Geopolitics

Dear Clients, This week we are issuing two Special Alerts on the Russo-Saudi market share war, one of which you have already received. Our weekly publication will proceed as usual on Friday, March 13. In this Special Alert, we update our view of the US election and address the urgent question of US fiscal stimulus. Upcoming reports will address the question of stimulus outside the United States. All very best, Matt Gertken Vice President Geopolitical Strategy Feature Turmoil has engulfed financial markets as a Russo-Saudi market share war erupts at the same time as panic over the coronavirus spreads from China to Europe and the United States. The US and global stock markets are nearing bear market territory while the 10-year Treasury and global bond yields plumb new lows and deeper negatives (Chart 1). Our key risk-off indicators have all broken down (Chart 2). Chart 1The Bear Awakens Chart 2Global Risk-Off While the daily new cases of the virus are far from peaking in the US, the Democratic Party nomination process has eliminated the downside risk of a left-wing populist presidency. Political risk in the US will shift to Congress, fiscal stimulus, the general election, and the “lame duck” risk now threatening President Trump. Trump Not Yet Doomed, But No Longer Favored The US election is now “too close to call,” with the risks tilted toward a Trump loss. Bear markets tend to coincide with recessions (Chart 3). Woe betide a president seeking reelection amid a recession. Chart 3Bear Markets Tend To Coincide With Recessions We need to look to a previous era to identify precedents for Trump’s survival. William McKinley hung onto the office in 1900, Teddy Roosevelt in 1904, and Calvin Coolidge in 1924, all despite recessions.1 Rising unemployment will undo Trump’s re-election bid. In today’s terms, it is still possible that the virus panic will subside over the summer while a wave of global monetary and fiscal stimulus will kick in around September, creating a rebound that sends voters to the polls in an optimistic mood. But it is increasingly unlikely. Unemployment will rise as consumer confidence collapses in the face of the virus outbreak (Chart 4). This is deadly to a president with such narrow margins of victory in the key swing states. Chart 4Confidence Will Suffer, Layoffs To Ensue Chart 5Trump’s Approval Heading South Chart 6Republican Revival To Fall Back The coronavirus scare is already derailing President Trump’s approval rating. It had only tentatively recovered from a very low level throughout his first term and is highly unlikely ever to breach 50% (Chart 5). The surge in voters identifying as Republicans – which had recently, remarkably, surpassed Democrats – will reverse (Chart 6). Our quant election model is “too close to call” but will soon signal Trump loss. Our quant model was already flashing that the election is “too close to call,” due to the negative impact of Trump’s trade war on key swing states like Michigan and Pennsylvania. The weight of a feather can shift Wisconsin into the Democratic camp and turn the election against Trump (Chart 7). The model will inevitably show Trump losing the election once state-level data starts to reflect the virus shock. Chart 7Our Quant Election Model Says “Too Close To Call” … But Virus Panic Will Cause Wisconsin To Switch Bottom Line: The US election is too close to call at this point. With eight months to go, many things could still change, but a spike in unemployment will ruin Trump’s reelection bid. Biden, Not Sanders, Waiting In The Wings Chart 8Biden Has All But Clinched The Democratic Nomination The bad news for Trump – but the good news for markets – is that former Vice President Joe Biden has solidified his status as presumptive nominee for the Democratic Party presidential candidate. Biden romped to victory in Michigan and Missouri on March 10 – and is virtually tied with Vermont Senator Bernie Sanders in Washington, a liberal state that should favor the self-professed democratic socialist Sanders. Biden now clearly leads the count of pledged delegates to the Democratic National Convention on July 13 – and voting patterns in the remaining primary elections would have to reverse entirely in order to give Sanders a 1,991-vote majority of delegates in the first round of voting in July (Chart 8). It is unlikely that Sanders can deprive Biden of a majority of delegates even though he will trounce Biden in the final debate on March 15. The important state elections on March 17 are all favorable to Biden: Arizona, Florida, Illinois, and Ohio. Our delegate projections show Biden winning an outright majority by May 12 (Chart 9). Chart 9Biden Set To Win Majority Of Democratic Delegates By Spring Over the past year many clients have argued to us that neither Biden nor Sanders is electable. We have rejected this view on the basis that the economic cycle would most likely determine the election, since Trump had the misfortune of being a late-cycle president. The financial markets have dodged a bullet with Biden’s nomination since Sanders was capable of winning the nomination and now, with an impending recession, would be even odds (or favored) to take the White House. Chart 10Head-To-Head Polls Show Trump Vulnerability Average head-to-head polls show both Biden and Sanders beating Trump in the battleground states. This always suggested that Trump was highly vulnerable. But on the margin Biden is more electable than Sanders: he polls better against Trump than any Democrat, while Trump polls worse against him than any Democrat. Biden has an Electoral College pathway to victory via Florida and Arizona, as well as via the Midwestern states where Sanders is also competitive (Chart 10). Democrats ultimately chose Biden because he seemed the most likely to beat Trump. He also has the best position on the issue most important after the economy, which is health care (Chart 11). This reputation comes from his association with both President Barack Obama and the Affordable Care Act (Obamacare). A contested convention, in which the Democratic Party splits and progressive voters sit out the election, was always unlikely and is now virtually foreclosed. As he clinches the nomination Biden will seek to win over the support of progressives by choosing a progressive running mate and adopting more left-leaning policies on issues like inequality and the environment. Chart 11Democrats Chose Biden To Win And Restore Obamacare Chart 12Democratic Primary Turnout Strong In Vital Midwest Voter turnout in the primary elections suggests that voters are fired up in the Midwest (Michigan, Minnesota) but more complacent in the South (Texas, North Carolina) (Chart 12). Primary elections are different from general elections, but a worsening economy will provoke higher turnout. At minimum these data reinforce the point above that Trump is highly vulnerable in the Midwestern “Blue Wall” that narrowly brought him to power. Bottom Line: Biden is not only electable but at this stage equally likely as Trump to sit in the Oval Office in 2021. This is a market-positive policy outcome compared with the alternative – a Sanders presidency – which was almost equally probable in the event of a recession. Financial markets will see Biden as less negative than Sanders on regulation and taxes, and less negative than Trump on trade and foreign policy. Fiscal Stimulus A major source of uncertainty surrounding the election is fiscal policy, as a Democratic victory implies an increase in taxes on households and businesses. Not only is there a spike in tax provisions set to expire (top panel, Chart 13), but President Trump’s signature Tax Cut and Jobs Act could be repealed if he loses or made permanent if he wins. Chart 13Fiscal Uncertainty Looms Over US The short-term outlook is also in flux because the Trump administration is frantically trying to piece together an economic stimulus package to respond to the coronavirus shock. Democrats control the House of Representatives and have an incentive to delay and water down Trump’s stimulus proposals. However, they cannot be seen as playing politics with the nation’s health and livelihood and will ultimately agree to fiscal stimulus. This contradiction implies that financial markets will experience ongoing volatility as talks take place. Ultimately, Trump and the Democrats will cooperate, particularly as the financial constraint intensifies through market selling. Trump’s bid will be to stimulate the overall economy while House Speaker Nancy Pelosi and Senate Minority Leader Chuck Schumer will target the virus so as to keep the nation’s attention on health care without granting Trump a re-election fiscal bonus. The most significant short-term stimulus on offer would be a cut to payroll taxes. Trump’s preference may be to eliminate the entire 6% tax levied on worker income permanently, but he is more likely to get something on the magnitude of the 2011-12 temporary payroll tax cut (second panel, Chart 13). This was a two percentage point reduction in the tax (to 4%) for one year that ended up being extended for a second year. The size of the impact is roughly $75 billion for each percentage point for each year ($300 billion for two percentage points over two years). The risk is that the House Democrats may require modifications to Trump’s Tax Cut and Jobs Act that cause an impasse and financial markets to sell off before an agreement is reached.2 The Democrats, for their part, have a wish list of spending programs that they will insist on in exchange for a payroll tax cut. In particular they will seek to expand unemployment insurance for workers who lose their jobs in the impending slowdown, food stamps for unemployed and for children at home amid school closures, and mandatory paid leave (for parents with kids at home as well as sick people). The bill for such items can easily add up to $50-$100 billion in new spending. In addition, Congress and the White House have already approved an $8 billion virus mitigation package and additional packages of this size can happen quickly as the crisis requires. Trump is interested in another round of farm aid, given that China will fall short of its commodity purchases under the “phase one” trade deal, which could amount to $12-$15 billion. And Trump could always unilaterally rollback some of his tariffs on China or other trade partners. The combination of new spending and payroll tax cuts could bring the package to the $300-$400 billion range that Trump’s top economic adviser, Larry Kudlow, disapprovingly said was out of the question. It could easily amount to half of that. If the market continues to tank and the outlook for the US economy grows blacker, it will convince the Democrats that Trump is ruined unless they hurt their own image by appearing blatantly obstructionist amid a crisis. Bear in mind that the market wants a substantial stimulus not only because of the desire for a clear rebound in activity once the virus panic subsides, but also because the increasing odds of a Democratic victory in November mean that US tax rates will go up and corporate earnings will be revised downward. The country now faces a 50% chance of a 1%-2% fiscal tightening for each year in 2021-25 (Chart 14). Chart 14Biden Tax Hike Will Hit Corporate Earnings Chart 15US Fiscal Thrust To Surprise To Upside Thus a 1% of GDP fiscal stimulus for 2020 is the minimum necessary to improve sentiment. The US fiscal thrust – the change in the cyclically adjusted budget deficit – has already turned slightly positive this year, from what was expected to be a slight negative, due to a fiscally profligate budget deal between Trump and the Democrats last year (Chart 15). The one thing these blood enemies have in common is the need for more spending. Infrastructure spending is popular and has room to rise. Eventually the US will get stimulus, and it will surprise to the upside, even if the Democrats drag their feet to ensure that maximum political damage is inflicted on Trump this year. Not only is the fiscal setting inherently more dovish than it was in 2008, but Congress is bailing out plague-stricken households, not just Wall Street, this time around. The real game changer would be an infrastructure package. Americans spend about $140 billion or 0.7% of GDP each year on transport infrastructure, but popular opinion in both major political parties supports increases (Chart 16). The proposed sums are very large – Trump is proposing $1 trillion over a decade while Biden is proposing $1.3 trillion. The House Democrats have a bill worth $760 billion in new spending over five years ready to be passed. Also Trump is willing to capitulate on the Democrats’ preferred type of spending (direct deficit spending) due to his election constraint. These plans are all projecting considerable infrastructure spending on top of the Congressional Budget Office’s base line projection (Chart 17). Chart 16US Spends 0.7% Of GDP On Infra Each Year Chart 17Median Voter Wants More Infra Spending The fiscal multiplier of government spending is generally higher than tax cuts. Furthermore, the coronavirus hurts the economy by frightening households into their homes, which means that even the Democrats’ proposed cash transfers for low-income earners (those with a high marginal propensity to consume) may be impeded. Government-mandated infrastructure spending, by contrast, ensures that economic activity will pick up once the measures take effect (that is, with a 6-12 month lag … something the Democrats will become increasingly willing to agree to this spring given the election calendar). The impending US fiscal stimulus provides justification for going long infrastructure, construction, engineering, materials, mining, and environmental services sub-sectors included in the BCA Infrastructure Equity Basket (Chart 18). China’s large-scale stimulus measures reinforce this recommendation, since these firms are levered to China/EM growth. On a tactical basis, this trade is akin to catching a falling knife. Given our expectation that the world still faces challenges in overcoming the current turmoil, and the Democrats will hem and haw so as not to grant Trump his re-election wish list immediately, we await an opportune time to initiate this trade. A final reason to remain defensive on risk assets: the “lame duck” risk. If and when Trump’s re-election appears out of reach, he has an incentive to turn the tables. This could involve a radical or disruptive move in foreign or trade policy (e.g. on Iran, North Korea, Venezuela, China, or even Russia). At that point Trump could attempt to cement his legacy of cold war with China, or he could even lash out against Russian President Vladimir Putin, who has ostensibly stabbed him in the back by initiating a market share war with Saudi Arabia that may not be pieced back together in time to prevent job losses in shale oil swing states (Chart 19). Chart 18Look For Chance To Go Long Infrastructure Stocks Chart 19A Russo-Saudi Oil Market War Hurts Trump In Shale Swing States Presidential powers are least constrained in the international sphere. At the moment Trump is trying to save the economy and his presidency. But if it becomes a foregone conclusion that they cannot be saved, then he becomes a pure liability for risk assets. Housekeeping We are throwing in the towel on our US tech sector shorts for a loss of 36% and 11%, respectively, and also closing our long Thailand relative trade for a loss of 17%. We are also closing our tactical long Italian government bonds relative to Spanish for a loss of 2%. Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1 Coincidentally all were Republicans, like Trump – not that it matters. 2 The Democrats may seek to have Trump increase the tax rate on the highest income earners to the pre-TCJA level, or they may seek to increase the cap on the state and local tax deduction, which allows households (mostly high-income earners) in high-tax states to reduce their federal tax bill.

