the SPX (see chart) along with many other reasons, such as expensive valuations and an expected gradual growth slowdown. The VIX curve has also shifted higher over the past several months making it more expensive to roll the hedge, but a 5-10% SPX correction will make this trade profitable. Bottom Line: Roll the June 2021 VIX hedge into the September 2021 contract.    

Dear Client, I am delighted to take charge of the US Equity Strategy publication upon Anastasios Avgeriou’s departure. By way of introduction, I have been an investor for nearly 20 years, with my career spanning both the buy and sell side, bottom-up stock selection and top-down asset allocation, and fundamental and quantitative approaches to investing. I have invested through two business cycles (starting on the third one now), watched the internet stock bubble burst, and seen grown men shedding tears on Bloomberg keyboards in the summer of 2008 – the market has a way of humbling us, mere mortals. As a result of these diverse professional experiences, I became an agnostic and don’t believe there is one correct way to invest as long as a thesis is well thought through and backed up by numbers and in-depth analysis. I believe that different approaches to investing, fundamental and quant, bottom up and top down, should complement each other leading to “best of all worlds” results.  I also rely on an investment framework which is disciplined enough to offer a structure to fall back on to minimize behavioral biases, and yet is flexible to rapidly accommodate both “black swan” and “grey rhino” themes into investment decision-making. The following are the guiding principles of this investment framework. I hope this week’s publication will provide insights into my approach to investing and the nature of the US Equity Strategy product under my stewardship. I look forward to your feedback and suggestions. Kind Regards, Irene Tunkel Chief Strategist, US Equity Strategy   Principle 1: The Business Cycle Matters The business cycle and macroeconomic conditions are the cornerstones of any investment decision as they underpin the fundamentals of most assets, and preordain the types of assets likely to outperform based on their level of risk and sensitivity to economic growth. Analyzing the stages of the business cycle is a succinct way to summarize a wide range of economic data, such as capacity utilization, growth, policy, credit conditions and valuation. Each business cycle is different, yet on average across all cycles, the stages have the following characteristics (Table 1). Table 1Business Cycle Is In Expansion Stage Recovery: Policy is easy, and liquidity is plentiful, profits rebound but growth is scarce, inflation is low, risk aversion elevated, and stocks are still cheap. In this environment cyclicals, small caps and value outperform. Expansion: Policy is neutral, inflation is moderate, growth is abundant, risk aversion is low. During this phase it is cyclicals and small caps that shine. Slowdown: Inflation is higher, and policy is tightened, growth is rolling over, valuations are extended, and risk aversion is rising. In this environment of slowing growth, growth stocks, large caps, defensives and real assets outperform (Chart 1). Contraction: Deflation (or fears thereof) ensues, output is falling, growth is scarce and risk aversion is high. In this environment defensives, quality and highly profitable stocks rule the day. Chart 1Performance Of Equities In Different Stages Of Business Cycle Although the pandemic is barely over, the markets have galloped through the recovery stage and have landed squarely in expansion territory. US equities exhibited exceptional earnings growth of 52.5% year-on-year in Q1-2021 on the back of economic reopening, fiscal and monetary stimulus, and pent-up demand. Monetary and fiscal policy remain easy. The only deviation from a textbook description of expansion is low capacity utilization and a high unemployment rate which persist as aftereffects of factors specific to the pandemic: School closures and elevated unemployment benefits. High unemployment whilst demand for labor is high triggered inflationary pressures. However, we believe that we are near the end of the expansion stage and are about to transition into a moderate slowdown. While growth is to remain robust, it is bound to slow modestly from its peak: The Manufacturing ISM PMI came down from 64.7 in April to 61.2 in June. According to Bloomberg consensus estimates GDP growth is to slow from 6.4% in 2021 to 4% in 2022. The Fed is starting to “talk about talking about tightening”, and with inflation elevated many expect somewhat hawkish rhetoric/intervention from the Fed sooner than the end of 2022. Valuations are rich. Now may be opportune time to reposition for a slowdown to be ahead of the game. To do well in a slowdown stage, which may last for months but by no means heralds the end of a bull market in equities, we recommend dusting off growth, large-cap and defensive stocks and taking profits in some of the recent cyclical outperformers. A barbell approach may do well at this point, with portfolio overweights in both cyclical sectors such as energy and industrials along with more defensive plays such as health care and technology Principle 2: Shocks And Transient Themes Trump Both Macro And Fundamentals Macro is important on the cyclical time horizon but, intra-cycle, it is transient themes and macro shocks that move markets. These themes, also known as “black swans” and “grey rhinos”, are exogenous shocks and developments that dominate investor psyche. Mostly, they are policy driven, like