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Please note that I will be hosting a webcast on Friday July 17 and that the webcast will replace next week’s report. Highlights Go tactically short stocks versus bonds. But express it as short DAX versus the US 10-year T-bond, given the greater scope for compression in US bond yields than in German bond yields. Target a profit of 10 percent but apply a stop-loss if stock versus bond outperformance continues for another 10 percent. There is now a strong incentive for short-term investing and a strong disincentive for long-term investing, forcing formerly long-term investors to think and behave like traders. Don’t obsess with the Covid-19 mortality rate. Focus instead on the morbidity, or hospitalization, rate. Covid-19 is unlikely to kill you, but it can make you ill and, in some unlucky cases, permanently ill. Feature Chart of the WeekA Sell Signal For Stocks To Bonds Financial markets have reached an absurdity. It is now more rewarding to be a short-term trader who holds investments for just three months than it is to be a long-term investor who buys and holds them for ten years. And just to be clear, we are comparing cumulative returns over the entire holding period of three months versus one that is forty times longer at ten years. The case for buying and holding most mainstream investments has collapsed. Investors seeking attractive long-term returns can no longer rely on mainstream bond and stock markets. Nowadays, the long-term investment story is about sectors and themes, and we will continue to tell this story in our regular reports. However, this week we will focus on the implications of short-termism in the mainstream markets. Short-Term Returns Now Beat Long-Term Returns Through the past year, anybody who has bought the German 10-year bund, with the intention of holding it until it redeems in 2029 is guaranteed a deeply negative return. Yet there have been many three-month periods in which the bund has generated a high single-digit return (Chart I-2). Chart I-23-Month Returns Now Beat 10-Year Returns! Likewise, anybody who owns the US 10-year T-bond has made almost as much money in the first three months of this year as they mathematically can by holding it for ten years! By extension, the same principle also applies to mainstream stock markets which are priced for feeble long-term returns – yet can rally by 20-30 percent in the space of a few weeks. It is now more rewarding to be a short-term trader who holds investments for three months than it is to be a long-term investor who buys and holds them for ten years. Admittedly, these are nominal returns, and the long-term real returns could be boosted by deflation. Nevertheless, the economy would have to experience Great Depression levels of deflation to make the long-term real returns genuinely attractive. Yet it wasn’t always like this. Until recent years, the cumulative returns available from long-term investing were many multiples of those available from short-term investing – as they should be (Chart I-3 and Chart I-4). But today, the incentive structure is back-to-front. There is a strong disincentive for long-term investing and a strong incentive for short-term investing, forcing formerly long-term investors to think and behave like traders. Albeit traders that must get their timing right. Chart I-3Today, There Is A Strong Disincentive For Long-Term Investing... Chart I-4...And A Strong Incentive For Short-Term Investing Unfortunately, when everybody behaves like traders there are worrying implications for financial market liquidity and stability. Short-Termism Destroys Market Liquidity We have been brought up to believe that agreement and consensus create peace and harmony, whereas disagreement and opposition create conflict and discord. Hence, it is natural to think that agreement and consensus also create calm and stability in the financial markets. Yet nothing could be further from the truth. A calm and stable market requires disagreement. Disagreement is the source of market liquidity and stability. Meaning, the ability to convert stocks into cash, or cash into stocks, quickly and in volume without destabilising the stock price. For an investor to convert a large amount of stocks into cash without destabilising the price, a mirror-image investor must be willing to take the opposite position. It follows that market liquidity comes from a disagreement about the attractiveness of the investment at a given price. As an aside, we often read comments such as ‘investors are moving out of stocks into cash’, or vice-versa. Such comments are nonsensical. If one investor is selling stocks, then a mirror-image investor must be buying stocks. The stocks cannot just vanish into thin air! A market which loses its variation of investment horizons loses its liquidity and stability. If institutional investors are selling, then a mirror-image investor must be buying. The mirror-image buyer could be less savvy retail investors, in which case we might interpret the institutional selling as a sell signal. Or the mirror-image buyer could be ‘smart money’ hedge funds, in which case we might interpret the institutional