Sectores

Underweight Presenters at this week's Detroit Auto Show have reason to celebrate; December light vehicle sales numbers showed the industry had sold more than 17 million vehicles for a third consecutive year, marking the best winning streak ever for auto makers. Even better, falling pricing appears to be staging a much needed comeback (third panel). The picture is somewhat murkier beneath the surface. J.D. Power reported that average manufacturer incentive spending per unit set a new record in December, exceeding 10% of MSRP for the 17th time in 18 months. At the same time, lenders have continued to clamp down sharply on auto lending (bottom panel), implying that ongoing incentives are required to maintain even the status quo. This is negative to component makers from both a pricing and potentially volume basis. Better growth can be found elsewhere; stay underweight. The ticker symbols for the stocks in the S&P auto components index are: BLBG: S5AUTC - DLPH, BWA, GT.

Informe especial

Highlights We are upgrading our allocation to Indian stocks from neutral to overweight within EM equity portfolios. India's public banks are much further along in their necessary adjustment process, and the credit cycle downturn is much more advanced relative to China's. To capitalize on this theme, we recommend going long Indian banks and shorting Chinese bank stocks. India's public bank recapitalization program will allow them to slowly augment credit origination, assisting the economic recovery. Feature Chart I-1Favor Indian Banks Versus Chinese Ones Our report this week highlights the results from stress tests we conducted on Indian and Chinese public banks, and also compares their respective equity valuations. Based on our findings, we are initiating a new relative equity trade: long Indian / short Chinese bank stocks (Chart I-1). The health of the banking system, the credit cycle outlook as well as the performance of bank share prices hold the key to relative performance of any bourse in the EM universe. Provided our positive bias toward Indian banks relative to their EM peers on all the above parameters, we are upgrading our allocation to India from neutral to overweight within EM equity portfolios. Indian Versus Chinese Public Banks From 2003 to 2012, India went through a large credit binge and capital misallocation cycle in its industrial and infrastructure sectors. During this period, banks' loans to companies and bank assets rose from 12% to 23% and 63% to 85% of GDP, respectively (Chart I-2A). By comparison, Chinese (ex-policy) commercial banks' claims on companies and their total assets have surged from 85% to 110% and from under 180% to 230% of GDP, respectively, since 2009 (Chart I-2B). In both countries, the banking sector remains dominated by public banks that hold more than 50% of banking system assets. Chart I-2ACredit Boom In Perspective: India Chart I-2BCredit Boom In Perspective: China Today, Indian public banks - who were the main lenders to industrial companies during the corporate credit binge in the 2003-12 period - have been experiencing mushrooming bad loans. Total public banks' NPLs and distressed asset ratios have reached 13.5% and 2.7% of total loans, respectively (Chart I-3). By contrast, for all Chinese banks, the current NPL ratio is at a mere 1.7%, while the distressed loan ratio stands at only 3.6% of total loans. Chart I-3NPL Ratios In Perspective: India & China Further, under pressure from the central bank, Indian public banks have been raising provisioning levels for bad assets very aggressively. On the flip side, Chinese regulators have been following tolerant policies toward their own commercial banks. As such, the provisions-to-loans ratio at all public banks now stands at 3% in China, compared with 5.6% in India. In addition, Chinese banks have bought a lot of corporate bonds that are not provisioned for at all. Does this higher NPL ratio in India relative to China mean that credit allocation is much worse in India? Not quite. The thesis that Indian public banks are more poorly managed than Chinese public banks is not accurate. These banks are managed by public sector executives who often allocate credit to support government growth policies. This is why it is reasonable to assume that the quality of credit allocation among Chinese and Indian public banks is probably similar. As such, we presume that Chinese banks' current NPL ratio is severely understated, and has the potential to rise to levels currently being reported by Indian public banks. The basis is that the Chinese credit boom has dramatically exceeded that of India (see Chart I-2A and I-2B on page 2). Typically, the resulting NPL ratio is proportional to the magnitude of the preceding credit frenzy. Finally, India's central government announced a major recapitalization plan in October 2017 to assist the country's public banks in cleaning up their balance sheets and to also support them in expanding credit. It is likely, therefore, that these banks are now approaching the final stages of their balance sheet repair and deleveraging process. Bottom Line: India's public banks are much further along in their necessary adjustment, and their credit cycle downturn is also much more advanced relative to Chinese banks. The latter have been postponing the inevitable balance sheet clean-up process. To capitalize on this theme, we recommend going long Indian banks and shorting Chinese bank stocks. Banking Stress Test For India And China We have conducted stress tests for India's top seven and China's top five listed public banks. We used the following assumptions for the three scenarios we considered: Non-performing risk-weighted assets (NPA) ratios to rise to 14% (pessimistic), 12% (baseline) and 10% (optimistic scenario) of risk-weighted assets for both Indian and Chinese public banks. Risk-weighted assets adjust banks' various types of assets based on their degree of riskiness. In that way, the risk-weighted asset values are comparable between the two banking systems. We assume a 30% recovery rate in all three NPA scenarios for both countries. The recovery rate on Chinese banks' NPAs in the 2001-2005 period was 20% amid a booming economy. The assumed recovery rate of 30% is therefore not low. The outcome of the stress tests is as follows: In the baseline scenario of 12% NPA, the losses post recovery and provisions would amount to 1.3 trillion rupees in India (0.9% of GDP) and RMB 3.4 trillion in China (4.2% of GDP). This would translate into a 33% equity impairment for India's seven public banks, and 48% for China's five public banks (Table I-1 and I-2, column 7). Table I-1Stress Test For Top 7 Indian Public Banks Table I-2Stress Test For Top 5 Chinese Public Banks From a valuation standpoint, the post-impairment price-to-book value (PBV) ratio would jump to 1.44 and 1.62 for Indian- and Chinese-listed public banks, respectively. Assuming a fair PBV ratio of 1.3 - which is the average PBV ratio for all EM banks since 2011 - Indian public banks are 11% overvalued and Chinese ones are about 25% overvalued. In other words, if one were to calculate the true PBV ratio of these banks after a comprehensive "clean-up" has been done, then Indian public bank stocks would be cheaper than Chinese ones. It is important to note that the above valuation exercise does not take into consideration banks' future profits. As such, we account for their recurring profits in the following manner: Table I-3 calculates the ratio of NPA losses to banks' recurring net profits before provisioning. Losses are the amount to be written-off post provisioning and recovery. In the baseline scenario of a 12% of NPA, this ratio is 2.5 for India and 3.4 for China. In other words, it will take 2.5 and 3.4 years of net profits before provisions close the "black hole" of NPA losses (post provisions and recovery) in India and China, respectively. Hence, on this measure as well, India's listed public banks appear more appealing than those in China. Table I-3Profit Coverage Of Loan Losses There is a caveat regarding Chinese banks' stress and their post-impairment book value. Our analysis is performed based on risk-weighted assets, and does not include off-balance-sheet assets. Therefore, any losses from off-balance-sheet assets will make losses for Chinese public banks greater than our analysis captures. Further, the Chinese financial authorities are currently tightening regulations, which will likely curtail banks' off-balance-sheet activities and by extension their profitability. These risks are not present in India, where banks have less off-balance-sheet assets. Bottom Line: Public bank stocks are currently overvalued by about 11% and 25% in absolute terms in both India and China, respectively. This favors Indian bank share prices outperforming their Chinese peers. The fact that the "clean-up" has not yet begun in China reinforces this trade. Banks' Recapitalization In India Saddled with NPLs, Indian public banks have not been willing to lend in recent years. Chart I-4 demonstrates that their loan growth has stalled. Credit to large industrial companies has in particular suffered (Chart I-4, bottom panel), as most of this type of credit is typically extended by public banks. Chart I-4India: Public Bank Loan Growth Has Slumped Consequently, India's capital expenditures have languished in recent years, weighing not only on cyclical growth but also depressing long-term productivity and potential growth. In October, the Indian government announced an estimated 2.11 trillion rupees public bank recapitalization program that will be implemented over the next two years. The program is for all public banks, while the above stress test was performed for only the top seven listed public banks. The latter account for around 60% of all public banks' assets, so we assume they will get around 60% of the stated recapitalization amount. The recapitalization program is designed as follows: The central government plans to inject 180 billion rupees of equity capital into all public banks via budgetary allocations. The public banks will in turn raise 580 billion rupees from the market. The remaining 1,350 billion rupees will come from government-issued Bank Recapitalization Bonds. The government will issue bonds to banks and then use the funds to buy more shares from public banks. It is important to note that in the stress test above and for the calculation of post-impairment PBV ratios, we assume the government will not subsidize existing shareholders when it injects money into public banks. This means the government will provide equity capital to public banks at post-impairment equity value - i.e., at a fair market price. It will be difficult for the Indian government to bail out its public banks without making current shareholders bear losses. If the government bails out public banks' private and foreign shareholders, the opposition parties will use the bank recapitalization program against Prime Minister Narendra Modi's government in the general elections scheduled to be held in 2019. Many investors and commentators assume that India's bank recapitalization program is automatically bullish for bank share prices. While it is positive for banks' ability to lend and drive growth in the medium and long term, the program is not necessarily bullish for share prices, particularly at their current high levels. The same is true for potential recapitalization programs in China. Overall, odds are that current shareholders of public banks will likely shoulder meaningful losses in India and possibly in China as well. How well off will capitalized public banks in India be after implementation of the recapitalization program? In the case of the seven Indian public banks we performed the stress test on, Table I-4 estimates that post-impairment and recovery, the total equity capital-to-risk-weighted assets ratio will be 8% in our baseline scenario. This is lower than the regulatory minimum of 9%. Table I-4Capital Ratios For India's Top 7 Public Banks The recapitalization will bring this equity capital adequacy ratio to 11.3%, which exceeds the regulatory minimum of 9%. Hence, after the program is completed, Indian public banks will likely become well capitalized and will be able to resume their lending and expand their assets. This in turn will facilitate the economic recovery. Bottom Line: The Indian government's recapitalization program is sufficient to raise public banks' capital adequacy ratio above the regulatory minimum. This will allow public banks to resume their lending. India's Cyclical Growth Outlook India's cyclical outlook will be one of muted recovery. Yet it is superior to other EMs, where we expect meaningful deceleration due to a potential slowdown in China and a rollover in commodities prices. Public banks' recap program will be slow in India - to be conducted over the next two years - and banks' ability to boost lending will improve only gradually. Meanwhile, private banks have and will probably continue to concentrate their lending efforts on