trade war or fiscal stimulus, but occasionally are force majeure events, like Covid-19. Transient themes may have a positive or negative effect on the market. These are news and developments that are not immediately priced by the market but are not to be ignored or dismissed: They dominate investment outcomes irrespective of the normal market order of things. Usually transient themes are short-lived and fade once macroeconomic and fundamental data have readjusted to the new reality: Economic and earnings growth estimates have been revised, and relevant stock and sector returns have absorbed the shock. Back in March 2020, neither fundamentals nor valuations mattered. Nor did macro. Stocks were first sledgehammered by a “corona” theme, and then soared on a “liquidity is abundant” theme. It took analysts three months to downgrade US GDP growth to contraction (Chart 2)! Over the past few months, the only theme that seemed to matter to market participants was inflation, and inflation alone. Implications? Fear of inflation and sooner-than-expected Fed tightening have triggered an energetic selloff in bonds and defensive/growth equities. However, there are early signs that this theme is beginning to fade with rates stabilizing and growth stocks rebounding (Chart 3). Chart 2Markets Take Time To Price In Shocks Chart 3Inflation Fears Triggered Equity Rotation Principle 3: Interplay Between Valuations And Fundamentals Once the macro backdrop and transient themes are well understood, we zoom in our analysis to the valuations and fundamentals of individual styles and sectors to select the most attractive opportunities. Ideally, we are looking for the reasonably priced sectors that have solid fundamentals and can deliver strong growth. Finding sectors like that is easier said than done: Rarely do good and cheap exist in the same incarnation. Hence, investors need to compromise: Buy cheap stocks with poor earnings growth and challenged fundamentals or pay a premium for solid growth. A classic value/growth dilemma. Our approach is as follows: Cheap Sectors: Relative valuations are very important: Most value investments are mean-reversion plays (Chart 4) We don’t attach much weight to fundamentals – we don’t expect a stellar balance sheet or earnings growth In order to screen out value traps, we are looking for a catalyst for mean reversion For cheap stocks valuations are more important than fundamentals. Expensive Sectors: Relative valuations are much less important than growth expectations and fundamentals. Are fundamentals continuing to improve or have they reached a peak? Is earnings growth about to accelerate or slow? If fundamentals, e.g. RoE or margins are improving, and a slowdown in growth is not expected, then the valuation premium is justified. Chart 4Value Is Mean Reverting The software industry group is a case in point. Back in 2019-2020 valuations were eyewatering (more than two standard deviations above 10 years of history) but earnings growth was resilient, and profitability was in a multi-year upward trend. The valuation premium was justified. But late in 2020 RoE started deteriorating, and the industry group experienced a pullback. More recently, RoE has stabilized and turned. Returns are following (Chart 5). Chart 5Changes In Profitability Drive Valuations Principle 4: Stock Markets Are Markets Of Stocks Understanding the behavior of individual stocks makes top-down sector and style selection much more informed and nuanced. After all, we are dealing not just with a stock market, but with a market of stocks. Those glued to Bloomberg screens in March 2020 may have noticed a rare green with companies like Zoom, Citrix and Amazon rallying amidst stock Armageddon. These were green shoots (no pun intended) of one the most vigorous stock market rallies in history. Paying attention to stock-level data also gave an early pointer that pandemic shutdowns, as awful as they were, would be a boon for selected technology and e-commerce sectors (Chart 6). At present, we notice that cyclicals have not outperformed defensives since March. We also notice over the past two-to-three weeks the comeback of hot technology stocks, many of which are former “Covid-19 winners”, beaten up by a “back-to-work rally”. These are fintech and e-commerce names such as PayPal, Pinterest and Peloton, some of which are more than 50% off from their February peak. Reversal in performance of growth stocks is a sign that rates have stabilized, inflation fears are overdone, and US economic growth is gradually slowing.   Chart 6Covid-19 Winners Led S&P 500 Rebound Principle 5: Markets Are Forward Looking As Warren Buffet succinctly put it “buy risky assets when there is blood in the streets”, and “be fearful [i.e., sell], when others are greedy.” In other words, it is important to anticipate turning points, and be one step ahead of the market. Last year’s rally is a case in point, with the S&P 500 delivering the best return in history despite not having much to show for it in terms of earnings growth, with nearly 70% of S&P 500 returns coming from multiple expansion. Investors looked past shutdowns, rightly believing that the profit recession is transitory, companies are in sound financial health, valuations are at abysmal, once-in-a-lifetime, levels, and the V-shaped recovery will ensue once the pandemic is over (Chart 7). Chart 7Stocks Returns Lead Earnings   Conversely, the Q1-2021 earnings season was stellar, but many stocks, even those which exceeded expectations, have ceded gains: Stocks are priced to perfection, and investors concluded that, for some of them, the best days