Special Report

Highlights Oil prices fell 30% when markets opened Monday morning, following a split between OPEC 2.0’s putative leaders – the Kingdom of Saudi Arabia (KSA) and Russia – over production cuts to balance global oil markets (Chart 1). If KSA and Russia are able to repair the break in what OPEC Secretary General Mohammad Barkindo once called their “Catholic Marriage” the sudden collapse in prices could serve a useful purpose in reminding producers, consumers and investors of the need for full-time management of production and inventories, and restore prices to the $60/bbl neighborhood in 2H20.1 If not, markets could be in for a drawn-out market-share war lasting the better part of this year, with damaging consequences for all involved, with Brent prices remaining closer to $30/bbl (Chart 2). Feature Much as we rely on modeling to guide our expectations, this is purely political at the moment. How Long Will The Oil Price Rout Last? That’s the question that repeatedly is being asked by clients following the breakdown in Vienna last week, and news over the weekend that KSA would engage a market-share war opened by Russian Energy Minister Alexander Novak prior to departing Vienna. Novak gave every impression of renewing a market-share war after Russia rejected the plan put forth by OPEC to remove an additional 1.5mm b/d of production from the market, to combat the demand destruction expected in the wake of COVID-19. The only answer we have to the question: No one knows with certainty. Chart 1Oil Sell-Off Accelerates, As Market-Share War Looms Chart 2A Market-Share War Will Keep Oil Prices Depressed Neither of the principal actors responsible for the 30% rout in oil prices on Monday morning when markets opened for trading – KSA and Russia – are providing guidance at present. Prices since recovered slightly and were down ~ 20% Monday afternoon. Much as we rely on modeling to guide our expectations, this is purely political at the moment. There are two large personalities involved – Saudi Crown Prince Mohammad bin Salman bin Abdulaziz Al Saud and Russian President Vladimir Putin – who have staked out opposing positions on the level of production cuts needed to balance markets in the short term, as the COVID-19 outbreak spreads beyond China leaving highly uncertain demand losses in its wake.2 If a meeting of OPEC 2.0’s leadership can be arranged before the end of March, a hope expressed by Iran's Oil Minister Bijan Namdar Zanganeh in a Bloomberg interview over the weekend,3 the stage could be set for a rapprochement between KSA and Russia allowing them to repair the rupture in the OPEC 2.0 leadership. Should that occur, the rally in prices could be dramatic – maybe not as dramatic as today's price collapse when markets awoke to the opening rounds of a full-on market-share war between OPEC and Russia. But, over the course of the next few weeks, prices for 2H20 Brent and WTI would begin recovering and moving back toward $60/bbl as markets price in lower inventories on the back of a return to production discipline by OPEC 2.0. If we do not see such a meeting next week, markets will be forced to price in a prolonged price-war that could extend into the end of this year, which will not be easy to arrest. If, as seems to be the case, the Russians' goal is to directly attack shale-oil production in the US with a market-share/price war, the effort most likely will fail. True, there will be an increase in bankruptcies among the shale producers and their services companies. This will set up another round of industry consolidation – i.e., more M&A in the US shales – with the large integrated multinational oil companies that now dominate these provinces adding to their holdings. It is worthwhile remembering that US bankruptcy law recycles assets; it does not retire them permanently. In addition, the acquirers of bankrupt firms’ assets get them at a sharp discount, which greatly helps their cost basis. So, shale assets will change hands, stronger balance sheets will take control of these assets, and a leaner, more efficient group of E+Ps will emerge from the wreckage. What’s Being Priced? It is in neither KSA’s nor Russia’s interest to engage in a prolonged market-share war that keeps Brent prices closer to $30/bbl than to $70/bbl. We estimate oil markets now have to price in the return of ~ 2.8mm b/d of OPEC 2.0 production at the end of this month – i.e., a 10% increase of GCC output, led by KSA’s production getting up to 11mm b/d by year-end; ~ 600k b/d of cuts we were assuming would be approved in last week’s Vienna meetings; and ~ 260k b/d from Russia (Chart 3). This could be understated, as KSA claims 12.5mm b/d of capacity (including its spare capacity). Unchecked supply growth would force inventories to build this year (Chart 4).  In fact, absent a return to production-management by OPEC 2.0, oil markets will extrapolate the higher production and low demand into an expectation for steadily rising inventories, that will – once it becomes apparent the supply of storage globally will be exhausted – force prices toward $20/bbl. Weaker-than-expected demand growth would accelerate this process. Chart 3Higher Production Will Overwhelm Demand In Market-Share War Chart 4Market-Share War Could Exhaust Storage Forcing Production Out of The Market It is in neither KSA’s nor Russia’s interest to engage in a prolonged market-share war that keeps Brent prices closer to $30/bbl than to $70/bbl. The apparent unwillingness of Putin and the Russian oligarchs running the country’s oil companies to make relatively small additional production cuts – vis-à-vis what KSA already has delivered – to support prices has not been well explained by Russian producers. The revenue benefits from small production cuts almost surely exceed the additional revenue that would accrue from a 200-300k b/d increase in  output and keeping prices in the $30-$40/bbl range, a level that is below Russian producers' cost of production onshore and offshore, according to the Moscow Times.  KSA's costs are ~ $17/bbl on the other hand.4 Russia’s economy was wobbly going into the Vienna meetings, which makes sorting this out even more complicated. One thing that can be said for certain is that over the past six months Vladimir Putin has entered into another consolidation phase in attempting to quell public unrest, improve the government’s image, and tighten up control over the country, while preparing for another extension of his time as Russia’s supreme leader. A Battle For Primacy? At one level, it would appear the Russians were pushing back against an apparent demand by OPEC (the old cartel led by KSA) to fall in line. Russia’s rejection of the OPEC proposal could be read as an assertion of their position to show they were, at the very least, KSA’s equal in the coalition. A stronger read of the rejection, given the Russian Energy Minister’s comments following the breakdown in Vienna at the end of last week – "... neither we nor any OPEC or non-OPEC country is required to make (oil) output cuts” – would be Russia was attempting to assert itself as the leader of OPEC 2.0. Giving Russia what amounted to a take-it-or-leave-it ultimatum on production cuts was a high-stakes gamble on KSA’s part. On KSA’s side, it is likely the Saudis grew irritated with the Russian failure to get on board to address a global oil-demand emergency that was spreading beyond China, when they were discussing extending and deepening production cuts in the lead-up to last week’s meetings. Giving Russia what amounted to a take-it-or-leave-it ultimatum on production cuts was a high-stakes gamble on KSA’s part, to say the least. However, as OPEC’s historic kingpin, KSA may have believed its role was to lead the coalition.  Russia’s in a better position now relative to KSA in the short term vis-à-vis foreign reserves ($446 billion), budget surplus (~ $8 billion), and its lower fiscal breakeven price for oil ($50/bbl) vs KSA’s ($84/bbl), as we discussed in our Friday alert (Chart 5). However, with Russian per-capita GDP at ~ half that of KSA’s, it is highly likely – if this market-share war is prolonged – its citizens are going to be hit with the consequences of the oil-price collapse in short order: FX markets are selling ruble heavily today, and, in short order this will feed through into higher consumer prices and inflation. Indeed, we estimate a 1 percentage-point (pp) depreciation in the ruble vs. the USD y/y leads to a 0.14pp increase in Russian inflation (Chart 6). Chart 5Foreign Exchange Reserves Chart 6Russian Ruble Sell-Off Presages Inflation The Saudi riyal is pegged to the USD, and does not move as much as the ruble. However, KSA’s citizens also will be buffeted once again by a collapse in oil prices, as they were during the 2014-16 market-share war when government revenues came under severe stress. Things To Watch The OPEC 2.0 joint market-monitoring committee could meet again next week in Vienna, but that is not a given. If they do meet, the agenda likely will be dominated by trying to find a face-saving way for both sides to resume production management. Arguably, the presumptive target of the Russian strategy – US shale producers – will be severely damaged by this week’s price collapse, and both could argue the short-term tactic of threatening a price war was a success. The Saudis could also go for a quick solution, if their primary objectives are to sort things out with Russia, stabilize the global economy, and keep President Trump in office, rather than to push down prices in an adventurous attempt to escalate Iran’s internal crisis. We believe Russia badly miscalculated, and was too early in making a play for dominance in OPEC 2.0, if that was its intent. If, on the other hand, these large personalities cannot agree, the price collapse begun today will continue until global oil storage – crude and products – is filled, forcing prices through cash costs of all but the most efficient producers in the world. This level is below $20/bbl. These lower prices could redound to the benefit of China, as fiscal and monetary stimulus provided by policymakers there in the wake of COVID-19 to get the economy back on track for 6% p.a. growth gets super-charged by low oil prices. Bottom Line: We believe Russia badly miscalculated, and was too early in making a play for dominance in OPEC 2.0, if that was its intent. Russian GDP has twice the sensitivity to Brent prices that KSA does, which means such a tactic takes a toll on it as well as the shale producers (Chart 7). Capital markets had the US shale producers on the ropes, so it is difficult to argue there was a need to accelerate the process and shock the world. We again note a full-blown market-share war will set up another round of industry consolidation in the US shales, but, over the medium to longer term, the shale assets of bankrupt companies will only be re-cycled to more efficient operators, as we saw following the last market-share war. This will contribute to a stronger shale sector in the US in the medium term. Chart 7Russian GDP More Sensitive to Brent Prices The only other consolation for Russia is a higher likelihood of regime change in the US (more political polarization in the US benefits Russia), and yet the Trump administration has been the most pro-Russian administration in years so this is not at all a clear objective. We will be watching very closely for a meeting of OPEC 2.0’s joint committee next week. If we get it and a face-saving resolution is agreed by KSA and Russia we would expect stronger demand growth in 2H20 to absorb whatever unintended inventory accumulation a still-born price war causes. If not, we will expect a price war into the end of the year, after which the economies of oil producers globally will have been sufficiently battered to naturally force production lower and investment in future production to contract sharply. At that point, oil and oil equities will be an attractive investments for the medium and long term.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com   Footnotes 1     Please see Russia and Saudi Arabia Hold 'Catholic Marriage' with Poem and Badges, Form Enormous Oil Cartel published by Newsweek July 3, 2019. 2     We will be updating our demand estimates in Thursday’s publication, after we get fresh historical data from the principal providers (EIA, IEA, OPEC). 3     Please see Iran's Oil Minister Wants OPEC+ Output Cut, Hopes for Russia Meeting Soon published by Bloomberg, March 8 2020. 4     Please see Russian Oil Production Among Most Expensive in World published November 12, 2019 by The Moscow Times.  

