Productos básicos de consumo

Aspectos destacados Estrategia de cartera La creciente demanda de materiales de embalaje, el aumento del poder de fijación de precios de la industria junto con valoraciones relativas atractivas señalan que las acciones descuidadas de envases y embalajes son una joya oculta dentro del sector materials de S&P. Mantener sobreponderación. El debilitamiento de la actividad de la industria junto con la ausencia de una válvula de alivio en las exportaciones en un momento en que la economía está en camino de funcionar a plena capacidad, nos obliga a poner el índice de bebidas sin alcohol S&P en nuestra lista de vigilancia de degradación.            Cambios recientes No hay cambios en nuestra cartera esta semana. Tabla 1 ¿Metamorfosis en pausa temporal? ¿Metamorfosis en pausa temporal? Característica La euforia del mercado de renta variable se ha apoderado del escenario con el SPX alcanzando nuevos máximos históricos en numerosas ocasiones durante las últimas dos semanas. Una Fed acomodaticia y políticas fiscales ultra-expansivas siguen siendo los principales impulsores macro de este mercado alcista. Si bien la economía está en camino de prosperar en 2021, los indicadores económicos adelantados pronto empezarán a mostrar problemas y tendrán que moderarse. Las lecturas ISM de manufactura y servicios están en niveles estratosféricos, lo que suscita dudas sobre cuánto más pueden subir (Gráfico 1). El inminente proyecto de ley de infraestructura de 2,4 billones de dólares, a continuación de los paquetes de alivio fiscal de 900.000 millones y 1,9 billones desde finales de diciembre, también probablemente está totalmente reflejado en los precios exuberantes de las acciones. Como mostramos hace dos semanas, ya se han descontado más de dos subidas de la Fed en el mercado OIS durante los próximos 24 meses, ¡y cuatro para finales de 2023 (Gráfico 2)! Gráfico 1 Tan bueno como puede ser Mejor imposible Mejor imposible Gráfico 2 Explicando la fortaleza del dólar estadounidense Explicando la fortaleza del dólar estadounidense Explicando la fortaleza del dólar estadounidense Las estimaciones de BPA a doce meses y a cinco años del S&P 500 han tocado techo y también lo han hecho las revisiones netas de beneficios (Gráfico 3). La tasa anual de variación del SPX no puede subir más durante el resto del año (segundo panel, Gráfico 1) y la amplitud es tan buena como puede ser, con el porcentaje de acciones del SPX por encima de sus medias móviles de 50 y 200 días acercándose al 100% (Gráfico 4).   Gráfico 3 ¿Euforia en su punto máximo? ¿Euforia en su apogeo? ¿Euforia en su apogeo? Gráfico 4 ¿Amplitud extendida? ¿Mayor amplitud? ¿Mayor amplitud? El VIX recientemente cayó por debajo de 16, los rendimientos basura alcanzaron mínimos históricos y el spread ajustado por opción de alto rendimiento tocó mínimos de varios años (Gráfico 5). En cuanto a los internos del mercado, mirar bajo el capó del SPX es revelador. Recientemente registramos ganancias considerables del 17% en nuestra cartera sesgada cíclicos/defensivos y nos movimos a la banda lateral. Esta relación desde entonces ha descendido, al igual que la relación small/large. Como recordatorio, consolidamos ganancias superiores al 16% a principios de año en el sesgo por tamaño y hemos estado neutrales desde el 12 de enero de 2021. Incluso nuestra operación long “Volver al Trabajo”/short “Ganadores COVID-19” ha chocado contra un muro y recientemente establecimos un stop móvil del 5% para proteger ganancias de más del 20% desde nuestra segunda puesta en marcha a principios de febrero (Gráfico 6). Gráfico 5 La complacencia domina La complacencia reina suprema La complacencia reina suprema Gráfico 6 Se está quedando sin impulso Perdiendo Impulso Perdiendo Impulso Finalmente, una serie de indicadores macro clave que seguimos nos mantienen alerta y nos ponen incómodos con la reciente estampida hacia las acciones. EURUSD fue el primero en alcanzar su pico a principios de enero, luego el oro se estancó y, finalmente, el índice Kospi de Corea del Sur tocó techo. Añádase el reciente bajo rendimiento relativo de los mercados de acciones emergentes y el riesgo es que estos indicadores hipersensibles al crecimiento están olfateando algún problema, potencialmente un parche de desaceleración económica fuera de EE. UU. Por tanto, se requiere cierta cautela hasta que todos estos indicadores clave salgan de su reciente bache (Gráficos 7 & 8). Gráfico 7 Tres activos macro a vigilar de cerca Tres activos macro a vigilar de cerca Tres activos macro a vigilar de cerca Gráfico 8 Se agota el estímulo Se acaba el estímulo Se acaba el estímulo Esta semana actualizamos nuestro modelo de descuento de dividendos (DDM) del SPX por quinto año consecutivo, junto con el análisis de sensibilidad BPA/múltiplo del SPX y la prima de riesgo de capital (ERP) forward del SPX. Las tres metodologías apuntan a un valor razonable del SPX cercano a 4.050. Como recordatorio, hemos sido, y seguimos siendo, muy conservadores en nuestras suposiciones del DDM. De nuevo este año asumimos que no habrá recompras, una suposición que mantenemos desde hace tiempo, es decir, proyectamos un divisor constante en el horizonte de cinco años. 2026 es nuestro año terminal cuando el crecimiento de dividendos se estabiliza en 6,6%, 60bps por debajo del promedio a largo plazo (panel inferior, Gráfico 9). Nuestra tasa de descuento del 8,2% refleja el promedio histórico del rendimiento del bono corporativo basura. En primer lugar, de manera notable, el dividendo anual completo del SPX para 2020 aumentó 4 centavos/acción en términos interanuales, ¡y superó incluso las estimaciones más optimistas que teníamos el pasado abril! Mientras que las financieras recortaron sus dividendos siguiendo la orientación de la Fed, el sector energético del S&P mantuvo sus dividendos tal como predijimos la pasada primavera. De forma impresionante, planteamos que XOM y CVX mantendrían su estatus de aristócratas del dividendo (es decir, un mínimo de 25 años consecutivos de aumento de los pagos de dividendos), lo cual fue controvertido en ese momento, y posteriormente estas dos grandes petroleras estadounidenses divergieron de sus homólogas europeas. Además, aunque muchos expertos usarán la crisis financiera global como un paralelo cercano, la recesión acelerada tras el 11-S resultó ser el episodio histórico más preciso desde la perspectiva de dividendos (panel inferior, Gráfico 9), y no nos sorprendería que se arraigara un salto en el crecimiento de dividendos similar al posterior a la recesión del 11-S. Gráfico 9 Dividendos resilientes del SPX Dividendos Resilientes del SPX Dividendos Resilientes del SPX Continuando desde el año pasado, este año utilizamos dos enfoques diferentes de crecimiento de dividendos: nuestras propias estimaciones y, alternativamente, el crecimiento derivado de los futuros de dividendos del S&P 500. Tablas 2 & 3 resumen los resultados. Tabla 2 Modelo de descuento de dividendos del SPX: Usando las suposiciones de crecimiento de dividendos de USES ¿Metamorphosis en pausa temporal? ¿Metamorphosis en pausa temporal? Tabla 3 Modelo de descuento de dividendos del SPX: Usando las suposiciones de crecimiento de futuros de dividendos del S&P ¿Metamorphosis en espera temporal? ¿Metamorphosis en espera temporal? Tabla 4 Sensibilidad de BPA y múltiplo del SPX ¿Metamorfosis en espera temporal? ¿Metamorfosis en espera temporal? Nuestras propias estimaciones de crecimiento de dividendos dan como resultado un valor razonable del SPX de 4.050 (Tabla 2). Nuestras suposiciones no son tan pesimistas como las de los futuros de dividendos del SPX, que dan lugar a un valor razonable del SPX de 2.900 (Tabla 3, por favor haga clic aquí si desea recibir nuestro DDM e insertar sus propias suposiciones). Tabla 5 Análisis de la prima de riesgo de capital forward ¿Metamorfosis en suspensión temporal? ¿Metamorfosis en suspensión temporal? Para complementar nuestra estimación de valor razonable del SPX de 4.050, las Tablas 4 y 5 destacan nuestro análisis de sensibilidad y las estimaciones de valor razonable del ERP forward. Nuestro punto de partida es la estimación de BPA de la Street de 203,1 dólares para el calendario 2022 y el P/E forward del SPX derivado de 20,3. De forma similar, para el análisis ERP forward usamos la estimación de BPA de la venta para 2022 junto con un rendimiento a 10 años del Tesoro de EE. UU. forward del 2% y un ERP de equilibrio cercano a 300bps debido a: el compromiso de la Fed de mantenerse extremadamente acomodaticia, la volatilidad en descenso, el colapso de la incertidumbre política y el incremento del ISM manufacturero (Gráficos 10 & 11). Gráfico 10 Economía en auge… Economía en auge… Economía en auge… Gráfico 11 …se traduce en un ERP en caída …Se traduce en Melting ERP …Se traduce en Melting ERP Este análisis dual corrobora el valor razonable de 4.050 del modelo DDM del SPX y sugiere que el SPX está completamente valorado en el momento actual, dejando poco, si es que hay alguno, margen ante cualquier percance. Nuestros dos riesgos macro clave para el resto del año siguen siendo la inminente desaceleración de China y la reducción de estímulos (tapering) de la Fed, lo que advierte que se justifica cierta cautela a corto plazo. Esta semana actualizamos un subsector de materiales nicho y establecemos una advertencia de degradación en un subgrupo de bienes de consumo básicos. Manténgase con envases y embalajes Las acciones de envases y embalajes ahora representan aproximadamente el 13% del índice materials de S&P, constituyen un grupo nicho dentro de un sector nicho y si no estuviéramos ya sobreponderados no dudaríamos en asignar capital a este índice. En pocas palabras, el Gráfico 12 captura el atractivo de las acciones de envases y embalajes. Estas acciones materials descuidadas son una apuesta por el aumento del poder de fijación de precios debido a la demanda insaciable de containerboard y otros materiales de embalaje. Añádase la disciplina de costes de los ejecutivos y una historia de expansión del margen de beneficio sorprenderá tanto a analistas como a inversores y servirá como catalizador para una fase de revaloración duradera (panel inferior, Gráfico 12). En más detalle, las exportaciones de alimentos envasados junto con el gasto de los consumidores en alimentos y bebidas están disparándose. El aumento de los envíos de la fabricación de alimentos corrobora este optimista telón de fondo de demanda y señala que la ruta de menor resistencia es al alza para las estimaciones de crecimiento de ingresos y beneficios de los analistas ultra-pesimistas de venta (Gráfico 13). Gráfico 12 ¿Qué no gusta? ¿Qué podría no gustarte? ¿Qué podría no gustarte? Gráfico 13 Demanda optimista… Demanda optimista… Demanda optimista… El auge de los cargamentos intermodales de vagones de ferrocarril que miden la demanda de la industria minorista también respaldan las ganancias de los fabricantes de envases y embalajes (panel intermedio, Gráfico 14). De forma similar, el índice CASS de fletes, que sigue la salud de diferentes industrias de transporte de EE. UU., está en auge y confirma que los beneficios relativos se recuperarán en la segunda mitad del año (panel inferior, Gráfico 14). Más allá de la vigorosa recuperación en la fabricación de alimentos según la última publicación de IP de la Fed, que es una bendición para los productores de embalajes (panel inferior, Gráfico 15), las ramificaciones del COVID-19 también representan una fuente creciente de demanda para la industria. El COVID-19 ha servido como acelerante de la tendencia en curso de las ventas minoristas fuera de tienda, que capturan una porción cada vez mayor de las ventas minoristas totales. A medida que las ventas por internet se llevan una porción mayor del conjunto, la implicación es que la demanda de cajas y otros materiales de embalaje como el plástico de burbujas está aumentando a un ritmo saludable (segundo panel, Gráfico 15). Gráfico 14 ...En todas partes… ...En todas partes… ...En todas partes… Gráfico 15 …Basta con mirar …Uno mira …Uno mira Finalmente, desde una perspectiva global, los volúmenes de exportación mundiales han alcanzado nuevos máximos históricos (tercer panel, Gráfico 15) y las lecturas globales de PMIs manufactureros han alcanzado velocidad de escape. La conclusión es que, a medida que el comercio gane impulso y los cuellos de botella y las escaseces se resuelvan probablemente en la segunda mitad de 2021, los volúmenes de exportación permanecerán boyantes, impulsando aún más el atractivo de las acciones de envases y embalajes. En resumen, la creciente demanda de materiales de embalaje, el aumento del poder de fijación de precios de la industria junto con valoraciones relativas atractivas señalan que las acciones descuidadas de envases y embalajes son una joya oculta dentro del sector materials de S&P. Conclusión: Mantener sobreponderación en el índice S&P de envases y embalajes. Los símbolos de cotización de las acciones en este índice son: BLBG: S5CONP– WRK, SEE, IP, AVY, BLL, PKG, AMCR. Ponga las bebidas sin alcohol en alerta de degradación Las bebidas sin alcohol han sufrido recientemente y estamos atentos a un rebote por sobreventa antes de pasar a infraponderar este subgrupo de bienes de consumo, por lo que hoy activamos una alerta de degradación. Aunque las ganancias de PEP fueron en el lado positivo, los indicadores macro adelantados señalan que a los inversores les irá mejor evitando este subíndice defensivo de bienes de consumo básicos. Es importante destacar que las acciones refugio de bebidas sin alcohol, que tienden a ser generadores de flujo de caja muy estables tanto en tiempos buenos como malos, lo hacen peor durante las primeras etapas de una expansión económica. A medida que el crecimiento pasa de la escasez a la abundancia, los inversores comienzan a deshacer exposición a valores defensivos como las bebidas sin alcohol (ISM mostrado invertido, panel intermedio, Gráfico 