selling as a buy signal. It follows that unless we know the identity of both the seller and the buyer, the ‘flows’ information is useless. The much more useful information is the variation of investment horizons in the market. This is because a market which possesses a variation of investment horizons also possesses the disagreement required for liquidity and stability. Conversely, a market which lacks this variation of investment horizons could soon run out of liquidity and undergo a change in trend. Investors with different time horizons disagree about the attractiveness of an investment at a given price because they interpret the same facts and information differently. For example, a day-trader will interpret an outsized rally as a ‘momentum’ buy signal, whereas a value investor will interpret the same information as a ‘loss of value’ sell signal. Therefore, the market possesses liquidity and stability when its participants possess a variation of investment horizons. For example, both a 1-day horizon and a 3-month (65 business days) horizon. The corollary is that the market’s liquidity and stability disappear when its participants no longer possess this healthy variation in horizons. In technical terms, this occurs when the market’s fractal structure collapses. In the above example, it would be signalled by the 65-day fractal dimension collapsing to its lower limit (Chart I-5). Chart I-5The Stock-To-Bond Fractal Structure Has Collapsed All of which brings us to our tactical stock-to-bond sell signal. A Sell Signal For Stocks To Bonds Since 2015, a collapsed 65-day fractal structure of the German stock-to-bond ratio has reliably presaged a change in trend, implying either a sell or buy signal based on the direction of the preceding trend. The two most recent occurrences happened this year on January 2, a sell signal, and March 9, a buy signal (Chart of the Week). A collapsed 65-day fractal structure of the German stock-to-bond ratio has reliably presaged a change in trend. The 65-day fractal structure of the German stock-to-bond ratio has collapsed once again, reinforced by a similar observation in the US stock-to-bond ratio. This suggests that the recent 40 percent rally in stocks versus bonds is approaching exhaustion and is susceptible to a tactical reversal (Chart I-6). Chart I-6The 40 Percent Rally In Stocks Versus Bonds May Be Near Exhaustion Hence, go tactically short stocks versus bonds. But express it as short DAX versus the US 10-year T-bond, given the greater scope for compression in US bond yields than in German bond yields. Target a profit of 10 percent but apply a stop-loss if the outperformance continues for another 10 percent. One caveat is that bullish fundamentals can swamp fragile fractal structures. Hence, the strong outperformance of stocks versus bonds would persist if, for example, a breakthrough treatment or vaccine suddenly emerged for Covid-19. On the other hand, it is worth noting that US hospitalizations for the disease are rising once again, even if deaths, so far, are not (Chart I-7). Nevertheless, we reiterate that the Covid-19 morbidity (severe illness) rate is much more important than the mortality rate, for two reasons. Chart I-7US Hospitalizations For Covid-19 Are Rising Again First, it is morbidity rather than mortality that swamps the finite and limited intensive care unit (ICU) capacity in healthcare systems. Second, the evidence now suggests that many recovered Covid-19 victims suffer long-term damage to their lungs and/or other vital organs such as kidneys, the liver, and the brain. This is the case even for apparently mild cases of the disease that do not require hospitalization. Therefore, don’t obsess with the Covid-19 mortality rate. Focus instead on the morbidity, or hospitalization, rate. The threat from Covid-19 is not that it will kill you. It almost certainly won’t. The threat is that it will make you ill and, in some unlucky cases, permanently ill. Fractal Trading System* As discussed, this weeks recommended trade is short DAX versus 10-year T-bond, setting a profit target and symmetrical stop-loss at 10 percent. Chart I-8GBP/RUB In other trades, long GBP/RUB is within a whisker of its 3 percent profit target. The rolling 1-year win ratio now stands at 59 percent When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated  December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System   Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

Today we update our Millennial Basket as four stocks have gone parabolic and are in need of rebalancing. Specifically, we rebalance AMZN, NFLX, SPOT and TSLA lower, and AAPL, HD, LEN, MSFT, V, UBER higher to bring the index back to an equally weighted state. Our Millennial Basket is up 80% in absolute terms and 58% relative to the SPX since inception in our June 11, 2018 Special Report. In addition, we also recommended investors overweight our Millennial Basket on a secular ten year view basis, predicated upon our Millennials spending theme. While profit potential has not changed, recent price action in AMZN, NFLX, SPOT, and TSLA compels us to rebalance this basket back to equal weight and protect profits as valuations went vertical. Bottom Line: We reiterate our structural and cyclical overweight stance on our Millennial Basket. The ticker symbols in this US Equity Strategy basket are: AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, and V.   ​​​​​​​

Dear Client, In lieu of our regular report next week, I will present our view on China’s economic recovery, geopolitical risks, and implications on financial markets in two live webcasts. The webcasts will take place next Wednesday, July 15 at 10:00AM EDT (English) and at 9:00PM EDT (Mandarin). Best regards, Jing Sima, China Strategist Highlights China’s economic recovery continues through June, but the pace of its demand-side recovery has been more muted compared to the V-shaped rebound in 2009. The intensity of the PBoC’s monetary easing may start to taper in H2, but the central bank is likely to stay on the easing course and keep liquidity conditions ample. Bank lending to the corporate sector should increase further in H2. Chinese stocks rallied through last week’s enactment of the new national security law for Hong Kong and the subsequently announced sanctions from the US government. The existing US sanctions should have limited impact on Hong Kong and mainland China’s economies and financial markets. We remain positive on Chinese stocks despite the recent rallies in China’s equity markets. Feature June’s official and Caixin manufacturing PMIs indicate that China’s economic recovery continues at a steady rate, with the production side of the economy picking up slightly faster than the demand side. The drag on China’s economic recovery from lackluster demand growth should be temporary. Unlike in 2015 when policy uncertainties hindered the recovery in both economic activity and stock prices, the Chinese government has been determined to support its economy and job market in the current cycle. The massive stimulus implemented since March has tremendously boosted activities in China’s construction sector. While households and the corporate sector remain reluctant to spend and to invest, their marginal propensity to spend usually catches up with credit growth with about a 6-9-month lag (Chart 1). The sharp pickup in credit growth should meaningfully support China’s economic rebound, while a better global growth outlook in H2 should also provide some modest tailwinds. On June 30, the PBoC announced a 0.25 percentage point cut to its relending rates for small and rural enterprises and to its general rediscount rate. While the scale of rate cuts in H2 will unlikely match that of Q1, China’s monetary and fiscal policy support will remain in place through the rest of the year. Chinese investable and domestic equities were some of the best performers among global asset classes in June, whereas they were the third-worst the month prior (Chart 2). In the first week of July, both Chinese investable and domestic stocks rallied even further. As we noted in our last week’s report,1 China’s stronger economic outlook, less uncertainty related to its domestic COVID-19 containment, and policy support should provide more room for Chinese stocks to trend upwards. Last week’s passing of the new national security law for Hong Kong and the subsequently announced sanctions from the US government, in our view, should have limited impact on investors’ sentiment for now. Chart 1China's Household And Corporate Marginal Propensities Lag The Credit Impulse By 6-9 Months Chart 2Chinese Equities Are Taking Flight   Tables 1 and 2 present key developments in China’s economic and financial market performance in the past month, and we highlight several of these developments below: Table 1China Macro Data Summary Table 2China Financial Market Performance Summary China’s June official manufacturing PMI ticked up to 50.9 from 50.6 in the previous month. The Caixin manufacturing PMI came in at 51.2, beating the expectation of 50.5 and compared to 50.7 in May. Both suggest that China’s manufacturing sector continues to expand, however the pace of its demand-side recovery has been more muted compared to the V-shaped rebound in 2009 (Chart 3). Although the import and export subcomponents have fared better in June from the low levels in April and May, their readings in June were still below the 50 boom-bust line (Chart 4). Headwinds remain strong for global trade as the US and many of emerging economies are still struggling with the pandemic. Even without re-imposing lockdowns, the resurge in the number of new cases in the US may result in a drag on consumption and global trade. The IMF projects a 12% contraction in global trade in 2020. While the external demand may improve in H2, positive contribution to China's GDP growth from the net exports will be limited this year. Chart 3Current Recovery Lies Somewhere Between 2009 And 2015 Chart 4Demand-Side Recovery Remains Muted   The employment situation in the manufacturing sector has worsened since May, and has returned to contraction following a brief improvement in March and April (Chart 5). An estimated 8.7 million new graduates in 2020,2 a historical high number, will hit the job market in July and August. As such, China’s labor market will likely remain under significant