consumers rather than on industrial companies and infrastructure. In the next 12-18 months, a slow improvement in public banks' ability to originate credit will allow only moderate improvement in capital spending growth. The latter is required to resolve bottlenecks and unleash the nation's productivity potential. Several indicators of capital spending are lukewarm (Chart I-5, top panel). However, new capex project announcements and the number of investment proposals have been dropping (Chart I-5, middle panel). Surprisingly, companies' foreign external borrowing is still contracting, despite booming capital inflows into EM (Chart I-5, bottom panel). On the consumer side, the outlook remains bright. Motorcycle sales have recovered sharply and commercial vehicle sales are beginning to pick up (Chart I-6). Chart I-5India's Capital Spending Is Sluggish Chart I-6Indian Consumer Health Is Strong Consumer/personal loans are accelerating from an already strong growth rate, largely thanks to the aggressiveness of private sector banks (Chart I-6, bottom panel). In turn, the employment outlook is finally beginning to show signs of improvement (Chart I-7). The manufacturing PMI has also risen substantially, and is currently in expansion territory (Chart I-8). Likewise, the service sector PMI has bounced above 50. Chart I-7India's Employment Is Turning The Corner Chart I-8India: PMIs Are Positive Finally, India is less exposed to China's growth and a retracement in commodities prices than many other emerging economies. This makes us upbeat on India's cyclical economic dynamics and relative equity and currency performance versus other EMs. Bottom Line: India's cyclical outlook is better than that of many other EMs. Structural Tailwinds And Impediments India holds huge promise for investors as it is a much-underinvested economy, and potential return on capital is considerably higher in those countries than in relatively overinvested ones. In addition, its population and labor force growth are among the highest in mainstream developing countries. On the other hand, for such potential to be realized, the country needs to be able to boost its productivity. On this count, the outlook is less positive. India's share of global goods and services exports has declined substantially since 2011 (Chart I-9). This should not be surprising, given weak investment spending has led to stagnation in trade competitiveness. Chart I-10 reveals that based on the UNCTAD1 dataset, India has been losing market share in both low- and high-skilled labor sectors export markets worldwide. Chart I-9India's Share In Global Trade Chart I-10India Has Been Losing Export Market Share While certain reforms such as the introduction of a sales tax will have a positive impact on the economy, other much-needed changes, such as land and labor market reforms, have so far remained unattainable. Moreover, the agriculture sector still faces material challenges. Without these vital reforms, it will be difficult to boost efficiency and productivity and build global competitiveness. Finally, in terms of education enrollment, India lags other EMs, especially China, in tertiary education (Chart I-11). This makes it even more difficult to boost productivity and growth potential. Bottom Line: India has great secular potential, but the structural advance has stalled since 2011. The jury is still out on whether it can implement additional reforms to realize this potential. Investment Conclusions India's banking sector outlook is brighter, and the deleveraging cycle is much more advanced, compared with many other EMs in general and China in particular. Therefore, we recommend a new relative equity trade: long Indian banks / short Chinese banks. Investors could buy Indian public banks or all banks with the understanding that private banks are typically in better shape than their state-owned peers, but are also much more expensive. We will be tracking this trade's performance using the Bankex index for India and the MSCI bank index for China. The Bankex index has a larger share of market cap of public banks than the MSCI India bank index. Within China, we are maintaining our short small and medium / long large banks position initiated on October 26th 2016. We are also recommending EM equity investors upgrade the Indian bourse from neutral to overweight. We shifted Indian stocks from overweight to neutral on August 23rd 2017, but the risk-reward has improved since then (Chart I-12). Chart I-11India's Education Improvement Is Lagging Chart I-12Upgrade Indian Bourse Within EM Universe Our primary concerns with EM stocks are a China slowdown, a rollover in commodities prices and a rebound in the U.S. dollar. Associated strains in countries with large foreign debt levels or wide current account deficits as well as lack of credit deleveraging and bank recapitalization will define EM financial markets' performance in the next 12-18 months. On all of these counts, India scores better than many EMs, justifying this equity upgrade. The absolute outlook for Indian stocks, however, is not inspiring. This equity market is rather expensive and overbought in absolute terms. If EM risk assets experience a setback in 2018, as we expect, Indian equities will also relapse in absolute terms. Ayman Kawtharani, Associate Editor ayman@bcaresearch.com Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com   1 United Nations Conference on Trade and Development.   Equity Recommendations Fixed-Income, Credit And Currency Recommendations

America's banks appear to have finished off 2017 with stellar core earnings as some of the largest lenders, including JPM, WFC and C, have all reported strengthening net interest income and loan growth while delivering EPS ahead of estimates. These earnings reports serve as early validation of our high-conviction investment thesis for banks, namely that bank profits should exceed expectations as the price of credit, loan growth and credit quality move steadily higher in the year to come. Rising inflation expectations (second panel) should keep a tailwind behind the 10-year yield, driving improving net interest margins (third panel). Combined with record low unemployment and the associated low default rates, margins should widen; EPS should soar as a result. We reiterate our high conviction overweight recommendation. The ticker symbols for the stocks in this index are: BLBG: S5BANKX - WFC, JPM, BAC, C, USB, PNC, BBT, STI, MTB, FITB, CFG, RF, KEY, HBAN, CMA, ZION, PBCT.

Informe especial

Equities have melted up in recent weeks, celebrating the tax bill passage, synchronized upswing in global economic data, still quiescent inflation and near vanishing tail risk. On July 10th when we penned the "SPX 3,000?" report, the S&P 500 was close to 2400.1 Over the past six months stocks have been in an uninterrupted upleg, moving to within 10% of our SPX 3,000 target. Table 1 Stocks have run "too far too fast" for our liking and there are increasing odds of a healthy pullback, especially now that no pundits are talking of a correction. In addition, were the selloff in the bond markets to accelerate in a short time frame, at some point it will cause equity market consternation. But, bonds still remain extremely overvalued versus stocks (Chart 1). Late last year, we began to modestly de-risk the portfolio via booking impressive gains in tactical market-neutral trades, as our upbeat cyclical view remains intact.2 Our cyclical strategy is to "buy the dip", as we do not foresee a recession in the coming 9-12 months. Importantly, profits will dictate the S&P 500's direction and the cyclical path of least resistance is higher still. Our SPX profit model continues to forecast healthy EPS growth in 2018 (Chart 2) and as we posited in the last report of 2017, earnings will do the heavy lifting at the current juncture with the forward P/E multiple likely moving laterally (Chart 3). Chart 1Simple Bond Valuation Metric Says:##br## Bonds Are Overvalued Vs. Stocks Chart 2All ##br##Clear Chart 3EPS Will Do The##br## Heavy Lifting In 2018 A simple decomposition shows that equity returns could reasonably reach a low-to-mid double digit level this year. Our assumptions are the following: nominal GDP can grow near 5% (3% real plus 2% inflation) and thus we estimate organic EPS growth that typically mimics GDP at this stage of the cycle of ~5%, ~2% dividend yield, ~2% buyback yield, ~5% tax related boost to EPS and no multiple expansion. The above assumptions are based on four key drivers: energy and financials will command a larger slice of the earnings pie,3 synchronized global capex upcycle will boost EPS,4 delayed positive translation effects from the U.S. dollar will lift profits5 and easy fiscal policy will also act as a tonic to EPS.6 On this note, this White Paper officially introduces the U.S. Equity Strategy earnings models for the eleven GICS1 equity sectors. We have identified key macro earnings drivers for each sector and incorporated them into individual sector models. The objective is to forecast the direction of earnings growth. Beyond introducing our EPS models, the purpose of this White Paper is to also compare and contrast the cyclical readings of our equity sector models with sell-side analysts' profit growth (Charts 4 & 5) and margin expectations and help clients position portfolios for the rest of 2018. The earnings models carry the most weight in determining our sector positioning, with our macro overlay and our valuation and technical indicators rounding out our methodology. Currently, our earnings models are consistent with maintaining a mostly cyclically biased portfolio structure (top panel, Chart 6), and thus participating in the broad market's overshoot. Chart 4What EPS Are Priced In... Chart 5...Per Sector For 2018 Chart 6Continue To Prefer Cyclicals Over Defensives Encouragingly, an equal weight of the 10 GICS1 sector model outputs (we are excluding real estate due to lack of history), accurately forecasts the S&P 500's profit growth (bottom panel, Chart 6), and currently also confirms the broad market's upbeat four factor macro EPS model (Chart 2). Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com Financials (Overweight) Our financials earnings growth model comprises bank credit growth, the U.S. dollar index and net earnings revisions. The U.S. credit impulse is gaining traction, indicating that the market has digested the almost doubling in long-term rates over the past 18 months. Bankers are willing extenders of C&I credit and, with the economy humming north of 3% in real GDP terms, the outlook for loan growth is excellent. Loosening U.S. banking regulatory requirements, and pent up demand for shareholder friendly activities are all welcome news for financials profitability. Tack on BCA's higher interest rate view in 2018 and net interest margins will also get a bump, further adding to the sector's EPS euphoria. Credit quality is the third key profit driver for bank profitability and pristine credit quality is a harbinger of increased profits. The unemployment rate is plumbing generational lows and suggests that non-performing loans as a percentage of total loans will remain on a downward trajectory. Our profit model is expanding at twice the current profit growth rate (second panel, Chart 7) and 10 percentage points above the Street's 12-month forward estimates (top panel, Chart 5). In fact, the latter have gone vertical of late playing catch up to our model's estimates. The S&P financials sector remains a core portfolio overweight and we reiterate our high-conviction overweight status in the heavyweight S&P banks index. Chart 7Financials (Overweight) Energy (Overweight) The three drivers behind the S&P energy sector EPS growth model are oil-related currencies, the U.S. oil & gas rig count and WTI crude oil prices. A depreciating greenback, whittling down OECD oil stocks and rising global oil demand are all boosting energy profitability. OPEC 2.0 cutbacks have not only helped stabilize oil markets, but also paved the way for a breakout in oil prices above the $62.50/bbl stiff resistance level. Sustained OPEC output restraint will counterbalance U.S. shale oil production increases and coupled with rising global demand likely continue to underpin oil prices. Our synchronized global capex upcycle theme included the basic resources following a multi-year drubbing in outlays. Energy capex cannot contract at double digit rates indefinitely. Already a V-shaped capex momentum recovery is in store, as 2018 capital spending budgets are on track to at least match 2017. Our EPS growth model (second panel, Chart 8) matches sell-side analyst optimism (third panel, Chart 5). Keep in mind that only recently did the energy space become profit positive, making a solid recovery from an extremely low base. Margins are only now renormalizing above the zero line and breakneck pace EPS growth should continue in 2018. Following a negative 2017 return, the S&P energy sector is the best performing sector year-to-date, and we reiterate the high-conviction