Special Report

Highlights Joe Biden is the Democratic Party’s presumptive nominee following Super Tuesday. The onus is on Bernie Sanders to upset the race yet again. This is unlikely. Biden’s nomination is less market-negative than that of Sanders, but increases the risk of a Democratic Senate and hence tax hikes. The coronavirus threat to Trump’s reelection is two-pronged – and rising. Go long global equities ex-US on the basis that the virus fears will give way to public resilience and global stimulus. Feature A non-populist, non-protectionist candidate is emerging as the Democratic Party nominee for the US presidency – a positive development for global risk assets in 2020. Judging by preliminary results from the Democratic Party’s “Super Tuesday” primary elections, former Vice President Joe Biden has become the presumptive nominee, one of our key 2020 views. Our simple, back-of-the-envelope projection of delegates to the Democratic National Convention in Milwaukee, Wisconsin, July 13-16 shows that as long as Biden maintains his average vote share thus far, he is narrowly on track to win a majority of pledged delegates and thus clinch the nomination by June (Chart 1).  Chart 1Projection Of Democratic Delegates To National Convention, Milwaukee, July 2020 The chief risk to our view – that Vermont Senator Bernie Sanders, a left-wing populist, would run away with his momentum in February – has peaked. While Sanders won an average of 38% of the delegates on offer, he only won 28% of the popular vote, compared to Biden’s 44% of the delegates and 33% of the popular vote. The centrists as a bloc are outvoting the progressives and only two candidates are left. Ultimately Biden’s two-pronged path to victory in the Electoral College in November reinforces the Super Tuesday results, giving him greater electability and making him the likeliest victor of the Democratic Party primary. Super Tuesday Makes Biden Presumptive Nominee Biden racked up victories in key states including Texas, Massachusetts, Minnesota, and Virginia. He is now the leader in delegates to the party’s national convention (Chart 2), the popular vote, the number of states won, and the biggest states. The exception is California, one of the country’s most left-leaning states, where Sanders won, albeit with the combined progressive vote less than 50%. The voting pattern shows that Democrats still prefer centrist candidates to left-wing or “progressive” candidates by 50% to 40% on average (Chart 3). With two candidates left, this dynamic should favor Biden. Chart 2The Delegate Count Thus Far Chart 3Popular Vote: Biden/Centrists Versus Sanders/Progressives Chart 4Super Tuesday And Beyond By winning Texas and sweeping the South, Biden is heavily favored to win Florida on March 17 – always one of his strong suits vis-à-vis Sanders and a sign of electability in November. But his surprise victories over Sanders in Minnesota and Massachusetts show that he is competitive in the Midwest and Northeast, meaning that he is also likely favored to come out on top in Michigan and Ohio on March 10. The same goes for Illinois, the home state of his 2008-12 running mate Obama, on March 17 (Chart 4). True, in Minnesota and Massachusetts Biden benefited from Senator Elizabeth Warren’s clearing the 15% threshold, thus subtracting from Sanders’s vote share and delegate share. Warren may or may not drop out of the race. Sanders needs to arrest Biden’s Super Tuesday bounce and convince Democratic voters that he is more electable against Trump than Biden. This is a tall order for March 10-17, but Sanders has performed as well or better than Biden in the Northeast and Midwest as a whole, and these are the two regions that yield the most delegates in the rest of the primary (Chart 5).  Biden’s centrist rivals dropped out of the competition after his big win in South Carolina on February 29. His remaining centrist rival, Mayor Michael Bloomberg, suffered a humiliating defeat – pulling in Aspen, Colorado and Napa Valley California along with American Samoa despite spending over $400 million in advertisements (Chart 6). As we have argued, it takes votes, not just money, to win elections. Chart 5The Battle For The Northeast And Midwest Chart 6Bloomberg’s Folly It is a two-man race. If Biden can beat Sanders surrounded by competitors, then the onus is on Sanders to change the game from here. Otherwise Biden wins. Bottom Line: Biden is the likeliest winner. We will have to see another drastic change in momentum for this outcome to be overturned. Sanders’s underperformance on Super Tuesday suggests that his challenge to our base case (a centrist nomination) has peaked.    A Contested Convention? Still Unlikely Chart 7Biden’s Super Tuesday Bounce The coalescing of the centrist and progressive blocs, combined with a likely Super Tuesday bounce, will put Biden back in the lead in national polling (Chart 7). A contested Democratic convention remains unlikely, though it cannot be ruled out. Biden and Sanders are racing neck-and-neck for delegates and another twist in the race could deprive Biden of the simple majority of pledged delegates needed to clinch the nomination. The problem for Sanders is that in a close delegate matchup, a centrist candidate is favored to come out with the nomination. VIX futures suggest that this outlook is priced in, as they are falling for July (the month of the convention) relative to June (the conclusion of the primary election). Volatility induced by the primary election should gradually subside from now through July. Volatility will spike with the conventions in July mostly because of the uncertainty over the general election, and it should also pick up in September and October ahead of the November 3 vote. The spike in volatility that is always to be expected in the October ahead of a presidential election should continue increasing relative to July (Chart 8).   How can we be confident? The combination of the party establishment and the alternate or “reformist” centrist faction should be sufficient to overwhelm the combined “progressive” or anti-establishment bloc. Biden could fail to win the nomination on the first ballot, but the pro-establishment “super delegates” (party stalwarts who are not pledged to any particular candidate) would have the ability to swing subsequent ballots either in his favor or in favor of an alternate centrist (Chart 9). From a game-theoretical point of view, a sequential voting procedure is deadly to Sanders. His only hope was to rack up such a strong plurality in the primaries that he could take the convention by force. That is now unlikely. Chart 8VIX, Rightly, Not Pricing Contested Convention Chart 9Which Way Will The Super Delegates Swing? Even without a contested convention – and certainly with one – the Democratic Party could suffer from internal divisions that affect its challenge to the Republicans in November. The closer Sanders comes to Biden in delegate count, and especially if he should lead Biden yet still lose the nomination, the more his supporters will cry foul. In that case the party would send anywhere from 30%-40% of its voters away feeling disenfranchised. The worst-case scenario for the Democrats would be a convention troubled by open partisan rancor and social unrest, as occurred in the infamous 1968 convention in Chicago. Peace protesters against the Vietnam War and supporters of anti-war Senator Eugene McCarthy besieged the convention and were hounded and repressed by police forces under Chicago Mayor Richard Daley. Moderate Vice President Hubert Humphrey won the nomination despite the strong showing of anti-war sentiment in the primary election. The convention exposed the party’s rifts for all the nation to see. Humphrey went on to lose the election to Republican Richard Nixon. Chart 10Democrats Need To Avoid 1968 Replay Something akin to 1968 could occur this summer if Sanders’s supporters believe he has, for the second time, been deprived of the nomination unfairly in preference for a lackluster establishment candidate who will lose to Trump. But circumstances today are not (yet) so dire. The backdrop in 1968 was one of general upheaval, with opposition to the Vietnam War and the assassinations of Martin Luther King Jr and Robert F. Kennedy, the latter directly contributing to the dispute over delegates at the convention. The labor market was extremely tight (as today), but inflation was spiking (unlike today), fueling domestic unrest (Chart 10). The Democratic Party establishment is neither as disconnected from its base nor as draconian as in 1968. Biden or any other centrist nominee will seek to placate the left wing, likely through a leftward shift on some policies and a progressive vice-presidential pick. Opposition to Trump will act as a unifying force among Democrats. Bottom Line: A contested convention remains unlikely, but it cannot be ruled out. Biden is more likely to win the nomination due to his Super Tuesday bounce and the tailwind for centrists over progressives within the primary voting patterns thus far. If the convention is contested, it will likely result in a centrist candidate and the alienation of the progressive wing, and thus favor Trump’s reelection odds. Implications For The General Election Since November 2018 we have emphasized that US presidential elections are referendums on the incumbent party. Only rarely can the opposition defeat a sitting president amid an expanding economy, even if the ruling party lost the midterm election (as did the GOP in 2018). Major scandals reduce the historic reelection rate, but Trump has been acquitted so his biggest scandal is largely neutralized (Chart 11). The uptick in his approval rating after signing trade deals with China, Canada, and Mexico and getting acquitted by his fellow Republicans in the Senate confirms that he should be seen as favored for reelection. His approval is historically low but not prohibitive, as it tracks with Obama’s ahead of the 2012 election – low approval being in part a structural indicator of highly partisan times (Chart 12).  Chart 11Unseating An Incumbent Is Difficult Chart 12Trump’s Low Approval Not Prohibitive Yet Trump is only slightly favored. The coronavirus outbreak – and more importantly, the fear of it – threatens to damage Trump’s economy and highlight his fatal policy flaw: health care. Most of his first year in office consisted of a failed attempt to repeal and replace the Affordable Care Act (Obamacare), leaving 28 million Americans without health insurance (uninsured individuals increased by 2 million in 2018, the first increase since Obamacare was passed). The Democrats weaponized this gaping policy vulnerability in the vital Rust Belt swing states during the midterm election. Anything that shifts the focus of the election to health, as opposed to the growing economy, is positive for the Democrats on the margin (Chart 13). Granted, the narrative over Trump’s handling of the coronavirus crisis will become a non-diagnostic partisan battle. Neither Xi Jinping nor Donald Trump are responsible for the virus outbreak, but Trump is accountable for the popular perception of his handling of it whereas Xi is not. Ultimately the underlying material conditions of the economy will prove decisive. If the fear factor at home and abroad results in a sharper slowdown and higher unemployment by November, Trump is doomed. The swing states are already vulnerable because they took a heavy blow as a result of Trump’s trade war with China (Chart 14). Chart 13Is Health Care Trump’s Fatal Flaw? Chart 14Virus Fears Threaten Trump's Economy On the other hand, if the fear factor subsides due to the virus’s non-apocalyptic death rate, globally coordinated stimulus – starting with China but reinforced by the Federal Reserve’s surprise 50 basis point rate cut on March 3 – could generate a rebound by Q4 that redounds to Trump’s favor. Doesn’t America’s extreme political polarization create a kind of tribalism that overwhelms traditional “pocketbook” variables in forecasting an election (Chart 15)? Aren’t Democrats sufficiently fired up against President Trump to generate massive voter turnout that wipes out his thin margins of victory in the key swing states? After all, turnout in some of the primary elections is on par with the year the Great Recession began (Chart 16). Chart 15Does Reality Matter Amid Polarization? YES Chart 16Democrats Not Turning Out At 2008 Levels Most likely the economy will be decisive. Democratic fury against Trump will not translate as easily to the broader public if the economy is decent or rebounding in the second half of the year. Voter turnout tends to correlate with unemployment, including in the swing states (Chart 17). The coronavirus shock to the economy, not the blame game surrounding the virus or health care system, will be the determining factor. Chart 17Voter Turnout Responds To Economy … Including In Key Swing States This offers little consolation for Trump, since the brunt of the coronavirus impact on the economy is yet to be felt. While we still give Trump the benefit of the doubt for reelection, our quantitative election model says that the election is “too close to call,” primarily because of weak state-by-state leading economic indicators for Pennsylvania, Michigan, and Wisconsin (Chart 18). These indicators will tick down further due to the virus impact before they tick back up. Our base case is that the uptick will occur, but clearly the fear factor is the biggest risk to Trump’s reelection. Chart 18Quant Model Says US Election “Too Close To Call” The fact that Biden is a slightly more competitive candidate against Trump than Sanders will not help. Biden has a broader Electoral College pathway than Sanders. Both are competitive in the key Rust Belt swing states on which the 2016 election hinged – Michigan, Pennsylvania, Wisconsin. But Biden is also competitive in Florida, Arizona, and North Carolina, states largely closed to Sanders. Still, the difference between the Democratic challengers is marginal as neither is extremely charismatic and the election is a referendum on the ruling party and national direction as a whole. The Senate race is critical to the general election outcome (Chart 19). A Democratic president will be constrained if the Republicans maintain control – Sanders’s revolutionary agenda would be put on ice from the beginning, whereas Biden would have to focus on compromise (and would be prevented from repealing Trump’s tax cuts). Because Republicans saw a banner year in the Senate election in 2014 they must defend a larger number of competitive seats this year (10) than Democrats do (3) (Chart 20). If Democrats win the White House then they also need to win all three “toss up” races (Arizona, Colorado, Maine) – which is very doable – as well as keeping hold of their weakest seat (Alabama) or winning one additional seat (Kansas? North Carolina? Iowa?) in order to get an even balance in the Senate. This would give them the minimum necessary for majority voting since the vice president casts the decisive vote in a tie. Chart 19Democrats Lead Generic Ballot Chart 20Balance Of Power In The US Senate, 2020   Winning this many seats seems extremely difficult, based on the voting patterns in 2016 and 2018 (Table 1, Appendix), unless one considers the type of national environment that would see the incumbent Trump removed from office: it is an environment in which either voter turnout or support rates have shifted, in which case voters who view the Republicans as discredited are less likely to retain Republican senators who carried Trump’s water in the impeachment trial. Note that Biden is an asset in every key Senate race mentioned above except