pressure. Even though employment usually lags economic recoveries, depressed expectations on the job market will refrain policymakers from prematurely withdrawing stimulus measures. Small and micro enterprises are an important part of China’s private sector, which provides 80% of jobs in China. The manufacturing PMI of small enterprises fell below the 50 boom-bust line in June, reflecting a persistent weakness in this part of China’s economy. The recent relending and rediscount rate cuts suggest that the PBoC is committed to stay on the easing course. The intensity of monetary easing may start to taper in H2, but the central bank is likely to keep liquidity conditions ample and encourage banks to accelerate lending to the corporate sector. The contraction in Chinese producer prices deepened to -3.7% (year-over-year) in May. However, we think PPI deflation is likely to bottom in Q3. Both the purchasing and producer price subcomponents of the manufacturing PMI ticked up sharply in June, while the drawdown in industrial product inventory relative to new orders has accelerated (Chart 6). The ongoing accommodative policy should provide powerful tailwinds to both economic activity and the PPI in H2. The improvement in the PPI will help to boost industrial profits growth, which turned positive in May (year-over-year) for the first time this year. We expect year-to-date industrial profits to end the calendar year with a modest positive growth rate.  Chart 5Labor Market Pressure Intensifies Chart 6PPI Deflation Nears Its Bottom   China’s property market indicators have notably trended up in May, with year-over-year growth in housing demand normalizing to its pre-pandemic level (Chart 7A & Chart 7B). As the demand in housing rebounded faster than the supply, housing prices have correspondingly turned the corner in May after trending down for 6 consecutive months. Chart 7AHousing Prices Ticked Up Slightly Following A Sharp Fall In Q1 Chart 7BStrong Rebound In Property Investments   Chart 7B shows that housing investments and land purchases have also recovered to near their pre-pandemic levels. Financing restrictions for property developers that were put in place since 2018 have been loosened in H1, which helped to boost real estate investments. We expect the property sector financing conditions to remain accommodative through the rest of this year. Moreover, there is a possibility that the PBoC will lower the 5-year MLF (medium lending facility) rate in Q3. As downward pressures on China's labor market and household income growth intensify, the government is likely to lower the mortgage rate to ease payment constraints on households. Chart 8Chinese Stocks Rallied Through Frictions Over Hong Kong Despite the passing of China’s new and controversial national security law for Hong Kong on June 30 and the subsequently announced sanctions from the US government, stock prices in both China’s onshore and offshore markets rallied (Chart 8). While we agree the US may impose further and more concrete sanctions on China during the months leading up to the November US presidential election, our preliminary assessment points to a limited economic cost on China from the existing US sanctions. The removal of Hong Kong’s special trade status will subject Hong Kong’s export goods to the same tariffs the US levies on Chinese exports. But the raised tariffs will barely make a dent in Hong Kong or mainland China’s export status quo. Hong Kong’s economy consists mainly of the financial, logistical and services sectors. The manufacturing sector only accounts for 1% of its overall economy. Chart 9 shows that Hong Kong’s exports to the US only accounted for around 1% of its total exports and 1.3% of its GDP in 2019. More importantly, of the $5 billion goods Hong Kong exports to the US, only 10% is actually produced in Hong Kong. Most of Hong Kong's exports to the US are goods produced in China that are re-exported through Hong Kong, which are already subject to the same tariffs as the goods China exports to the US directly.3 On the other hand, US exports to Hong Kong accounts for 2% of its total exports, with a trade surplus of about $30 billion in the past two years (Chart 9, bottom panel). The US trade surplus with Hong Kong has drastically reduced since the US-China trade war broke out in 2018, suggesting that the US has already imposed restrictions on its export goods to mainland China through Hong Kong. Moreover, the large trade surplus with Hong Kong as well as China’s commitment to the Phase One trade deal may be part of the reason President Trump is unwilling to impose more substantial sanctions on China right now. The US senate and house have also passed a bill which, if signed and implemented by President Trump, will allow the US government to levy any foreign financial institutions for knowingly conducting business with individuals who are involved in jeopardizing Hong Kong’s autonomy. Chinese banks with operations in the US will be mostly exposed to such sanctions. However, Chinese banks are largely domestic-focused with very low reliance on foreign-currency funding (Chart 10). Hence, the direct impact of a deteriorating operating environment in the US will be limited on Chinese banks. Chart 9Trade Sanctions On Hong Kong Exports Have A Minimum Impact On Its Local Economy Chart 10Chinese Banking Sector Stock Performance Is Largely Driven By Domestic Policy Factors   Qingyun Xu, CFA Senior Analyst qingyunx@bcaresearch.com Jing Sima China Strategist jings@bcaresearch.com   Footnotes 1 Please see China Investment Strategy Weekly Report "Upgrading Chinese Stocks To Overweight," dated July 1, 2020, available at cis.bcaresearch.com 2 iiMediaReport, Analysis report on current situation and development trend of Chinese employment entrepreneurship market in 2020. 