16). De forma similar en el frente operativo, nuestro Proxy de Actividad de la Industria de Bebidas ha tocado techo últimamente y advierte que las estimaciones relativas de crecimiento de beneficios que están cayendo probablemente resultarán precisas (panel inferior, Gráfico 16). Es cierto que los analistas de venta parecen haber tirado la toalla con este subgrupo de bienes de consumo, con estimaciones de crecimiento de beneficios a 12 meses y a cinco años cayendo a mínimos de varios años (panel intermedio, Gráfico 17). Sin embargo, las valoraciones relativas han seguido la senda de este castigo del BPA, y la relación P/E forward relativa cotiza un 14% por debajo de la media histórica (panel inferior, Gráfico 17). Gráfico 16 Algunas banderas amarillas Algunas señales de advertencia Algunas señales de advertencia Gráfico 17 Blues de desvaloración Los blues del derating Los blues del derating Los beneficios y los ingresos reales han cerrado el círculo debido al salto considerable durante el auge de quedarse en casa inducido por la pandemia; sin embargo, una repetición de ese crecimiento espectacular sigue siendo esquiva para 2021. Esto es especialmente cierto si la válvula de alivio en las exportaciones permanece firmemente cerrada para la industria. Ya existe una brecha considerable entre la inteligente recuperación del índice de divisas asiáticas, pero las exportaciones de la industria todavía están intentando lograr un impulso interanual positivo (Gráfico 18). La ligera caída relativa en la producción industrial (IP) de bebidas sin alcohol, según la última publicación de IP de la Fed, corrobora nuestra visión de que existe un elemento de “robar demanda del futuro” debido al COVID-19, y el crecimiento de la cifra superior probablemente sorprenderá a la baja, especialmente dado el ascendente indicador ISM manufacturero (ISM mostrado invertido, panel inferior, Gráfico 19). Gráfico 18 La válvula de exportación está bloqueada La válvula de exportación está bloqueada La válvula de exportación está bloqueada Gráfico 19 La economía rugiente pesa sobre los defensivos Economía en auge pesa sobre los valores defensivos Economía en auge pesa sobre los valores defensivos No obstante, somos pacientes antes de apretar el gatillo y degradar a una asignación por debajo del benchmark, ya que no solo los aspectos técnicos están exhaustos, sino que también tres indicadores adicionales nos mantienen en la banda lateral, al menos por ahora: Primero, si hay incluso una leve recaída económica, el rendimiento a 10 años del Tesoro de EE. UU. será el primero en detectarlo y la reciente pausa en la venta en el mercado de bonos es motivo de ligera preocupación (panel superior, Gráfico 20). Segundo, los envíos de la industria, aunque son un indicador rezagado, siguen siendo resistentes (panel intermedio, Gráfico 20). Finalmente, el poder de fijación de precios de las bebidas sin alcohol también es robusto y hay evidencia tentativa de que los productores de bebidas han tenido éxito en traspasar al menos parte de sus crecientes costes de insumos – mayormente por la inflación de las materias primas (panel inferior, Gráfico 20). En resumen, la debilitación de la actividad de la industria junto con la ausencia de una válvula de alivio en las exportaciones en un momento en que la economía está en camino de funcionar a plena capacidad, nos obliga a poner el índice de bebidas sin alcohol S&P en nuestra lista de vigilancia de degradación. Conclusión: Active una alerta de degradación en el índice S&P de bebidas sin alcohol. Los símbolos de cotización de las acciones en este índice son: BLBG: S5SOFD – KO, PEP, MNST. Gráfico 20 Pero hay algunos contrapesos sustanciales Pero Hay Algunas Compensaciones Sustanciales Pero Hay Algunas Compensaciones Sustanciales   Anastasios Avgeriou Estratega de renta variable de EE. UU. anastasios@bcaresearch.com   Recomendaciones actuales Operaciones actuales Recomendaciones estratégicas (10 años) ¿Sobredosis? ¿Sobredosis? Vistas de tamaño y estilo 24 de febrero de 2021 Mantener neutro: cíclicos frente a defensivos 12 de enero de 2021  Mantener neutro: pequeñas frente a grandes capitalizaciones 11 de junio de 2018 Posición larga en la cesta BCA Millennial  Los símbolos de cotización son: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, ABNB, V). 22 de enero de 2018 Favorecer value sobre growth

Highlights President Biden’s $2.4 trillion “American Jobs Plan” is a major US public investment that will dispel any endogenous deflationary tail risk from the US economy this cycle, increase inflation expectations yet boost productivity, and hike corporate taxes. The proposal has an 80% chance of passage before the end of the year given that infrastructure is popular and Democrats can pass the bill via reconciliation with zero Republican votes.   The $2.4 trillion infrastructure proposal will take effect over eight years and will be offset by corporate tax hikes that will take effect over 15 years. The increase in the budget deficit will be around $400 billion if all tax hikes pass and $1.4 trillion if only half the tax hikes pass. The American Families Plan will follow with another roughly $700 billion to $1.3 trillion increase to the budget deficit, depending on how much individual/household taxes go up. But this bill only has a 50/50 chance of passing before the 2022 midterm elections. Investors should maintain a bullish cyclical (12-month) bias and keep favoring value stocks, industrials, and materials over tech and health care. We also recommend going long consumer discretionary stocks and energy large caps versus small caps. Feature President Joe Biden spoke in Pittsburgh on Wednesday to unveil his economic vision and policy proposals going forward. Biden proposed a $2.4 trillion “American Jobs Plan” infrastructure and green energy package to be implemented over eight years, which will be part of a $4 trillion-plus “Build Back Better” legislative agenda that will be partially offset by an estimated $3 trillion in tax hikes to take effect over 15 years. The result will be a pro-cyclical boost to fiscal thrust, GDP growth, and inflation expectations; some potential for a productivity boom; a possible expansion of the social safety net; and tax reform that reduces US corporate profits. Pennsylvania is a Rust Belt state, Biden’s home state, and a critical swing state in the 2016 and 2020 elections, so the location makes sense. Biden aims to solidify the economic recovery and restore the Democratic Party’s leadership on infrastructure and manufacturing after Republican President Trump nearly stole their thunder. If he succeeds then his administration and party will improve their support substantially. The US economy is opening rapidly while the COVID-19 vaccination campaign continues apace. Chart 1 shows that household disposable income and net worth surged as a result of giant fiscal relief while consumer spending lags behind due to social distancing. The $1.7 trillion treasure chest of personal savings creates the basis for an increase in spending as consumers get vaccinated and regain their freedom. Economic policy uncertainty has collapsed, even relative to global uncertainty (Chart 2). There are no longer doubts about whether government will spend the country out of a slump. Even state and local governments have been bailed out despite having much stronger finances than predicted. However, there are doubts about how much more deficit spending the Biden administration will be able to push through, and that is what will now be debated in Congress following Biden’s Pittsburgh proposals. Chart 1Lower Spending And Higher Income Led To Mounting Excess Savings Chart 2US Policy Uncertainty Soon To Revive There will not be much of a deflationary tail risk to the new business cycle in the context of this expansive fiscal policy, as bullish investors are well aware. However, policy uncertainty will revive going forward as more spending will raise the risk of economic overheating, tax hikes will affect different sectors disproportionately, deficits and debt will balloon, and Biden’s challenges with immigration and foreign policy will intensify. There is an upside risk for the stock market that Congress delays tax hikes but this is not our base case. In this week’s report we revise and update our estimates for the impact of Biden administration’s legislative proposals – including his projected $4 trillion-plus in spending on infrastructure, health, and education – taking into consideration Biden’s Pittsburgh speech, his first press conference on March 25, and all the rumors and leaks that have come to light over the past two weeks. Back-Of-The-Envelope Estimates Of US Growth And Output Gap After ARPA First we need to revise our back-of-the-envelope estimates of the impact of the $1.9 trillion American Rescue Plan Act (ARPA). Chart 3 shows two scenarios for US GDP growth. The first is the “maximum” scenario, in which US real GDP grows by 10.7% because all of the money authorized under the new law is spent. The second scenario puts real growth at 6% by using only the Congressional Budget Office’s expected federal outlays (as opposed to budget authority) to estimate the government spending component of GDP. In both cases we assume that 33% of the fiscal relief is spent in FY2021 and the remainder in FY2022. These scenarios do not include Biden’s American Jobs and Families Plans because those bills have yet to be drafted, let alone pass Congress. Chart 3Revised US GDP Estimates With ARPA Consensus estimates put real GDP growth at 5.7% and the Federal Reserve estimates that 2021 growth will clock in at 6.5%, as shown in Chart 4. Not all of the government spending will translate directly into aggregate demand because 37% of the ARPA consists of direct checks and unemployment benefits to households that may only spend one-third of the amount they receive (while paying down debt with a third of it and saving a third of it). Yet more government deficit spending is coming down the pike and consumers are sitting on a huge pile of savings, which implies that growth could surprise to the upside of consensus estimates. Chart 4Consensus Estimates Of US GDP PosT-ARPA Chart 5 uses our same back-of-the-envelope calculation to estimate the impact of current law (including ARPA) on the US output gap. The output gap is the difference between actual GDP growth and potential GDP growth – during busts the country’s growth falls well beneath potential while during booms it rises above potential. The chart shows that if all of the government relief funds are spent then the output gap will be more than closed by the end of the year. By contrast, the CBO’s January projection shows the output gap persisting through 2025. While our estimates in Chart 5 may be too generous regarding federal cash handouts translating directly to consumer spending and higher demand, nevertheless the consensus estimate is entirely understated and out of date as a result of ARPA and the Biden administration’s additional fiscal spending that is coming. Chart 5Revised US Output Gap Estimates With ARPA Chart 6Revised US Budget Deficit Projection Post-ARPA Chart 6 updates our US budget deficit outlook using the CBO’s February budget baseline. The ARPA’s increase in government spending is added to create the new Democratic Party status quo scenario over the next ten years, with the budget normalizing by 2025. The Democratic low spending scenario assumes that Biden passes the $2.4tn infrastructure-plus plan announced in Pittsburgh (Table 1) using all the revenue from all the corporate tax hikes. Biden’s agenda will be broken into separate bills with varying probabilities of success. So in our budget deficit outlook we only include the infrastructure-and-corporate-tax-hikes component that is apparently being prioritized. Table 1Biden's 'American Jobs Plan' Bottom Line: US growth will surprise to the upside of consensus estimates while the US output gap will be closed much sooner than expected. Financial markets are largely prepared for this outcome, although it reinforces that investors should maintain a cyclically bullish view and tactically should buy on the dips. Biden’s Pittsburgh Speech And ‘American Jobs Plan’ Budget Impacts Our view is that the Biden administration has a subjective 80% chance of passing a second major budget reconciliation bill (FY2022) and a 50% chance of passing a third budget reconciliation bill (FY2023). The question appears to be resolved that Democrats will prioritize infrastructure over social welfare. Whichever one they prioritize can be linked to tax hikes and yet will still be highly likely to pass given that no Republican votes are needed under budget reconciliation rules. Moderate Democrats may water down the tax provisions but they would be suicidal to oppose their entire party on the administration’s signature piece of legislation. The social spending bill, assuming it follows infrastructure, would have to be pursued via a third reconciliation bill for FY2023 but it is less likely to pass. By next year Biden will have spent a lot of his political capital, fiscal spending fatigue will be a real phenomenon, and the 2022 midterm elections will loom. What matters for investors is the impact on the budget deficit since that will determine how big of an impact will hit GDP and how long US fiscal policy remains accommodative. Table 2 shows the impact on the budget balance if Biden gets all of his spending and all revenue proposals (Baseline), if he gets all the spending but only half the tax hikes (Scenario 1), and if he gets half the spending and half the tax hikes (Scenario 2). Scenarios 3 and 4 treat the social spending plan with varying degrees of tax revenue from the proposed individual tax hikes, while Scenarios 5 and 6 treat the infrastructure plan with varying tax revenue from corporate tax hikes. Table 2Biden’s Forthcoming ‘American Jobs Plan’ Legislative Proposals Table 3 shows the