are behind, and growth is slowing (Chart 8). At present, trailing valuations of nearly all sectors and styles in the S&P 500 are at extreme levels, trading at 36x trailing earnings. However, forward PEs are on average 9 points lower, around 21x forward earnings. Hope is that the stock market will rerate and grow into its big shoes within the next 12 months with expected EPS growth of 23%. We think it will! Chart 8During Q1-2021 Earning Season, Beats Were Not Rewarded  Principle 6: Asset Prices Respond To The “Second Derivative” This principle is a corollary to “markets are forward looking”. Usually the rate of growth is already priced in, as markets are efficient and new information arrives as a change in expected growth, i.e. the impulse. Change in the growth outlook is absorbed by the markets and is a leading indicator of turning points in equity returns. Most often the impulse relates to change in economic or earnings growth expectations. For example, sales for the hotels industry group are still falling, but at a lower rate than before (the second derivative is improving). These “less bad” numbers are enough to send hotels returns soaring (Chart 9). Chart 9Hotels Are Rallying On “Less Bad” Sales Principle 7: Thematic Investing: Channeling Cathie Woods Thematic investing is really “smart” momentum investing, but its appeal lies in being able to identify a theme/catalyst that unites stocks and makes them move in unison. Knowing a theme behind momentum helps one to understand its thematic drivers and anticipate turning points. Arguably, thematic investing is a nuisance for stock pickers, but a boon for top-down investors: Identifying a theme has a higher impact on portfolio returns than choosing the individual stocks to represent it. For example, identifying recovery in air travel and investing into the Jets ETF is a more important decision than choosing the right airline stock. Since February 2020, American Airlines is 94% and Delta is 98% correlated with Jets ETF (Chart 10). Knowing the drivers, we can brainstorm what can trigger a reversal of this theme, for example: An increase in the price of oil, a structural shift in business travel, falling consumer confidence, and a high household dissaving rate. Thematic investing is popular as it allows an investor to ride the momentum yet also be equipped to anticipate turning points. Chart 10Air Travel Stocks Are Highly Correlated Thematic investing may be over a variety of investment horizons (stocks benefitting from retirement of baby boomers being an example of a structural theme versus stocks benefitting from post-corona supply-chain disruption being (hopefully) a short-lived theme). Further, themes can be high tech, such as autonomous driving or green energy, and low tech, such as the pandemic “puppy boom”. The most prominent and widely discussed themes in the recent months are “Covid-19 winners” vs “back to work”. Arguably, thematic investing is the “passive investing” of the future – a trend illustrated by the popularity of the ARK funds managed by Cathie Woods. Going forward, the US Equity service will be covering investment themes in a series of Special Reports. Principle 8: “No Country Is An Island” Lastly, while the focus of this publication is squarely on the US equity market, it is important to keep an eye on developments in the rest of the world. Companies in the S&P 500 derive 43% of sales from abroad. As a result, corporate earnings are highly sensitive to the direction of the trade-weighted dollar both due to the price of goods and to translation effects. Recent depreciation of the dollar will boost corporate earnings growth, especially for the technology (58% of earnings outside the US), materials (56%) and energy (50%) sectors. It takes roughly three to six months to fully absorb dollar moves into sales growth (Chart 11). Further, the economic growth rates of the major US trading partners, i.e., Europe, Mexico, Canada, and China, also have a profound effect on the US economy with transmission through the US trade balance, dollar movements and Treasury yields (Chart 12). Chart 11US Dollar Drives S&P 500 Sales Chart 12Major US Trading Partners Affect US Economy Bottom Line Markets are complex: Macro works until it does not, expensive stocks can be a good investment, and an equity rally may take off in the midst of an earnings recession. Yet, we believe that the eight principles of investing that we have outlined above will guide us through the noise and help successfully navigate equity markets. Irene Tunkel Chief Strategist, US Equity Strategy irene.tunkel@bcaresearch.com  

The 10-year US Treasury yield has been range bound between 1.5% and 1.7% for the past three months despite fireworks in the US economic data, from CPI readings to unemployment beats. The fact that the bond market has refused to budge no matter how positive US data got, confirms our view that all the good news has already been priced in. Citigroup US economic surprise index (CESI) is hovering around zero, which corroborates the same message. Given a tight positive correlation (0.44) between CESI and UST10Y, and the fact that growth is peaking, it is unlikely that the bond market will enter another aggressive sell-off phase (see chart). The implication for equities is that long-duration growth equities, beaten down by rising yields, may stage a come back, especially once inflation data makes a clear ∩-turn on a year-over-year basis. Bottom Line: Bond market is likely to remain calm over the next three to six months, and it’s time to revisit beaten down growth names. Stay tuned for future research on the topic.