Colorado, whereas Sanders is probably a liability. Chart 21Balance Of Power In the US House Of Representatives, 2020 By contrast the Democrats are defending many more seats than Republicans in the House of Representatives (Chart 21). Yet Republicans would have to retain their five toss-up seats, three vacant seats, while poaching 18 of the Democrats 19 toss-up seats, to reclaim a majority (Table 2, Appendix). This is possible if there is a strong economic rebound in the second half of the year and Trump is “winning” on other policies, but it is unlikely. Thus a second-term President Trump is much more likely to be constrained by the House than a first-term President Biden is likely to be constrained by the Senate. It follows that Trump would focus on foreign policy, where he faces the fewest constitutional constraints – and in a second term he would be unshackled from reelection concerns. He would only be constrained by the desire for a magnificent legacy that keeps Ivanka Trump electable someday. This is not a constraint worth betting money on, especially not in the first two years when he is fresh off reelection (2021-22). The implication is more trade war with China, Europe, or both. Meanwhile Biden with the Senate would focus on the Democrats’ domestic legislative agenda – and would be likely to rack up successes. Without the Senate he too would be driven toward foreign policy, and given his age he would face a limited reelection constraint, like Trump. Bottom Line: Biden’s likely nomination solidifies our view that if Democrats win, they are likely to eke out a bare one-vote majority in the Senate, though not guaranteed. Biden is a Democratic asset for key Senate races while Sanders would be more likely to be constrained by a Republican Senate. If Democrats lose, they would have to lose in the context of a big economic rebound (or some other policy windfall for Trump) in order to yield the House of Representatives. In the context of the coronavirus shock, this seems unlikely. But it is likeliest if the economy is rebounding and the Democrats run a “socialist” for the presidency. Economic Policy Implications The most important investment takeaway from Super Tuesday is that the “Bernie Sanders Panic Index” risk will now tend to subside and the key sectors of the US stock market – tech and health – plus financials and energy will no longer have as big of a threat of punitive regulation hanging over their heads (Chart 22). Chart 22Bernie Panic Index Will Subside Biden’s approach to health would be to restore and expand Obamacare, which is already the law of the land and thus not nearly as disruptive as the attempt by Sanders to create a universal single-payer program that would eliminate private insurance (a large source of uncertainty since it would have been extremely difficult to achieve yet central to his agenda). Incidentally, Big Pharma faces headwinds under Democrats or Republicans, as the populist demand for lower prices will carry the day. President Biden would certainly re-regulate, reversing the deregulatory tailwind for corporate profits and animal spirits under President Trump (Chart 23). But there is much less negative of an impact on business optimism and the job market under Biden than Sanders. Business concern over tax hikes, as outlined, will largely depend on the Senate outcome (Chart 24). The consolation for the financial markets is that, with Biden the presumptive nominee, the tax cut rollback would not be complete: Biden aims for a 28% corporate rate, which is still a net seven percentage point cut from 2016. Chart 23Trump’s De-Regulatory Shock Chart 24The Oval Office Has A Pen And A Phone   The financial industry has faced a long and rocky recovery since the 2008 crash, reminiscent of the tech sector in the wake of the dotcom bubble (Chart 25). A Democratic victory will be negative on the margin, as even Biden will need to sharpen his knives when it comes to the banks. Even the Wall Street candidate Bloomberg had proposed a financial transactions tax. By contrast, Trump would clearly benefit this sector – as long as the business cycle recovers and the yield curve steepens. Chart 25Regulation Returns To Financial Industry? The loser, in either outcome, is the tech sector – which is the most richly valued. Both Republicans and Democrats are investigating Big Tech for anti-competitive practices. Wealth inequality, and the eventual end of the bull market and business cycle, will generate public unrest and encourage the government to identify and punish scapegoats, as in the past with leading companies that had excessive market concentration (Chart 26). Yet neither Trump nor Biden will be as aggressive on this front as Sanders would be. Chart 26Anti-Trust Suits Distract From Inequality, Late-Cycle Woes Chart 27Infrastructure Stocks Will Reboot There is little difference between Trump and Biden (or Sanders for that matter) on the question of infrastructure. Americans want better infrastructure but an economic slowdown is required to provide the impetus. Democrats are unlikely to grant new spending to Trump prior to the election unless he is reelected or a full-blown economic collapse is occurring (in which it is his final act). The performance of BCA’s Infrastructure Basket will improve after the election given that both parties are embracing expansive fiscal spending while China is launching another stimulus mini-cycle (Chart 27). The fiscal trajectory of the United States is unlikely to correct anytime soon. Trumpism has routed the fiscal hawks within the Republican Party and Biden is attempting to lead a Democratic Party that is making increasingly extravagant spending demands. The median American voter is demanding greater government provision of services and social spending. If Democrats win the White House and Senate, they will be able to claw back some revenue by repealing Trump’s tax cuts, but the pressure to spend will outweigh their ability to increase taxes (Chart 28). They will need to expand non-defense discretionary spending even as mandatory outlays rise inexorably due to the aging of the population (Chart 29). Chart 28More Fiscal Profligacy In The US Outlook Chart 29Zero Chance Of Entitlement Cuts Investment Conclusions The US election is eight months away and much can change between now and then. What we know is that Biden now has the clearest path to the Democratic nomination, while Sanders would require another rapid reversal in momentum in order to take the lead. Even if he does, the Democratic convention will favor a centrist as long as Sanders falls short of a commanding lead, which is likely given the 50%-versus-40% split in favor of centrists over progressives thus far. A two-man race will favor Biden as long as this dynamic persists. Biden is slightly more competitive against Trump than Sanders, and slightly more likely to take the Senate for the Democrats. Yet ultimately Trump’s presidency will live or die based on the economy. Otherwise a significant policy humiliation (or surprise right-wing third party candidate) would be required to undo his reelection bid. Chart 30Valuations Favor Non-US Stocks Unfortunately for Trump, the coronavirus outbreak presents precisely this two-pronged risk of worsening economy and policy failure. If this risk fully materializes then he is finished, but markets will most likely have the consolation that it is Biden, not Sanders, waiting in the wings. Our base case remains constructive over the next twelve months, particularly for global stocks ex-US, which are much more heavily discounted and will benefit from Chinese stimulus (Chart 30). The virus shock is clearly a massive risk, but as long as the death rate does not surprise to the upside the ultimate impact will be public resilience and global stimulus.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Appendix Table 1Democrats Likely To Win The Senate If They Win White House Table 2Republicans Unlikely To Reclaim House Even If They Keep White House Footnotes

Highlights The latest interest rate cuts by central banks confirms the narrative that the authorities view economic risks as asymmetrical to the downside. This all but assures that competitive devaluation will become the dominant currency landscape in the near future. If the virus proves to be just another seasonal flu, the global economy will be awash with much more stimulus, which will be fertile ground for pro-cyclical currencies. In the event that we get a much more malignant outcome, discussions around interest rate cuts will rapidly evolve into quantitative easing and debt monetization. The dollar will be the ultimate loser in both scenarios, but this path could be lined with intermediate strength. Our highest-conviction call before the dust settles is to short USD/JPY. We are also making a few portfolio adjustments in light of recent market volatility. Buy NOK/SEK and NZD/CHF and take profits soon on long SEK/NZD. Feature The DXY rally that began last December faltered below overhead psychological resistance at 100, and has since broken below key technical levels. The V-shaped reversal has been a mirror image of developments in equity markets, with the S&P 500 off 6% from its lows. The catalyst was aggressive market pricing of policy action from the Federal Reserve, to which the authorities yielded. The latest policy action confirms the narrative that most central banks continue to view deflation as a much bigger threat than inflation, since few have been able to achieve their mandate. This all but assures that competitive devaluation will become the dominant currency landscape, as each central bank prevents appreciation in their respective currency. Should the Fed continue on the path of much more aggressive stimulus, this will have powerful implications for the dollar and across both G10 and emerging market currencies.   The US 10-year Treasury yield broke below 1% around 1:40 p.m. EST on March 3rd. This was significant not because of the level but because it emblematically erased the US carry trade for a number of countries (Chart I-1). Should the Fed continue on the path of much more aggressive stimulus, this will have powerful implications for the dollar and across both G10 and emerging market currencies.  Chart I-1The Big Convergence To Buy Or Sell The DXY? If the virus proves to be only slightly more lethal than the seasonal flu, the global economy will be awash with much more stimulus, which will be fertile ground for pro-cyclical currencies. As a counter-cyclical currency, the dollar will buckle, lighting a fire under our favorites such as the Norwegian krone and the Swedish krona. The euro will be the most liquid beneficiary of this move. Chart I-2 shows that the global economy was already on a powerful V-shaped recovery path before the outbreak. More importantly, this recovery was on the back of easier financial conditions. Chart I-2V-Shaped Recovery At Risk Chart I-3A Second Wave Of Infections? Our roadmap is the peak in the momentum of new infections outside of China. During the SARS 2013 episode, the bottom in asset prices (and peak in the DXY) occurred when the momentum in new cases peaked. Currency markets are currently pricing a much worse outcome than SARS. The risk is that we are entering a second wave of infections outside Hubei, China, which will be more difficult to control than when it was relatively more contained within the epicenter (Chart I-3). As we aptly witnessed a fortnight ago, currency markets will make a binary switch to risk aversion on such an outcome. This warns against shorting the DXY index or buying the euro or pound in the near term. As we go to press, the virus has been identified on almost every continent except Antarctica. Even in countries such as the US, with modern and sophisticated health facilities, the costs to get tested are exorbitant for underinsured individuals.1 This all but assures that the number of underreported cases is likely non-trivial, which could trigger another market riot once they surface. Chart I-4DXY and USD/JPY Tend To Move Together Our highest-conviction call before the dust settles is therefore to short USD/JPY. As Chart I-1 highlights, the Bank of Japan is much closer to the end of their rope in terms of monetary policy tools. Long bond yields have already hit the zero bound, which means that real rates in Japan will continue to rise until the authorities are forced to act. One of the triggers to act will be a yen soaring out of control, which is not yet the case. Speculative evidence is that it will take a yen rally in the order of 12% to catalyze the BoJ. More importantly, the speed of the rally will matter. This was the trigger for negative interest rates in January 2016 as well as yield curve control in September of 2016. The first rally from USD/JPY 125 to around 112 and the subsequent rise towards 100 were both in the order of 12%. A similar rally from the recent peak near 112 will pin the USD/JPY at 100.   Bottom Line: The yen is the most attractive currency to play dollar downside at the moment. Remain short USD/JPY. If global growth does pick up and the dollar weakens, the USD/JPY and the DXY tend to be positively correlated most of the time, providing ample room for investors to rotate into more pro-cyclical pairs (Chart I-4). Competitive Devaluation? In the event that we get a much more malignant outcome, discussions around interest rate cuts will rapidly evolve into quantitative easing and debt monetization. The Reserve Bank of Australia has already stated that QE is on the table if rates touch 0.25%.2 Other central banks are likely to follow suit. As the chorus of central banks cutting rates and stepping into QE on COVID-19 rises, the rising specter of currency brinkmanship is likely to unnerve countries pursuing more orthodox monetary policies. The currency of choice will be gold and other precious metals, though the dollar, Swiss franc, and yen are likely to also outperform.  The velocity of money in both the US and the euro area was in a nascent upturn, but has started to roll over.  Whether or not countries adopt QE, what is clear is that balance sheet expansion at both the Fed and the European Central Bank is set to continue. Chart I-5 shows that the velocity of money in both nations was in a nascent upturn, but has started to roll over. This tends to lead inflation by a few quarters. On a relative basis, our bias is that the pace of expansion should be more pronounced in the US. This will eventually set the dollar up for a significant decline, albeit after a knee-jerk rally. Chart I-5ADownside Risks To US Inflation Chart I-5BDownside Risks To Euro Area Inflation In terms of quantitative easing, it is most appealing when a country has low growth, low inflation, and large amounts of public debt. If we are right that inflation is about to roll over in the US, then the public debt profile and political capital to expand the budget deficit places the nation as a prime candidate for QE (Chart I-6). Fiscal stimulus is a much more difficult discussion in Europe, Japan, or elsewhere for that matter, and likely to arrive late. Chart I-6US Government Debt Is Very High The backdrop for the US dollar is a 37% rise from the bottom. The New York Fed estimates that a 10 percentage point appreciation in the dollar shaves 0.5 percentage points off GDP growth over one year, and an additional 0.2 percentage points in the following year.3 With growth now hovering around 2%, a strong currency could easily nudge US growth to undershoot potential.  