Biden campaign’s proposed tax hikes by line item along with the spending proposals. The range of net deficit spending runs from about $400 billion to about $3 trillion over ten years, which is a broad range and not very telling but which seems, subjectively, likely to settle in the $2 trillion range. Chart 7 shows the budget deficit’s deviation from the status quo trajectory in each of these scenarios, i.e. additional fiscal thrust. Table 3Biden’s Tax-And-Spend Proposals In Detail Chart 7US Budget Deficit Projections With ‘American Jobs Plan’ Agenda The infrastructure package consists of a range of proposals having to do with traditional roads and bridges, renewable energy, rural broadband Internet, domestic manufacturing incentives, supply chain security initiatives, affordable housing, and research and development (see Table 1 above). The social safety net expansion consists of making permanent the child tax credit that was extended in the ARPA; lowering the Medicare eligibility requirement to age 60 from 65; lengthening paid family/medical leave for workers; funding universal pre-school; and funding tuition-free community college. Some Democrats will oppose delaying social spending and tax hikes because they may not pass before the midterms and Republicans could easily take back control of the House of Representatives in 2022. Hence there is still a chance that Biden will pursue infrastructure on a bipartisan and piecemeal basis while using the FY2022 budget reconciliation for his social spending and tax hikes. The reasoning goes as follows: Historically the House has a high probability of shifting against a new president’s party in his first midterm election. The only exception to this rule were George W. Bush and Franklin D. Roosevelt. Republicans will definitely oppose social welfare and tax hikes, whereas they could be convinced to support an infrastructure plan. Republicans will not vote for infrastructure if it includes tax hikes and many Democrats believe that long-term infrastructure spending will enhance productivity and hence need not require revenue offsets. Hence there is still a chance of a bipartisan infrastructure bill. This would jeopardize its overall passage but it would ensure that Democrats could pass their social agenda via FY2022 reconciliation. What are the odds of bipartisanship? Throughout this year we have reserved some space for bipartisan lawmaking to take place under the radar. A recent example is the Paycheck Protection Program (PPP) Extension Act of 2021, which Biden signed into law on March 30. This is a bipartisan extension of the small business emergency loan program that began under President Trump. Senate Majority Leader Mitch McConnell quashed objections from within his party to extending the program, which has substantial support from the National Federation of Independent Business.1 The result was a 92-7 vote majority in the Senate, showing that Republican cooperation is possible. The fact that Republicans also cleared the way for the use of earmarks, or pork barrel spending directed at a critical lawmaker’s constituency in exchange for his or her vote, also suggests that bipartisanship is possible, particularly on infrastructure. Republicans can also be brought to support efforts to secure supply chains and energize the US technological race with China, such as the $50 billion funding for semiconductor manufacturing, which could be part of a major infrastructure package or regular budget appropriations. The catch is that Republicans will not support tax hikes, unionization, IRS strengthening, workplace enforcement, or climate change policies pursued under the guise of infrastructure. As a result the Democrats are highly incentivized to bypass Republicans from the beginning and pursue their agenda through two separate reconciliation bills. Finally, Democrats still have the option of removing the Senate filibuster, enabling regular bills to pass with merely 51 votes. Investors should plan on this occurring despite the news media narrative suggesting that moderate Democrats do not want it to happen – the point is that it is not an invincible check on the ruling party’s power. Biden signaled in his first press conference on March 25 that he is willing to see the filibuster removed. Bottom Line: Democrats can pass most of their infrastructure and social safety net proposals via budget reconciliation bills for FY2022 and FY2023, without a single Republican vote. If they do so they can only spare three votes in the House and zero votes in the Senate – meaning that the devil is in the details. Their odds of passing the first are high at a subjective 80% but then their odds of passing the second are 50/50 at best. Thus it is not wise to bet against Democratic tax hikes or new spending. The net impact on the deficit will be negative and hence stimulating for the economy. Growth and inflation will surprise to the upside. Biden’s Political Capital Still Moderate-To-Strong Our argument above is based in great part on Biden’s political capital, which is moderate but likely to strengthen as consumer sentiment rises. Table 4 updates our US Political Capital Index. Political polarization is subsiding from extreme peaks, and business sentiment and economic conditions are improving (with a surge in capex intentions albeit rising concerns over regulation). Table 4Biden’s Political Capital Sufficient For Another Major Bill The weak spot is household sentiment as Biden’s approval rating is falling (normal for presidents as their honeymoon ends). However, consumer confidence is already picking up and will surely accelerate with vaccinations gaining ground, the dole being delivered, and the service sector reviving. Chart 8 shows that Biden’s approval rating is settling in the mid-50% range, which is substantially better than Trump’s at this time although worse than President Obama’s. Biden can be understood as a synthesis of these two predecessors given that he is coopting Trump’s agenda on fiscal spending, infrastructure, trade, and manufacturing while continuing Obama’s legacy on regulation, immigration, civil rights, and foreign policy. We expect Biden’s approval rating not to fall too far, unless he suffers a foreign policy disaster with China, Iran, or Russia, given that over 50% of voters will tend to support him as long as President Trump is the obvious alternative. Chart 9 suggests that Biden’s economic approval rating is weak but this score is going to rise once the new relief funds are distributed and the economic recovery gets going full steam. The early business cycle will probably be a constant source of support for the president over his four-year term. Chart 8Biden’s Approval Rating Fairly Stout Chart 9Biden’s Approval On Economy Will Rise Remarkably even the US Congress is gaining greater popular approval (Chart 10). This is very rare in modern times and could suggest that a major change is taking shape as Congress pursues populist fiscal policy under both Trump and Biden. Congress is handing out free money so people suddenly don’t hate it as much. There is a limit to how popular Congress will become and it will certainly not shake off its hard-earned reputation for gridlock and partisan rancor by suddenly exemplifying enlightenment and bipartisanship. But any rise in congressional approval is notable and would imply greater political capital for the current government and hence greater policy certainty for investors in the short run. Biden’s political capital is not yet suffering due to economic overheating as the latter has not yet happened – but it is a risk to monitor over the medium term. Inflationary pressures continue to build across the supply chain. Small businesses are increasingly flagging cost of labor as a rising concern while consumer price inflation is likely to pick up. Chart 10Congress Is Becoming More Popular Inflation expectations are critical and will take time to change. Americans think about inflation through prices at the pump. Chart 11 shows the US and global crude oil price and average gasoline prices at the gas station for US consumers. Gasoline prices have surged although they are not yet at the $4 per gallon level that causes popular concern to escalate sharply. Chart 11Inflation Is Coming But Geopolitics Brings Oil Price Volatility Oil prices are expected to go higher in the coming two years, according to our Commodity & Energy Strategy, but over a five-year period global supply-demand trends and balances suggest that the price will fluctuate within the $60-$80 dollar range. Biden’s regulations and foreign policy will introduce some volatility by hampering domestic US production, triggering sparks in the Middle East over Iran, and yet ultimately increasing global supply via any diplomatic deal with Iran. The BCA Research House View holds that today’s inflation is a temporary phenomenon whereas a more substantial bout of inflation is waiting in the medium-to-long term. The reason our strategists are not overly concerned in the near term is that there is still substantial slack in the economy: the labor force participation rate has fallen from 63.3% to 61.4% since the pandemic, the U6 unemployment rate stands at 11.1% (up from 7% prior to the pandemic), and the all-important employment-to-population ratio for prime-age workers stands at 57.6%, down from 61.1% prior to the pandemic. However, this slack is on pace to be tightened quickly as long as the pandemic subsides and Biden’s American Jobs Plan passes. Bottom Line: Our US Political Capital Index suggests Biden’s political capital is moderate-to-strong, which supports our view that he can pass at least one more major piece of legislation and possibly two. Inflation expectations will rise further and the selloff in US treasuries will continue. Investment Takeaways The market rally since January has priced a lot of the good news from Biden’s proposals, which are broadly similar to his campaign proposals. There is not a clear legislative strategy and passing two major bills before the midterm elections is a stretch. The priority bill, however, looks to pass by the end of this year after a roller-coaster ride of congressional negotiations and horse-trading. Deep cyclical sectors will benefit the most. We remain long value over growth stocks, specifically industrials and materials. We are also maintaining our long BCA infrastructure basket at least until passage of the bill is secured. Our infrastructure basket consists of a range of materials and machinery producers, construction services, and environmental services, and does not focus on headline “infrastructure” companies in the utilities and telecoms sectors. We recommend going long large cap energy stocks relative to small caps, which will have a harder time adjusting to Biden’s regulatory, tax, and green agenda. A long-term infrastructure plan that includes green energy, manufacturing, digital infrastructure, and R&D could create a productivity boost. Hiking the corporate tax rate to 28% is negative for corporate earnings but it will take place over a longer time frame and is being introduced in the context of a cyclical upswing. Hence we remain bullish over the course of this year. Biden’s Pittsburgh speech ostensibly confirmed the news flow over the past month suggesting that the Democrats will not propose a government-provided health insurance option in their upcoming legislative proposals. Instead they are prioritizing lowering the Medicare eligibility requirement and enabling Medicare to negotiate pharmaceutical prices. Our short of the managed health care sub-sector suffered from this shift in policy focus although we will maintain the trade as we expect the public option to reemerge at a later date. Meanwhile our pair trade of long health equipment and facilities relative to pharmaceuticals and bio-tech continues to perform well (Chart 12). A clear beneficiary of the US’s newfound proactive fiscal policy is the consumer. Consumer spending has not fully recovered from the pandemic and recession. Household disposable income ticked down in February from January, after the distribution of the government’s $900 billion COVID-19 relief funds in the Consolidated Appropriations Act passed in December. However, disposable income is up 8% over the 12 months since COVID broke out, due to fiscal relief. The result of lower spending and higher income is an increase in the personal saving rate to 13.6% in February, well above normal, as our US Bond Strategy highlights in its latest report. Recent research from our US Investment Strategy highlights that consumer growth should track relatively well with increases in household net worth, implying that nominal personal consumption expenditures could grow at a rate of 8.8% by the end of the year and 6.9% by the end of next year. Chart 12Stay Long Industrials Over Health Care Chart 13Go Long Consumer Discretionary Stocks In this context we take a positive view of consumer stocks in general. Cyclically we would favor consumer discretionary stocks and recommend investors go long. While discretionary spending should outperform as the economic upswing gains pace, we are holding consumer staples as a hedge against bad news (Chart 13). Not only will Biden’s tax hikes, inflation, and the rise in bond yields cause ongoing risks to cyclical sectors, but Biden also faces a series of imminent foreign policy tests with China/Taiwan, Iran, Russia, and North Korea, as highlighted in our sister Geopolitical Strategy.     Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Appendix Table A1Political Risk Matrix Table A2APolitical Capital: White House And Congress Table A2BPolitical Capital: Household And Business Sentiment Table A2CPolitical Capital: The Economy And Markets Table A3Biden’s Cabinet Position Appointments   Footnotes 1     Bill Scher, “The Bipartisan Senate Bill You Haven’t Heard About,” Real Clear Politics, realclearpolitics.com.          