overweight stance. Chart 8Energy (Overweight) Industrials (Overweight) Our S&P industrials EPS model comprises the ISM manufacturing survey, raw industrials commodity prices and interest rates. It has an excellent track record in forecasting industrials EPS momentum, and sports one of the highest explanatory powers amongst all sector EPS models. While industrials EPS growth has been bouncing off the zero line for the better part of the past five years, our profit model has spoken: forecast EPS are in a V-shaped recovery since the end of the recent manufacturing recession (second panel, Chart 9). Commodity prices are recovering and increasing final demand, coupled with a soft U.S. dollar suggest that more gains are in store. Tack on the global virtuous capex upcycle, and the stars are aligned for this deep cyclical sector to break out of its multi-year trading range funk on the back of a surge in profits. China is a wild card, but signs of stability are enough to sustain the upward trajectory in the commodity-levered complex, including industrials stocks. Our industrials sector EPS model suggests that industrials profits will easily surpass the low (and below the overall market) analysts' EPS growth hurdle (third panel, Chart 4). The late-cyclical S&P industrials sector remains an overweight. Chart 9Industrials (Overweight) Consumer Staples (Overweight) The S&P consumer staples EPS growth model key drivers are: food exports, non-discretionary retail sales and analysts' net earnings revision ratio. Overall industry exports are expanding at a healthy clip as a consequence of a softening U.S. dollar and robust European and rebounding emerging markets demand. Deflating raw food commodity prices are offsetting rising energy and labor input costs, heralding a sideways move to margins. Sell side analysts are also currently penciling in a lateral profit margin move (middle panel, Chart 10). Our model is expanding at a near double digit rate, and is in line with 12-month forward EPS growth estimates (second panel, Chart 4). Investors have been vehemently avoiding staples stocks during the board market's uninterrupted run up, and have put out positioning offside. However, in the context of our cyclical over defensive portfolio bent we refrain from putting all our eggs in one basket, and prefer to keep consumer staples as our sole defensive sector overweight. This small hedge will serve our portfolio well if we do indeed get a healthy Q1/2018 pullback, as we expect. Chart 10Consumer Staples (Overweight) Consumer Discretionary (Neutral - Downgrade Alert) Measures of consumer confidence, consumer discretionary exports and the net earnings revisions ratio comprise BCA's global consumer discretionary EPS growth model, which has an excellent track record in forecasting the path of consumer discretionary profits. Consumer confidence is rolling over, albeit from a nose-bleed level, signaling that, at the margin, discretionary consumer outlays will remain tame. Worrisomely, rising interest rates coupled with a breakout in crude oil prices are net negatives for consumer spending. Our consumer drag indicator captures these consumer headwinds and warns that the sector is not out of the woods yet (bottom panel, Chart 11). The Fed is on track to raise rate three more times in 2018 and continue to mop up liquidity via renormalizing its balance sheet. This dual tightening backdrop bodes ill for early cyclical discretionary stocks as we highlighted in the September 25th Weekly Report. Our consumer discretionary EPS growth model is making an effort to bounce, signaling that contracting earnings will likely reverse course and come out of their recent funk (second panel). But, analysts are overly optimistic penciling in a near double-digit profit growth backdrop for the consumer discretionary sector (fourth panel, Chart 5). Netting it all out, the anemic message from our profit model along with the ongoing Fed tightening cycle and spiking energy prices warrant a downgrade alert. Stay tuned. Chart 11Consumer Discretionary (Neutral-Downgrade Alert) Telecom Services (Neutral) Telecom pricing power and capital expenditures expectations comprise our S&P telecom services EPS growth model. Telecom capital expenditures have bounced off the zero line and are growing at 4% per annum while sector sales growth has been nil. This capital-intensive industry must continually invest to stay relevant. A push by telecom carriers into TV offerings as part of a quad-play (internet, wireline, wireless and TV) has rekindled an M&A boom, and capex is slated to increase. However, margins will suffer if increased investment fails to translate into new sales (bottom panel, Chart 12). Steeply contracting pricing power is a bad omen both for top and bottom line growth prospects (fourth panel). Hopefully, industry consolidation will lead to a better pricing backdrop, but the jury is still out. Our EPS model has sunk into the contraction zone (second panel). Analysts are a little bit more sanguine, penciling in low single-digit profit growth (bottom panel, Chart 4). Industry deflation is not alone as a headwind as the bond market selloff is weighing on the high dividend yielding telecom services stocks. Despite all the bearish news, near all-time lows in relative valuation and washed out technicals are keeping us on the sidelines. Chart 12Telecom Services (Neutral) Materials (Neutral) Materials EPS growth is a far cry from the near 100% year-over-year mark hit during the commodity super-cycle the mid-2000s and the reflex rebound following the Great Recession (second panel, Chart 13). Our S&P materials EPS model inputs include the U.S. currency, metals commodity prices and a measure of borrowing costs. The model has been steadily decelerating recently, and moving in the opposite direction compared with sell-side analysts' optimistic estimates (bottom panel, Chart 5). Consequently, there is scope for downward revisions. Materials stocks are reflationary beneficiaries and also high fixed cost high operating leverage deep cyclicals that benefit most during the later stages of the business cycle when a virtuous capex/EPS upcycle takes root. A number of both developed and developing central banks have recently embarked on tightening monetary policy following in the Fed's footsteps. Global liquidity is on the verge of getting mopped up as even the ECB and the BoJ have started to hint that they would remove some of their ultra-accommodative and unconventional policy measures. These opposing forces keep us at bay and we continue to recommend a benchmark allocation in the S&P materials index. Chart 13Materials (Neutral) Real Estate (Neutral) Commercial real estate loan demand, a labor market measure and the EUR/USD comprise our S&P real estate profit growth model (second panel, Chart 14). The 10-year Treasury yield and real estate relative performance have been nearly perfectly inversely correlated since the GFC as REITs sport a hefty dividend yield and thus are considered a fixed income proxy. BCA's higher interest rate 2018 theme suggests that more downside looms for this rate-sensitive sector. Similarly, a firming EUR/USD reflecting the nearly 100% domestic exposure of the sector weighs on real estate relative performance. Our EPS model has recently sunk into the contraction zone and is in sync with sell-side analysts' negative profit growth figures for calendar 2018 (second panel, Chart 5). While all this signals that an underweight stance is appropriate, we would rather stay on the sidelines for three reasons: First, sector pricing power (mostly rents) has not eroded yet, despite the surge in multi-family housing construction. Second, most of the bad news is likely already discounted in sinking valuations and extremely oversold technicals. Finally, we would rather concentrate our interest rate related underweight in the pure play fixed income proxy, the utilities sector (please see page 15). Stick with a benchmark allocation in the S&P real estate index. Chart 14Real Estate (Neutral) Health Care (Underweight) Our S&P health care EPS growth model consists of health care pricing power, labor costs and a measure of health care outlays. Health care demand is fairly inelastic, signaling that health care spending prospects remain upbeat, especially given the aging population. However, the industry's up-to-recently structurally robust pricing power backdrop is under intense scrutiny. Medical commodity cost inflation is melting and drug pricing power has nearly halved since early 2016. Democrats and Republicans alike, despise the pharmaceutical/biotech industry's pricing tactics and drug price containment is on nearly every legislator's agenda. Add on the generic drug inroads, and Big Pharma/biotech resilient profits appear vulnerable, weighing heavily on the sector's relative performance. From a secular perspective, there is scope for health care sector profit gains. Developing countries are only just starting to institute social "safety nets" that the developed world already has in place. Our profit model is decelerating (second panel, Chart 15) and forecasting single digit EPS growth, in line with the Street's 12-month forward profit estimates (fourth panel, Chart 4). The S&P health care sector is a core underweight portfolio holding and we reiterate the high-conviction underweight status in the heavy weight S&P pharma sub index. Chart 15Health Care (Underweight) Utilities (Underweight) Utilities pricing power, the yield curve and analysts' net earnings revisions are the key inputs in our S&P utilities EPS growth model (second panel, Chart 16). While natgas prices, the industry's marginal price setter, have been stuck in a trading range between $2.6 and $3.4/mmbtu over the past 18 months, they are currently contracting and weighing heavily on industry pricing power. The U.S. economy is firing on all cylinders (bottom panel, Chart 16) and a selloff in the 10-year Treasury market near 3% is BCA's base-case scenario for 2018. Under such a backdrop, fixed income proxied defensive equities lose their luster, and thus utilities stocks will likely remain under intense downward pressure, Our S&P utilities EPS growth model is expanding at a mid-single digit growth rate, broadly in line with sell-side analysts' forecasts (fifth panel, Chart 4) and roughly 700bps below the broad market. The S&P utilities sector is a high-conviction underweight. Chart 16Utilities (Underweight) Technology (Underweight - Upgrade Alert) Our three-factor global technology EPS growth model includes capex intentions, the trade-weighted U.S. dollar and sell-side analysts' net earnings revision ratio. While the tech sector is still largely considered a deep cyclical, we view it as more defensive. The majority of large capitalization tech companies are mature, cash rich, cash flow generating, dividend paying and high margin. Tech firms thrive in a deflationary backdrop as business models have been built to withstand the inherently disinflationary "creative destruction" process. BCA's interest rate view calls for an inflationary driven sell off in bonds for 2018, suggesting that investors avoid high-flying tech stocks. Weakness in basic resources explains most of the delta in cyclical capital outlays. Encouragingly, technology's share of the U.S. capex pie is making inroads rising to roughly 10% (bottom panel, Chart 17). Tech investment has been so abysmal for so long that it is hard to get any worse. In fact, it has started to improve both on an absolute and relative basis, as pent-up tech demand is being unleashed. Our synchronized global capex upcycle theme is gaining traction and the tech sector will continue to make gains at the expense of resource-related spending. Our global tech EPS model is forecasting modest double-digit growth in the coming quarters (second panel, Chart 17), largely aligned with sell-side analysts' profit growth expectations (fifth panel, Chart 5). On balance, we are putting the S&P tech sector on upgrade alert reflecting the capex tailwind offsetting the rising interest rate backdrop, and reiterate our capex-related high-conviction overweight in the S&P software sub-index. Chart 17Technology (Underweight-Upgrade Alert) 1 Please see BCA U.S. Equity Strategy Weekly Report, "SPX 3,000?," dated July 10, 2017, available at uses.bcaresearch.com. 2 Please see BCA U.S. Equity Strategy Weekly Report, "EPS And "Nothing Else Matters"," dated December 18, 2017, available at uses.bcaresearch.com. 3 Please see BCA U.S. Equity Strategy Weekly Report, "Dissecting Profit Composition," dated July 24, 2017, available at uses.bcaresearch.com. 4 Please see BCA U.S. Equity Strategy Weekly Report, "Invincible," dated November 6, 2017, available at uses.bcaresearch.com. 5 Please see BCA U.S. Equity Strategy Weekly Report, "Dollar The Great Reflator," dated September 18, 2017, available at uses.bcaresearch.com. 6 Please see BCA U.S. Equity Strategy Weekly Report, "Can Easy Fiscal Offset Tighter Monetary Policy?," dated October 9, 2017, available at uses.bcaresearch.com.