3 Please see Nicholas Lardy, “Trump’s latest move on Hong Kong is bluster”. Peterson Institute For International Economies, dated June 1, 2020.   Cyclical Investment Stance Equity Sector Recommendations

In mid-April we boosted the S&P internet retail index to overweight as it was poised to benefit from the shifting consumer spending habits due to the COVID-19 outbreak. True, the “amazonification” of the economy is not a new phenomenon, but COVID-19 acted as an accelerant to an already powerful uptrend in online retail sales (see chart). Today, our overweight in the S&P internet retail index surpassed the 29% relative return mark since the mid-April inception, which compels us to protect profits by instituting a stop at the 20% mark. Bottom Line: We remain overweight the S&P internet retail index, but from a portfolio risk management perspective today we add a stop at the 20% relative return mark in order to protect profits.   ​​​​​​​

Dear Client, US Investment Strategy will take the first of two summer breaks next week, so there will be no publication on July 13th. We will return on July 20th with the latest installment of our Big Bank Beige Book, reviewing the five largest banks’ second quarter earnings calls. Best regards, Doug Peta   Highlights Bottom-up S&P 500 earnings expectations for 2021 are probably high: I/B/E/S expectations incorporating periods six or seven quarters away are little more than extrapolations and investors shouldn’t get hung up on them. The higher corporate income tax rates that would follow a Democratic sweep are a bigger concern. Policymakers have decisively won the early rounds of their bout with the pandemic’s economic effects, … : Transfer payments pushed April and May personal income well above its February level, and households have accordingly stayed current on their rent and other financial obligations. … and they will win the fight provided Congress doesn’t tire, … : Volatility may rise amidst the back and forth of negotiations, but Republican Senators cannot risk allowing aid to elapse three months before the election. … but what’s good for the economy in the long run may come at the expense of active managers’ performance: Value investors can’t catch a break, and all stock pickers will have to contend with a policy backdrop that challenges their established modus operandi.   Feature We have not traveled any farther for work than the kitchen table in three and a half months. Renewing our expiring passport could take a year, and the clock is ticking on our ability to fly domestically on a driver’s license from the persona non grata state of New York. Unless the administration or the electorate has a change of heart, the REAL ID rules may prevent us from seeing a client in person until well into 2021. At least the construction at LaGuardia may be finished by then. Even if we’re not seeing clients face to face, however, communication continues. Several topics have come up repeatedly in virtual discussions and we devote this week’s report to examining them. Our overriding impression is that global investors have been surprised by risk assets’ resilience and are skeptical that it can be sustained. We share the surprise and some measure of the skepticism, though we are more constructive than most BCA clients because of our conviction that policymakers can bridge the economic gap created by the pandemic and the commercially restrictive measures undertaken to combat it. Yes, Estimates Are Too High (But It’s Mainly An Election Story) Q: Consensus S&P 500 earnings estimates for next year are in line with actual 2019 earnings, yet 2019 was the tenth full year of an expansion and we’re likely to begin 2021 with an unemployment rate close to 10%. Isn’t there something wrong with this picture? We agree that consensus estimates for 2021 S&P 500 earnings are too high. It seems unlikely on its face that 2021 earnings, currently estimated at $163, will match 2018 ($162) and 2019 ($163) when the public health and economic backdrops are so uncertain. An additional 14% of EPS growth in 2022 seems like a pipe dream. We put very little stock in consensus estimates more than two quarters into the future, however, because analysts put very little effort into producing them. They focus on the current quarter and the following quarter; estimates beyond that range are nothing more than simple extrapolation. Investors familiar with sell-side analysts’ processes presumably don’t look beyond near two-quarter estimates themselves. We therefore doubt that the equity market is hanging on stated 2021 estimates and will be at risk when they are eventually revised down. We simply conclude that the S&P 500’s forward four-quarter earnings multiple of 24 is somewhat more elevated than it appears to the naked eye. Stocks are not cheap, and investors have probably gotten somewhat complacent. Equities have little margin for safety now and are therefore vulnerable to a near-term decline. Valuation is a notoriously poor timing tool, however, and we are content to remain neutral on equities over the tactical zero-to-three-month timeframe. A much stronger case against the earnings outlook for 2021 and beyond comes from the president’s flagging re-election prospects. Our Geopolitical Strategy service continues to estimate Joe Biden’s probability of winning the election at 65%. The virtual betting market PredictIt places Biden’s odds at 62%, and has had him as the favorite since May 30th. It is too simplistic to say that a Democratic president, backed by majorities in both houses of Congress,1 would be bad for the economy, but a Biden victory would introduce two profit headwinds. First, reversing half of the decline in the top marginal corporate tax rate, as the Biden campaign has proposed, would directly strike at the earnings stream available to common shareholders. Precisely quantifying that drop is not easy. S&P 500 constituents’ effective tax rates vary widely, with only a small proportion paying the statutory rate, and they do not disclose the federal component of their tax bill. We make the simple back-of-the-envelope assumption that the maximum net earnings impact of the cut in the top marginal rate from 35% to 21%, beginning in 2018, was 21.5%, as .79 (1-.21) is 21.5% greater than .65 (1-.35). Similarly, the maximum net earnings impact of hiking the top marginal rate to 28% from 21%, beginning in 2021, would be -9%, as .72 (1-.28) is nearly 9% less than .79 (1-.21). Equities seem to be ignoring the negative profit margin consequences of an increasingly likely Democratic sweep. Chart 1The Tax Cut Materially Boosted Median S&P 500 Earnings The change in effective tax rates before and after the 2018 tax cuts was about half of our maximum ballpark estimate. In the two years before the rate cut, excluding 4Q17 and its myriad one-time adjustments, the median effective tax rate for S&P 500 constituents was around 28%; in the two subsequent years, excluding 1Q18, the median rate has hovered near 20% (Chart 1). The change suggests that the tax cuts have boosted median S&P 500 earnings by about 11%.2 In addition to raising taxes, a Biden administration would be considerably more friendly to labor than the Trump administration. A soft labor market in which full employment is at least a few years away argues against broad wage gains, but companies that have benefitted from a complaisant National Labor Relations Board for the last four years could face a rude awakening. If Biden wins, we wager that McDonald’s workers will be unionized before next summer,3 a scenario that McDonald’s stock clearly does not anticipate (Chart 2). Chart 2For McDonald's, A Biden Win Means An NLRB Reversal Bottom Line: A Democratic sweep would weigh on earnings via higher corporate income tax rates and revived advocacy for labor at executive branch departments like the NLRB. Considering these incremental drags, it is unlikely that S&P 500 earnings will match their 2019 levels in 2021. Policymakers Versus The Virus: The Fight So Far Chart 3D.C. Is Keeping Households Afloat ... Q: Your constructive cyclical take depends on policymakers’ ability to offset the pandemic’s economic consequences. How do the data say that’s going so far? The data say that it’s going swimmingly. Thanks to generous transfer payments from the federal government, personal income in April and May comfortably surpassed February’s pre-pandemic peak (Chart 3). Households have not spent much of their windfall (Chart 4), choosing instead to squirrel it away, driving the savings rate to 32% in April and 23% in May. The mountain of savings will make it easy for households to service their debt (Chart 5), which they have been paying down. Chart 4... And They're Saving The Money, ... Chart 5... Much To Their Creditors' Relief The apartment REITs will not likely disclose June rent collection data before their earnings calls, but the National Multifamily Housing Council rent tracker shows that June collections have built on May’s month-over-month improvement. Through June 27th, June collections are tracking ahead of April and May collections and are barely off of last year’s pace (Table 1). Table 1Apartment Tenants Are Paying Their Rent Table 2Consumer Borrowers Are Making Their Payments TransUnion’s monthly consumer loan delinquency data for May reinforce the conclusion that policymakers are achieving their goal of preventing a default spiral. Auto loan delinquencies rose sharply in May, but delinquencies in all other personal loan categories fell on a month-over-month basis (Table 2). Mortgage delinquencies are below their year-ago level, while credit cards and other personal loans have risen only slightly from a low base. Auto loan delinquencies are up appreciably from May 2019, but TransUnion’s data show that the true rot is concentrated in loans made by independent lenders. Their 60-day delinquencies rose to 7.2% in May from 4.5% in April, while bank (0.62%) and credit union delinquencies (0.51%) eased slightly in May. Bottom Line: Extremely generous income assistance has helped households amass formidable cash reserves. The aid has allowed households to pay their rent and service their debt, shielding landlords, banks and many specialty lenders from pressure. Policymakers Versus The Virus: Going The Distance Q: What might cause the Fed to waver in its resolution to help the economy battle the virus? Will the Senate block future stimulus efforts? Nothing will cause the Fed to waver in its resolution to shield the economy from the virus; investors can take Chair Powell’s pledge to do whatever it takes for as long as it takes to the bank. Capitol Hill’s commitment is much less certain and public posturing during Senate negotiations could stoke market volatility. Elected officials reliably respond to career incentives, however, and those incentives will keep recalcitrant Senate Republicans from blocking another round of fiscal largesse. Investors need not worry that Republicans in the Senate will pull the rug out from under the economy and markets – doing so would wreck their own political fortunes. The Republicans’ election prospects have been sliding for a month. Four months is an eternity in a campaign, and they have ample time to reverse their fortunes. But if Republican Senators were to obstruct the passage of the next aid bill, they would be signing their own death warrant. They simply cannot cut off ailing households’ lifeline, or strip municipalities of essential services, as the campaign enters the homestretch. Any individual Senator would be imperiling his/her own quest for influence, and the party’s majority status and relevance, if s/he were to cast one of the votes that blocked a new spending round, and it would be folly to do so over a minor matter like principle. Policymakers Versus Active Managers Q: If valuations no longer matter, how do we show our clients that we’re adding value? It chagrined us to acknowledge on a call last week that equity valuations have been greatly deemphasized in our base case scenario. That scenario calls for overweighting equities in balanced portfolios over a twelve-month timeframe on the view that the flood of emergency stimulus will linger in the system long after it’s needed, stoking aggregate demand and pushing up the prices of cyclically exposed assets. Provided that policymakers succeed in limiting defaults and bankruptcies, thus preventing a pernicious chain reaction from taking hold, we are willing to overlook elevated valuations. Massive accommodation makes active managers' jobs harder because there's no telling who's swimming naked when policymakers won't let the tide go out. Those valuations are supported arithmetically by discount rates which appear as if they will remain very low for an extended period as long as investors don’t become nervous and demand a higher equity risk premium, diluting the impact of nominally lower interest rates. Our base case is that they won’t, but there is no doubt that equity investors’ margin of safety is quite thin. We cannot use the term margin of safety without thinking of Benjamin Graham, and it gives us a pang to think that his disciples may face another few years of wandering in the wilderness. Value investing is predicated on making distinctions between individual companies, as is security analysis more generally. A rising tide lifts all boats, however, and the massive stimulus efforts that have been unleashed in all the major economies (Chart 6) have the effect of obliterating differences between companies. That potentially limits the value that skilled active managers can add to an investment portfolio via a focus on traditional bottom-up metrics. Chart 6All Together Now Our solution is to try to focus on the varying impact top-down factors will have on different companies and sub-industry groups. We are overweight the SIFI banks because we view them as the biggest beneficiary of policymakers’ attempt to suppress defaults and their rock-bottom valuations stand in sharp contrast with the rest of the market. We echo our fixed income strategists’ recommendations to buy the bonds the Fed is buying. We also think that positioning portfolios for regulatory changes that might ensue in 2021 and beyond could be a rich source of alpha if a blue wave really is poised to strike the US on the first Tuesday in November.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com     Footnotes 1 Our geopolitical team expects the Democrats to take the Senate if they win the White House. PredictIt markets imply that Democrats have a 61% probability of winning a Senate majority. 2After-tax earnings before the tax cut were 72 cents on the dollar (1-28%) = .72. After the tax cut, they rose to 80 cents (1-20%) = .80. 80 is 11.11% greater than 72. 3Please see the NLRB/McDonald’s discussion on pp.7-9 of the February 3, 2020 US Investment Strategy Special Report, “Labor Strikes Back, Part 3: The Public-Approval Contest,” available at usis.bcaresearch.com.