Highlights Fiscal stimulus is no longer a free lunch. US mortgage applications are down by 20 percent since the start of February. With rising bond yields now starting to choke private sector borrowing, bond yields are nearing an upper-limit, and even a reversal point. In which case, the tide out of defensives into cyclicals, and growth into value, will be a tide that reverses. New 6-month recommendation: underweight US banks (XLF) versus consumer staples (XLP). Fractal trade shortlist: US banks, bitcoin, ether, and GBP/JPY. Feature Chart of the WeekMortgage Applications Are Down 20 Percent Why would anybody not get excited about trillions of dollars of fiscal stimulus? The two word answer is: crowding out. If a dollar that is borrowed and spent by the government (or even forecast to be borrowed and spent by the government) pushes up the bond yield, it makes it more expensive for the private sector to borrow and spend. If, as a result, the private sector scales back its borrowing by a dollar, the dollar of government spending has crowded out a dollar of private sector spending. In this case, fiscal stimulus will have no impact on GDP. The fiscal multiplier will be zero. Under some circumstances though, fiscal stimulus does not crowd out the private sector and the fiscal multiplier is extremely high. 2020 was the perfect case in point. As the pandemic gripped the world, much of the private sector was on its knees. Or to be more precise, in lockdown at home, doing nothing, receiving no income, and unwilling and unable to borrow. In such a crisis, the government became the ‘borrower of last resort’. It could, and had to, borrow at will to replace the private sector’s lost income and thereby to stabilise the collapse in demand. With no competition from private sector borrowers for the glut of excess savings, bond yields stayed depressed. Meaning that fiscal stimulus was a free lunch: it had lots of benefit with little cost (Chart I-2). Chart I-2Fiscal Stimulus Was A Free Lunch In 2020, But Not In 2021 Fiscal Stimulus Is No Longer A Free Lunch Covid-19 is still with us, and could be with us forever. Yet the economy will adapt and even thrive with structural changes, such as decentralisation, hybrid office/home working, a shift to online shopping, and less international travel. In fact, all these structural changes were underway long before Covid-19. Meaning that the pandemic was the accelerant rather than the cause of what was happening to the economy anyway. As the private sector now gets back on its feet to restructure, spend, and invest accordingly, fiscal stimulus is no longer a free lunch. Fiscal stimulus is most effective when it is not pushing up the bond yield. To repeat, last year’s massive fiscal stimulus was highly effective because it had little impact on the bond yield, so there was no crowding out of private sector borrowing. The markets have fully priced the 2021 stimulus, but not the crowding out. However, the most recent stimulus package has pushed up the bond yield or, at least, is a major culprit for the recent spike in yields. Hence, there will be some crowding out of private sector borrowing. Worryingly, US mortgage applications, for both purchasing and refinancing, are down by 20 percent since the start of February (Chart of the Week and Chart I-3). Chart I-3Mortgage Applications For Refi Are Down 20 Percent The resulting choke on private sector borrowing and investment will at least partly negate any putative boost from this fiscal stimulus. The concern is that the markets have fully priced the stimulus, but not the crowding out. Time To Rotate Back In our February 18 report, The Rational Bubble Is Turning Irrational, we warned that high-flying tech stocks were at a point of vulnerability. Specifically, since 2009, the technology sector earnings yield had always maintained a minimum 2.5 percent premium over the 10-year T-bond yield, defining the envelope of a ‘rational bubble.’ In February, this envelope was breached, indicating that tech stock valuations were in a new and irrational phase (Chart I-4). Chart I-4The Rational Bubble Turned Irrational The warning proved to be prescient. In the second half of February, tech stocks did sell off sharply and entered a technical correction.1 As a result, tech-dominated stock markets such as China and the Netherlands also suffered sharp declines. Proving once again that regional and country stock market performance is nothing more than an extension of sector performance (Chart I-5). Chart I-5As Tech Corrected, So Did Tech-Heavy Markets But the aggregate stock market has remained more resilient than we expected, and is only modestly down versus its mid-February peak. The reason is that while highly-valued growth stocks suffered the anticipated correction, value stocks continued to advance (Chart I-6). Chart I-6Time To Rotate Back We can explain this divergence in terms of the three components of stock market valuation: The bond yield. The additional return or ‘risk premium’ for owning stocks. The expected growth of earnings. Tech and other growth stocks are ‘long-duration’ assets meaning that their earnings are weighted into the distant future. Hence, for growth stocks the relevant valuation comparison is a long-duration bond yield, say the 10-year yield. Whereas for ‘shorter-duration’ value stocks the relevant valuation comparison is a shorter-duration bond yield, say the 2-year yield. Given that the 10-year yield has risen much more than the 2-year yield, the pain has been much more pronounced for growth stock valuations. Turning to the ‘risk premium’ for owning stocks, at ultra-low bond yields the risk premium just moves in tandem with the bond yield. Hence, as the 10-year yield has spiked, the combination of a rising yield plus a rising risk premium has doubled the pain for growth stock valuations. For a detailed explanation of this dynamic please see our February 18 report. Regarding the expected growth of earnings, the market believes that stimulus is much more beneficial for economically sensitive value stocks than for economically insensitive growth stocks. But now that we are at the point where rising bond yields are starting to choke private demand, the rise in bond yields is nearing a limit, and even a reversal point. In which case, the strong tide out of defensives into cyclicals will also be a tide that reverses. On this basis, and supported by the strong technical arguments in the next section, we are opening a new 6-month position: Underweight US banks versus US consumer staples, expressed as underweight XLF versus XLP. US Banks, Bitcoin, Ether, And The Pound This week we have identified susceptibilities to countertrend moves in three areas. The bullish groupthink in US banks is at an extreme. First, based on its fragile fractal structure, the (bullish) groupthink in US banks versus consumer staples is at an extreme approaching February 2016 (bearish), December 2016 (bullish), and March 2020 (bearish). All these previous extremes in fragility proved to be turning points in relative performance. If this proves true again, the next six months could see a reversal of US bank outperformance (Chart I-7). Chart I-7The Groupthink In US Banks Is At An Extreme Second, we are extremely bullish on the structural prospects for cryptocurrencies, and are preparing a report detailing the compelling investment case. Look out for it. That said, the composite fractal structures of both bitcoin and ethereum indicate that they are technically very overbought (Chart I-8 and Chart I-9). Accordingly, we are hoping for pullbacks that provide better strategic entry points for bitcoin at $40,000, and for ethereum at $1300. Chart I-8Bitcoin Is Technically Overbought Chart I-9Ethereum Is Technically Overbought Third, the UK’s Covid-19 vaccination program was one of the fastest out of the blocks. As the vaccination rate quickly rose to over half the adult population (based on at least one vaccination dose), the pound was a major beneficiary. But now, the UK vaccination program is facing the hurdle of reduced supplies. Additionally, there is the danger that the third wave of infections in Continental Europe washes onto the shores of Britain. Hence, the recent strong rally in the pound is susceptible to a countertrend reversal (Chart 10). This week’s recommended trade is short GBP/JPY setting the profit target and symmetrical stop-loss at 2.2 percent. Chart I-10The Pound Is Susceptible To A Reversal Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Footnotes 1 A technical correction is defined as a 10 percent price decline. Fractal Trading System Structural Recommendations Closed Fractal Trades Asset Performance Equity Market Performance Indicators Bond Yields Chart II-1Euro Area Chart II-2Europe Ex Euro Area Chart II-3Asia Chart II-4Other Developed   Interest Rate Chart II-5Expectations Chart II-6Expectations Chart II-7Expectations Chart II-8Expectations ​​​​​​

While the Fed’s dots dovishly surprised, the FOMC’s output and inflation projections were on the hawkish side. Adding the committee’s core PCE price inflation estimate for 2021 to their real GDP forecast results in a roughly 9% nominal GDP estimate, assuming the PCE and GDP deflators approximate one another. The last time the US economy hit such a high mark on a q/q annualized basis (ex-2020) was in late-2003 (Chart 1). Back then the Bush tax cuts were signed into law in late May 2003 turbocharging the economy. Chart 2 shows that the fed funds rate was pegged at 1% and the bond market was in selloff mode, with both the 10-year US Treasury yields surging violently and inflation breakevens galloping higher. While the S&P eventually shrugged off the bond market’s new equilibrium yield, drilling beneath the surface is revealing. Chart 1 Chart 2 As a reminder, back then the Fed was actually sowing the seeds of the housing bubble by keeping rates at 1%, which resulted in an economy running on steroids. Deep cyclical sectors outperformed the SPX and defensives significantly lagged the broad market especially as the economic data caught on fire in 2004 (see Appendix Charts A1, A2, A3, ). Financials were range bound and relative tech performance slumped in 2004 (for inclusion purposes Charts A4-A9 in the Appendix also show GICS2 sector relative performance). Bottom Line: Using the 2003/4 parallel as a guidepost we remain comfortable with our current positioning of preferring industrials and energy to consumer staples and communication services. Appendix Chart A1 Chart A2 Chart A3 Chart A4 Chart A5 Chart A6 Chart A7 Chart A8 Chart A9  

Highlights Duration: Only 2 of the 5 items on our Checklist For Increasing Portfolio Duration have been checked. We will heed this message and stick with below-benchmark portfolio duration for the time being. We will have an opportunity to re-assess the items on our Checklist after the March FOMC meeting when the Fed’s interest rate forecasts will be updated. The Fed & Financial Conditions: The recent dip in the stock market is not the result of investors pricing-in worse economic outcomes. Rather, it is a sector rotation driven by extreme economic optimism. It is certainly not a concern for the Fed. The Fed & The Labor Market: We need to see monthly nonfarm payroll growth coming in consistently above 419 thousand before we can be confident that the Fed will hike rates by the end of 2022. Feature Chart 1Bearish Trend Intact The bond bear market rages on. The Bloomberg Barclays Treasury Index returned -1.8% in February, its worst monthly performance since 2016. The sell-off then continued through the first week of March, culminating with the 10-year Treasury yield touching 1.56% as of Friday’s close (Chart 1). The 5-year/5-year forward Treasury yield ended the week at 2.41%, near the top-end of primary dealer estimates of the long-run neutral fed funds rate (Chart 1, bottom panel). We don’t want to catch a falling knife, but eventually, yields will look attractive enough for us to increase our recommended portfolio duration. To help us make that decision, we unveiled a Checklist For Increasing Portfolio Duration in our February Webcast (Table 1).1 Table 1Checklist For Increasing Portfolio Duration This week, we check-in with our Checklist, concluding that it is still too early to increase portfolio duration. Checking-In With Our Duration Checklist Chart 2Cyclical & Valuation Indicators The first item on our Checklist is the 5-year/5-year forward Treasury yield reaching levels consistent with survey estimates of the long-run neutral fed funds rate. As noted above, this condition has been met. Second, we would like to see survey-derived measures of the 10-year term premium reach extended levels. Specifically, we’d like to see them approach their 2018 peaks (Chart 2). Currently, our two measures are sending diverging signals. The term premium derived from the New York Fed’s Survey of Market Participants is 60 bps, only 15 bps off its 2018 peak. However, the term premium derived from the New York Fed’s Survey of Primary Dealers is only 22 bps, 53 bps off its 2018 peak. For now, our assessment is that this condition has not been met. It’s important to note that the surveys used to construct our two term premium measures and to obtain our fair value range for the 5-year/5-year forward Treasury yield have not been updated since January, and that they will be revised ahead of this month’s FOMC meeting. If primary dealers and market participants revise up their fed funds rate expectations, then our valuation measures will give the 10-year yield more room to rise. Third, we continue to track high-frequency cyclical economic indicators like the CRB/Gold ratio (Chart 2, panel 3) and the relative performance of cyclical versus defensive equity sectors (see section titled “The Fed’s Approach To Financial Conditions” below). These measures have yet to show any signs of deterioration, consistent with an environment where bond yields should be rising. Fourth, if current trends continue, we are concerned that US yields may rise too far compared to yields in the rest of the world. This could entice foreign inflows into the US bond market, sending yields back down. Historically, bullish sentiment toward the US dollar is a good indicator of when US yields have risen too far. At present, dollar sentiment remains extremely bearish (Chart 2, bottom panel). This suggests that we are not yet close to the point when