Puntos destacados Las reformas medioambientales en China continúan reduciendo la capacidad siderúrgica. El cierre de instalaciones de inducción ilegales en China también está ajustando los mercados. Aunque la producción oficial de acero en China es más alta, esto probablemente refleja el hecho de que la producción de los molinos de inducción ilegales no se registraba —y por tanto no se contabilizaba— mientras que la producción de los molinos legales está aumentando para cubrir el vacío dejado por los cierres. Los beneficios de los acereros están aumentando de forma pronunciada, lo que significa que la demanda de mineral de hierro en China se mantendrá firme al menos durante la 1S18. El cobre ha estado bien demandado desde junio de 2017, tras interrupciones en la oferta y un fuerte crecimiento de la demanda impulsado por la recuperación económica mundial. Esperamos que obtenga un impulso adicional en la 1S18, ya que los trabajos de cableado y fontanería en proyectos de construcción que ahora absorben acero en China se pondrán en marcha. Más adelante, el crecimiento global compensará cualquier desaceleración en China. Nuestro análisis indica que el mercado mundial del acero se estrechará en la 1S18, como ya está ocurriendo en China. En consonancia con esto, estamos abriendo una posición táctica larga en futuros de barras corrugadas de acero Mar/18 en la Bolsa de Futuros de Shanghai, que se cotizan en RMB/ton. Incluimos un stop loss del 10% en esta recomendación. Energía: Sobreponderar. Nuestra visión sobre el petróleo, que antaño estaba fuera del consenso, es ahora el consenso, por lo que estamos tomando ganancias en opciones spread alcistas sobre Brent y WTI $55 vs. $60/bbl para entrega en mayo y julio al cierre de esta noche. Estas posiciones registraron ganancias de 109.2% y 123.5% al cierre del martes. Cualquier caída ofrecerá una oportunidad para restablecer posiciones largas a lo largo de estas curvas a futuro. Metales básicos: Neutral. El cobre seguirá estando bien demandado este año mientras continúe la recuperación económica mundial. Un gran número de renegociaciones de contratos en minas constituye un riesgo adicional al alza para los precios del cobre este año. Metales preciosos: Neutral. Dada nuestra expectativa de cuatro subidas de tipos por parte de la Fed, es difícil ser demasiado optimistas con el oro. Sin embargo, cualquier indicio de que el banco central se incline hacia una postura más dovish —particularmente si no vemos una inflación más alta este año— hará repuntar el metal. Ags/Softs: Infraponderar. Los mercados se mantendrán en compás de espera hasta el WASDE del USDA del viernes. Mantenemos una infraponderación, excepto en maíz. Artículo principal Gráfico de la semana El mineral de hierro y los precios del acero se desviaron en 2017 Los precios del mineral de hierro y del acero divergieron en 2017 Los precios del mineral de hierro y del acero divergieron en 2017 Las acciones de política medioambiental de China han reducido la capacidad siderúrgica mundial en 100 mm MT entre la 1S16 y la 1S18. Esto es más visible en los precios del acero chinos, que ganaron más del 30% en 2017, tras un aumento de casi el 80% en 2016. La ganancia total en los precios del acero desde el inicio del enfoque de Pekín en las reformas del mercado del acero es un contundente 135%. Los precios del mineral de hierro registraron ganancias similares a las del acero en 2016, pero se desviaron bruscamente en 2017, desplomándose más del 40% entre mediados de marzo y mediados de junio, terminando casi un 8% por debajo interanual (interanual) (Gráfico de la semana). Los precios del acero en alza dispararon los márgenes de beneficio en los molinos chinos, lo que, por supuesto, se tradujo en demanda de mineral de hierro, el ingrediente crítico para la fabricación de acero en China, hacia finales de año: los precios del mineral de hierro subieron un 20% en los dos últimos meses de 2017. ¿Cómo llegamos hasta aquí? Un resumen de las reformas del sector siderúrgico de China Como parte de sus reformas destinadas a reducir la contaminación del aire eliminando capacidad industrial obsoleta y excesiva, Pekín se comprometió a eliminar entre 100-150 mm MT de capacidad siderúrgica durante el período 2016-2020. Hasta la fecha ha cerrado una estimada capacidad de 100 mm MT. Además de estas reformas, Pekín se comprometió a cerrar los pequeños hornos de inducción en China, que funden chatarra y producen acero de mala calidad. Se estima que estos hornos de inducción representan entre 80-120 mm MT de capacidad anual, aunque su producción real es mucho menor: produjeron entre 30-50 mm MT en 2016, según S&P Global Platts.1 Esto es menos del 7% de la producción total de acero crudo de China. Los recortes de producción de los molinos de inducción no son evidentes en los datos oficiales: las cifras de producción de acero crudo de China han seguido aumentando en medio de estos recortes, como discutimos en investigaciones anteriores (Gráfico 2).2 Los datos del International Iron and Steel Institute muestran que la producción mundial de acero alcanzó un récord en los primeros 11 meses de 2017, aumentando más del 5% interanual. Asimismo, la producción de acero crudo de China —que representa el 50% de la producción mundial— alcanzó su punto máximo en agosto: la producción en el mismo período fue la más alta registrada, aumentando un 5.28% en comparación con el mismo período de 2016. Esta paradoja de la producción puede atribuirse al hecho de que muchos hornos de inducción chinos son ilegales y, como resultado, su producción no se contabiliza en los datos oficiales de producción. A medida que los productores legales de acero aumentaron su producción para compensar las disminuciones de los hornos de inducción cerrados, las cifras oficiales de producción de crudo aumentaron. De hecho, un examen más detallado de los datos siderúrgicos chinos deja claro que el mercado del acero de China está en realidad más ajustado de lo que se puede inferir a partir de las cifras de producción de crudo (Gráfico 3). Las siguientes observaciones apuntan a un mercado tensionado: Mientras la producción de acero crudo de China ha ido marcando nuevos récords, los datos de China Stat Info revelan una imagen contradictoria acerca de los productos de acero. La producción de productos de acero en el período de marzo a noviembre de 2017 fue un 3.46% inferior interanual, marcando la primera caída interanual para ese período desde 1995! Mientras que el acero crudo producido por hornos de inducción no se incluiría en las cifras oficiales de acero crudo, el metal acabaría utilizándose para fabricar productos de acero —alambres, varillas, rieles y barras— y están representados en estos datos. Por lo tanto, la caída en los productos de acero indica que la menor oferta de crudo ha lastrado la producción de productos siderúrgicos. Las exportaciones de acero de China han estado en descenso. En teoría, esto puede deberse bien a un aumento de la demanda interna o a una disminución de la demanda externa. Dado el buen estado de la economía mundial y lo que sabemos sobre la producción de acero en China, creemos en la primera teoría. Las exportaciones de productos siderúrgicos de China bajaron un 30% interanual en los primeros 11 meses de 2017. Aparte de la caída interanual del 3.04% en 2016, estas marcan las primeras disminuciones anuales en las exportaciones desde 2009. Ante una menor oferta interna, China probablemente redujo sus exportaciones para satisfacer la demanda de los usuarios locales del acero. Las importaciones de chatarra de acero de China cayeron en la 2S17. A diferencia de los altos hornos, que utilizan mineral de hierro como principal insumo en la fabricación de acero, los acereros ilegales cerrados usan chatarra que funden en un horno de inducción. Coincidiendo con la eliminación de estos hornos, las importaciones de chatarra de acero de China cayeron un 14.35% interanual en la 2S17. Esto es otra evidencia de la menor demanda de chatarra por parte de estos hornos. Los inventarios de acero en China están cayendo. De hecho, los inventarios de productos siderúrgicos en las principales ciudades industriales están en mínimos históricos (Gráfico 4). Esto es un síntoma de un mercado ajustado con demanda superando la oferta, contradiciendo las cifras de producción de acero crudo de China. Gráfico 2 Producción china récord de acero crudo##BR##En medio de la caída en la producción de productos siderúrgicos Récord de producción de acero crudo en China en medio de la caída de la producción de productos siderúrgicos Récord de producción de acero crudo en China en medio de la caída de la producción de productos siderúrgicos Gráfico 3 Evidencia de los datos comerciales de China##BR##De un mercado ajustado Datos comerciales de China: evidencia de un mercado ajustado Datos comerciales de China: evidencia de un mercado ajustado Gráfico 4 Los inventarios de acero##BR##En China están cayendo Los inventarios de acero en China están cayendo. Los inventarios de acero en China están cayendo. Además, según la World Steel Association (WSA), la utilización de la capacidad en los 66 países para los que recopilan datos aumentó en 3.12 puntos porcentuales interanuales para el período de julio a noviembre de 2017 hasta promediar 72.64%, frente al promedio de 69.52% en el mismo período de 2016. Estas observaciones son evidencia de que, a pesar del aumento en las cifras oficiales de producción de acero crudo, la producción real ha caído y la oferta está más ajustada. Que los precios del acero se mantengan impulsados por la escasez dependerá de si China tiene éxito en cerrar de forma permanente la capacidad excesiva y a los productores de acero de mala calidad, o si los operadores de hornos de inducción logran eludir estas políticas y traer acero ilegal de vuelta al mercado. Las reformas de China dominarán el mercado del acero, al menos este invierno Tras la conclusión de la Conferencia Central de Trabajo Económico de mediados de diciembre, las autoridades chinas anunciaron las "tres batallas difíciles" para los próximos tres años, que consideran cruciales para la prosperidad económica futura. Estas batallas se resumen en (1) prevenir riesgos mayores, (2) alivio de la pobreza dirigido, y (3) control de la contaminación. La Agencia Internacional de la Energía (IEA) estima que la contaminación del aire ha provocado ~1 millón de muertes prematuras mientras que la contaminación del aire en los hogares causó otras 1.2 millones de muertes prematuras en China anualmente.3 Por ello, mejorar la calidad del aire en China es un objetivo social y de salud primordial para el país. Gráfico 5 La menor producción china de acero##BR##Impactará la producción mundial La menor producción de acero en China afectará la producción mundial. La menor producción de acero en China afectará la producción mundial. Esto significará que las medidas para reducir la contaminación y despejar los cielos de China serán críticamente importantes para el sector siderúrgico. Según el Ministerio de Protección Ambiental, China se comprometió a una reducción interanual del 15% en la concentración de partículas en suspensión de menos de 2.5 micras de diámetro, conocidas como PM2.5, en 28 ciudades del norte propensas al smog. La industria del acero, que se concentra mayormente en la región norteña de China de Pekín-Tianjin-Hebei, es una de las principales fuentes de emisiones contaminantes en esa región. De hecho, las emisiones industriales —especialmente de los sectores del acero y del cemento— son supuestamente responsables del 40-50% de estas pequeñas partículas en suspensión. El "plan de batalla" contra el smog invernal de China