The Fed is one of the few G10 central banks with room to ease monetary policy. This sets the dollar up for an eventual decline. However, the path to QE will be lined by a strong dollar if the backdrop is flight to safety. This entails rolling currency depreciations among some developed and emerging markets. When looking for the next candidates for competitive devaluation, the natural choices are the countries with overvalued exchange rates that are exerting a powerful deflationary impulse into their economies. Chart I-7 shows the deviation of real effective exchange rates from their long-term mean, according to the BIS. Chart I-7Competitive Devaluation Candidates Bottom Line: The Fed is one of the few G10 central banks with room to ease monetary policy. This sets the dollar up for an eventual decline. It will first occur among the safe havens (currencies with already low interest rates), before it rotates to more procyclical currencies. Where Does US Politics Fit In? Politics should start to have a meaningful impact on the dollar once the democratic nominee is sealed. Super Tuesday revealed a powerful shift to the center, pinning former Vice President Joe Biden as the preferred candidate (Chart I-8). The dollar tends to thrive as political uncertainty rises. While not a forgone conclusion, a Sanders–Trump rivalry would have been a very polarized outcome, putting a bid under the greenback. Markets are likely to take a more conciliatory tone from a Biden victory, which will be negative for the greenback.   Chart I-8US Politics Will Be Important Our colleague Matt Gertken, chief geopolitical strategist, just published his analysis of Super Tuesday.4 While a contested convention remains unlikely, it will likely favor Trump’s reelection odds. What is common about a Biden-Sanders-Trump trio is that fiscal policy is set to expand in the US. This will ultimately be dollar bearish (Chart I-9). Chart I-9The Dollar And Budget Deficits Bottom Line: The election is still many months away and much can change between now and then. For now, Biden is the preferred democratic nominee. Portfolio Adjustments Chart I-10Sell CHF/NZD The sharp rally in the VIX index has opened up a trading opportunity on the short side. The historical pattern of previous spikes in the VIX is that unless the market starts to price in an actual recession, which is quite plausible, the probability of a short-term reversal is close to 100%. Given our base case that we are not headed for a recession over the next six to 12 months, we are opening a short CHF/NZD trade today. The cross tends to benefit from spikes in volatility, correcting sharply as the market unwinds overreactions. More importantly, the cross has already priced in an overshoot in the VIX in an order of magnitude akin to 2008. Place stops at 1.75 with a target of 1.45 (Chart I-10). We are also placing a limit buy on NOK/SEK at parity. The risk to this trade is a further down-leg in oil prices, but at parity, the cross makes for a compelling tactical trade. Momentum on the cross is currently bombed out. We will be closely watching whether Russia complies with OPEC production cuts and act accordingly. Remain long NOK within our petrocurrency basket against the euro. We are also looking to take profits on our long SEK/NZD trade, a nudge below our initial target. The market has fully priced in a rate cut by the Reserve Bank of New Zealand, suggesting the kiwi could have a knee-jerk rally, similar to the Aussie on the actual announcement. Finally, we were stopped out of our short gold/silver trade for a loss of 5.5%. We will be looking to re-establish this trade in the coming weeks. Stay tuned. Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Footnotes 1 Bertha Coombs and William Feuer, “The coronavirus test will be covered by Medicaid, Medicare and private insurance, Pence says,” CNBC, dated March 4, 2020. 2 Michael Heath, “RBA Says QE Is Option at 0.25%, Doesn’t Expect to Need It,” Bloomberg News, dated November 26, 2019. 3 Mary Amiti and Tyler Bodine-Smith, “The Effect of the Strong Dollar on U.S. Growth,” Federal Reserve Bank of New York, dated July 17, 2015. 4  Please see Geopolitical Strategy Special Report, titled “US Election: A Return To Normalcy?”, dated March 4, 2020, available at gps.bcaresearch.com. Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the US have been positive: The ISM manufacturing PMI fell slightly to 50.9, dragged down by the prices paid and new orders component, while the non-manufacturing index ticked up to 57.3. Core PCE inflation increased to 1.6% year-on-year in January. Unit labor costs came in at 0.9% quarter-on-quarter in Q4 of last year. This is a deceleration from the previous print of 2.5%. The DXY index depreciated by 1.4% this week. Following a conference call with G7 central banks, the Fed made an emergency rate cut of 50bps. Chairman Powell cited risks to the outlook from Covid-19 but acknowledged that the Fed can keep financial conditions accommodative, not fix broken supply chains or cure infections. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Building A Protector Currency Portfolio - February 7, 2020 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been positive: Core CPI inflation increased slightly to 1.2% year-on-year in February.  The producer price index contracted by 0.5% year-on-year in January. The unemployment rate remained flat at 7.4% in January. Retail sales grew by 1.7% year-on-year in January, remaining flat from the previous month. The euro appreciated by 3.6% against the US dollar this week. As the ECB is limited by the zero lower bound, the euro strengthened on expectations that rate differentials with the US will continue to narrow. The ECB could resort to policy alternatives such as a special facility targeting small and medium enterprises. Markets are pricing in an 81% probability of a rate cut as we go into the ECB meeting next week. Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 Japanese Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: The Tokyo CPI excluding fresh food grew by 0.5% year-on-year in February from 0.7% the previous month. The jobs-to-applicants ratio decreased to 1.49 from 1.57 while the unemployment rate increased to 2.4% from 2.2% in January. The consumer confidence index declined to 38.4 from 39.1 in February. Housing starts contracted by 10.1% year-on-year in January from 7.9% the previous month. The Japanese yen appreciated by 2.5% against the US dollar this week. Lower US yields, combined with continued risk-on flows, have extended the rally in the Japanese yen. Weakness in the Japanese economy is broad based, but the BoJ has limited policy space and fiscal action looks unlikely anytime soon. Global central bank action will drive the yen in the near term. Report Links: The Near-Term Bull Case For The Dollar - February 28, 2020 Building A Protector Currency Portfolio - February 7, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the UK have been mixed: Consumer credit decreased to GBP 1.2 billion from GBP 1.4 billion while net lending to individuals fell to GBP 5.2 billion from GBP 5.8 billion in January. Mortgage approvals increased to 70.9 thousand from 67.9 thousand in January, while the Nationwide housing price index grew by 2.3% year-on-year in February from 1.9% the previous month.  The British pound appreciated by 0.2% against the US dollar this week. At a hearing this week, incoming governor Andrew Bailey stated that the BoE is still assessing evidence on the nature of the shock from Covid-19. The BoE has limited room to cut and is constrained by possible stagflation; we expect targeted supply chain finance and cooperation with fiscal authorities to take precedence.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: GDP grew by 2.2% year-on-year in Q4 2019, improving from 1.7% the previous quarter.  Imports and exports both contracted by 3% while the trade balance dropped to AUD 5.2 billion in January. Building permits contracted by a dramatic 15.3% month-on-month in January, compared to growth of 3.9% in December. The RBA commodity price index contracted by 6.1% year-on-year in February.  The Australian dollar appreciated by 0.8% against the US dollar this week. The Reserve Bank of Australia cut its official cash rate to 0.5%, an all-time low, citing the impact of Covid-19 on domestic spending, education, and travel. Watch to see if the signal from building permits is confirmed by other housing market indicators. The RBA might not be done easing. Report Links: On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been negative: The terms of trade index grew by 2.6% quarter-on-quarter in Q4 2019, improving from 1.9% in Q3. The ANZ commodity price index contracted by 2.1% in February, deepening from 0.9% the previous month. Building permits contracted by 2% month-on-month in January, from growth of 9.8% in December.  The global dairy trade price index contracted by 1.2% in March.  The New Zealand dollar appreciated by 0.3% against the US dollar this week. There is pressure on the Reserve Bank of New Zealand (RBNZ) to ease at its next meeting on March 27, with markets pricing in 42 basis points of easing over the next 12 months. However, the RBNZ has dispelled notions of a pre-meeting cut. Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been negative: Annualized GDP grew by 0.3% quarter-on-quarter in Q4 2019, slowing from 1.4% the previous quarter.  The raw material price index contracted by 2.2% and industrial product price index contracted by 0.3% month-on-month in January.  Labor productivity contracted by 0.1% quarter-on-quarter in Q4 2019, compared to growth of 0.2% the previous quarter. The Canadian dollar depreciated by 0.1% against the US dollar this week. The Bank of Canada (BoC) followed the Fed and cut rates by 50bps. In addition to the confidence hit from Covid-19, the BoC cited falling terms of trade, depressed business investment, and dampened economic activity due to the CN rail strikes. The BoC stands ready to ease further, and Prime Minister Trudeau has raised the possibility of a fiscal response.   Report Links: The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been positive: GDP grew by 1.5% year-on-year in Q4 2019, from growth of 1.1% the previous quarter. The SVME PMI increased to 49.5 from 47.8 in February. The KOF leading indicator increased to 100.9 from 100.1 in February. CPI contracted by 0.1% year-on-year in February, from growth of 0.2% the previous month. The Swiss franc appreciated by 1.6% against the US dollar this week. A combination of strong domestic data and global risk-off flows contributed to strength in the Swiss franc. However, the Swiss government will be revising down growth forecasts and a recent UN report has estimated that Switzerland lost US$ 1 billion in exports in February due to Chinese supply disruptions. Combined with a strong franc, this puts the domestic outlook at risk.  Report Links: On The DXY Breakout, Euro, And Swiss Franc - February 21, 2020 Currency Market Signals From Gold, Equities And Flows - January 31, 2020 Portfolio Tweaks Before The Chinese New Year - January 24, 2020 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been positive: The current account decreased to NOK 19.1 billion from NOK 29.5 billion in Q4 2019. The credit indicator grew by 5% year-on-year in January. Registered unemployment decreased slightly to 2.3% from 2.4% in February.  The Norwegian krone appreciated by 1.3% against the US dollar this week. Expect the petrocurrency to trade on news from the OPEC meetings in the coming days. The committee has proposed a production cut of 1.5 million barrels per day through Q2 2020, conditional on approval from Russia, to offset the demand shock from Covid-19.  Report Links: Building A Protector Currency Portfolio - February 7, 2020 On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive: The Swedbank manufacturing PMI increased to 53.2 from 52 in February. Industrial production grew by 0.9% year-on-year, from a contraction of 2.6% the previous month. GDP grew by 0.8% year-on-year in Q4 2019, slowing from 1.8% the previous month. The Swedish krona appreciated by 1.5% against the US dollar this week. After hitting a 2-decade high near 10, USD/SEK has violently reversed and is now trading at the 9.45 level. What is evident from incoming data is that the cheap currency has been a perfect shock absorber, cushioning the domestic economy. We are protecting profits on long SEK/NZD today and we will be looking for other venues to trade SEK on the long side.   Report Links: Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

Special Report

Highlights Joe Biden is the Democratic Party’s presumptive nominee following Super Tuesday. The onus is on Bernie Sanders to upset the race yet again. This is unlikely. Biden’s nomination is less market-negative than that of Sanders, but increases the risk of a Democratic Senate and hence tax hikes. The coronavirus threat to Trump’s reelection is two-pronged – and rising. Go long global equities ex-US on the basis that the virus fears will give way to public resilience and global stimulus. Feature A non-populist, non-protectionist candidate is emerging as the Democratic Party nominee for the US presidency – a positive development for global risk assets in 2020. Judging by preliminary results from the Democratic Party’s “Super Tuesday” primary elections, former Vice President Joe Biden has become the presumptive nominee, one of our key 2020 views. Our simple, back-of-the-envelope projection of delegates to the Democratic National Convention in Milwaukee, Wisconsin, July 13-16 shows that as long as Biden maintains his average vote share thus far, he is narrowly on track to win a majority of pledged delegates and thus clinch the nomination by June (Chart 1).  Chart 1Projection Of Democratic Delegates To National Convention, Milwaukee, July 2020 The chief risk to our view – that Vermont Senator Bernie Sanders, a left-wing populist, would run away with his momentum in February – has peaked. While Sanders won an average of 38% of the delegates on offer, he only won 28% of the popular vote, compared to Biden’s 44% of the delegates and 33% of the popular vote. The centrists as a bloc are outvoting the progressives and only two candidates are left. Ultimately Biden’s two-pronged path to victory in the Electoral College in November reinforces the Super Tuesday results, giving him greater electability and making him the likeliest victor of the Democratic Party primary. Super Tuesday Makes Biden Presumptive Nominee Biden racked up victories in key states including Texas, Massachusetts, Minnesota, and Virginia. He is now the leader in delegates to the party’s national convention (Chart 2), the popular vote, the number of states won, and the biggest states. The exception is California, one of the country’s most left-leaning states, where Sanders won, albeit with the combined progressive vote less than 50%. The voting pattern shows that Democrats still prefer centrist candidates to left-wing or “progressive” candidates by 50% to 40% on average (Chart 3). With two candidates left, this dynamic should favor Biden. Chart 2The Delegate Count Thus Far Chart 3Popular Vote: Biden/Centrists Versus Sanders/Progressives Chart 4Super Tuesday And Beyond By winning Texas and sweeping the South, Biden is heavily favored to win Florida on March 17 – always one of his strong suits vis-à-vis Sanders and a sign of electability in November. But his surprise victories over Sanders in Minnesota and Massachusetts show that he is competitive in the Midwest and Northeast, meaning that he is also likely favored to come out on top in Michigan and Ohio on March 10. The same goes for Illinois, the home state of his 2008-12 running mate Obama, on March 17 (Chart 4). True, in Minnesota and Massachusetts Biden benefited from Senator Elizabeth Warren’s clearing the 15% threshold, thus subtracting from Sanders’s vote share and delegate share. Warren may or may not drop out of the race. Sanders needs to arrest Biden’s Super Tuesday bounce and convince Democratic voters that he is more electable against Trump than Biden. This is a tall order for March 10-17, but Sanders has performed as well or better than Biden in the Northeast and Midwest as a whole, and these are the two regions that yield the most delegates in the rest of the primary (Chart 5).  