foreign purchases will push US yields lower. Finally, we consider the market’s fed funds rate expectations relative to the Fed’s most recent forecast, as inferred from its quarterly “dot plot”. Currently, the market is priced for Fed liftoff to occur in January 2023, with a second rate hike delivered in May 2023 and a third in October 2023 (Chart 3). This is considerably more hawkish than the Fed’s median forecast from December, which called for no rate hikes until at least 2024! Chart 3Market Expects Liftoff In January 2023 We think it’s conceivable that economic conditions could warrant Fed liftoff in late-2022 (see section titled “Tracking Payrolls And The Countdown To Fed Liftoff” below), but the Fed will probably be more cautious about how quickly it brings its expected liftoff date forward. FOMC participants will have an opportunity to push back against the market when they update their funds rate forecasts at this month’s meeting. The Fed will likely bring forward its anticipated liftoff date, but probably not all the way to January 2023. This could halt the uptrend in bond yields, at least for a while. Bottom Line: Only 2 of the 5 items on our Checklist For Increasing Portfolio Duration have been checked. We will heed this message and stick with below-benchmark portfolio duration for the time being. We will have an opportunity to re-assess the items on our Checklist after the March FOMC meeting when the Fed’s interest rate forecasts will be updated. Other surveys used in the construction of our term premium estimates and 5-year/5-year yield targets will also be updated around this time. The Fed’s Approach To Financial Conditions Chart 4Financial Conditions Are Easy Remarks from Fed Chair Jay Powell were a catalyst for higher bond yields last week. Apparently, there had been some expectation in the market that Powell would use his platform to express concern about the recent increase in long-maturity bond yields. In fact, many expected him to foreshadow changes to the Fed’s balance sheet policy, either extending the maturity of its ongoing asset purchases or initiating an Operation Twist, where the Fed sells short-dated securities and buys long-dated ones.2 Powell didn’t announce any of these things. In fact, he didn’t even express concern about the recent rise in long-dated yields despite being given several opportunities to do so. To understand why, we need to understand how the Fed thinks about financial conditions. The Fed only cares about conditions in financial markets to the extent that they are expected to influence the real economy. This means that the Fed takes a broad view of financial conditions, including bond yields, credit spreads and equity prices. From this perspective, financial markets do not currently pose a risk to the economy (Chart 4). Yes, long-dated bond yields have risen, but short-dated yields remain low. Credit spreads also remain very tight and equity prices have only dipped modestly from high levels. The Chicago Fed’s broad index of financial conditions shows that they are extremely accommodative (Chart 4), and thus support continued economic recovery. This financial market back-drop is not one that will cause the Fed to take additional actions to ease policy. Even the recent drop in the stock market appears to be more a reflection of economic optimism than a cause for concern. Looking at the performance of different equity sectors, we find that the sectors that stand to benefit from the end of the pandemic and economic re-opening are surging. Meanwhile, the sectors that are performing poorly are simply giving back some of the huge gains that were realized when the pandemic was raging last year. For example, cyclical sectors (Industrials, Energy and Materials) are soaring while defensive sectors (Healthcare, Communications, Consumer Staples and Utilities) have hooked down (Chart 5A). The ratio between the two remains tightly correlated with the 10-year Treasury yield. Similarly, Bank stocks have exploded higher since bond yields troughed last fall while the Technology sector has had difficulty making further gains (Chart 5B). Last year, the Tech sector benefited from low bond yields and surging demand. This year, Banks stand to profit from higher yields and an improving labor market. Finally, our US Equity Strategy team put together a basket of “COVID-19 Winners” designed to profit from the pandemic and a basket of “Back To Work” stocks designed to benefit from economic re-opening. Not surprisingly, the former is dragging the S&P 500 lower while the latter is on a tear (Chart 5C). Chart 5ASector Rotation: Cyclicals Vs. Defensives Chart 5BSector Rotation: Banks Vs. Tech Chart 5CSector Rotation: COVID Winners Vs. Re-Open Winners The bottom line is that the recent dip in the stock market is not the result of investors pricing-in worse economic outcomes. Rather, it is a sector rotation driven by extreme economic optimism. It is certainly not a concern for the Fed. Other Reasons For The Fed To Change Its Balance Sheet Policy In addition to concerns about a drop in the stock market, several other reasons have been given for why the Fed might consider either increasing its asset purchases or shifting them toward the long end of the curve. 1) Treasury Market Liquidity Chart 6Treasury Market Liquidity First, there is an ongoing tension in the Treasury market between imposing stricter capital regulations on dealer banks and ensuring that they have enough balance sheet capacity to maintain Treasury market liquidity during periods of stress.3 This delicate equilibrium broke down last March when Treasury market liquidity evaporated at a time when both equities and bonds were crashing. The Fed was forced to step into the Treasury market to sustain market functioning. Last week’s Treasury sell-off had a whiff of illiquidity about it as well. One liquidity index that measures the average curve fitting error across all government bond yields increased slightly, but not nearly as much as it did last March (Chart 6). Treasury bid/ask spreads also widened a touch, but unlike last March, Treasury ETFs continued to trade close to their net asset values. A significant deterioration in Treasury liquidity would prompt a quick response from the Fed. That is, the Fed would quickly ramp up purchases to restore market functioning. However, last week’s blip was not nearly severe enough to raise alarm bells. Other periods of Treasury market stress that have prompted the Fed to step in have occurred during periods of extreme economic deterioration and market panic, such as in March 2020 and 2008. With economic growth accelerating rapidly, we place low odds on a major Treasury market liquidity event occurring this year. 2) Expiry Of The SLR Exemption Chart 7Reserve Supply Is Massive A second possible reason for the Fed to change its balance sheet policy is the upcoming expiry of the exemption to the Supplementary Leverage Ratio (SLR). The SLR is a regulation that requires large banks to hold common equity capital totaling at least 5% of assets. Assets are not risk-weighted for the purposes of the SLR. A problem arose with the SLR last March when the Fed bought massive amounts of bonds, flooding the banking system with reserves (Chart 7). The problem is that banks are forced to hold those reserves, and this makes it more difficult for them to meet their SLR requirement. To alleviate the problem, the Fed announced that reserves and Treasury securities would be exempted from the SLR calculation. Today, the issue is that this exemption is scheduled to expire at the end of March and the Fed has yet to announce whether it will be extended or allowed to lapse. Table 2US Bank Supplementary Leverage Ratios If the exemption lapses, then banks may try to unload Treasury securities to remain compliant with the SLR. In theory, this could lead to upward pressure on Treasury yields that the Fed could mitigate by ramping up its asset purchases. However, it’s unclear how much of an impact a lapsing of the SLR exemption would actually have on the Treasury market. Even adjusting for a lapsing of the exemption, all major US banks remain compliant with the 5% SLR (Table 2). Also, banks could always decide to increase their SLRs by reducing share buybacks rather than by shedding Treasuries.   In any event, an increase in Fed asset purchases to lean against rising Treasury yields driven by bank selling would be counterproductive. It would only flood the banking system with more reserves, making the SLR even more difficult to meet. Our view is that a fair compromise would be for the Fed to continue the SLR exemption for bank reserves, but to allow the Treasury security exemption to lapse. But even if the SLR exemption is allowed to lapse completely, we doubt that it will lead to enough market turmoil to prompt a change in the Fed’s balance sheet strategy. 3) Supply/Demand Imbalance In Money Markets Finally, some have noted that the large and growing supply of bank reserves could lead to problems in money markets. Specifically, with the Treasury Department now in the process of paying down its cash account (Chart 7, bottom panel), there is a lot of cash flooding into money markets and coming up against limited T-bill supply. In theory, the Fed could try to mitigate this problem by engaging in an Operation Twist – selling some T-bills and buying some coupon bonds. But we doubt this will occur. The Fed already has tools in place to maintain control over short rates in such circumstances. For example, the same situation arose in 2013 when an over-supply of bank reserves pushed short rates down toward the bottom of the Fed’s target range (Chart 8A). The Fed’s response was to create the Overnight Reverse Repo Facility (ON RRP). This facility allows counterparties to park excess cash at the Fed in exchange for a security off the Fed’s balance sheet. This proved to be an effective floor on repo rates and the fed funds rate, and we expect it will be again (Chart 8B). Chart 8AFed Created ON RRP In 2013... Chart 8B... It Remains A Firm Floor On Rates T-bill yields remained below the ON RRP rate for some time in 2014 and 2015, and the same thing could happen again this year. But this will not be a major concern for the Fed as long as it maintains control over the fed funds rate and the overnight repo rate. Eventually, the Treasury Department can deal with the lack of bill supply by increasing the amount of T-bill issuance. Bottom Line: Treasury market liquidity remains an ongoing concern for the Fed, and the possible expiry of the SLR exemption and lack of T-bill supply present additional near-term technical challenges. We think it’s unlikely that any of these things will prompt the Fed to deviate from its current pace and composition of asset purchases in 2021. Tracking Payrolls And The Countdown To Fed Liftoff Chart 9The Fed's Maximum Employment Targets Employment growth surprised to the upside in February as 379 thousand jobs were added to nonfarm payrolls. This sent bond yields higher, but we caution that even stronger employment growth will be required to keep bond yields rising going forward. The Fed needs to see a return to “maximum employment” before it will lift rates off the zero bound. This means not only that the unemployment rate will have to fall to a range of 3.5% to 4.5%, but also that the labor force participation rate must make a full recovery to pre-pandemic levels (Chart 9). We calculate that average monthly employment growth of 419 thousand will be required to achieve this goal by the end of 2022 (Table 3). In other words, to justify the market’s January 2023 expected liftoff date, we will need to see average monthly payroll growth of at least 419 thousand going forward.   Table 3Average Monthly Nonfarm Payroll Growth Required For The Unemployment Rate To Reach 4.5% By The Given Date This number seems high, but it may be attainable. With vaccine distribution kicking into high gear, many service sectors of the economy will soon be able to re-open. This already started to happen last month when the Leisure & Hospitality sector added 355 thousand jobs. Even after last month’s gains, Leisure & Hospitality still accounts for 36% of the net job loss since last February (Table 4). This means that there is scope for extremely large employment gains this year if the coronavirus can be contained. Table 4Employment By Industry Bottom Line: We need to see monthly nonfarm payroll growth coming in consistently above 419 thousand before we can be confident that the Fed will hike rates by the end of 2022. Ryan Swift US Bond Strategist rswift@bcaresearch.com Footnotes 1 https://www.bcaresearch.com/webcasts/detail/387 2 https://www.bloomberg.com/news/articles/2021-03-01/treasury-curve-dysfunction-ignites-talk-of-federal-reserve-twist?sref=Ij5V3tFi 3 For more details please see US Investment Strategy / US Bond Strategy Special Report, “Alphabet Soup, Part 2: Shocked And Awed”, dated July 28, 2020, available at usbs.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification

Underweight “COVID-19 Winners” hypermarket equities remain a solid underweight call. Worrisomely, relative share prices recently broke down and propelled relative returns for our portfolio into the double digits since the late-August inception. While there is a number of factors that weigh on this defensive industry, today we turn our attention to the US dollar. As the greenback depreciates, it reduces the purchasing power of US importers, including Big Box retailers that source most of their goods from abroad (bottom panel, import prices shown inverted). As a result, relative margins bear the brunt of the USD’s fall – especially given that these input cost increases are difficult to pass on to the consumer – profits slip and relative share prices find an equilibrium lower. True, the US dollar has retraced part of its losses recently, but given the lag between the currency debasing and its effects on import prices and margins, the FX related damage will likely have a lasting effect (see chart). Tack on the stealing of demand from the future that these defensive retail stores enjoyed all of last year, as WMT recently admitted on their earnings call, and the revenue and profit outlooks darken further for this safe haven industry. Bottom Line: Remain underweight the S&P hypermarkets index. The ticker symbols for the stocks in this index are: BLBG: S5HYPC – WMT, COST.   