apuntará a estas industrias contaminantes ordenando recortes en la producción de acero, cemento y aluminio durante los meses propensos al smog, de mediados de noviembre a mediados de marzo, así como restringiendo el uso doméstico de carbón, los camiones diésel y los proyectos de construcción. Los recortes de producción de acero apuntan a un rango entre el 30-50%, lo que, según estimaciones de Platts, reducirá 33 mm MT de producción de acero —equivalente a ~3.9% de la producción de acero crudo prevista de China para 2017— durante el invierno. De hecho, según el ministro de medio ambiente de China, Li Ganjie, "estas campañas especiales no son puntuales, en cambio son una exploración de mecanismos a largo plazo."4 Por lo tanto, estos recortes podrían convertirse en un evento recurrente en el sector siderúrgico chino. Las cifras oficiales de acero crudo de China comienzan a mostrar el impacto de estos recortes con la producción cruda de noviembre cayendo un 8.6% mes a mes (mom) y creciendo solo un 2.2% interanual —significativamente más lento que el promedio interanual del 7.6% experimentado desde julio. Como consecuencia, aunque la producción cruda en el resto del mundo creció en línea con los meses anteriores, la producción mundial de acero cayó casi un 6% mes a mes en noviembre, mientras que la producción interanual creció un 3.7% –una desaceleración significativa respecto al ritmo promedio interanual del 6.6% observado desde el comienzo de la 2S17 (Gráfico 5). Los riesgos para esta perspectiva provienen del bajo cumplimiento de estos recortes. Hay informes recientes de evasiones por parte de productores de aluminio y acero en Shandong. No obstante, dado el enfoque de China en estas reformas, no prevemos violaciones generalizadas. Otro riesgo proviene del lado de la demanda. Como parte de su agenda medioambiental, Pekín anunció planes para posponer la construcción de importantes proyectos públicos en la ciudad —proyectos viales y de agua— hasta la primavera. La suspensión no pretende afectar a los "proyectos de gran impacto en la vida de las personas" como ferrocarriles, aeropuertos y vivienda asequible. La construcción es el mayor usuario final del acero —según la WSA más de la mitad del acero mundial se utiliza en edificios e infraestructura— una desaceleración en el sector de la construcción lastraría la demanda de acero.5 Si otras zonas de construcción importantes adoptan una política similar, el impacto de la menor oferta de acero se compensará con una demanda débil, atenuando el efecto general sobre el mercado del acero. Conclusión: Esperamos ver una menor producción y exportaciones de acero de China en los próximos meses. Dada la determinación de Xi Jinping de mejorar la calidad del aire, esperamos que el cumplimiento de las reformas medioambientales entre los acereros sea fuerte este invierno. Esto, junto con la menor producción de los hornos de inducción en China, indica que el mercado podría estar más ajustado de lo que comúnmente se supone, al menos en la 1S18. La probabilidad de que la recuperación y expansión económica mundial persista durante 2018 sugiere que los mercados del acero podrían seguir bien demandados en la 2S18, particularmente si, como esperamos, el crecimiento fuera de China compensa la pérdida resultante de cualquier desaceleración en China. Sin embargo, tendremos que ver cómo serán las reformas reales para la industria tras la Asamblea Nacional Popular en marzo de 2018.6 Los márgenes de beneficio del acero impulsan la demanda de mineral de hierro Dadas las excepcionales ganancias de precio del acero durante los últimos dos años, y el desempeño poco brillante del mineral de hierro en 2017, los márgenes de beneficio en los productores de acero chinos alcanzaron máximos de varios años (Gráfico 6). Normalmente, esto alentaría la producción de acero, lo que inundaría el mercado con oferta y presionaría los precios a la baja. Sin embargo, las reformas medioambientales de China limitarán la producción en la región siderúrgica más productiva del país en los próximos meses. En consecuencia, a menos que haya violaciones masivas de las políticas por parte de los productores de acero este invierno, no anticipamos un ajuste rápido de los precios a la baja. En cambio, los productores de acero se están preparando para funcionar a plena capacidad cuando las restricciones de producción se levanten en la primavera. Por ello, están llenando inventarios de mineral de hierro y aprovechando los precios más bajos del mineral antes de que el mercado del mineral de hierro alcance al del acero. Las importaciones de mineral de hierro de China alcanzaron un récord histórico en septiembre, mientras que los últimos datos muestran un salto del 19% mes a mes (mom) en las importaciones, correspondiente a un aumento interanual del 2.8% (Gráfico 7). Gráfico 6 Márgenes de beneficio saludables##BR##en el acero Sólidos márgenes de beneficio del acero Sólidos márgenes de beneficio del acero Gráfico 7 Productores de acero acumulando mineral de hierro##BR##En preparación para la primavera Productores de acero se abastecen de mineral de hierro en previsión de la primavera Productores de acero se abastecen de mineral de hierro en previsión de la primavera Esto va en contra de lo que esperaríamos durante un período de producción siderúrgica moderada. Especialmente en un entorno de inventarios saludables de mineral de hierro, como el que tiene actualmente China. Aunque los inventarios chinos bajaron desde los picos de mitad de año, reanudaron su tendencia al alza en el 4T17. Esto coincide con los recortes de capacidad del invierno siderúrgico y probablemente se deba a la menor demanda del mineral por parte de los molinos de acero. Hay dos teorías para explicar este fenómeno: 1. Los acereros chinos están aprovechando los precios más bajos del mineral de hierro y asegurando márgenes de beneficio más altos, anticipando precios más altos del mineral una vez que la producción de acero aumente de nuevo en la primavera. 2. En medio de los recortes invernales, los acereros chinos están demandando mineral de hierro de alta ley, importado de Brasil y Australia. Esto les ayudará a asegurarse de que pueden maximizar su producción sin violar las políticas medioambientales. La conciencia medioambiental amplía los diferenciales del mineral de hierro Una consecuencia de los recortes de capacidad del invierno siderúrgico es una mayor demanda de materias primas de mayor ley para reducir las fases más contaminantes de la producción de acero. El mineral de hierro de mayor ley, definido por su pureza o contenido de hierro, es más eficiente para los altos hornos, permitiéndoles producir más acero por cada tonelada de mineral de hierro que consumen, maximizando la producción y el beneficio. Esto es especialmente cierto en un mercado del acero ajustado, con márgenes de beneficio saludables: los acereros pueden permitirse las calidades superiores y están favoreciendo la eficiencia productiva. El descuento por finos de mineral de hierro de menor ley —contenido de hierro del 58%— así como la prima por la mayor ley del 65% se han ampliado (Gráfico 8). Esto se debe a que los molinos han encontrado una manera de eludir legalmente las restricciones medioambientales invernales y seguir cumpliendo. Además, los minerales más puros son menos contaminantes, lo que ayuda a servir la agenda medioambiental de China. Además, las primas por pellets de mineral de hierro y por guijarros de mineral de hierro también se han ampliado. A diferencia de los guijarros y pellets, que pueden alimentarse directamente a los altos hornos, los finos requieren un proceso de sinterización que es altamente contaminante. Por lo tanto, las reformas medioambientales de China han aumentado la demanda de minerales de mayor ley y menos contaminantes. Un factor adicional que podría estar impulsando los diferenciales al alza son los mayores precios del coque metalúrgico (Gráfico 6). El mineral de hierro de mayor ley contiene menos sílice y, por tanto, requiere menos coque metalúrgico para purificar los minerales. Según evidencia anecdótica desde China, los finos de Carajás de Brasil —que tienen el mayor contenido de hierro y el menor contenido de sílice— están supuestamente en alta demanda.7 Además, las importaciones de China muestran una disminución del mineral de hierro procedente de India —que es de menor ley. En el período de julio a octubre, las importaciones cayeron un 11.26% interanual, con las importaciones de octubre cayendo casi un 25% interanual y un 30% mes a mes. Esto es consistente con la teoría de que los acereros están rechazando los minerales de menor ley. Por otro lado, se espera que las importaciones de Brasil y Australia se mantengan fuertes (Gráfico 9). El último Australian Resources and Energy Quarterly pronostica que las exportaciones australianas y brasileñas de mineral de hierro crecerán un 5.4% y un 4.2% respectivamente en 2018, mientras que se proyecta que las exportaciones indias caigan un 57.5% interanual. Gráfico 8 Amplios diferenciales##BR##de precios del mineral de hierro Amplios diferenciales de precio del mineral de hierro Amplios diferenciales de precio del mineral de hierro Gráfico 9 Las preocupaciones medioambientales apoyarán##BR##la demanda de mineral de hierro de alta ley Las Preocupaciones Medioambientales Respaldarán la Demanda de Mineral de Hierro de Alto Grado Las Preocupaciones Medioambientales Respaldarán la Demanda de Mineral de Hierro de Alto Grado Conclusión: En un esfuerzo por mantener la producción alta y beneficiarse de los fuertes precios del acero frente a los recortes invernales de producción, los productores de acero están recurriendo a mineral de hierro de mayor ley, aumentando el diferencial entre minerales de alta y baja ley. El grado en que los productores de acero puedan mantener con éxito la producción gracias a los minerales de mayor ley amortiguará el impacto de los recortes de producción invernales en el sector siderúrgico. Dado que el enfoque medioambiental de China es un plan a largo plazo, esperamos que estos diferenciales permanezcan amplios, en lugar de volver a su promedio histórico. Precios del acero y mercados del cobre Gráfico 10 El consumo de acero ayuda a##BR##predecir los precios del cobre El consumo de acero ayuda a predecir los precios del cobre El consumo de acero ayuda a predecir los precios del cobre El mercado del cobre vivió una montaña rusa en el cuarto trimestre. Los precios del metal rojo mantuvieron una tendencia general al alza desde mayo y alcanzaron un primer pico a principios de septiembre en $3.13/lb antes de tocar suelo en $2.91/lb a la segunda mitad de ese mes. Poco después, los precios del cobre alcanzaron un nuevo máximo de $3.22/lb a mediados de octubre —su nivel más alto en más de tres años. Los temores de una desaceleración en China tras los mensajes del XIX Congreso del Partido Comunista hicieron que el metal perdiera casi un 10% de su valor, cuando tocó fondo por segunda vez a principios de diciembre. De hecho, esto coincidió con una caída del 4.65% en el precio el 5 de diciembre. Aunque no hay una justificación clara para esta caída, puede atribuirse a una mezcla de factores que incluyen un aumento de ~10 th MT en los inventarios de la LME, preocupaciones sobre una desaceleración en China, así como una liquidación de posiciones antes del año nuevo. No obstante, el cobre ha recuperado estas pérdidas y cerró el año en $3.28/lb. En nuestro modelado del cobre, encontramos que el consumo de acero es significativo para pronosticar el comportamiento futuro del precio del cobre. Más específicamente, el consumo de acero de China tiene una relación positiva significativa con los precios del cobre seis meses en el futuro (Gráfico 10). Esto se puede explicar por la importancia del sector de la construcción como usuario final de ambos materiales. Sin embargo, cada metal llega al sitio de construcción en marcos temporales diferentes. Mientras que los productos de acero se utilizan en la construcción de las estructuras y, por tanto, se necesitan al inicio del proyecto, el cobre se utiliza en el cableado eléctrico y la fontanería, y por tanto se necesita más tarde (aproximadamente 6 meses) en el proyecto. Esto está en línea con nuestros hallazgos de que el acero es más significativo con un rezago de seis meses —reflejo del período medio entre la construcción de la estructura y la necesidad del cableado y la fontanería. El consumo de acero en China es un indicador adelantado útil de los mercados del cobre cuando los fundamentos del lado de la demanda dominan los mercados del acero y del cobre. El estímulo gubernamental y un sólido sector de la construcción impulsaron la demanda de acero de China en 2017. Sin embargo, según la WSA Short Range Outlook, la demanda de acero se moderará este año debido a la reflación en China, parcialmente compensada por un fuerte crecimiento global. La WSA señala que el cierre de hornos de inducción infló las cifras de crecimiento de la demanda de acero hasta el 12.4% interanual, y en su lugar cita una estimación más razonable en torno al 3% interanual de crecimiento de la demanda de acero de China en 2017, llevando la tasa de crecimiento de la demanda mundial de acero al 2.8%. Mientras que la demanda de acero fuera de China creció un estimado del 2.6% en 2017, prevén que alcance el 3% en 2018. En contraste, esperan una demanda plana de China en 2018, llevando el crecimiento de la demanda mundial de acero al 1.6% en 2018 (Tabla 1). Tabla 1 Demanda de acero (tasas de crecimiento interanual) Las reformas ambientales de China impulsan el acero y el mineral de hierro Las reformas ambientales de China impulsan el acero y el mineral de hierro La moderación de la demanda desde China y la estabilidad (o falta de ella) del lado de la oferta dominarán el mercado del cobre este año. En el lado de la demanda, el mercado del acero de China ofrece perspectivas sobre la dirección futura del metal rojo. Conclusión: Dado que el apetito de China por el acero se ha mantenido sano hasta la fecha y se proyecta que mantenga su nivel de 2017 este año, no esperamos una caída inducida por la demanda en los precios del cobre en el horizonte de 6 meses. Roukaya Ibrahim, Editora asociada Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 Véase "Will China's induction furnace steel whac-a-mole finally come to an end?" publicado por S&P Global Platts el 6 de marzo de 2017. 2 Véase el Commodity & Energy Strategy Weekly Report de BCA Research "Slow-Down In China's Reflation Will Temper Steel, Iron Ore In 2018," publicado el 7 de septiembre de 2017, disponible en ces.bcaresearch.com. 3 Véase el informe especial World Energy Outlook 2016 de la IEA titulado "Energy and Air Pollution," disponible en iea.org. 4 Véase "Provincial China officials used fake data to evade aluminium, steel capacity curbs - China Youth Daily," publicado el 26 de diciembre de 2017, disponible en reuters.com. 5 Véase "Steel Markets" en worldsteel.org. 6 Para discusión adicional, véase "Shifting Gears in China: The Impact On Base Metals," en la edición del 9 de noviembre de 2017 de Commodity & Energy Strategy de BCA Research. Está disponible en ces.bcaresearch.com. 7 Véase "High-medium grade iron ore fines spread widens to all-time high of $23.55/dmt," publicado el 22 de agosto de 2017, disponible en platts.com. Visiones y temas de inversión Recomendaciones Recomendaciones estratégicas Operaciones tácticas Tabla de referencia de precios y estrategias de materias primas Las reformas medioambientales de China impulsan el acero y el mineral de hierro Las reformas medioambientales de China impulsan el acero y el mineral de hierro Operaciones cerradas en 2017

A finales del año pasado, rebajamos el índice S&P de constructores de viviendas a infraponderación de alta convicción, citando tres razones: el aumento de los costos de endeudamiento que afecta la asequibilidad, una reforma fiscal pendiente desfavorable para los propietarios y costos elevados (y en aumento). Con respecto a la primera de ellas, la asequibilidad de la vivienda ha ido disminuyendo a medida que la tasa hipotecaria a 30 años se ha movido en la dirección opuesta (segundo panel). Súmele el tope más bajo aprobado recientemente para la deducibilidad de los intereses hipotecarios, la menor deducibilidad del impuesto sobre la propiedad y la eliminación de las deducciones por intereses hipotecarios de las casas de vacaciones, y la asequibilidad debería sufrir un descenso importante en 2018. Al mismo tiempo, los costos han estado aumentando a un ritmo insostenible, con las ganancias en la construcción creciendo al ritmo más rápido desde el colapso inmobiliario y los precios de la madera muy por encima del nivel clave de $400. Esto indica que los constructores tendrán que o bien aumentar los precios, suprimiendo aún más la asequibilidad, o bien asumir un golpe en los márgenes, que creemos que es lo más probable. Cualquiera de los dos escenarios es perjudicial para las ganancias por acción (EPS) de los constructores; manténgase en infraponderación. Los símbolos bursátiles de las acciones en este índice son: BLBG: S5HOME-DHI, LEN, PHM, LEN / B. Los constructores de viviendas deberían ponerse a la venta Los constructores de viviendas deberían ponerse a la venta

Informe especial

Highlights The beta of Chinese stocks has been steadily increasing over the past few years, versus both emerging markets and global stocks. Rising relative currency volatility has likely durably increased the cyclicality of Chinese stock prices. The high-beta nature of Chinese investable stocks suggests that they should be favored when the EM and global stock benchmarks are rising. This supports our current overweight stance. A portfolio strategy that favors equity sectors with high alpha significance has outperformed the broad investable market by a non-trivial amount over time, without adding to portfolio risk. Barring a few exceptions, the model's current allocation is generally consistent with our theme of a benign slowdown in Chinese economic growth. Feature Chart 1Beta Matters, But So Does Alpha While concepts such as alpha, beta, and correlation are frequently applied by investment managers at the security or sector level, they are less commonly employed from a top-down regional equity perspective and are rarely examined as a time series. In addition, the concept of alpha persistence (i.e. alpha that is persistently positive or negative) is also frequently ignored by investors, despite it having significant implications for portfolio returns. This is vividly illustrated by the relative performance of developed commodity markets during the last economic expansion: these countries resoundingly outperformed a rising global benchmark from 2000 to 2007, despite having a market beta that averaged one over the period (Chart 1). This seeming inconsistency is explained by persistent volatility-adjusted outperformance throughout the period (panel 3), underscoring the importance of tracking this measure from a top-down perspective. In this report we examine the recent evolution of MSCI China's alpha and beta versus both the emerging market (EM) and global benchmarks. We conclude that China is no longer a low-beta market (supporting an overweight stance), and also present a simple alpha-based sector model for Chinese investable stocks that has generated impressive outperformance over time without adding to portfolio risk. The Evolution Of China's Alpha & Beta Chart 2 presents the evolution of alpha and beta for Chinese investable stocks since 2010, versus the emerging market and global index. Given the significant outperformance of the technology sector over the past year, we also present this analysis in ex-tech terms. The values shown in Chart 2 are calculated using a standard single-factor model approach to estimating alpha and beta, namely a regression of weekly stock price returns in US$ terms in excess of the return from U.S. short-term Treasury bills on excess returns of the benchmark index.1 The chart yields the following observations: The beta of Chinese stocks has been steadily increasing over the past few years, versus both emerging markets and global stocks, regardless of whether the tech sector is removed from the picture. Chinese stocks had a beta of 1.4 versus their global peers in 2017, placing it in the 80th percentile of all country equity market betas for the year. Chinese stocks earned a modestly negative alpha vs global stocks in 2016, which was even larger when compared to the EM benchmark. This likely occurred because of lower exposure to resource-oriented sectors, given the significant rebound in commodity prices in 2016. Chinese stocks experienced a surge in alpha in 2017, even excluding technology stocks. In 2017, in all cases (vs EM and global, including or excluding tech) Chinese equities moved into the top right alpha/beta quadrant, which is the quadrant that offers the highest return to investors when the benchmark is rising. This is a remarkable development given that there were indications of a peak in Chinese economic momentum in the first half of the year, and suggests that investors do not view the ongoing slowdown as being problematic for investable equity performance. Chart 2 raises the obvious question of why China has become a higher beta market. We have two theories, but only the second one appears to fit the data. The first theory is that the establishment of the stock connect in late-2014 caused a volatility spillover from China's domestic stock market into the investable market. But while it is true that A-shares were considerably riskier than investable stocks in late-2015 / early-2016, Chart 3 makes it clear that A-shares have not historically been much more volatile than investable stocks. In addition, Chart 2 underscores that the rise in China's market beta since 2014 has been persistent, whereas A-shares in 2017 recorded their lowest share price volatility in over 15 years. So to us, this does not appear to be the most probable explanation. Chart 2China Has Become A High-Beta Market The second theory, which seems much more likely, is that the rising currency volatility has increased the cyclicality of Chinese stock prices. China's decision to devalue the RMB in August 2015 clearly led to a period of significantly increased capital controls, but Chart 4 highlights that the CNY/USD exchange rate has steadily become more volatile. This is especially true when compared with a basket of emerging market currencies, with CNY/USD actually being more volatile than the basket over the past year. Chart 3The Stock Connect Does Not Explain##br## The Rise In China's Beta Chart 4Rising Relative Currency Volatility ##br##= Higher Beta While it is certainly true that Chinese policymakers have stepped up their management of the currency by tightening capital controls over the past year, the PBOC's decision to pursue its "partial" version of the impossible trinity still implies, in our view, that RMB volatility will now be structurally higher than what prevailed on average prior to August 2015.2 This suggests that China's equity market beta will be durably higher than before, absent a presently negative correlation between CNY/USD and EM or global stock prices. Bottom Line: The beta of Chinese stocks has been steadily increasing over the past few years, versus both emerging markets and global stocks. Rising relative currency volatility has likely durably increased the cyclicality of Chinese stock prices. Investment Implications Of China's Recent Relative Performance There are two clear investment strategy implications from Chinese equities becoming a high-beta asset. The first is that Chinese investable stocks are now a pro-risk asset to be favored when the EM and global stock benchmarks are rising. Chart 5 shows that both are currently well above their 200-day moving averages, which supports our overweight stance towards China. The second is that when comparing the performance of China's overall investable index versus that excluding technology, it is clear that a non-trivial amount of the alpha earned by China's overall index in 2017 came from the tech sector. This suggests that a reversal of the high-flying performance of Chinese technology stocks is a material risk to our overweight stance towards Chinese equities. For now, this high-alpha outperformance appears to be fundamentally-based: Chart 6 highlights that forward earnings for Chinese tech shares have risen enormously relative to the investable benchmark over the past three years, a trend that we have noted appears to be driven by Chinese consumer demand (and thus unlikely to decline over the coming year).3 In addition, the relatively modest but positive alpha earned by Chinese ex-tech stocks in 2017 was likely driven by extremely cheap valuation, and these multiples remain quite low relative to other countries. We highlighted in our December 7 Weekly Report that the relative re-rating of Chinese investable ex-tech stocks was a key theme for 2018,4 suggesting that there is room for further re-rating/alpha if China's economic slowdown remains benign (as we expect). Chart 5Investors Should Overweight ##br##Chinese Stocks In This Environment Chart 6Tech's Recent Alpha Appears ##br##Fundamentally-Based Bottom Line: The now high-beta nature of Chinese investable stocks suggests that they are a pro-risk asset to be favored when the EM and global stock benchmarks are rising. This supports our current overweight stance. Alpha, Applied: A Simple Sector Model For Chinese Investable Stocks We noted earlier that the concept of alpha has had significant implications for regional equity portfolio returns in the past. In order to test the predictive power of alpha within the context of a Chinese equity portfolio, we evaluate the returns of an investment strategy that allocates to China's investable equity sectors based on the significance of alpha. Table 1 presents statistics summarizing the performance of this sector alpha portfolio relative to the overall investable market, Table 2 shows the portfolio's current sector allocation, and Chart 7 illustrates the cyclical behavior of the portfolio's relative performance trend since 2004. Several important conclusions emerge: Table 1An Alpha-Based Sector Model Has Historically Outperformed ##br##China's Investable Stock Market Table 2Sector Alpha Portfolio Weights Are Generally Consistent With ##br##A Benign Growth Slowdown The model has outperformed the broad investable market by an impressive 235 bps per year without appearing to take on any additional risk. Measured either as volatility or drawdown, the riskiness of the portfolio appears to be the same as that of the overall investable market. The outperformance of the model occurs in spurts, but sustained periods of underperformance are not common. The 2007-2009 period served as an exception to this rule, but even in this case the cumulative underperformance of the model vs the investable index was not large (roughly 6%). Chart 7Impressive Outperformance Over Time The model is currently underweight financials (significantly), energy, industrials, telecoms, and utilities. Overweights are concentrated in the tech sector, real estate, health care, and consumer stocks. For now, these weights are generally consistent with our benign slowdown scenario, although there are some potential exceptions to monitor (such as the overweight stance towards real estate and materials). Bottom Line: A portfolio strategy that favors equity sectors with high alpha significance has outperformed the broad investable market by a non-trivial amount over time, without adding to portfolio risk. Barring a few exceptions, the model's current allocation is generally consistent with our theme of a benign slowdown in Chinese economic growth. Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com 1 2 Please see China Investment Strategy Weekly Report, "How Will China Manage The Impossible Trinity", dated December 8, 2016, available at cis.bcaresearch.com. 3 Please see China Investment Strategy Special Report, "The Data Lab: Testing The Predictability of China's Business Cycle", dated November 30, 2017, available at cis.bcaresearch.com. 4 Please see China Investment Strategy Weekly Report, "Three Themes For China In The Coming Year", dated December 7, 2017, available at cis.bcaresearch.com. Cyclical Investment Stance Equity Sector Recommendations

Fed data released this week showed consumer credit growth surging at close to its fastest pace since the turn of the century, driven in large part by exceptional growth in revolving consumer credit (second panel). The last time this kind of growth was seen on a consistent basis was 2007, which would be potentially concerning were it not for the historically low household debt service ratios and the resulting pristine credit quality of credit card borrowers (third panel). Add on a widening credit card interest rate spread (bottom panel), typically an excellent leading indicator of earnings improvements and 2018 should be an exceptionally powerful earnings growth year for consumer finance stocks; stay overweight. The ticker symbols for the stocks in the S&P consumer finance index are: BLBG: S5CFINX-AXP, COF, DFS, SYF, NAVI.

Highlights Chart 1Bond Bear On Pause? The start of a new year often brings optimism and nowhere is this more evident than in economic projections. In three of the past four years (2017 being the exception) Bloomberg consensus GDP growth expectations ended the year lower than where they began. A related pattern played itself out in the Treasury market. At the turn of each of the past four years the average yield on the Bloomberg Barclays Treasury Index increased in December only to fall back in January. In two of those instances the January decline exceeded the December increase. Should we expect a similar January bond rally this year? Our favorite short-term indicators are not sending a strong signal (Chart 1). Net speculative futures positions weakly suggest that the 10-year yield will be lower in three months, but our auto regressive model suggests the Economic Surprise Index will still be in positive territory at the end of the month. In a recent report we showed that yields tend to rise in months where the Surprise Index is above zero.1 Perhaps most importantly, our 2-factor Treasury model shows that yields are significantly lower than is suggested by global economic fundamentals. Maintain below-benchmark duration. Feature Investment Grade: Overweight Chart 2Investment Grade Market Overview Investment grade corporate bonds outperformed the duration-equivalent Treasury index by 49 basis points in December and by 335 bps in 2017. At 94 bps, the average index spread is 28 bps tighter than at the beginning of 2017 and investment grade corporate spreads are extremely expensive compared to history (Chart 2). After adjusting for changes in the average duration of the index over time, we calculate that A-rated corporate spreads have only been tighter 5% of the time since 1989 (panel 2), and Baa-rated spreads have only been tighter 7% of the time (panel 3). Essentially, at this stage of the credit cycle we should expect excess returns no greater than carry. As for the credit cycle itself, we noted in our last report that with corporate balance sheets deteriorating, low inflation and still-accommodative monetary policy are the sole supports for corporate spreads.2 We expect spreads will start to widen later this year once inflation rises and policy becomes more restrictive. With excess returns likely to be lower in 2018 than in 2017, we should also expect a lower marginal return from increasing the riskiness within credit portfolios.3 For investors looking to scale back on credit risk, our model shows that Financials and Technology are the most attractive low-risk sectors. Energy, Basic Industry and Communications are all attractive high-risk sectors (Table 3). Table 3ACorporate Sector Relative Valuation And Recommended Allocation* Table 3BCorporate Sector Risk Vs. Reward* High-Yield: Overweight Chart 3High-Yield Market Overview High-Yield outperformed the duration-equivalent Treasury index by 23 basis points in December and by 602 bps in 2017. The average index option-adjusted spread tightened 1 bp on the month and 66 bps in 2017. Though spreads appear somewhat more attractive than for investment grade corporates, there is still not much room for spread compression in high-yield. In fact, we calculate that if the high-yield index spread tightens another 117 bps, junk bonds will be the most expensive they have been since 1995. In an optimistic scenario where the index spread tightens 100 bps, bringing it close to all-time expensive levels, then we would expect junk excess returns to be in the range of 600 bps (annualized). Given trends in corporate leverage, another 100 bps of spread tightening should be viewed as unlikely. More realistically, we expect excess returns in the range of 200 bps to 500 bps (annualized) between now and the end of the credit cycle (Chart 3). Given our forecast for default losses, flat spreads translate to a 12-month excess return of 213 bps. An additional warning sign for junk spreads is that the slope of the 2/10 Treasury curve is hovering around 50 bps. We showed in a recent report that when the 2/10 slope is between 0 bps and 50 bps, junk bonds underperform Treasuries in 48% of months, and average monthly excess returns (though still positive) are much lower than when the curve is steeper.4 MBS: Neutral Chart 4MBS Market Overview Mortgage-Backed Securities outperformed the duration-equivalent Treasury index by 16 basis points in December and by 51 bps in 2017. The conventional 30-year zero-volatility MBS spread narrowed 2 bps in December, the combination of a flat option-adjusted spread (OAS) and a 2 bps decline in the compensation for prepayment risk (option cost). The Z-spread widened 2 bps in 2017, as an 8 bps OAS widening was offset by a decline of 6 bps in the compensation for prepayment risk. The substantial OAS widening in early 2017 was almost certainly caused by investors pricing-in the eventual run-off of the securities on the Fed's balance sheet. Now that run-off has begun we see no obvious catalyst for further OAS widening in the months ahead. Turning to the compensation for prepayment risk, with Treasury yields biased higher as the Fed continues to lift rates, we see little risk of a material increase in refinancing activity. This will ensure that overall MBS spreads stay capped near historically low levels (Chart 4). All in all, with MBS OAS looking more attractive relative to Aaa-rated credit than at any time since 2015 (panel 3), we think this is an opportune time for investors looking to de-risk their portfolios to shift some of their spread product allocation away from corporate bonds and into MBS. We already upgraded our recommended allocation to MBS from underweight to neutral in October, and will likely