Biden’s centrist rivals dropped out of the competition after his big win in South Carolina on February 29. His remaining centrist rival, Mayor Michael Bloomberg, suffered a humiliating defeat – pulling in Aspen, Colorado and Napa Valley California along with American Samoa despite spending over $400 million in advertisements (Chart 6). As we have argued, it takes votes, not just money, to win elections. Chart 5The Battle For The Northeast And Midwest Chart 6Bloomberg’s Folly It is a two-man race. If Biden can beat Sanders surrounded by competitors, then the onus is on Sanders to change the game from here. Otherwise Biden wins. Bottom Line: Biden is the likeliest winner. We will have to see another drastic change in momentum for this outcome to be overturned. Sanders’s underperformance on Super Tuesday suggests that his challenge to our base case (a centrist nomination) has peaked.    A Contested Convention? Still Unlikely Chart 7Biden’s Super Tuesday Bounce The coalescing of the centrist and progressive blocs, combined with a likely Super Tuesday bounce, will put Biden back in the lead in national polling (Chart 7). A contested Democratic convention remains unlikely, though it cannot be ruled out. Biden and Sanders are racing neck-and-neck for delegates and another twist in the race could deprive Biden of the simple majority of pledged delegates needed to clinch the nomination. The problem for Sanders is that in a close delegate matchup, a centrist candidate is favored to come out with the nomination. VIX futures suggest that this outlook is priced in, as they are falling for July (the month of the convention) relative to June (the conclusion of the primary election). Volatility induced by the primary election should gradually subside from now through July. Volatility will spike with the conventions in July mostly because of the uncertainty over the general election, and it should also pick up in September and October ahead of the November 3 vote. The spike in volatility that is always to be expected in the October ahead of a presidential election should continue increasing relative to July (Chart 8).   How can we be confident? The combination of the party establishment and the alternate or “reformist” centrist faction should be sufficient to overwhelm the combined “progressive” or anti-establishment bloc. Biden could fail to win the nomination on the first ballot, but the pro-establishment “super delegates” (party stalwarts who are not pledged to any particular candidate) would have the ability to swing subsequent ballots either in his favor or in favor of an alternate centrist (Chart 9). From a game-theoretical point of view, a sequential voting procedure is deadly to Sanders. His only hope was to rack up such a strong plurality in the primaries that he could take the convention by force. That is now unlikely. Chart 8VIX, Rightly, Not Pricing Contested Convention Chart 9Which Way Will The Super Delegates Swing? Even without a contested convention – and certainly with one – the Democratic Party could suffer from internal divisions that affect its challenge to the Republicans in November. The closer Sanders comes to Biden in delegate count, and especially if he should lead Biden yet still lose the nomination, the more his supporters will cry foul. In that case the party would send anywhere from 30%-40% of its voters away feeling disenfranchised. The worst-case scenario for the Democrats would be a convention troubled by open partisan rancor and social unrest, as occurred in the infamous 1968 convention in Chicago. Peace protesters against the Vietnam War and supporters of anti-war Senator Eugene McCarthy besieged the convention and were hounded and repressed by police forces under Chicago Mayor Richard Daley. Moderate Vice President Hubert Humphrey won the nomination despite the strong showing of anti-war sentiment in the primary election. The convention exposed the party’s rifts for all the nation to see. Humphrey went on to lose the election to Republican Richard Nixon. Chart 10Democrats Need To Avoid 1968 Replay Something akin to 1968 could occur this summer if Sanders’s supporters believe he has, for the second time, been deprived of the nomination unfairly in preference for a lackluster establishment candidate who will lose to Trump. But circumstances today are not (yet) so dire. The backdrop in 1968 was one of general upheaval, with opposition to the Vietnam War and the assassinations of Martin Luther King Jr and Robert F. Kennedy, the latter directly contributing to the dispute over delegates at the convention. The labor market was extremely tight (as today), but inflation was spiking (unlike today), fueling domestic unrest (Chart 10). The Democratic Party establishment is neither as disconnected from its base nor as draconian as in 1968. Biden or any other centrist nominee will seek to placate the left wing, likely through a leftward shift on some policies and a progressive vice-presidential pick. Opposition to Trump will act as a unifying force among Democrats. Bottom Line: A contested convention remains unlikely, but it cannot be ruled out. Biden is more likely to win the nomination due to his Super Tuesday bounce and the tailwind for centrists over progressives within the primary voting patterns thus far. If the convention is contested, it will likely result in a centrist candidate and the alienation of the progressive wing, and thus favor Trump’s reelection odds. Implications For The General Election Since November 2018 we have emphasized that US presidential elections are referendums on the incumbent party. Only rarely can the opposition defeat a sitting president amid an expanding economy, even if the ruling party lost the midterm election (as did the GOP in 2018). Major scandals reduce the historic reelection rate, but Trump has been acquitted so his biggest scandal is largely neutralized (Chart 11). The uptick in his approval rating after signing trade deals with China, Canada, and Mexico and getting acquitted by his fellow Republicans in the Senate confirms that he should be seen as favored for reelection. His approval is historically low but not prohibitive, as it tracks with Obama’s ahead of the 2012 election – low approval being in part a structural indicator of highly partisan times (Chart 12).  Chart 11Unseating An Incumbent Is Difficult Chart 12Trump’s Low Approval Not Prohibitive Yet Trump is only slightly favored. The coronavirus outbreak – and more importantly, the fear of it – threatens to damage Trump’s economy and highlight his fatal policy flaw: health care. Most of his first year in office consisted of a failed attempt to repeal and replace the Affordable Care Act (Obamacare), leaving 28 million Americans without health insurance (uninsured individuals increased by 2 million in 2018, the first increase since Obamacare was passed). The Democrats weaponized this gaping policy vulnerability in the vital Rust Belt swing states during the midterm election. Anything that shifts the focus of the election to health, as opposed to the growing economy, is positive for the Democrats on the margin (Chart 13). Granted, the narrative over Trump’s handling of the coronavirus crisis will become a non-diagnostic partisan battle. Neither Xi Jinping nor Donald Trump are responsible for the virus outbreak, but Trump is accountable for the popular perception of his handling of it whereas Xi is not. Ultimately the underlying material conditions of the economy will prove decisive. If the fear factor at home and abroad results in a sharper slowdown and higher unemployment by November, Trump is doomed. The swing states are already vulnerable because they took a heavy blow as a result of Trump’s trade war with China (Chart 14). Chart 13Is Health Care Trump’s Fatal Flaw? Chart 14Virus Fears Threaten Trump's Economy On the other hand, if the fear factor subsides due to the virus’s non-apocalyptic death rate, globally coordinated stimulus – starting with China but reinforced by the Federal Reserve’s surprise 50 basis point rate cut on March 3 – could generate a rebound by Q4 that redounds to Trump’s favor. Doesn’t America’s extreme political polarization create a kind of tribalism that overwhelms traditional “pocketbook” variables in forecasting an election (Chart 15)? Aren’t Democrats sufficiently fired up against President Trump to generate massive voter turnout that wipes out his thin margins of victory in the key swing states? After all, turnout in some of the primary elections is on par with the year the Great Recession began (Chart 16). Chart 15Does Reality Matter Amid Polarization? YES Chart 16Democrats Not Turning Out At 2008 Levels Most likely the economy will be decisive. Democratic fury against Trump will not translate as easily to the broader public if the economy is decent or rebounding in the second half of the year. Voter turnout tends to correlate with unemployment, including in the swing states (Chart 17). The coronavirus shock to the economy, not the blame game surrounding the virus or health care system, will be the determining factor. Chart 17Voter Turnout Responds To Economy … Including In Key Swing States This offers little consolation for Trump, since the brunt of the coronavirus impact on the economy is yet to be felt. While we still give Trump the benefit of the doubt for reelection, our quantitative election model says that the election is “too close to call,” primarily because of weak state-by-state leading economic indicators for Pennsylvania, Michigan, and Wisconsin (Chart 18). These indicators will tick down further due to the virus impact before they tick back up. Our base case is that the uptick will occur, but clearly the fear factor is the biggest risk to Trump’s reelection. Chart 18Quant Model Says US Election “Too Close To Call” The fact that Biden is a slightly more competitive candidate against Trump than Sanders will not help. Biden has a broader Electoral College pathway than Sanders. Both are competitive in the key Rust Belt swing states on which the 2016 election hinged – Michigan, Pennsylvania, Wisconsin. But Biden is also competitive in Florida, Arizona, and North Carolina, states largely closed to Sanders. Still, the difference between the Democratic challengers is marginal as neither is extremely charismatic and the election is a referendum on the ruling party and national direction as a whole. The Senate race is critical to the general election outcome (Chart 19). A Democratic president will be constrained if the Republicans maintain control – Sanders’s revolutionary agenda would be put on ice from the beginning, whereas Biden would have to focus on compromise (and would be prevented from repealing Trump’s tax cuts). Because Republicans saw a banner year in the Senate election in 2014 they must defend a larger number of competitive seats this year (10) than Democrats do (3) (Chart 20). If Democrats win the White House then they also need to win all three “toss up” races (Arizona, Colorado, Maine) – which is very doable – as well as keeping hold of their weakest seat (Alabama) or winning one additional seat (Kansas? North Carolina? Iowa?) in order to get an even balance in the Senate. This would give them the minimum necessary for majority voting since the vice president casts the decisive vote in a tie. Chart 19Democrats Lead Generic Ballot Chart 20Balance Of Power In The US Senate, 2020   Winning this many seats seems extremely difficult, based on the voting patterns in 2016 and 2018 (Table 1, Appendix), unless one considers the type of national environment that would see the incumbent Trump removed from office: it is an environment in which either voter turnout or support rates have shifted, in which case voters who view the Republicans as discredited are less likely to retain Republican senators who carried Trump’s water in the impeachment trial. Note that Biden is an asset in every key Senate race mentioned above except Colorado, whereas Sanders is probably a liability. Chart 21Balance Of Power In the US House Of Representatives, 2020 By contrast the Democrats are defending many more seats than Republicans in the House of Representatives (Chart 21). Yet Republicans would have to retain their five toss-up seats, three vacant seats, while poaching 18 of the Democrats 19 toss-up seats, to reclaim a majority (Table 2, Appendix). This is possible if there is a strong economic rebound in the second half of the year and Trump is “winning” on other policies, but it is unlikely. Thus a second-term President Trump is much more likely to be constrained by the House than a first-term President Biden is likely to be constrained by the Senate. It follows that Trump would focus on foreign policy, where he faces the fewest constitutional constraints – and in a second term he would be unshackled from reelection concerns. He would only be constrained by the desire for a magnificent legacy that keeps Ivanka Trump electable someday. This is not a constraint worth betting money on, especially not in the first two years when he is fresh off reelection (2021-22). The implication is more trade war with China, Europe, or both. Meanwhile Biden with the Senate would focus on the Democrats’ domestic legislative agenda – and would be likely to rack up successes. Without the Senate he too would be driven toward foreign policy, and given his age he would face a limited reelection constraint, like Trump. Bottom Line: Biden’s likely nomination solidifies our view that if Democrats win, they are likely to eke out a bare one-vote majority in the Senate, though not guaranteed. Biden is a Democratic asset for key Senate races while Sanders would be more likely to be constrained by a Republican Senate. If Democrats lose, they would have to lose in the context of a big economic rebound (or some other policy windfall for Trump) in order to yield the House of Representatives. In the context of the coronavirus shock, this seems unlikely. But it is likeliest if the economy is rebounding and the Democrats run a “socialist” for the presidency. Economic Policy Implications The most important investment takeaway from Super Tuesday is that the “Bernie Sanders Panic Index” risk will now tend to subside and the key sectors of the US stock market – tech and health – plus financials and energy will no longer have as big of a threat of punitive regulation hanging over their heads (Chart 22). Chart 22Bernie Panic Index Will Subside Biden’s approach to health would be to restore and expand Obamacare, which is already the law of the land and thus not nearly as disruptive as the attempt by Sanders to create a universal single-payer program that would eliminate private insurance (a large source of uncertainty since it would have been extremely difficult to achieve yet central to his agenda). Incidentally, Big Pharma faces headwinds under Democrats or Republicans, as the populist demand for lower prices will carry the day. President Biden would certainly re-regulate, reversing the deregulatory tailwind for corporate profits and animal spirits under President Trump (Chart 23). But there is much less negative of an impact on business optimism and the job market under Biden than Sanders. Business concern over tax hikes, as outlined, will largely depend on the Senate outcome (Chart 24). The consolation for the financial markets is that, with Biden the presumptive nominee, the tax cut rollback would not be complete: Biden aims for a 28% corporate rate, which is still a net seven percentage point cut from 2016. Chart 23Trump’s De-Regulatory Shock Chart 24The Oval Office Has A Pen And A Phone   The financial industry has faced a long and rocky recovery since the 2008 crash, reminiscent of the tech sector in the wake of the dotcom bubble (Chart 25). A Democratic victory will be negative on the margin, as even Biden will need to sharpen his knives when it comes to the banks. Even the Wall Street candidate Bloomberg had proposed a financial transactions tax. By contrast, Trump would clearly benefit this sector – as long as the business cycle recovers and the yield curve steepens. Chart 25Regulation Returns To Financial Industry? The loser, in either outcome, is the tech sector – which is the most richly valued. Both Republicans and Democrats are investigating Big Tech for anti-competitive practices. Wealth inequality, and the eventual end of the bull market and business cycle, will generate public unrest and encourage the government to identify and punish scapegoats, as in the past with leading companies that had excessive market concentration (Chart 26). Yet neither Trump nor Biden will be as aggressive on this front as Sanders would be. Chart 26Anti-Trust Suits Distract From Inequality, Late-Cycle Woes Chart 27Infrastructure Stocks Will Reboot There is little difference between Trump and Biden (or Sanders for that matter) on the question of infrastructure. Americans want better infrastructure but an economic slowdown is required to provide the impetus. Democrats are unlikely to grant new spending to Trump prior to the election unless he is reelected or a full-blown economic collapse is occurring (in which it is his final act). The performance of BCA’s Infrastructure Basket will improve after the election given that both parties are embracing expansive fiscal spending while China is launching another stimulus mini-cycle (Chart 27). The fiscal trajectory of the United States is unlikely to correct anytime soon. Trumpism has routed the fiscal hawks within the Republican Party and Biden is attempting to lead a Democratic Party that is making increasingly extravagant spending demands. The median American voter is demanding greater government provision of services and social spending. If Democrats win the White House and Senate, they will be able to claw back some revenue by repealing Trump’s tax cuts, but the pressure to spend will outweigh their ability to increase taxes (Chart 28). They will need to expand non-defense discretionary spending even as mandatory outlays rise inexorably due to the aging of the population (Chart 29). Chart 28More Fiscal Profligacy In The US Outlook Chart 29Zero Chance Of Entitlement Cuts Investment Conclusions The US election is eight months away and much can change between now and then. What we know is that Biden now has the clearest path to the Democratic nomination, while Sanders would require another rapid reversal in momentum in order to take the lead. Even if he does, the Democratic convention will favor a centrist as long as Sanders falls short of a commanding lead, which is likely given the 50%-versus-40% split in favor of centrists over progressives thus far. A two-man race will favor Biden as long as this dynamic persists. Biden is slightly more competitive against Trump than Sanders, and slightly more likely to take the Senate for the Democrats. Yet ultimately Trump’s presidency will live or die based on the economy. Otherwise a significant policy humiliation (or surprise right-wing third party candidate) would be required to undo his reelection bid. Chart 30Valuations Favor Non-US Stocks Unfortunately for Trump, the coronavirus outbreak presents precisely this two-pronged risk of worsening economy and policy failure. If this risk fully materializes then he is finished, but markets will most likely have the consolation that it is Biden, not Sanders, waiting in the wings. Our base case remains constructive over the next twelve months, particularly for global stocks ex-US, which are much more heavily discounted and will benefit from Chinese stimulus (Chart 30). The virus shock is clearly a massive risk, but as long as the death rate does not surprise to the upside the ultimate impact will be public resilience and global stimulus.   Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Appendix Table 1Democrats Likely To Win The Senate If They Win White House Table 2Republicans Unlikely To Reclaim House Even If They Keep White House Footnotes

Feature “Bayesian: …statistical methods that assign probabilities or distributions to events…based on experience or best guesses before experimentation and data collection and that apply Bayes' theorem to revise the probabilities and distributions after obtaining experimental data.” — Merriam-Webster Dictionary Markets have reacted pretty rationally to the outbreak of the COVID-19 virus. Equities initially rebounded a few days ahead of the peak of new cases in China (Chart 1). But then, once the number of cases in the rest of the world started to accelerate, stock markets sold off again sharply. The MSCI All Country World Index is now down 13% from its peak on February 12. Recommended Allocation Chart 1Markets Have Reacted In Line With New COVID-19 Cases No one knows whether this episode will turn into an unprecedented pandemic, which will kill millions worldwide, last for months, and trigger a global recession. So it is the sort of environment in which Bayesian analysis becomes useful. Our “prior” for the probability of a full pandemic would be around 10-20%. If it doesn’t happen, an attractive buying opportunity for risk assets should present itself soon. But there could be further downside first, especially if the number of cases in major countries such as the US, Germany, and the UK were to accelerate significantly. There are some sign that Chinese activity is beginning to recover. There are some signs that Chinese activity is beginning to recover, as new cases of COVID-19 slow, thanks to the draconian measures taken by the authorities. Big Data can help analyze this. For example, live traffic statistics from TomTom show that by February 28, weekday road congestion in Shanghai was back to 50% of its normal level, compared to 19% on February 14 (Chart 2). The Chinese authorities have relaunched fiscal and monetary stimulus, causing short-term rates to fall to their lowest level since 2010 (Chart 3). Monetary policy has been upgraded from “prudent” to “flexible and moderate.” BCA Research’s China strategists believe there is even an increasing possibility of a stimulus overshoot in the next 6-12 months, as the authorities plan for the worst-case scenario but the economy rebounds.1 Chart 2Chinese People Getting Back On The Roads Chart 3Chinese Stimulus Pushing Down Rates In the short-term, it is clear that global growth will weaken, though quantifying this is hard. A 1% quarter-on-quarter decline in Chinese GDP in Q1 would bring growth down to 3.5% year-over-year. Our colleagues in BCA’s Global Investment Strategy estimate this would cause global growth to fall 0.8% below trend in Q1, mainly from a contraction in tourism, but that this would be largely made up in Q2, assuming that the epidemic is over by then (Chart 4).2 Could even a limited epidemic tip the world into recession? We doubt it. Consumer confidence remains strong in developed economies (Chart 5) and the virus is not yet serious enough to stop most consumers going out to spend. The global economy was in the process of bottoming out before COVID-19 hit (Chart 6) and there is little reason to think that we will not return to the status quo ante. Chart 4Global Growth To Slow In Q1, But Rebound In Q2   Chart 5Consumers Remain Confident Chart 6Before COVID-19, Growth Was Bottoming Out We see the two biggest risks being: 1) a rise in defaults in China, especially among smaller companies, that the government is unable or unwilling to prevent (Chart 7); and 2) a deterioration in the jobs market in the US, as companies start to postpone hiring, or lay off staff (Chart 8). We will watch these carefully over coming weeks. Chart 7Are Chinese Companies Vulnerable? Chart 8Is The US Job Market Starting To Wobble? Chart 9Markets Believe Trump Would Beat Sanders There is one other risk that might give equity markets an excuse for a further sell-off: November’s US presidential election. The probability that Bernie Sanders wins the Democratic nomination has risen to 60% from 15% over the past two months. The consensus believes that Trump can easily defeat Sanders, which is why the President’s probability of being reelected has risen in tandem (Chart 9). But, if the economy starts to weaken and Trump’s approval rating slips, investors could become nervous about the likelihood of a market-unfriendly Sanders administration. We would not recommend long-term investors sell out of risk assets at this point. There could be an attractive buying opportunity over the next few weeks, and investors who have derisked should be looking for a reentry point. With US 10-year bonds yields at 1.2% and German yields at -60 basis points, it is hard to see much further upside for risk-free bonds. Equities should be able to outperform over the next 12 months, as growth rebounds following the COVID-19 episode. We have been recommending overweights in cash and gold, as hedges, since December, and these still make sense. However, if events over the coming weeks point to the risk of global pandemic being higher than we currently think, then investors should Bayesianally adjust and move more risk-off. Otherwise, a peak in COVID-19 cases ex-China should be a strong signal to buy risk assets again. Chart 10Why Should Long-Run Inflation Expectations Fall? Fixed Income: US Treasurys have become investors’ safe haven of choice over the past few weeks. A marked drop in long-run inflation expectations (Chart 10), in particular, has pushed the 10-year yield to a record low. This seems somewhat illogical, since the Fed will announce this summer the results of its review of monetary policy, which is likely to lead to a more dovish long-term inflation target (perhaps a commitment to achieve 2% on average over the cycle). The market has also priced in at least three Fed rate cuts by year-end (Chart 11). The Fed will certainly cut rates if US growth falters as a result of COVID-19, but this is by no means a certainty. History shows that Treasury yields jumped sharply once previous viral outbreaks ended (Chart 12). We expect yields to be significantly higher in 12 months, and so are underweight duration and prefer TIPS over nominal bonds. Credit will continue to underperform in the risk-off phase, but some interesting opportunities should arise soon, especially among the lowest-rated credits and in the Energy sector. Chart 11Will The Fed Really Be This Accommodating? Chart 12After Previous Virus Outbreaks, Rates Leapt Equities: The sell-off has already put on fire sale some stocks most affected by the epidemic. For example, cruise lines are down by 40% over the past month or so, European oil stocks 25%, some luxury goods makers 30%, and airlines 30%. Opportunistic investors might want to buy a basket of the most oversold quality names. Our overweight on euro area stocks has not worked in the sell-off. But, as a cyclical, export-oriented market, we continue to expect Europe to outperform when global growth rebounds. Euro area banks, in particular, represent the best call option on a rise in bond yields, since their performance is highly correlated to the shape of the yield curve. We continue to have a somewhat cyclical tilt among our sector weightings (with overweights on, for example, Energy and Industrials), but may adjust this in our Quarterly Portfolio Outlook in early April if we decide to reduce risk. The sell-off has already put on fire sale some stocks most affected by the epidemic. Currencies: The dollar is a safe-haven currency and so, unsurprisingly, has benefitted from the rush to safety in recent weeks. However, it remains overvalued (Chart 13), and interest rate differentials would move further against it if the Fed does cut rates, since other major developed central banks have much less room to move (Chart 14). This suggests that it will probably resume the weakness it experienced from August to December last year as soon as global growth rebounds. Chart 13Dollar Is Overvalued... Chart 14...And Interest Differentials Have Moved Against It Chart 15Metals Prices Stabilized In Recent Weeks Commodities: Industrial metals fell sharply on the outbreak of COVID-19 in China, but have bottomed in line with the stabilization of the situation in that country (Chart 15). Gold has worked predictably as the best hedge in the sell-off. While it is starting to look technically overbought and would be hurt by a rise in bond yields (Chart 16), for prudent investors it remains a useful hiding place amid heightened risk and ultra-low interest rates. Oil is the commodity that has fallen the most surprisingly, with Brent close to the low it reached during the sell-off in December 2018 (Chart 17).  It is much less dependent on Chinese demand than metals are, and so is maybe pricing in a global recession – as well as questioning the commitment of OPEC to cut production further. This would suggest upside to the oil price if global growth turns out not to be so bad, oil demand continues to pick up, and supply remains constrained.   Chart 16How Much Could Gold Overshoot? Chart 17Oil Discounting A Global Recession Garry Evans, Senior Vice President Chief Global Asset Allocation Strategist garry@bcaresearch.com Footnotes 1    Please see China Investment Strategy Weekly Report, “China: Back To Its Old Economic Playbook?” dated 26 February 2020, available at cis.bcaresearch.com 2   Please see Global Investment Strategy Weekly Report, “Market Too Complacent About The Coronavirus,” dated 21 February 2020, available at cis.bcaresearch.com GAA Asset Allocation  