Today we close two high-conviction trades and place a stop buy order for the June 2021 expiry VIX futures as a hedge to the remaining positions. Homebuilders have proven to be more resilient than we expected, especially given the selloff in the bond market. Clearly the US consumer is not concerned about a rebound in rates, at least not yet. Moreover, the looming fiscal stimulus will only facilitate more excesses, even in the residential housing market, as a fresh wave of liquidity will likely more than offset the tightening in monetary conditions. Thus, we have lost confidence in our high-conviction underweight stance in this niche consumer discretionary group and are taking a loss of 11% since inception. The S&P consumer staples sector was a natural high-conviction underweight given our end-2021 4,000 SPX target that we arrived at on the November 9 Special Report. Now that the market is within spitting distance of our target, the risk reward is no longer as favorable as it used to be for this defensive sector. Thus, we are closing this high-conviction trade today for a gain of 8% since inception. Finally, we successfully capitalized on our long VIX futures hedge to the tune of 19% recently, but given that volatility is settling down, it pays to institute a stop buy order for the June 2021 expiry VIX futures near the 25 mark. Bottom Line: Close the S&P consumer staples and the S&P homebuilding high-conviction underweights for 8% and -11% returns, respectively since the December 7 inception; and place a stop buy order for the June 2021 VIX futures at the 25 level.

Dear client, Next week instead of our regular Strategy Report we will be sending you a Special Report from BCA’s Equity Analyzer service on Inflation and Factor investing penned by my colleague Lucas Laskey, Senior Quantitative Analyst. Finally, on February 22 we will be hosting our quarterly webcast one at 10am EST for North American and EMEA clients and one at 8pm EST for Asia Pacific, Australian and New Zealand clients “From Alpha To Omega With Anastasios”. Mathieu Savary, who heads our Daily Insights service, will be our special guest in the morning webcast. On March 1 we will resume our regular publication schedule. Kind Regards, Anastasios Highlights Portfolio Strategy China’s engineered economic deceleration, the knee jerk US dollar bounce along with signs of soft US capital expenditures entice us to protect our deep cyclicals versus defensives portfolio gains and institute a 2.5% rolling stop to this share price ratio. Rising relative capital outlays, firming software pricing power and an M&A frenzy more than offset the negative relative profit signal from our models that sell side analysts already anticipate. Continue to overweight the S&P software index.  Recent Changes Last Tuesday we closed out our VIX futures hedge for a gain of 19% since the December 7, 2020 inception. Last Wednesday we re-initiated our long “Back-To-Work”/short “COVID-19 Winners” pair trade. Feature Equity volatility settled down last week following a ferocious ten-day SPX oscillation that sent the VIX soaring to roughly 38 near the peak at the end of January, courtesy of the GME/Wallstreetbets (WSB) saga before collapsing back down near 21 last week. Chart 1 shows that this was likely an equity-only event: both risk off currencies – the yen and the franc – actually fell versus the USD, junk bond spreads barely budged and the vol curve violently inverted, a move that more often than not signals that complacency has morphed into panic. Importantly, when the Fed embarks on active QE the SPX drawdown maxes out at 10% based on empirical evidence, including the recent September/October 10% drawdown. Using the ES futures low hit two Sundays ago, the S&P 500 experienced a 5.3% peak-to-trough pullback well within the range of previous Fed active QE iterations. As a reminder, the 2010 and 2011, 17% and 20% respective drawdowns took root after the Fed had concluded QE1 and QE2 operations. The implication is that for a more significant drawdown to materialize, likely the Fed has to end the current QE operation and reinject some volatility in the bond markets (bottom panel, Chart 1).  Isolating the true signal from all this noise, convinced us to book handsome gains to the tune of 19% in our VIX June futures hedge (conservatively assuming that no leverage was used), reinitiate the long “Back-To-Work”/short “COVID-19 Winners” pair trade and put the small cap size bias on our upgrade watch list. As volatility has slowly died down, investors can start to refocus on profit fundamentals. Similar to the steep fall in EPS that the SPX 35% drawdown predicted in March of 2020, in recent research we showed that were we to hold the SPX at current levels, its 12-month rate-of-change would surpass the 61% mark next month and forecast that profit growth would rise by a similar amount. Indeed, sell side analysts’ bottom up earnings estimates corroborate this analysis as quarterly EPS will peter out roughly at a 48% year-over-year (YOY) growth rate next quarter and vault to all-time highs in quarterly level terms in Q3 following a three-year hiatus (Chart 2). Chart 1Equity-only Event Chart 2Joined At The Hip Importantly, the tech sector no longer commands an earnings weight similar to its market cap weight likely because it’s run ahead of itself and also because the rest of the sectors are playing catch up this year as the US economy is slated to reopen on the back of the herculean inoculation efforts (profit weight and mkt cap weight columns, Table 1). Table 1Sector EPS And Market Cap Weights This is most evident on the sector contribution to this year's SPX earnings growth. Historically, the tech sector commanded the lion’s share of profit explanation for the SPX, but not in 2021. In fact, the S&P IT sector is ranked 4th in terms of contribution to overall SPX profits, behind industrials, financials and consumer discretionary (Chart 3).   Delving deeper into 12-month forward earnings growth figures is instructive. Table 2 shows our universe of coverage ranked first by GICS1 sector growth rates and then re-ranked per sub-group. As an aside the energy sector’s EPS is slated to contract in calendar 2020 and thus any YOY growth rate figures are rendered useless for the broad sector and the energy sub-industries. Chart 3Sector Contribution To 2021 SPX EPS Growth Table 2Identifying S&P 500 Sector EPS Growth Leaders And Laggards Our portfolio positioning is well aligned with the sector ranking of EPS growth for the coming year. Put differently, given the havoc that COVID-19 wreaked to the US industrial and service bases it is normal that deep cyclical sectors along with financials and the decimated services-heavy parts of the consumer discretionary sector to occupy the top ranks. In contrast, defensives sectors that were largely COVID-19 beneficiaries (especially health care and consumer staples) are near the bottom of the pit. The sole misalignment is the bombed out real estate sector that we remain overweight (Table 2). Netting it all out, our sense is that the market has successfully navigated a tumultuous two-week period and we reiterate our long-held sanguine 9-12 month cyclical view on the prospects of the S&P 500. This week, we update a defensive tech sub-group and put a tight stop in the cyclicals/defensives portfolio bent in order to protect profits. Risks To The Cyclicals Over Defensives Portfolio Bent Last December we highlighted that China’s four year cycle will peter out in the back half of 2021 and could cause some equity market consternation, with stocks likely sniffing out any trouble likely by the end of Q1/2021. It appears that investors have been sleeping at the wheel and largely distracted by the GME/WSB saga. Not only did they neglect the robust SPX profit season, but they also ignored that something is amiss in China as we first showed last week (please refer to Chart 12 here). Importantly, what worries us most is the transition from China being the primary locomotive of global growth to the US taking the reins in coming quarters. Clearly such a handoff is tumultuous, especially given the recent added risk of a reflex rebound in the greenback that we first warned about on January 12 when we set the cyclicals/defensives ratio on downgrade alert. Subsequently, we upgraded the S&P utilities sector to neutral locking in gains of 15% for the portfolio, and today we decide to institute a 2.5% rolling stop in the cyclicals/defensives portfolio bent, in order to participate on further upside but also protect 16% gains for the portfolio since the July 27, 2020 inception in case of a market relapse. Practically, when the rolling stop gets triggered we will move the cyclicals/defensives bent down to neutral via executing the downgrade alert we have in the S&P materials sector. In more detail, China’s slamming on the brakes is the key risk to cyclicals/defensives. Not only are the Chinese authorities trying to engineer a slowdown with the recent reverse repo operations, but also BCA’s China Monetary Indicator, the selloff in the Chinese sovereign bond market and the cresting in the PBOC’s balance sheet are all corroborating the economic deceleration signal (Chart 4). Chinese total social financing has peaked, the 6-month credit impulse is plunging, and the nosedive in Goldman Sachs’ Chinese current activity indicator (CAI) are all firing warning shots that the economy is slated to slowdown (Chart 5).  Chart 4Everywhere… Chart 5…One Looks… Already both the Chinese manufacturing and services PMIs have hooked down with the manufacturing new orders-to-inventories (NOI) in free fall and export orders in outright contraction. Tack on the reversal in the Citi economic surprise index (ESI) for China and the outlook dims further for US cyclicals/defensives (Chart 6). No wonder Chinese demand for loans has turned the corner, infrastructure spending has topped out and railway freight volumes have ticked down as a direct response to the tightening in Chinese monetary conditions (Chart 7). Chart 6…China… Chart 7…Is Slowing… Chinese imports flirting with the zero line best capture all this softening in Chinese data and also warns that the US cyclicals/defensives ratio is nearing a zenith (Chart 8). Beyond the dual risk of a counter trend rally in the USD and China’s undeniable deceleration, returning to US shores reveals another source of potential trouble for cyclicals/defensives. Chart 8…Down The US Citi ESI has come back down to earth, and the ISM manufacturing PMI cooled off last month with the NOI ratio flashing red (Chart 9). Importantly, Goldman Sachs’ US CAI is sinking like a stone corroborating that, at the margin, US economic data is softening (Chart 10). Moreover, US capex is in the doldrums courtesy of the collapse in EPS last year that dealt a blow to CEO confidence. Worrisomely, the rollover in the latest capex intentions from regional Fed surveys along with the downbeat NFIB survey’s capital outlays in 6-months component underscore that CEOs remain reluctant to invest (Chart 9). Chart 9Even US Trouble… Finally, relative valuations have surged to all-time highs leaving no cushion in case of a mishap, while relative technicals are in extreme overbought territory near a level that has marked the commencement of prior relative share price drawdowns (Chart 11). Chart 10…Is Brewing Netting it all out, China’s engineered economic deceleration, the knee jerk US dollar bounce along with signs of soft US capital expenditures entice us to protect our deep cyclicals versus defensives portfolio gains and institute a 2.5% rolling stop to this share price ratio. Bottom Line: Prepare to move the cyclicals/defensives portfolio bent back down to neutral from currently overweight. Today we recommend investors establish a 2.5% rolling stop to the cyclicals/defensives relative share price ratio as a risk management tool in order to protect profits. Chart 11Overstretched And Pricey Software On The Ascend While we remain on the sidelines with regard to the broad S&P technology sector we continue to recommend a barbell portfolio approach preferring defensive software and services stocks to aggressive hardware and equipment equities. In that light, we reiterate our overweight stance in the key S&P software sub-industry that still commands the highest market cap weight in the tech sector just shy of 33%. While overall capex is sluggish as we highlighted above, software capital outlays have recovered smartly and according to national accounts are growing at a 10%/annum pace. Stock market-reported capex confirms that software capital expenditures are on an absolute tear and remain a key pillar of our secular preference for this defensive tech group (Chart 12). On the sales front, COVID-19 accelerated the push to the cloud and 2020 has been a bumper year for industry sales. True there is an element of stealing revenues from the future, but as long-time readers of our publication know we do not believe that SaaS is a fad and the adoption of cloud services remains in the early innings. Impressively, while relative forward top line growth expectations have rolled over, the attempt of the software price deflator to exit deflation suggests that software stocks will easily surpass this lowered revenue bar in coming quarters (Chart 13). Chart 12Primary Capex Beneficiary Amidst the IPO frenzy that has captured investors’ imagination especially given the spectacular increases in both SNOW and PLTR (neither of which is in the SPX yet), software M&A fever remains as high as ever. This constant reduction of software stock supply, coupled with the insatiable appetite of software executives to aggressively retire equity, signals that software equity prices will remain well bid (Chart 14). Chart 13Software Tries To Exit Deflation Chart 14Positive Share Price Dynamics Nevertheless, our relative EPS growth models are waving a yellow flag. The SPX is slated to grow profits north of 25% this year, but according to our profit models software will only manage to grow in the single digits, thus trailing the broad market by a wide margin. Encouragingly, this grim relative profit growth backdrop is already reflected in depressed sell side analysts’ forecasts (Chart 15). Finally, while relative valuations are still lofty they recently have corrected back to one standard deviation above the historical mean. Similarly, relative technicals have worked off overbought conditions and have settled down near the recent historical average (Chart 16). Chart 15Risks… In sum, rising relative capital outlays, firming software pricing power and an M&A frenzy more than offset the negative relative profit signal from our models that sell side analysts already anticipate. Bottom Line: Continue to overweight the S&P software index. The ticker symbols for the stocks in this index are: BLBG: S5SOFT – MSFT, ADBE, CRM, ORCL, INTU, NOW, ADSK, ANSS, SNPS, CDNS, FTNT, PAYC, CTXS, NLOK, TYL. Chart 16…To Monitor   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views January 12, 2021  Stay neutral small over large caps July 27, 2020 Overweight cyclicals over defensives (2.5% rolling stop) June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, ABNB, V). January 22, 2018 Favor value over growth