further increase exposure as we advance toward the end of the credit cycle. Government-Related: Underweight Chart 5Government-Related Market Overview The Government-Related index underperformed the duration-equivalent Treasury index by 5 basis points in December, but outperformed by 216 bps in 2017. Sovereign bonds underperformed the Treasury benchmark by 36 bps in December, Foreign Agencies and Domestic Agencies underperformed by 8 bps and 1 bp, respectively. Local Authorities outperformed the benchmark by 17 bps, and Supranationals underperformed by 1 bp. Sovereign bonds were the best performers within the Government-Related index in 2017, delivering excess returns of 538 bps relative to duration-matched U.S. Treasuries. This outperformance was concentrated early in the year and was driven by the sharp depreciation of the U.S. dollar (Chart 5). With the market still priced for a relatively modest 63 bps of Fed rate hikes during the next 12 months, further sharp dollar depreciation appears unlikely. We recommend an underweight allocation to Sovereign debt. We remain overweight Local Authority and Foreign Agency bonds, sectors that delivered excess returns of 420 bps and 248 bps, respectively in 2017. Despite the outperformance, both of these sectors still offer attractive spreads after adjusting for credit rating and duration. We remain underweight Domestic Agency and Supranational bonds. Though both sectors offer low risk and high credit quality, they also only offer 15 bps and 17 bps of option-adjusted spread, respectively. We much prefer Agency-backed MBS and CMBS which are also relatively low risk and offer option-adjusted spreads of 28 bps and 42 bps, respectively. Municipal Bonds: Underweight Chart 6Municipal Market Overview Municipal bonds outperformed the duration-equivalent Treasury index by 99 bps in December and by 332 bps in 2017 (before adjusting for the tax advantage). The average Aaa Municipal / Treasury (M/T) yield ratio fell 5% in December, and is 12% below where it began 2017 (Chart 6). The recent decline follows a sharp increase that was driven by fluctuating supply trends related to the passage of U.S. tax legislation. The final tax bill ends the practice of advance refunding municipal bonds. As a result, December set a new high of $55.6 billion for municipal issuance as issuers rushed to get their advance refunding deals to market before the bill was passed (panel 3). Now that the bill has passed, visible supply has evaporated and the average M/T yield ratio has fallen back to one standard deviation below its post-crisis mean. The absence of advance refunding will bias municipal bond issuance lower in 2018, thus removing one potential risk for yield ratios. The M/T yield ratio for short maturity debt has risen considerably relative to the yield ratio for long maturity debt in recent months (panel 2), and the risk/reward trade-off now appears more balanced. We close our recommendation to favor long maturities versus short maturities on the Aaa Muni curve. The third quarter update of our Muni Health Monitor showed a slight improvement (panel 5), but still no clear reversal of trend. Although health remains supportive for now - and consistent with municipal upgrades outpacing downgrades - with yield ratios close to their lows we maintain an underweight allocation to Municipal bonds.  Treasury Curve: Favor 5-Year Bullet Over 2/10 Barbell Chart 7Treasury Yield Curve Overview The Treasury curve bear-flattened in December. The 2/10 Treasury slope flattened 13 bps on the month, and the 5/30 Treasury slope flattened 15 bps. The evolution of the Treasury curve in 2018 will come down to a trade-off between how quickly inflation rises versus how quickly the Fed lifts rates. For example, in a recent report we showed that the 10-year Treasury yield will likely settle into a range between 2.80% and 3.25% by the time that core PCE inflation reaches the Fed's 2% target.5 That same report shows that if that adjustment occurs relatively quickly, and the Fed has only lifted rates once or twice between now and then, then the 2/10 Treasury slope is much more likely to steepen than to flatten. Conversely, if the Fed lifts rates three or four more times between now and the time that inflation returns to target, then the curve is more likely to flatten. For our part, we think it is wise to maintain a position long the 5-year bullet and short a duration-neutral 2/10 barbell. Such a position profits from a steeper curve, and our model shows that the butterfly spread is currently priced for significant curve flattening (Chart 7). According to our model, the 2/5/10 butterfly spread is discounting 27 bps of 2/10 flattening during the next six months.6 In other words, if the 2/10 slope steepens or flattens by less than 27 bps, then our recommended position will profit. TIPS: Overweight Chart 8TIPS Market Overview TIPS outperformed the duration-equivalent nominal Treasury index by 41 basis points in December, but underperformed by 43 bps in 2017. The 10-year TIPS breakeven inflation rate went on a wild ride last year. It started 2017 at 1.95% and, driven by strong inflation prints and continued post-election euphoria, reached as high as 2.09% in January. The breakeven dropped to a low of 1.66% in June, as inflation started to disappoint in the second quarter, but has rebounded during the past couple of months and just recently broke back above 2%. The 10-year TIPS breakeven rate is currently 2.02%, above where it began 2017. According to our TIPS Financial Model, the recent widening in breakevens is in line with the message from other related financial market instruments (Chart 8). Specifically, oil prices, the trade-weighted dollar and the stock-to-bond total return ratio. Further, measures of pipeline inflation pressure continue to signal an increase in inflationary pressures (panels 3 and 4), and the trimmed mean PCE shows that the realized inflation data are forming a tentative bottom (bottom panel). The annualized 6-month rate of change in the trimmed mean PCE ticked up to 1.68% in November, higher than the 12-month rate of change (1.67%). The 1-month rate of change is higher still at 2.19%, annualized. We continue to see signs that inflation will start to rebound in the coming months, and this will cause long-maturity TIPS breakeven inflation rates to reach a range between 2.4% and 2.5% by the time that inflation returns to the Fed's target. Remain overweight TIPS versus nominal Treasury securities. ABS: Neutral Chart 9ABS Market Overview Asset-Backed Securities performed in line with the duration-equivalent Treasury index in December and outperformed by 92 basis points in 2017. In 2017, Aaa-rated ABS outperformed the Treasury benchmark by 79 bps and non-Aaa ABS outperformed by 217 bps. The index option-adjusted spread for Aaa-rated ABS widened 1 bp in December, but tightened 21 bps in 2017. It now sits at 31 bps, only 4 bps above its all-time low (Chart 9). At 31 bps, Aaa-rated ABS now offer only a 3 bps spread advantage over Agency-backed MBS, and offer 11 bps less spread than Agency-backed CMBS. With consumer lending standards tightening and delinquency rates rising, we view no more than a neutral allocation to ABS as appropriate. On lending standards, the Fed's October Senior Loan Officer's Survey showed a continued tightening in lending standards on both credit cards and auto loans (panel 4), and also that demand for credit card and auto loans was essentially unchanged from the prior quarter. It also included a set of special questions regarding the reasons for changes in the supply and demand for consumer credit. Banks cited a less favorable or more uncertain economic outlook, a deterioration in existing loan quality and a general reduced risk tolerance as reasons for tightening the supply of credit. The hard data confirm that banks are seeing a deterioration in the quality of their consumer loan books (bottom panel). Although delinquencies remain depressed compared to history, with ABS spreads near all-time tights, rising delinquencies and tightening lending standards make for a poor risk/reward trade-off in the sector. Non-Agency CMBS: Underweight Chart 10CMBS Market Overview Non-Agency Commercial Mortgage-Backed Securities outperformed the duration-equivalent Treasury index by 20 basis points in December and by 201 bps in 2017. The index option-adjusted spread for non-agency Aaa-rated CMBS tightened 2 bps in December and 13 bps in 2017. At its current level of 64 bps, the index spread is about one standard deviation below its pre-crisis mean, and only 13 bps above its all-time low reached in 2004 (Chart 10). With spreads at such low levels in an environment of tightening commercial real estate (CRE) lending standards and falling CRE loan demand, we continue to view the risk/reward trade-off in non-Agency CMBS as unfavorable. Agency CMBS: Overweight Agency CMBS outperformed the duration-equivalent Treasury index by 21 basis points in December and by 133 bps in 2017. The index option-adjusted spread for Agency CMBS tightened 3 bps in December and 13 bps in 2017. At its current level of 42 bps, the sector offers greater option-adjusted compensation than a position in Agency-backed MBS (28 bps) and Aaa-rated consumer ABS (31 bps). Such an attractive spread pick-up in a sector that benefits from Agency backing is surely worth grabbing.   Treasury Valuation Chart 11Treasury Fair Value Models The current reading from our 2-factor Treasury model (based on Global PMI and dollar sentiment) pegs fair value for the 10-year Treasury yield at 2.94% (Chart 11). Our 3-factor version of the model (not shown), which also incorporates the Global Economic Policy Uncertainty Index, places fair value at 2.92%. PMIs across the world continue to surge. December PMI data show increases in the four largest economic blocs (U.S., Eurozone, China, Japan), and more broadly show that 86% of the 36 countries with available data currently have PMIs above the 50 boom/bust line. Meanwhile, bullish sentiment toward the U.S. dollar continues to trend lower in response to strong growth in the rest of the world (bottom panel). This is also a bearish development for U.S. bonds. For further details on our Treasury models please refer to U.S. Bond Strategy Weekly Report, "The Message From Our Treasury Models", dated October 11, 2016, available at usbs.bcaresearch.com. At the time of publication the 10-year Treasury yield was 2.48%. Ryan Swift, Vice President U.S. Bond Strategy rswift@bcaresearch.com Alex Wang, Research Analyst alexw@bcaresearch.com Jeremie Peloso, Research Assistant jeremiep@bcaresearch.com 1 Please see U.S. Bond Strategy Weekly Report, "How Much Higher For Yields?", dated October 31, 2017, available at usbs.bcaresearch.com 2 Please see U.S. Bond Strategy Weekly Report, "Ill Placed Trust?", dated December 19, 2017, available at usbs.bcaresearch.com 3 Please see U.S. Bond Strategy Weekly Report, "Proactive, Reactive Or Right?", dated December 12, 2017, available at usbs.bcaresearch.com 4 Please see U.S. Bond Strategy Weekly Report, "Proactive, Reactive Or Right?", dated December 12, 2017, available at usbs.bcaresearch.com 5 Please see U.S. Bond Strategy Weekly Report, "Ill Placed Trust?", dated December 19, 2017, available at usbs.bcaresearch.com 6 For further details on the model please see U.S. Bond Strategy Special Report, "Bullets, Barbells And Butterflies", dated July 25, 2017, available at usbs.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification Corporate Sector Relative Valuation And Recommended Allocation Total Return Comparison: 7-Year Bullet Versus 2-20 Barbell (6-Month Investment Horizon)