Highlights We spent last week meeting with clients in South Africa, who maintained their equanimity despite the spread of the coronavirus: Maybe it was because there were not yet any reported cases close to home, but investors discussed the global outbreak dispassionately. We repeated our view that a US recession is not imminent, ex-a significantly adverse exogenous event: Tight monetary policy is a necessary precondition of a recession, and there’s no reason to expect that the Fed will make any move to remove accommodation in 2020. Investors were open to our view that the US economy is subject to upward inflation pressures, even if the time is not yet ripe for them to manifest themselves: Excess global capacity is still thwarting goods inflation, but it appears to be on its way to being absorbed. In the meantime, the Fed is deliberately encouraging the economy to run hot. Inflation just might surprise investors who have been lulled to sleep by its post-crisis absence. The presidential election is a hot topic in South Africa, too: The Democratic nomination appears to be Bernie Sanders’ to lose, and he has more of a chance in the general election than investors might expect. Feature We spent last week meeting with clients in South Africa. They expressed considerably more optimism about financial markets and the global economy than they did on our previous visit in January 2019, though we all conceded that the coronavirus outcome was unknowable. We discussed a wide range of topics, with COVID-19, recession prospects, the inflation outlook, and November’s election coming up in nearly every meeting. A summary of our discussions, organized by topic, follows below. Coronavirus Impressions We discussed the coronavirus at the beginning of every meeting, albeit after acknowledging that no one can know for sure how it will unfold. We discussed the virus’ potential outcomes, our base-case expectation, and the news and data we’re monitoring to track its course. Everyone is familiar by now with the best- and worst-case scenarios, and the continuum of possibilities in between, so we will not rehash them here. The main variables we have been watching – infection, mortality and recovery rates – are also surely familiar. From a review of those metrics within China – the daily rate of new incidences inside and outside of Hubei province (Chart 1), mortality (Chart 2) and recovery rates (Chart 3) within and without Hubei – there is good reason to conclude that China is gaining the upper hand, having sharply limited the virus’ spread beyond Hubei, and steadily slowing its spread in the epicenter. Chart 1Stringent Quarantine Measures Seem To Have Gotten Some Traction Chart 2Mortality Rates Are Inconclusive, ... Chart 3... But Recovery Rates Are Encouraging Unfortunately, however, other countries cannot perfectly replicate China’s template for corralling the virus, as their governments have considerably less ability to limit their citizens’ movements. It is a lot easier to impose and enforce a quarantine or other emergency restrictions in China than it is in any other major country. It is important, then, to consider not just the number of countries to which the virus spreads, but the characteristics of the countries themselves. In this sense, Italy and Iran may offer some insight. The Italians reacted swiftly and decisively when the first cluster emerged in northern Italy. They drew a circle with a large radius around the cluster, restricted movement in and out of that circle, and sharply limited activities within it. Carnival celebrations in Venice were called off, and Sunday’s slate of matches in Italy’s Serie A professional soccer league were cancelled (subsequent matches are being played in empty stadiums). Although the number of reported infections in Italy has been rising, and infections have begun to pop up in western and central Europe, Italian officials appear to have both the ability and the will to contain it. The Iranian experience contrasts with Italy’s. In Iran, the mortality rate (deaths divided by confirmed cases) is roughly five times greater than it has been everywhere else the virus has erupted. That seems improbably high, and our best guess is that the infections denominator is being undercounted. A country that cannot provide a reliable count (or a reasonably accurate estimate) of infections presumably lacks the public health infrastructure to contain the virus. We conclude that it matters where the infections occur – the wealthy countries of western Europe, North America, Asia and Oceania likely have a better chance of bringing the virus to heel than developing countries. Our interactions in South Africa, among the wealthiest countries in the developing world, may further reinforce the point. In several meetings, clients asked what entering the country was like. I told them that when I arrived at the Johannesburg airport on the morning of Sunday the 23rd, all passengers from international destinations had to pass by a screener who pointed a clunky object shaped like a radar gun in the vicinity of their nose and forehead. Several planes had landed just before mine and the passport control line wound around three or four times, affording repeated opportunities to look over the radar-gun employee’s shoulder at the images on her screen. They appeared to be simple black-and-white video of the arriving passengers without any color imagery to indicate body temperature ranges. The clients uniformly laughed at that detail, exclaiming that of course the screening was ineffectual. They then soberly conceded that Africa is especially vulnerable to an outbreak. If the coronavirus or another severe adverse exogenous event doesn't do it, it will take restrictive monetary policy to induce a recession. Infections outside of China are rising with no end yet in sight (Chart 4), but the news isn’t all bad. There are some promising treatment developments that may yield effective therapies, either from the conventional drug that worked wonders on an infected patient in Washington State and is now being tested on infected groups in China, or from antibody-based therapies of the type that were successfully deployed against Ebola. Our own views are conditional upon COVID-19’s evolution, but our current base case is that it is more likely to produce a soft patch within the context of a global expansion, and a correction within the context of a continuing equity bull market, than it is to trigger a recession or a bear market. Chart 4Now It's The Rest Of The World's Turn Recession Prospects Chart 5Necessary, If Not Sufficient Nearly every client asked us about the prospects for a US recession. We discussed how the negative term premium had made the yield curve more prone to invert, thereby diluting its predictive value, and asserted our view that restrictive monetary conditions are a necessary precondition of recessions (Chart 5). We touched on the rest of the points covered in last week’s report, which argued that a strong near-term outlook for consumption, dependable government spending and a post-trade-tensions recovery in investment would keep the US out of recession over a 12-month horizon. But we spent the most time outlining what we see as the most likely route to the next recession. Expansions don’t die of old age, they die because the Fed murders them, and we told our clients that we expect that maxim will be especially apropos in this cycle. Investors should therefore focus on the factors that will prod the Fed to embark on a tightening cycle with the express intent of reining in an overheating economy. We see two main catalysts: concern that inflation may get away from the Fed on the upside (discussed in the following section), and/or concern that there are unsustainable excesses in either the economy or financial markets. Chart 6The Real Economy Isn't Close To Overheating We contend that there are currently no signs of excesses in the real economy. Its most cyclical elements, which have driven overheating in the past, have not gotten back to their mean level, much less the red-line levels that have been associated with previous business cycle peaks (Chart 6, top panel). Proportional spending on consumer durables remains around the bottom of its 60-year range (Chart 6, second panel), investment in non-residential structures is quite low relative to history and comfortably in the middle of its post-1990-91-recession range (Chart 6, fourth panel), and residential investment is sitting at the level that previously marked business-cycle troughs (Chart 6, bottom panel). The only cyclical activity that looks a little frisky is equipment and software spending (Chart 6, third panel), which has the best chance of enhancing productivity and thereby yielding ongoing dividends. Financial market excesses are in the eye of the beholder, and reasonable people can disagree about their existence. The promiscuous application of the word “bubble” to anything and everything market related, however, has become as familiar and tiresome as rappers’ boasts of their prowess. The S&P 500’s steady climb higher doesn’t begin to approach the manic paths of prior decades’ hot assets (Chart 7). The key takeaway is that the economic or financial overheating likely to trigger the expansion’s ultimate denouement is yet to arrive. Until it does, the Fed will have no reason to intervene to stop it. Chart 7Which One Of These Is Not Like The Others? Inflation Prospects Many clients asked about inflation prospects before we could bring up the subject, a notable turnabout from our last visit thirteen months ago, when our arguments for accelerating wage gains met mostly with indifference. We were happy to oblige, as inflation occupies an essential place in our base-case cyclical scenario. Tight monetary policy is a necessary precondition for an endogenously occurring recession. Ex-a severe exogenous shock, like a global pandemic, the expansion cannot end without tight monetary conditions, and the Fed won’t knowingly impose them unless it is concerned that inflation is getting away from it on the upside. Q: Why has there been no whiff of US inflation in the last eleven years? A: Because the negative US output gap rendered it impossible until 2018. We are not daunted by inflation’s post-crisis hibernation. Meaningful price increases at the level of the entire economy cannot occur when an economy has a negative output gap (aggregate demand persistently falls short of economic capacity) unless its currency is sliding and it imports a lot of goods and services. From that perspective, inflation has only been possible in the US since 2018, because it didn’t close its output gap until 2017, according to estimates from both the IMF and the CBO. 2018 was the year that the US embarked on an unprecedented macroeconomic experiment (Chart 8), injecting fiscal stimulus amounting to one half of the economy’s long-run capacity (about 100 basis points) at a time when it was already operating at full capacity (2-2.25%). If corporations and other businesses viewed the surge in aggregate demand as a one-off event that couldn’t be replicated in the future, they would likely choose not to invest in additional capacity to meet it. The net result was demand in excess of supply in 2018 and in 2019, when an additional 50 basis points of stimulus was deployed. Inflation did not break out in either year, but negative output gaps in the rest of the developed world provided the US with the convenient out of importing other countries’ excess capacity. Chart 82018's Unprecedented Macroeconomic Experiment May Yet Produce Inflation The Bank of Canada estimated that Canada closed its output gap in 2018, and the IMF estimates that Europe’s output gap has now closed (Chart 9, top panel), and while even Japan has made a lot of progress on narrowing its output gap (Chart 9, bottom panel). Goods inflation is largely globally determined, and with excess capacity being absorbed around the world, it’s possible that the conditions that would allow for higher goods prices could soon lock into place. Services inflation, a predominantly domestic phenomenon, is poised to rise thanks to the tight-as-a-drum labor market. Just when inflation will rear its ugly head is uncertain, however, as it is a lagging indicator that often doesn’t peak, until a recession has nearly ended, or trough for nearly three years after a recession begins (Chart 10). Chart 9The Slack Is Being Absorbed Chart 10It May Take A Long Time For 2018's Seeds To Germinate We find supply and demand arguments compelling, and the excess-supply constraint on global goods inflation has quietly been easing. The bottom line is that we think the US economy harbors upward inflation pressures, though it is highly unlikely that they will manifest themselves this year. That will give the Fed free rein to allow the economy to run hot across all of 2020, in service of its primary goal of pushing inflation expectations higher, and the labor market as well, in service of its secondary goal of spreading the benefits of easy policy more evenly across the economy. The upshot is that the longer inflation remains outwardly dormant, the harder it will be to root it out once it eventually does begin to bloom. The World Is Watching American Voters As an indication of the anticipation surrounding November’s election, South African investors, who recognized Bernie Sanders’ name, asked about it in every meeting. We laid out our geopolitical strategists’ views, augmented in places by our own, on the key issues as follows: Presidential elections are referendums on the incumbent party. An incumbent president running for re-election has a sizable built-in advantage. In the postwar era, only major economic, social or international shifts have been sufficient to erode that advantage. Incumbents lose when a recession occurs near an election, but the president has to be considered a favorite if the expansion continues. The president may be an especially poor front-runner. Donald Trump personifies variability. That’s a great trait to have as an underdog, because a wide dispersion of individual outcomes broadens the range of possible competitive outcomes, but it’s a vulnerability for a favorite. It is nearly impossible for a golfer with a two-stroke lead ahead of the final par-four eighteenth hole to lose if s/he conservatively plays for par. It seems to us that the president is not wired to play conservatively, and our geopolitical strategists currently give him just a 55% chance of re-election. Bernie Sanders is not unelectable. Our geopolitical strategists note that the median voter is moving to the left, and that Sanders is many Biden supporters’ second choice. He may not be anathema to the broader public in the general election, and his leveling platform may play well in the Rust Belt states that are poised to decide the election once again. A Sanders administration would not transform America into France, but it would chip away at corporate profits. Our personal view is that a President Sanders would not mark the end of the US as a beacon of free enterprise. The Constitution was designed to obstruct dramatic changes, and his ability to pass major legislative initiatives is likely exaggerated. We think he could make his influence felt much more directly in the bureaucratic and regulatory spheres, where a president can act virtually unimpeded. A Sanders administration would be a devoted and presumably activist friend of labor, and a tenacious foe of corporate concentration. An administration that energetically champions organized labor and vigorously enforces anti-trust statutes would exert downward pressure on corporate profit margins. Bullish Or Bearish Borrowing a line from longtime Street economist and strategist Ed Yardeni, our mandate is bullish or bearish, not good or bad. We are charged with making objective decisions about what is most likely to occur in markets, not to daydream about what we would most like to happen. Our base-case scenario turns on our expectation that accommodative monetary policy will remain in place until well into 2021, and will continue to be effective in forestalling defaults and inflating asset valuations. It may not be the most comforting basis for being long risk assets, and we make no implied endorsement of its quality, but if we think it’s going to continue to work beyond the edge of the visible horizon, then we have to reiterate our recommendation that investors should remain at least equal weight equities in multi-asset portfolios, and at least equal weight credit in fixed income portfolios. Austrian adherents and self-styled monetary policy experts can howl about moral hazard and manipulation all they want, but we have to invest in the backdrop that we have, not the backdrop that we want. We do not yet see the approach of a catalyst that will prevent life insurers, pension funds, endowments and other investors who need yield from continuing to go further out the risk curve in search of it. And we don’t yet see the approach of a catalyst that will prevent equity investors from continuing to bid multiples higher. We remain constructive over the cyclical twelve-month timeframe.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com