Underweight Countercyclical consumer staples stocks served their purpose and supported our portfolio in the front half of 2020. Now that vaccines are here, we added the S&P consumer staples sector to the high-conviction underweight call list. The current macro backdrop underscores that the path of least resistance is lower for relative share prices. Not only is the ISM manufacturing survey on fire, but also, consumer confidence is forming a trough (ISM manufacturing shown inverted, second panel). One of the factors that will drive relative earnings lower is the weaker US dollar. As a reminder, the S&P consumer staples sector derives approximately 32% of its sales from abroad, which is 10 percentage points lower than the S&P 500. As a consequence, on a relative basis, staples stocks benefit much less than the rest of the market from a falling currency (third panel). Our relative macro earnings model does an excellent job in encapsulating all these moving parts and paints a dark profit picture for this GICS1 sector this year (fourth panel). Bottom Line: The S&P consumer staples sector is a high-conviction underweight.

Dear client, Next Monday December 14, 2020 we will be hosting our last webcasts for the year “From Alpha To Omega With Anastasios”, one at 10am EST for our US, European and Middle Eastern clients and one at 8pm EST for our Asia Pacific, Australia and New Zealand clients; our final weekly publication for 2020 will be on Monday December 21, 2020 where we will highlight our top charts of the past year. Kind Regards, Anastasios Highlights Portfolio Strategy Our high-conviction overweight calls comprise four “Back-To Work” beneficiaries, and a hedge. In marked contrast, all of our high-conviction underweights are focused on “COVID-19 Winners” that should lose some of their luster next year. Recent Changes Upgrade the S&P real estate sector to overweight, today. Feature Favorable Macro Backdrop Easy monetary and loose fiscal policies will remain intact and sustain flush liquidity conditions next year. As a result, the global economy will continue to gain traction. Importantly, early-August marked a critical economic inflection point. Gold prices peaked and 10-year real and nominal yields troughed (yields shown inverted, top & middle panels, Chart 1). The bullion and bond markets corroborated the economic recovery that equities and the ISM manufacturing surveys sniffed out in late-spring. This is important for cementing the bull market in equities which is predicated on a durable economic recovery. In other words, the rise in real yields serves as a green light for further stock gains as it signals that the economy is on the recovery path. The bottom panel of Chart 1 also highlights that non-US equity markets started sporting accelerating profit growth expectations in August. Eurozone and other ex-US bourses zoomed past the US EPS growth trajectory as the latter reached a plateau. Chart 1Inflection Point This gives us confidence that 2021 will be a bumper year for SPX profits and help carry the market higher near our 4,000 target. As a reminder, on November 9 in a Special Report, we lifted our EPS estimate to $168 for calendar 2021 and introduced an end-2021 SPX target of 4,000 (Chart 2). Chart 2Earnings Will Do The Heavy Lifting In 2021 Two Risks To Monitor Nevertheless, the bond market represents a risk to our sanguine equity market view. Simply put, if the 10-year US Treasury yield stalls, then it will also stop the rotation trade in its tracks. The budding improvement in the Chinese and EM economic cycles will likely be sustainable next year, consistent with the Chinese four-year cycles of the past twenty years (Chart 3). Each up-cycle has typically been driven by credit expansion and capital spending, on the back of fiscal and monetary easing. These conditions are in place once again. Chart 3Follow The Chinese Four-year Cycle We recently showed that China’s fiscal easing will likely continue to grease the wheels of global trade into mid-2021 and thus debase the greenback (Chart 4), but will likely run out of steam in the back half of next year. Thus, China’s reflation going on hiatus is another key risk we will monitor in 2021 that could serve as a growth scare catalyst and reset stocks. Chart 4Laggard Deep Cyclicals Have The Upper Hand Year In Review 2020 is a year to forget as far as the coronavirus human toll is concerned; the economic and EPS recessions, while short lived, were deep. The COVID-19-inflicted wounds, especially to services industries the world over, were deep and there will be severe scarring. Early in the year, equities felt the COVID-19 tremor and collapsed 35% from the February 19 highs, but extremely aggressive monetary and fiscal policy responses filled the void and were the dominant themes in the ensuing recovery that saw the SPX vault to all-time highs. Our portfolio was resilient and was able to absorb the COVID-19 shock as we were bulletproofing it in the back half of 2019 and early-2020 for a recession owing largely to the yield curve inversion. Importantly, we were not dogmatic and on March 16 we turned cyclically bullish. This eventually culminated into the March 23 Strategy Report where we penned 20 reasons to start buying stocks and coincided with the trough in the SPX. This cyclical shift in our view from bearish-to-bullish aided our portfolio performance as we started adding cyclical exposure and trimming defensive exposure in order to benefit from the immense monetary and fiscal policy responses. Early on, we deemed these macro forces were forceful enough to really turn things around and we remained bullish on a cyclical time horizon. All in all, our trades produced alpha to the tune of 425bps. While our pair trades were sub-par (as is custom we are closing the remaining today), our high-conviction trades and cyclical portfolio moves recorded solid gains (please see the final tally below). Ray Of Light Encouragingly, there is light at the end of the tunnel, as a number of vaccines will become available late this year and/or early in 2021. This is great news for the economy and for stocks. We have positioned the portfolio to benefit from the reopening of the economy and the vaccine will act as an accelerant as our flagship publication posited last week while documenting BCA’s upbeat Outlook for 2021. Our portfolio enjoys a cyclical-over-defensive bent, has a small cap bias and we remain committed to the “Back-To-Work” basket versus the “COVID-19 Winners” basket (Chart 5). In the short-term, equities have discounted a lot of good news, which is likely to steal from next year’s returns. However, as populations get inoculated and large parts of the global economy reopen, a virtuous cycle of increasing consumer and business confidence would boost investment and GDP and prove a boon for corporate profits. Already the rally is broadening out with the value line arithmetic and geometric indexes outshining the SPX (Chart 6). An active ETF (RVRS:US) that has a reverse weighting to US large caps is also besting the S&P 500 and signals that more gains are in store in the New Year, especially for the still beaten down deep cyclical laggards. Chart 5Stick With The Reopening Trade Chart 6Rally Is Broadening Out, And That’s Healthy More Overweights Than Underweights As is custom every year, this Strategy Report introduces our high-conviction calls for 2021. This year we have four overweights, a bonus volatility trade on the long side, three underweights, and a bonus structural trade that we add to our trades of the decade first introduced in mid-December 2019. Our overweights comprise three “Back-To-Work” beneficiaries, a great rotation trade and a hedge. All of our underweights are focused on “COVID-19 Winners” that should lose some of their luster next year. Finally, this year we take a page out of Byron Wien’s annual “10 surprises” list and offer our clients three “also rans”, which got close but ultimately failed to make our high-conviction list.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com   Overweight Hotels (Back-To-Work Theme) The recent positive vaccine news is a key reason we are warming up to this consumer discretionary sub group. While neither lodging nor cruise line vacationing will return to their previous peaks any time soon, both industries will survive and thus should no longer be priced for bankruptcy. One key industry demand determinant is confidence. Consumer sentiment has staged a W-shaped recovery. It is still flimsy, but the vaccine efficacy news should catapult confidence higher in the coming quarters. The implication is that the wide gulf between consumer confidence and relative share prices will narrow via a catch up phase in the latter (top panel, Chart 7). Moreover, the ISM non-manufacturing survey is on a sling shot recovery following the bombed out spring readings. This rebound also suggests that the path of least resistance is higher for lodging stocks (second panel, Chart 7). Our hotel demand indicator does an excellent job in encapsulating all these different forces and forecasts an enticing lodging services demand backdrop into 2021 (third panel, Chart 7). Already, consumer outlays on hotels are staging a comeback, albeit from an extremely depressed level. The upshot is that an earnings-led bounce is in the cards (fourth panel, Chart 7). Finally, washed out technicals and extremely alluring valuations provide an attractive reward/risk tradeoff at the current juncture (bottom panel, Chart 7). Bottom Line: The S&P hotels, resorts & cruise lines index is a high-conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5HOTL – MAR, HLT, CCL, RCL, NCLH. Chart 7Buy Hotels Overweight Real Estate (Back-To-Work Theme) Boost the S&P real estate sector all the way to overweight today, in order to benefit from the looming full reopening of the economy on the back of the vaccine’s arrival. We have been bearish this niche S&P sector and delivered alpha to our portfolio both via the cyclical and high-conviction underweights this year. Nevertheless, we do not want to overstay our welcome and the time is ripe for a bullish commercial real estate (CRE) stance. The bearish story is well known, but some bullish undertones are widely neglected. The rebound in relative share prices is substantially trailing the 2009 episode, when REITs outshined the SPX by 65% one year following the March 2009 trough. Currently, on a similar SPX advance from the March 2020 lows, REITs are lagging the S&P 500 by 22% (top panel, Chart 8). As large parts of CRE have been at the epicenter of the pandemic, any return to even semi-normalcy in 2021 should see these beaten down stocks sling shot passed the SPX. When the fiscal package finally passes, it will likely serve as a fresh reflationary bridge to support the economy. The proverbial “kicking the can down the road” will thus lift some uncertainty hanging over CRE landlords receiving rents and also via banks not foreclosing distressed properties which would have further depressed CRE prices. CRE prices will likely recover in the New Year as vulture funds and opportunistic investors are already bargain hunting. Tack on the likely refinancing lifeline bankers will extend to CRE debt originators (middle & bottom panels, Chart 8) and such a backdrop will loosen the noose around distressed property landlords. Bottom Line: Boost the S&P real estate sector to an above benchmark allocation and add it to the high-conviction overweight call list.   Chart 8Upgrade Real Estate To Overweight Overweight Industrials (Back-To-Work Theme) Add the S&P industrials sector to the high-conviction overweight list. Emerging markets (EM) and China represent the key source for the sector’s buoyancy. The EM manufacturing PMI clocking in at 53.9 hit an all-time high (top panel, Chart 9). China’s PMIs are also on a similar trajectory, and the Chinese Citi economic surprise index has swung a whopping 277 points from -239 to +38 over the past nine months (second panel, Chart 9). The upshot is that US industrials stocks should outperform when China and the EM are vibrant. Peering over to the currency market, the debasing of the US dollar should also underpin industrials stocks via the export relief valve. A depreciating greenback also lifts the commodity complex and hence industrials equities that are levered to the extraction of commodities and other derivative activities (middle panel, Chart 9). Capex intentions are firming and CEO confidence is upbeat for the coming six months. The ISM manufacturing new orders-to-inventories ratio is corroborating the budding recovery in the soft data. Green shoots are also evident in hard data releases. Durable goods orders are on the verge of expanding anew (fourth panel, Chart 9). Sell-side analysts have never been more pessimistic with regard to the sector’s long-term EPS growth rate that is penciled in to trail the broad market by almost 800bps (bottom panel, Chart 9)! This bearishness is contrarily positive as a little bit of good news can go a long way. Bottom Line: The S&P industrials sector is a high-conviction overweight.  Chart 9Overweight Industrials Overweight Small Caps At The Expense Of Large Caps (Rotation Trade) Recent vaccine efficacy announcements have paved the way for a sustainable great rotation trade into small caps and out of large caps. One of the key small size bias drivers is the delta in sector composition between the small and large cap indexes. The relative gap in deep cyclicals alone is 13% as we highlighted in recent research. Relative share prices remain far apart from the budding recovery in the commodity complex including Dr. Copper’s flirtations with seven-year highs. Thus, the small caps catch up phase has a long ways to go (top & fourth panels, Chart 10). The financials sector gulf is also significant, with small caps’ exposure relative to their large cap brethren clocking in at over 700bps. Already, the yield curve is steepening and there are high odds of a selloff in the bond market as the economy continues to reopen (third panel, Chart 10). In addition, easy fiscal policy is a tonic to the small/large share price ratio. As a flood of money enters the economy with a slight lag, small caps will continue to make up ground lost during the early stages of the pandemic (fiscal balance shown inverted, second panel, Chart 10). Not only is fiscal stimulus providing a lifeline to debt-burdened small caps, but also the Fed’s opening up of the monetary spigots has pushed fixed income investors out the risk spectrum. Thus, the proverbial “kicking the can down the road” is boosting the allure of small cap stocks (junk spread shown inverted, bottom panel, Chart 10). Bottom Line: A small size bias is a high-conviction call for 2021. Chart 10Prefer Small Caps To Large Caps Long VIX June 2021 Expiry Futures (Hedge Trade) We want to hedge our overweight exposures with a long VIX futures position for the June 16, 2021 expiry. We are spending $25.3 to go long and are comfortable paying up for insurance when the SPX is at all-time highs and there is a risk of some growth disappointment in the next six months. Chart 11 draws a parallel with the March 2009 SPX lows and plots the VIX in 2009 and 2010. While the path of least resistance is lower for volatility, sporadic surges are typical in the year following recessions. The S&P 500 also troughed in March 2020 and if history is an accurate guide, the path to SPX 4,000 will be rocky next year. As a reminder, the S&P 500 suffered a 16% correction in May 2010 and the VIX spiked higher. Positioning remains lopsided with both VIX put/call ratios (volume and open interest) at historically high levels, underscoring investor complacency. Net speculative futures positions as a percent of open interest are also probing multi-year lows, corroborating the complacent options data. Finally, the equity volatility curve has flipped from a 10% backwardation to a steep contango in the past month with the 3rd month now trading at a 25% premium to spot VIX; such a complacent level typically warns of a looming spike in the VIX. Bottom Line: Go long the VIX June 2021 futures as a small hedge to overweight equity positions. Chart 11Go Long VIX Futures As A Hedge Underweight Homebuilders (COVID-19 Winner Theme) We deem that most, if not all, of the good news (low mortgage rates, low inventories, high demand, work-from-home reality, all-time highs on the overall NAHB housing sentiment survey) is already priced in galloping homebuilders stock prices and exuberant expectations. While being contrarian is fraught with danger, because more often than not the herd is right, there is a key macro driver that gives us confidence to be bearish homebuilders: interest rates. If our economic reopening thesis proves accurate next year, then the COVID-19 winners – homebuilders included – will take the back seat. Historically, interest rates and relative share prices have been inversely correlated and a steep selloff in the bond market is bad news for homebuilding stocks (top panel, Chart 12). On the operating housing front, some cracks are forming. New home sales, while brisk in absolute terms, are losing out to existing housing sales and homebuilders have resorted to price concessions in order to drive volumes (second & third panels, Chart 12). Profit margins are at the highest level since the subprime crisis and are vulnerable to a squeeze, not only from lower selling prices, but also from rising input costs. Framing lumber comprises roughly 15% of a new home’s commodity related costs and lumber prices have been expanding all year long (bottom panel, Chart 12). Bottom Line: Put the S&P homebuilding index to the high-conviction underweight call list. The ticker symbols for the stocks in this index are: BLBG: S5HOME – LEN, PHM, DHI, NVR. Chart 12Avoid Homebuilders Underweight Pharma (COVID-19 Winner Theme) The S&P pharmaceutical index is a high-conviction underweight for 2021. On the macro front, the Fed’s ZIRP bodes ill for defensive pharma equities. The Fed was uncharacteristically quick this recession to drop rates to the lower zero bound to reflate the economy. As a result, safe haven equities, Big Pharma included, typically trail the broad market as the economy gets out of the ER and into the recovery room (second panel, Chart 13). Importantly, relative pharmaceutical profits are highly counter cyclical: they rise at the onset of recession and collapse as the economy heals. Currently, as the world economy has transitioned to a V-shaped recovery, the reopening of the economy into the New Year will continue to knock the wind out of relative pharma profitability. Similarly, an appreciating greenback has historically been synonymous with pharma outperformance and vice versa (third panel, Chart 13). Keep in mind, Big Pharma make the lion’s share of their profits domestically, further cementing the positive correlation with the US dollar. This local profit sourcing represents one of the main reasons why politicians on both sides of the aisle are after domestic pharma profits. Pharma prices are on the cusp of contracting. Importantly, President Trump’s late-July executive order “to allow importation of certain prescription drugs from Canada” among other provisions is a direct blow to the profit prospects of Big Pharma (bottom panel, Chart 13). Bottom Line: We are cognizant that the COVID-19 vaccine will lift Big Pharma, but only temporarily, as cyclical forces will more than offset the positive vaccine news. The S&P pharmaceuticals index is a high-conviction underweight. The ticker symbols for the stocks in this index are: BLBG – S5PHARX: JNJ, PFE, MRK, LLY, BMY, ZTS, CTLT, MYL, PRGO. Chart 13Sell Pharma Underweight Consumer Staples (COVID-19 Winner Theme) Countercyclical consumer staples stocks served their purpose and supported our portfolio in the front half of 2020. Now that vaccines are coming, we are adding the S&P consumer staples sector to the high-conviction underweight call list. The current macro backdrop underscores that the path of least resistance is lower for relative share prices. Not only is the ISM manufacturing survey on fire, but also, consumer confidence is forming a trough (ISM manufacturing shown inverted, second panel, Chart 14). One of the factors that will drive relative earnings lower is the weaker US dollar. As a reminder, the S&P consumer staples sector derives approximately 32% of its sales from abroad, which is 10 percentage points lower than the S&P 500. As a consequence, on a relative basis, staples stocks benefit much less than the rest of the market from a falling currency (third panel, Chart 14). Our relative macro earnings model does an excellent job in encapsulating all these moving parts and paints a dark profit picture for this GICS1 sector in the New Year (fourth panel, Chart 14). Bottom Line: The S&P consumer staples sector is a high-conviction underweight.   Chart 14Underweight Consumer Staples Short NASDAQ 100 / Long S&P 500 (Secular 10-year Call) We first wrote about the extreme market cap concentration in January when we were cautioning investors of an SPX drawdown and drew parallels with the dotcom era. Back in late-1999/early-2000 the top 5 stocks comprised 18% of the S&P 500. In July we delved deeper and split the S&P 500 in the S&P 5 versus the S&P 495 to highlight the extraordinary narrow returns since 2015. Such extreme concentration in a handful of tech titan stocks is clearly unsustainable. The bullish case for tech is well documented and understood; the COVID-19 pandemic acted as an accelerant to the technological adoption of the new remote working realities. However, $2tn valuations (AAPL, MSFT & AMZN) make little sense to us, especially if there is little earnings follow through and most of the returns are explained by multiple expansion. In all likelihood, the easy money has been made. Going back to the early 1970s is instructive in order to put the tech juggernaut into proper perspective. Every decade or so there have been clearly defined booms and busts in US tech stocks (Chart 15). Schumpeter’s “creative destruction” forces are undoubtedly at play. What is interesting is that not only have tech stocks likely stalled near the dotcom era peak, but also they have been outperforming since the end of the GFC (i.e. roughly a decade); they are due for at least a breather. If history rhymes, we have entered a new bust cycle and the tech sector’s underperformance will play out over the coming decade. Bottom Line: We are compelled to add to our structural trades and recommend investors underweight the tech sector on a ten-year time horizon via the short QQQ / long SPY exchange traded funds which offer the most liquidity. Chart 15Short QQQ / Long SPX For The Next Decade Also Rans Within consumer discretionary, automobiles & auto parts & components piqued our interest from the long side. These stocks would greatly benefit from a reopening economy as a semblance of normality returns sometime next year. Nevertheless, two key factors kept us at bay. First, similar to homebuilders, this index has gone vertical since the March lows, besting the SPX by a factor of 2:1 (top panel, Chart 16). We maintain exposure via our “Back-To-Work” basket with GM, but even this auto manufacturer is up 50% since the September 8, 2020 inception. Finally, TSLA is about to enter the SPX at a stratospheric valuation that would dominate the automobile sub group. This is eerily reminiscent of YHOO’s SPX inclusion in late-1999 that led the dotcom bubble peak by four months. The parallel is making us nervous, therefore we are staying patiently on the sidelines. On the underweight side we wanted to include the niche S&P semi equipment index, but opted not to as the Bitcoin mania has really pushed these stocks to the stratosphere (middle panel, Chart 16). In addition, this chip sub-group has one of the highest export exposures in the SPX with a large slice of foreign revenue originating in China. Hence, news of a Biden presidency also served as a catalyst to propel them higher (i.e. at the margin, a less hawkish president on the Sino/American trade war). We really struggled with global gold miners (GDX:US). Our initial thinking was to downgrade them to underweight (from currently neutral), which is consistent with global growth reaccelerating and interest rates rising. However, we missed the boat when it set sail in early August (bottom panel, Chart 16). Now, the gold bearish trade is gaining momentum and has become a consensus trade as big macro investors (Tudor and Druckenmiller among others) are shifting toward Bitcoin and have been vociferous about their positioning. Thus, we preferred to remain on the sidelines with a benchmark allocation. Chart 16Three “Also Rans” Footnotes   Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views October 26, 2020 Favor small over large caps July 27, 2020 Overweight cyclicals over defensives June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth