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Our top five geopolitical “Black Swans” are risks that the market is seriously underpricing. With the “phase one” trade deal signed, Chinese policy could become less accommodative, resulting in a negative economic surprise. The trade deal may fall victim to domestic politics, raising the risk of a US-China military skirmish. A Biden victory at the Democratic National Convention or a Democratic takeover of the White House could trigger social unrest and violence in the US. A pickup in the flow of migrants to Europe would fundamentally undermine political stability there. Russia’s weak economy will add fuel to domestic unrest, risking an escalation beyond the point of containment. Over the past four years, BCA’s Geopolitical Strategy service has started off each year with their top five geopolitical “Black Swans.” These are low-probability events whose market impact would be significant enough to matter for global investors. Unlike the great Byron Wien’s perennial list of market surprises, we do not assign these events a “better than 50% likelihood of happening.” We offer risks that the market is seriously underpricing by assigning them only single-digit probabilities when we think the reality is closer to 10%-15%, a level at which a risk premium ought to be assigned. Some of our risks below are so obscure that it is not clear how exactly to price them. We exclude issues that are fairly probable, such as flare-ups in Indo-Pakistani conflict. The two major risks of the year – discussed in our Geopolitical Strategy’s annual outlook – are that either US President Donald Trump or Chinese President Xi Jinping overreaches in a major way. But what would truly surprise the market would be a policy-induced relapse in Chinese growth or a direct military clash between the two great powers. That is how we begin. Other risks stem from domestic affairs in the US, Europe, and Russia. Black Swan 1: China’s Financial Crisis Begins Chart II-1A Crackdown On Financial Risk Could Cause China's Economy To Derail The risk of Xi Jinping’s concentration of power in his own person is that individuals can easily make mistakes, especially if unchecked by advisors or institutions. Lower officials will fear correcting or admonishing an all-powerful leader. Inconvenient information may not be relayed up the hierarchy. Such behavior was rampant in Chairman Mao Zedong’s time, leading to famine among other ills. Insofar as President Xi’s cult of personality successfully imitates Mao’s, it will be subject to similar errors. If President Xi overreaches and makes a policy mistake this year, it could occur in economic policy or other policies. We begin with economic policy, as we have charted the risks of Xi’s crackdown on the financial system since early 2017 (Chart II-1). This year is supposed to be the third and final year of Xi Jinping’s “three battles” against systemic risk, pollution, and poverty. The first battle actually focuses on financial risk, i.e. China’s money and credit bubble. The regime has compromised on this goal since mid-2018, allowing monetary easing to stabilize the economy amid the trade war. But with a “phase one” trade deal having been signed, there is an underrated risk that economic policy will return to its prior setting, i.e. become less accommodative (Chart II-2). When Xi launched the “deleveraging campaign” in 2017, we posited that the authorities would be willing to tolerate an annual GDP growth rate below 6%. This would not only cull excesses in the economy but also demonstrate that the administration means business when it says that China must prioritize quality rather than quantity of growth. While Chinese authorities are most likely targeting “around 6%” in 2020, it is entirely possible that the authorities will allow an undershoot in the 5.5%-5.9% range. They will argue that the GDP target for 2020 has already been met on a compound growth rate basis (Chart II-3), as astute clients have pointed out. They may see less need for stimulus than the market expects. Chart II-2Easing Of Trade Tensions May Re-Incentivize Tighter Policy Chart II-3Chinese Authorities Might Tolerate A Growth Undershoot In 2020   Similarly, while urban disposable income is ostensibly lagging its target of doubling 2010 levels by 2020, China’s 13th Five Year Plan, which concludes in 2020, conspicuously avoided treating urban and rural income targets separately. If the authorities focus only on general disposable income, then they are on track to meet their target (Chart II-4). This would reduce the impetus for greater economic support. The Xi administration may aim only for stability, not acceleration, in the economy. There are already tentative signs that Chinese authorities are “satisfied” with the amount of stimulus they have injected: some indicators of money and credit have already peaked (Chart II-5). The crackdown on shadow banking has eased, but informal lending is still contracting. The regime is still pushing reforms that shake up state-owned enterprises. Chart II-4Lower Impetus For Economic Support Due To Improvements In National Income? Chart II-5Has China's Stimulus Peaked?   An added headwind for the Chinese economy stems from the currency. The currency should track interest rate differentials. Beijing’s incremental monetary stimulus, in the form of cuts to bank reserve requirement ratios (RRRs), should also push the renminbi down over time (Chart II-6). However, an essential aspect of any trade deal with the Trump administration is the need to demonstrate that China is not competitively devaluing. Hence the CNY-USD could overshoot in the first half of the year. This is positive for global exports to China, but it tightens Chinese financial conditions at home. A stronger than otherwise justified renminbi would add to any negative economic surprises from less accommodative monetary and fiscal policy. Conventional wisdom says China will stimulate the economy ahead of two major political events: the centenary of the Communist Party in 2021 and the twentieth National Party Congress in 2022. The former is a highly symbolic anniversary, as Xi has reasserted the supremacy of the party in all things, while the latter is more significant for policy, as it is a leadership reshuffle that will usher in the sixth generation of China’s political elite. But conventional wisdom may be wrong – the Xi administration may aim only for stability, not acceleration, in the economy. It would make sense to save dry powder for the next US or global recession. The obvious implication is that China’s economic rebound may lose steam as early as H2 – but the black swan risk is that negative surprises could cause a vicious spiral inside of China. This is a country with massive financial and economic imbalances, a declining potential growth profile, and persistent political obstacles to growth both at home and abroad. Corporate defaults have spiked sharply. While the default rate is lower than elsewhere, the market may be sniffing out a bigger problem as it charges a much higher premium for onshore Chinese bonds (Chart II-7). Chart II-6CNY/USD Overshoot Would Tighten Chinese Financial Conditions Chart II-7Is China's Bond Market Sniffing Out A Problem?   Bottom Line: Our view is that China’s authorities will remain accommodative in 2020 in order to ensure that growth bottoms and the labor market continues to improve. But Beijing has compromised its domestic economic discipline since 2018 in order to fight trade war. The risk now, with a “phase one” deal in hand, is that Xi Jinping returns to his three-year battle plan and underestimates the downward pressures on the economy. The result would be a huge negative surprise for the Chinese and global economy in 2020. Black Swan 2: The US And China Go To War In 2013, we predicted that US-China conflict was “more likely than you think.” This was not just an argument for trade conflict or general enmity that raises the temperature in the Asia-Pacific region – we included military conflict. At the time, the notion that a Sino-American armed conflict was the world’s greatest geopolitical threat seemed ludicrous to many of our clients. We published this analysis in October of that year, months after the Islamic State “Soldier’s Harvest” offensive into Iraq. Trying to direct investors to the budding rivalry between American and Chinese naval forces in the South China Sea amidst the Islamic State hysteria was challenging, to say the least. Chart II-8Americans’ Attitudes Toward China Plunged… The suggestion that an accidental skirmish between the US and China could descend into a full-blown conflict involved a stretch of the imagination because China was not yet perceived by the American public as a major threat. In 2014, only 19%of the US public saw China as the “greatest threat to the US in the future.” This came between Russia, at 23%, and Iran, at 16%. Today, China and Russia share the top spot with 24%. Furthermore, the share of Americans with an unfavorable view of China has increased from 52% to 60% in the six intervening years (Chart II-8). The level of enmity expressed by the US public toward China is still lower than that toward the Soviet Union at the onset of the Cold War in the 1950s (Chart II-9). However, the trajectory of distrust is clearly mounting. We expect this trend to continue: anti-China sentiment is one of the few sources of bipartisan agreement remaining in Washington, DC (Chart II-10). Chinese sentiment toward the United States has also darkened dramatically. The geopolitical rivalry is deepening for structural reasons: as China advances in size and sophistication, it seeks to alter the regional status quo in its favor, while the US grows fearful and seeks to contain China. Chart II-9…But Not Yet To War-Inducing Levels Chart II-10Distrust Of China Is Bipartisan Chart II-11Newfound American Concern For China’s Repression One example of rising enmity is the US public’s newfound concern for China’s domestic policies and human rights, specifically Beijing’s treatment of its Uyghur minority in Xinjiang. A Google Trends analysis of the term “Uyghur” or “Uyghur camps” shows a dramatic rise in mentions since Q2 of 2018, around the same time the trade war ramped up in a major way (Chart II-11). While startling revelations of re-education camps in Xinjiang emerged in recent years, the reality is that Beijing has used heavy-handed tactics against both militant groups and the wider Uyghur minority since at least 2008 – and much earlier than that. As such, the surge of interest by the general American public and legislators – culminating in the Uyghur Human Rights Policy Act of 2019 – is a product of the renewed strategic tension between the two countries. The same can be said for Hong Kong: the US did not pass a Hong Kong Human Rights and Democracy Act in 2014, during the first round of mass protests, which prompted Beijing to take heavy-handed legal, legislative, and censorship actions. It passed the bill in 2019, after the climate in Washington had changed. Why does this matter for investors? There are two general risks that come with a greater public engagement in foreign policy. First, the “phase one” trade deal between China and the US could fall victim to domestic politics. This deal envisions a large step up in Sino-American economic cooperation. But if China is to import around $200 billion of additional US goods and services over the next two years – an almost inconceivable figure – the US and China will have to tamp down on public vitriol. This is notably the case if the Democratic Party takes over the White House, given its likely greater focus on liberal concerns such as human rights. And yet the latest bills became law under President Trump and a Republican Senate, and we fully expect a second Trump term to involve a re-escalation of trade tensions to ensure compliance with phase one and to try to gain greater structural concessions in phase two. Second, mounting nationalist sentiment will make it more difficult for US and Chinese policymakers to reduce tensions following a potential future military skirmish, accidental or otherwise. While our scenario of a military conflict in 2013 was cogent, the public backlash in the United States was probably manageable.1 Today we can no longer guarantee that this is the case. The “phase one” trade deal risks falling victim to domestic politics due to greater public engagement in foreign policy. China has greater control over the domestic narrative and public discourse, but the rise of the middle class and the government’s efforts to rebuild support for the single-party regime have combined to create an increase in nationalism. Thus it is also more difficult for Chinese policymakers to contain the popular backlash if conflict erupts. In short, the probability of a quick tamping down of public enmity is actively being reduced as American public vilification of China is closing the gap with China’s burgeoning nationalism at an alarming pace. Another of our black swan risks – Taiwan island – is inextricably bound up in this dangerous US-China dynamic. To be clear, Washington will tread carefully, as a conflict over Taiwan could become a major war. Nevertheless Taiwan’s election, as we expected, has injected new vitality into this already underrated geopolitical risk. It is not only that a high-turnout election (Chart II-12) gave President Tsai Ing-wen a greater mandate (Chart II-13), or that her Democratic Progressive Party retained its legislative majority (Chart II-14). It is not only that the trigger for this resounding victory was the revolt in Hong Kong and the Taiwanese people’s rejection of the “one country, two systems” formula for Taiwan. It is also that Tsai followed up with a repudiation of the mainland by declaring, “We don’t have a need to declare ourselves an independent state. We are an independent country already and we call ourselves the Republic of China, Taiwan.” Chart II-12Tsai Ing-Wen Enjoys A Greater Mandate On Higher Turnout… Chart II-13…Popular Support… Chart II-14…And A Legislative Majority This statement is not a minor rhetorical flourish but will be received as a major provocation in Beijing: the crystallization of a long-brewing clash between Beijing and Taipei. Additional punitive economic measures against Taiwan are now guaranteed. Saber-rattling could easily ignite in the coming year and beyond. Taiwan is the epicenter of the US-China strategic conflict. First, Beijing cannot compromise on its security or its political legitimacy and considers the “one China principle” to be inviolable. Second, the US maintains defense relations with Taiwan (and is in the process of delivering on a relatively large new package of arms). Third, the US’s true willingness to fight a war on Taiwan’s behalf is in doubt, which means that deterrence has eroded and there is greater room for miscalculation. Bottom Line: A US-China military skirmish has been our biggest black swan risk since we began writing the BCA Geopolitical Strategy. The difference between then and now, however, is that the American public is actually paying attention. Political ideology – the question of democracy and human rights – is clearly merging with trade, security, and other differences to provoke Americans of all stripes. This makes any skirmish more than just a temporary risk-off event, as it could lead to a string of incidents or even protracted military conflict. Black Swan 3: Social Unrest Erupts In America There are numerous lessons that one can learn from the ongoing unrest in Hong Kong, but perhaps the most cogent one is that Millennials and Generation Z are not as docile and feckless as their elders think. Images of university students and even teenagers throwing flying kicks and Molotov cocktails while clad in black body armor have shocked the world. Perhaps all those violent video games did have a lasting impact on the youth! What is surprising is that so few commentators have made the cognitive leap from the ultra-first world streets of Hong Kong to other developed economies. Perhaps what is clouding analysts’ minds is the idiosyncratic nature of the dispute in Hong Kong, the “one China” angle. However, Hong Kong youth are confronted with similar socio-economic challenges that their peers in other advanced economies face: overpriced real estate and a bifurcated service-sector labor market with few mid-tier jobs that pay a decent wage. There is a risk of rebellion from Trump’s most ardent supporters if he loses the White House. In the US, Millennials and Gen Z are also facing challenges unique to the US. First, their debt burden is much more toxic than that of the older cohorts, given that it is made up of student loans and credit card debt (Chart II-15). Second, they find themselves at odds – demographically and ideologically – with the older cohorts (Chart II-16). Chart II-15Younger American Cohorts Plagued By Toxic Debt Chart II-16Younger And Older Cohorts At Odds Demographically Chart II-17Massive Turnout To The 2016 Referendum On Trump The adage that the youth are apolitical and do not turn out to vote may have ended thanks to President Trump. The 2018 midterm election, which the Democratic Party successfully turned into a referendum on the president, saw the youth (18-29) turnout nearly double from 20% to 36% (the 30-44 year-old cohort also saw a jump in turnout from 35.6% to 48.8%). The election saw one of the highest turnouts in recent memory, with a 53.4% figure, just two points off the 2016 general election figure (Chart II-17). Despite the high turnout in 2018, the-most-definitely-not-Millennial Vice President Joe Biden continues to lead the Democratic Party in the polls. His probability of winning the nomination is not overwhelming, but it is the highest of any contender. In recent polls, Biden comes third place in Millennial/Gen-Z vote preferences (Chart II-18). Yet he is hardly out of contention, especially for the 30-44 year-old cohort. The view that “Uncle Joe” does not fit the Democratic Party zeitgeist has become so entrenched in the Democratic Party narrative that it became conventional wisdom last year, pulling oddsmakers and betting markets away from the clear frontrunner (Chart II-19). Chart II-18Biden Unpopular Among Young American Voters Chart II-19Bookies Pulled Down 'Uncle Joe’s' Odds, Capturing Democratic Party Zeitgeist     As such, a Biden victory at the Democratic National Convention in Milwaukee, Wisconsin on July 13-16 may come as an affront to the left-wing activists who will surely descend on the convention. This will particularly be the case if Biden wins despite the progressive candidates amassing a majority of overall delegates, which is possible judging by the combined progressive vote share in current polling (Chart II-20). He would arrive in Milwaukee without clearing the 1990 delegate count required to win on the first ballot. On the second ballot, his presidency would then receive a boost from “superdelegates” and those progressives who are unwilling to “rock the boat,” i.e. unify against an establishment candidate with the largest share of votes. This is also how Mayor Michael Bloomberg could pull off a surprise win. Chart II-20Progressives Come Closest To Victory Such a “brokered” – or contested – convention has not occurred since 1952. However, several Democratic Party conventions came close, including 1968, 1972, and 1984. The 1968 one in Chicago was notable for considerable violence and unrest. Even if the Milwaukee Democratic Party convention does not produce unrest, it could sow the seeds for unrest later in the year. First, a breakout Biden performance in the primaries is unlikely. As such, he will likely need to pledge a shift to the left at the convention, including by accepting a progressive vice-presidential candidate. Second, an actual progressive may win the primary. Chart II-21Zealots In Both Parties Perceive Each Other As A National Threat It is likely that either of the two options would be seen as an existential threat to many of Trump’s loyal supporters across the United States. President Trump’s rhetoric often paints the scenario of a Democratic takeover of the White House in apocalyptic terms. And data suggests that the zealots in both parties perceive each other as a “threat to the nation’s wellbeing” (Chart II-21). The American Civil War in the nineteenth century began with the election of a president. This is not just because Abraham Lincoln was a particularly reviled figure in the South, but because the states that ultimately formed the Confederacy saw in his election the demographic writing-on-the-wall. The election was an expression of a general will that, from that point onwards, was irreversible. Given demographic trends in the US today, it is possible that many would see in Trump’s loss a similar fait accompli. If one perceives progressive Democrats as an existential threat to the US constitution, rebellion is the obvious and rational response. Bottom Line: Year 2020 may be a particularly violent one for the US. First, left wing activists may be shocked and angered to learn that Joe Biden (or Bloomberg) is the nominee of the Democratic Party come July. With so much hype behind the progressive candidates throughout the campaign, Biden’s nomination could be seen as an affront to what was supposed to be “the big year” for left-wing candidates. Second, investors have to start thinking about what happens if Biden – or a progressive candidate – goes on to defeat President Trump in the general election. While liberal America took Trump’s election badly, it has demographics – and thus time – on its side. Trump’s most ardent supporters may conclude that his defeat means the end of America as they know it. Black Swan 4: Europe’s Migration Crisis Restarts It is a testament to Europe’s resilience that we do not have a Black Swan scenario based on an election or a political crisis set on the continent in 2020. Support for the common currency and the EU as a whole has rebounded to its highest since 2013. Even early elections in Germany and Italy are unlikely to produce geopolitical risk. The populists in the former are in no danger of outperforming whereas the populists in the latter barely deserve the designation. But what if one of the reasons for the surge in populism – unchecked illegal immigration – were to return in 2020? Chart II-22Decline In Illegal Immigration Dampened European Populism The data suggests that the risk of migrant flows has massively subsided. From its peak of over a million arrivals in 2015, the data shows that only 125,472 migrants crossed into Europe via land and sea routes in the Mediterranean last year (Chart II-22). Why? There are five reasons that we believe have checked the flow of migrants: Supply: The civil wars in Syria, Iraq, and Libya have largely subsided. Heterogenous regions, cities, and neighborhoods have been ethnically cleansed and internal boundaries have largely ossified. It is unlikely that any future conflict will produce massive outflows of refugees as the displacement has already taken place. These countries are now largely divided into armed, ethnically homogenous, camps. Enforcement: The EU has stepped up border enforcement since 2015, pouring resources into the land border with Turkey and naval patrols across the Mediterranean. Individual member states – particularly Italy and Hungary – have also stepped up border enforcement policy. While most EU member states have publicly chided both for “draconian” policies, there is no impetus to force Rome and Budapest to change policy. Libyan Imbroglio: Conflict in Libya has flared up in 2019 with military warlord Khalifa Haftar looking to wrest control from the UN-backed Government of National Accord led by Fayez al-Serraj. The Islamic State has regrouped in the country as well. Ironically, the conflict is helping stem the flow of migrants as African migrants from sub-Saharan countries dare not cross into Libya as they did in 2015 when there was a brief lull in fighting. Turkish benevolence: Ankara is quick to point out that it is the only thing standing between Europe and a massive deluge of migrants. Turkey is said to host somewhere between two and four million refugees from various conflicts in the Middle East. Fear of the crossing: If crossing the Mediterranean was easy, Europe would have experienced a massive influx of migrants throughout the twentieth century. Not only is it not easy, it is costly and quite deadly, with thousands lost each year. Furthermore, most migrants are not welcomed when they arrive to Europe, many are held in terrible conditions in holding camps in Italy and Greece. Over time, migrants who made it into Europe have reported these dangers and conditions, reducing the overall demand for illegal migration. We do not foresee these five factors changing, at least not all at once. However, there are several reasons to worry about the flow of migrants in 2020. US-Iran tensions have sparked outright military action, while unrest is flaring up across Iran’s sphere of influence. Going forward, Iran could destabilize Iraq or fuel Shia unrest against US-backed regimes. Second, Afghanistan has been the source of most migrants to Europe via sea and land Mediterranean routes – 19.2%. The conflict in the country continues and may flare up with President Trump’s decision to formally withdraw most US troops from the country in 2020. Third, a break in fighting in Libya may encourage sub-Saharan migrants to revisit routes to Europe. Migrants from Guinea, Cote d’Ivoire, and the Democratic Republic of Congo make up over 10% of migrants to Europe. Finally, Turkish relationship with the West could break up further in 2020, causing Ankara to ship migrants northward. We highly doubt that President Erdogan will risk such a break, given that 50% of Turkish exports go to Europe. A European embargo on Turkish exports – which would be a highly likely response to such an act – would crush the already decimated Turkish economy. Bottom Line: While we do not see a return to the 2015 level of migration in 2020, we flag this risk because it would fundamentally undermine political stability in Europe. Black Swan 5: Russia Faces A “Peasant Revolt” Our fifth and final black swan risk for the year stems from Russia. This risk may seem obvious, since the US election creates a dynamic that revives the inherent conflict in US-Russian relations. Russia could seek to accomplish foreign policy objectives – interfering in US elections, punishing regional adversaries. The Trump administration may be friendly toward Russia but Trump is unlikely to veto any sanctions passed by the House and Senate in an election year, should an occasion for new sanctions arise. Conversely Russia could anticipate greater US pressure if the Democrats win in November. Yet it is Russia’s domestic affairs that represent the real underrated risk. Putin’s fourth term as president has been characterized by increased focus on domestic political control and stability as opposed to foreign adventurism. The creation of a special National Guard in 2016, reporting directly to Putin and responsible for quelling domestic unrest, symbolizes the shift in focus. So too does Russia’s adherence to the OPEC 2.0 regime of production control to keep oil prices above their budget breakeven level. Meanwhile Putin’s courting of Europe for the Nordstream II pipeline, and his slight peacemaking efforts with Ukraine, has suggested a slightly more restrained international posture. Strategically it makes little sense for Russia to court negative attention at a time when the US and Europe are at odds over trade and the Middle East, the US is preoccupied with China and Iran, and Russia itself faces mounting domestic problems. The domestic problems are long in coming. The central bank has maintained a stringent monetary policy for the better part of the decade. Despite cutting interest rates recently, monetary and credit conditions are still tight, hurting domestic demand. Moscow has also imposed fiscal austerity, namely by cutting back on state pensions and hiking the value added tax. Real wage growth is weak (Chart II-23), retail sales are falling, and domestic demand looks to weaken further, as Andrija Vesic of BCA Emerging Markets Strategy observes in a recent Special Report. The effect of Russia’s policy austerity has been a drop in public approval of the administration (Chart II-24). Protests erupted in 2019 but were largely drowned out by the larger and more globally significant protests in Hong Kong. These were met by police suppression that has not removed their underlying cause. Putin’s first major decision of the new year was to reshuffle the government, entailing Prime Minister Dmitri Medvedev’s transfer to a new post and the appointment of a new cabinet. This move reveals the need to show some accountability to reduce popular pressure. While Moscow now has room to cut interest rates and ease fiscal policy, it is behind the curve and the weak economy will add fuel to domestic unrest. Chart II-23Sluggish Wage Growth Threatens Russian Stability Chart II-24Austerity Weighed On The Administration's Popularity In Russia   Meanwhile Putin’s efforts to alter the Russian constitution so he can stay in power beyond current term limits, effectively becoming emperor for life, like Xi Jinping, should not be dismissed merely because they are expected. They reflect a need to take advantage of Putin’s popular standing to consolidate domestic political power at a time when the ruling United Russia party and the federal government face discontent. They also ensure that strategic conflict with the United States will take on an ideological dimension. Russia's recent cabinet shakeup is positive from the point of view of economic reform. And the country's monetary and fiscal room provide a basis for remaining overweight equities within EM, as our Emerging Markets Strategy recommends. However, Russian equities have rallied hard and the political risk is understated. Chart II-25Russian Political Risk Is Unsustainably Low Bottom Line: It is never easy predicting Putin’s next international move. Our market-based indicators of Russian political risk have hit multi-year lows, but both the domestic and international context suggest that these lows will not be sustained (Chart II-25). A new bout of risk can emanate from Putin, or from changes in Washington, or from the Russian people themselves. What would take the world by surprise would be domestic unrest on a larger scale than Russia can easily suppress through the police force. Housekeeping We are closing our long European Union / short Chinese equities strategic trade with a 1.61% loss since inception on May 10, 2019. Dhaval Joshi of BCA’s European Investment Strategy downgraded the Eurostoxx 50 to underweight versus the S&P 500 and the Nikkei 225 this week. He makes the point that the Euro Area bond yield 6-month impulse hit 100 bps – a critical technical level – and will be a strong headwind to growth. We will look to reopen this trade at a later date when the euphoria over the “phase one” trade deal subsides, as we still favor European equities and DM bourses over EM. We will reinstitute our long Brent crude H2 2020 versus H2 2021 tactical position, which was stopped out on January 9, 2020. We remain bullish on oil fundamentals and expect Middle East instability to add a political risk premium. China's stimulus and the oil view also give reason for us to reinitiate our long Malaysian equities relative to EM as a tactical position. The Malaysian ringgit will benefit as oil prices move higher, helping Malaysian companies make payments on their large pile of dollar-denominated debt and improving household purchasing power. Higher oil prices also correlate with higher equity prices, while China's stimulus and the US trade ceasefire will push the US dollar lower and help trade revive in the region. Marko Papic Chief Strategist, Clocktower Group Matt Gertken Geopolitical Strategist Footnotes 1 Observe how little attention the public paid to US-China saber-rattling around China’s announcement of an Air Defense Identification Zone in the East China Sea that year.

Highlights The liquidity-driven rally will soon be followed by an acceleration in global growth. The economic recovery will bump up expectations of long-term profit growth. The dollar has downside, but the euro will not benefit much. Overweight stocks relative to bonds and bet on traditional cyclical sectors and commodities. The potential for outperformance of value relative to growth favors European equities. The probability of a tech mania is escalating: how should investors factor an expanding bubble into their portfolios? Feature Chart I-1A Bull Market In Stocks And Volatility? Despite all odds, the nCoV-2019 outbreak is barely denting the S&P 500’s frenetic rally. Plentiful liquidity, thawing Sino-US trade relations and improving economic activity in Asia, all have created ideal conditions for risk assets to appreciate on a cyclical basis. Stocks may look increasingly expensive and are primed to correct, but the bubble will expand further. After lifting asset valuations, monetary policy easing will soon boost worldwide economic activity. Consequently, earnings in the US and Europe will improve. As long as central bankers remain unconcerned about inflation, investors will bid up stocks. Investors should remember we are in the final innings of a bull market. Stocks can deliver outsized returns during this period, but often at the cost of elevated volatility, and the options market is not pricing in this uncertainty (Chart I-1). Moreover, timing the ultimate end of the bubble is extremely difficult. Hence, we prefer to look for assets that can still benefit from easy monetary conditions and rebounding growth, but are not as expensive as equities. Industrial commodities fit that description, especially after their recent selloff. The dollar remains a crucial asset to gauge the path of least resistance for assets. If it refuses to swoon, then it will indicate that global growth is in a weaker state than we foresaw. The good news is that the broad trade-weighted dollar seems to have peaked. Accommodative Monetary Conditions Are Here To Stay Easy liquidity has been the lifeblood of the S&P 500’s rally. The surge in the index coincided with the lagged impact of the rise in our US Financial Liquidity Index (Chart I-2). Low rates have allowed stocks to climb higher, yet earnings expectations remain muted. For example, since November 26, 2018, the forward P/E ratio for the S&P 500 has increased from 15.2 to 18.7, while 10-year Treasury yields have collapsed from 3.1% to 1.6%. Meanwhile, expectations for long-term earnings annual growth extracted from equity multiples using a discounted cash flow model have dropped from 2.4% to 1.2%. Historically, easier monetary policy pushes asset prices higher before it lifts economic activity. Historically, easier monetary policy pushes asset prices higher before it lifts economic activity. Yet, stocks and risk assets normally continue to climb when the economy recovers. Even without any additional monetary easing, as long as policy remains accommodative, risk assets will generate positive returns. Expectations for stronger cash flow growth become the force driving asset prices higher. Policy will likely remain accommodative around the world. Within this framework, peak monetary easing is probably behind us, even though liquidity conditions remain extremely accommodative. Nominal interest rates remain very low, and real bond yields are still falling. Unlike in 2018 and 2019, dropping TIPs yields reflect rising inflation expectations (Chart I-3). Those factors together indicate that policy is reflationary, which is confirmed by the gold rally. Chart I-2A Liquidity Driven Rally Chart I-3Today, Lower TIPS Yields Are Reflationary   Chart I-4Economic Activity To Respond To Liquidity Based on the historical lags between monetary easing and manufacturing activity, the global industrial sector is set to mend (Chart I-4). Moreover, the liquidity-driven surge in stock prices, combined with low yields and compressed credit spreads, has eased financial conditions, which creates the catalyst for an industrial recovery. Where will the growth come from? First, worldwide inventory levels have collapsed after making negative contributions to growth since mid-2018 (Chart I-5). Thus, there is room for an inventory restocking. Secondly, auto sales in Europe and China have rebounded to 18.5% from -23% and to -0.1% from -16.4%, respectively. Thirdly, China’s credit and fiscal impulse has improved. The uptick in Chinese iron ore imports indicates that the pass-through from domestic reflation to global economic activity will materialize soon (Chart I-6). Finally, following the Phase One Sino-US trade deal, global business confidence is bottoming, as exemplified by Belgium’s business confidence, Switzerland KOF LEI, Korea's manufacturing business survey, or US CFO and CEO confidence measures. The increase in EM earnings revisions shows that US capex intentions should soon re-accelerate, which bodes well for investment both in the US and globally (Chart I-7). Chart I-5Room For Inventory Restocking Chart I-6China Points To Stronger Global Growth   Construction activity, a gauge of the monetary stance, is looking up across the advanced economies. In the US, housing starts – a leading indicator of domestic demand – have hit a 13-year high. A pullback in this volatile data series is likely, but it should be limited. Vacancies remain at a paltry 1.4%, household formation is solid and affordability is not demanding (Chart I-8). In Europe, construction activity has been relatively stable through the economic slowdown. Even in Canada and Australia, housing transactions have gathered steam quickly following declines in mortgage rates (Chart I-9). Chart I-7Capex Is Set To Recover Chart I-8US Housing Is Robust Chart I-9Even The Canadian And Australian Housing Markets Are Stabilizing Consumers will remain a source of strength for the global economy. The dichotomy between weak manufacturing PMIs and the stable service sector reflects a healthy consumer spending. December retail sales in Europe and the US corroborate this assessment. The stabilization in US business confidence suggests that household incomes are not in as much jeopardy as three months ago. As household net worth and credit growth improve further, a stable outlook for household income will underwrite greater gains in consumption. Policy will likely remain accommodative around the world. For the time being, US inflationary pressures are muted. The New York Fed’s Underlying Inflation Gauge has rolled over, hourly earnings growth has moved back below 3%, our pipeline inflation indicator derived from the ISM is weak, and core producer prices are flagging (Chart I-10). This trend is not US-specific. In the OECD, core consumer price inflation is set to decelerate due to the lagged impact of the manufacturing slowdown. Central banks are also constrained to remain dovish by their own rhetoric. The Fed's statement this week was a testament to this reality. Central banks are increasingly looking to set symmetrical inflation targets. After a decade of missing their targets, a symmetric target would imply keeping policy easier for longer, even if realized inflation moves back above 2%. A rebound in global growth and weak inflation should create a poisonous environment for the US dollar. Finally, fiscal policy will make a small positive contribution to growth in most major advanced economies in 2020, particularly in Germany and the UK (Table I-1). Chart I-10Limited Inflation Will Allow The Fed To Remain Easy Table I-1Modest Fiscal Easing In 2020   The Dollar And The Sino-US Phase One Deal At first glance, a rebound in global growth and weak inflation should create a poisonous environment for the US dollar (Chart I-11). As we have often argued, the dollar’s defining characteristic is its pronounced counter-cyclicality. Chart I-11A Painful Backdrop For The Greenback Deteriorating dollar fundamentals make this risk particularly relevant. US interest rates are well above those in the rest of the G10, but the gap in short rates has significantly narrowed. Historically, the direction of rates differentials and not their levels has determined the trend in the USD (Chart I-12). Moreover, real differentials at the long end of the curve support the notion that the maximum tailwinds for the dollar are behind us (Chart I-12, bottom panel). Furthermore, now that the US Treasury has replenished its accounts at the Federal Reserve, the Fed’s addition of excess reserves in the system will likely become increasingly negative for the dollar, especially against EM currencies. Likewise, relative money supply trends between the US, Europe, Japan and China already predict a decline in the dollar (Chart I-13). Chart I-12Interest Rate Differentials Do Not Favor The Dollar... Chart I-13...Neither Do Money Supply Trends   Chart I-14The Phase One Deal Is Ambitious The recent Sino-US trade agreement obscures what appears to be a straightforward picture. According to the Phase One deal signed mid-January, China will increase its US imports by $200 billion in the next two years vis-à-vis the high-water mark of $186 billion reached in 2017. This is an extremely ambitious goal (Chart I-14). Politically, it is positive that China has committed to buy manufactured goods and services in addition to commodities. However, the scale of the increase in imports of US manufactured goods is large, at $77 billion. China cannot fulfill this obligation if domestic growth merely stabilizes or picks up just a little, especially now that the domestic economy is in the midst of a spreading illness. It will have to substitute some of its European and Japanese imports with US goods. A consequence of this trade deal is that the euro’s gains will probably lag those recorded in normal business cycle upswings. Historically, European growth outperforms the US when China’s monetary conditions are easing and its marginal propensity to consume is rising (Chart I-15). However, given the potential for China to substitute European goods in favor of US ones, China’s economic reacceleration probably will not benefit Europe as much as it normally does. China may not ultimately follow through with as big of US purchases as it has promised, but it is likely, at least initially, to show good faith in the agreement. The euro’s gains will probably lag those recorded in normal business cycle upswings. While the trade agreement is a headwind for the euro, it is a positive for the Chinese yuan. The US output gap stands at 0.1% of potential GDP and the US labor market is near full employment. The US industrial sector does not possess the required spare capacity to fulfill additional Chinese demand. To equilibrate the market for US goods, prices will have to adjust to become more favorable for Chinese purchasers. The simplest mechanism to achieve this outcome is for the RMB to appreciate. Meanwhile, the euro is trading 16% below its equilibrium, which will allow European producers to fulfill US domestic demand. A widening US trade deficit with Europe would undo improvements in the trade balance with China. The probability that US equities correct further in the short-term is elevated. The implication for the dollar is that the broad trade-weighted USD will likely outperform the Dollar Index (DXY). The euro represents 18.9% of the broad trade-weighted dollar versus 57.6% of the DXY. Asian currencies, EM currencies at large, the AUD and the NZD, all should benefit from their close correlation with the RMB (Chart I-16). Chart I-15Europe Normally Wins When China Recovers Chart I-16EM, Asian, And Antipodean Exchange Rates Love A Strong RMB   Obviously, before the RMB and the assets linked to it can appreciate further, the panic surrounding the coronavirus will have to dissipate. However, the economic damage created by SARS was short lived. This respiratory syndrome resulted in a 2.4% contraction Hong-Kong’s GDP in the second quarter of 2003. The economy of Hong Kong recovered that loss quickly afterward. Investment Forecasts BCA continues to forecast upside in safe-haven yields. Global interest rates remain well below equilibrium and a global economic recovery bodes poorly for bond prices (Chart I-17). However, inflation expectations and not real yields will drive nominal yield changes. The dovish slant of global central banks and the growing likelihood that symmetric inflation targets will become the norm is creating long-term upside risks for inflation. Moreover, if symmetric inflation targets imply lower real short rates in the future, then they also imply lower real long rates today. Investors should begin switching their risk assets into industrial commodity plays, especially after their recent selloff. Easy monetary conditions, decreased real rates and an improvement in economic activity are also consistent with an outperformance of assets with higher yields. High-yield bonds, which offer attractive breakeven spreads, will benefit from this backdrop (Chart I-18). Furthermore, carry trades will likely continue to perform well. In addition to low interest rates across most of the G10, the low currency volatility caused by an extended period of easy policy will continue to encourage carry-seeking strategies. Chart I-17Bonds Are Still Expensive Chart I-18Where Is The Value In Credit?   An environment in which growth is accelerating and monetary policy is accommodative argues in favor of stocks. Our profit growth model for the S&P 500 has finally moved back into positive territory. As earnings improve, investors will likely re-rate depressed long-term growth expectations for cash flows (Chart I-19). The flip side is that equity risk premia are elevated, especially outside the US (Chart I-19). Hence, as long as accelerating growth (but not tighter policy) drives up yields, equities should withstand rising borrowing costs. The use of passive investing and the prevalence of “closet indexers” accentuates the risk that a tech mania could blossom. The 400 point surge in the S&P 500 since early October complicates the picture. The probability that US equities correct further in the short-term is elevated, based on their short-term momentum and sentiment measures, such as the put/call ratio (Chart I-20). Foreign equities will continue to correct along US ones, even if they are cheaper. Chart I-19Elevated Stock Multiples Reflect Low Yields, Not Growth Exuberance Chart I-20Tactical Risks For Stocks   Chart I-21Buy Commodities/Sell Stocks? The coronavirus panic seems to be the catalyst for such a correction. When a market is overextended, any shock can cause a pullback in prices. Moreover, as of writing, medical professionals still have to ascertain the virus’s severity and potential mutations. Therefore, risk assets must embed a significant risk premium for such uncertainty, even if ultimately the infection turns out to be mild. However, that risk premium will likely prove to be short lived. During the SARS crisis in 2003, stocks bottomed when the number of reported new cases peaked. The tech sector has plentiful downside if the correction gathers strength. As indicated in BCA’s US Equity Sector Strategy, Apple, Microsoft, Google, Amazon and Facebook account for 18% of the US market capitalization, which is the highest market concentration since the late 1990s tech bubble. Investors should begin switching their risk assets into industrial commodity plays, especially after their recent selloff. Commodity prices are trading at a large discount to US equities. Moreover, the momentum of natural resource prices relative to stocks has begun to form a positive divergence with the price ratio of these two assets (Chart I-21). Technical divergences such as the one visible in the ratio of commodities to equities are often positive signals. Low real rates, an ample liquidity backdrop, a global economic recovery, a weak broad trade-weighted dollar and a strong RMB, all benefit commodities over equities. Tech stocks underperform commodities when the dollar weakens and growth strengthens. Moreover, our positive stance on the RMB justifies stronger prices for copper, oil and EM equities (Chart I-22). Chart I-22The Winners From A CNY Rebound Our US Equity Strategy Service has also reiterated its preference for industrials and energy stocks, and it recently upgraded materials stocks to neutral.1 All three sectors trade at significant valuation discounts to the broad market and to tech stocks in particular. They are also oversold in relative terms. Finally, their operating metrics are improving, a trend which will be magnified if global growth re-accelerates. Do not make these bets aggressively. A weakening broad trade-weighted dollar would allow for a rotation into foreign equities and an outperformance of value relative to growth stocks. The share of US equities in the MSCI All-Country World Index is a direct function of the broad trade-weighted dollar (Chart I-23). Moreover, since 1971, the dollar and the relative performance of growth stocks versus value stocks have exhibited a positive correlation (Chart I-24). Thus, the dollar’s recent strength has been a key component behind the run enjoyed by tech stocks. Chart I-23Global Stocks Love A Soft Dollar Chart I-24Value Stocks Needs A Weaker Dollar To Outperform Growth Stocks Despite the risks to the euro discussed in the previous section, European equities could still outperform US equities. Such a move would be consistent with value stocks beating growth equities (Chart I-24, bottom panel). This correlation exists because the euro area has a combined 17.7% weighting to tech and healthcare stocks compared with a 37.1% allocation in US benchmarks. Moreover, a cheap euro should allow European industrials and materials to outperform their US counterparts. Finally, the recent uptick in the European credit impulse indicates that an acceleration in European profit growth is imminent, a view that is in line with our preference for European financials (Chart I-25).2 Chart I-25Euro Area Profits Should Improve Bottom Line: The current environment remains favorable for risk assets on a 12-month investment horizon. As such, we expect stocks and bond yields to continue to rise in 2020. Moreover, a pick-up in global growth, along with a fall in the broad trade-weighted dollar, should weigh on tech and growth stocks, and boost the attractiveness of commodity plays, industrial, energy and materials stocks, as well as European and EM equities. Forecast Meets Strategy Liquidity-driven rallies, such as the current one, can carry on regardless of the fundamentals. As Keynes noted 90 years ago: “Markets can remain irrational longer than you can stay solvent.” The gap between forecast and strategy can be great. The use of passive investing and the prevalence of “closet indexers” accentuates the risk that a tech mania could blossom. We assign a substantial 30% probability to the risk of another tech mania. Outflows from equity ETFs and mutual funds have been large. Investors will be tempted to move back into those vehicles if stocks continue to rally on the back of plentiful liquidity and improving global growth (Chart I-26). In the process, the new inflows will prop up the over-represented, over-valued, and over-extended tech behemoths. Chart I-26Depressed Equity Flows Should Pick Up The current tech bubble can easily run a lot further. Based on current valuations, the NASDAQ trades at a P/E ratio of 31 compared with 68 in March 2000 (Chart I-27). Moreover, momentum is becoming increasingly favorable for the NASDAQ and other high-flying tech stocks. The NASDAQ is outperforming high-dividend stocks and after a period of consolidation, its relative performance is breaking out. Momentum often performs very well in liquidity-driven rallies. Chart I-27Where Is The Bubble? Chart I-28Debt Loads Are Already High Everywhere A full-fledged tech mania would make our overweight equities / underweight bonds a profitable call, but it would invalidate our sector and regional recommendations. Moreover, with a few exceptions in China and Taiwan, the major tech bellwethers are listed in the US. A tech bubble would most likely push our bearish dollar stance to the offside. Bubbles are dangerous: participating on the upside is easy, but cashing out is not. Moreover, financial bubbles tend to exacerbate the economic pain that follows the bust. During manic phases, capital is poorly invested and the economy becomes geared to the sectors that benefit from the financial excesses. These assets lose their value when the bubble deflates. Moreover, bubbles often result in growing private-sector indebtedness. Writing off or paying back this debt saps the economy’s vitality. Making matters worse, today overall indebtedness is unprecedented and central banks have little room to reflate the global economy once the bubble bursts (Chart I-28). Finally, US/Iran tensions will create additional risk in the years ahead. Matt Gertken, BCA’s Geopolitical Strategist, warns that the ratcheting down of tensions following Iran’s retaliation to General Soleimani’s assassination is temporary.3 As a result, the oil market remains a source of left-handed tail-risk. Section II discusses other potential black swans lurking in the geopolitical sphere. We continue to recommend that investors overweight industrials and energy, upgrade materials to neutral, Europe to overweight, and curtail their USD exposure as long as US inflation remains well behaved and the US inflation breakeven rate stays below the 2.3% to 2.5% range. However, do not make these bets aggressively. Moreover, some downside protection is merited. Due to our very negative view on bonds, we prefer garnering these hedges via a 15% allocation to gold and the yen. The yen is especially attractive because it is one of the few cheap, safe-haven plays (Chart I-29). Chart I-29The Yen Offers Cheap Portfolio Protection Mathieu Savary Vice President The Bank Credit Analyst January 30, 2020 Next Report: February 27, 2020   II. Five Black Swans In 2020 Our top five geopolitical “Black Swans” are risks that the market is seriously underpricing. With the “phase one” trade deal signed, Chinese policy could become less accommodative, resulting in a negative economic surprise. The trade deal may fall victim to domestic politics, raising the risk of a US-China military skirmish. A Biden victory at the Democratic National Convention or a Democratic takeover of the White House could trigger social unrest and violence in the US. A pickup in the flow of migrants to Europe would fundamentally undermine political stability there. Russia’s weak economy will add fuel to domestic unrest, risking an escalation beyond the point of containment. Over the past four years, BCA’s Geopolitical Strategy service has started off each year with their top five geopolitical “Black Swans.” These are low-probability events whose market impact would be significant enough to matter for global investors. Unlike the great Byron Wien’s perennial list of market surprises, we do not assign these events a “better than 50% likelihood of happening.” We offer risks that the market is seriously underpricing by assigning them only single-digit probabilities when we think the reality is closer to 10%-15%, a level at which a risk premium ought to be assigned. Some of our risks below are so obscure that it is not clear how exactly to price them. We exclude issues that are fairly probable, such as flare-ups in Indo-Pakistani conflict. The two major risks of the year – discussed in our Geopolitical Strategy’s annual outlook – are that either US President Donald Trump or Chinese President Xi Jinping overreaches in a major way. But what would truly surprise the market would be a policy-induced relapse in Chinese growth or a direct military clash between the two great powers. That is how we begin. Other risks stem from domestic affairs in the US, Europe, and Russia. Black Swan 1: China’s Financial Crisis Begins Chart II-1A Crackdown On Financial Risk Could Cause China's Economy To Derail The risk of Xi Jinping’s concentration of power in his own person is that individuals can easily make mistakes, especially if unchecked by advisors or institutions. Lower officials will fear correcting or admonishing an all-powerful leader. Inconvenient information may not be relayed up the hierarchy. Such behavior was rampant in Chairman Mao Zedong’s time, leading to famine among other ills. Insofar as President Xi’s cult of personality successfully imitates Mao’s, it will be subject to similar errors. If President Xi overreaches and makes a policy mistake this year, it could occur in economic policy or other policies. We begin with economic policy, as we have charted the risks of Xi’s crackdown on the financial system since early 2017 (Chart II-1). This year is supposed to be the third and final year of Xi Jinping’s “three battles” against systemic risk, pollution, and poverty. The first battle actually focuses on financial risk, i.e. China’s money and credit bubble. The regime has compromised on this goal since mid-2018, allowing monetary easing to stabilize the economy amid the trade war. But with a “phase one” trade deal having been signed, there is an underrated risk that economic policy will return to its prior setting, i.e. become less accommodative (Chart II-2). When Xi launched the “deleveraging campaign” in 2017, we posited that the authorities would be willing to tolerate an annual GDP growth rate below 6%. This would not only cull excesses in the economy but also demonstrate that the administration means business when it says that China must prioritize quality rather than quantity of growth. While Chinese authorities are most likely targeting “around 6%” in 2020, it is entirely possible that the authorities will allow an undershoot in the 5.5%-5.9% range. They will argue that the GDP target for 2020 has already been met on a compound growth rate basis (Chart II-3), as astute clients have pointed out. They may see less need for stimulus than the market expects. Chart II-2Easing Of Trade Tensions May Re-Incentivize Tighter Policy Chart II-3Chinese Authorities Might Tolerate A Growth Undershoot In 2020   Similarly, while urban disposable income is ostensibly lagging its target of doubling 2010 levels by 2020, China’s 13th Five Year Plan, which concludes in 2020, conspicuously avoided treating urban and rural income targets separately. If the authorities focus only on general disposable income, then they are on track to meet their target (Chart II-4). This would reduce the impetus for greater economic support. The Xi administration may aim only for stability, not acceleration, in the economy. There are already tentative signs that Chinese authorities are “satisfied” with the amount of stimulus they have injected: some indicators of money and credit have already peaked (Chart II-5). The crackdown on shadow banking has eased, but informal lending is still contracting. The regime is still pushing reforms that shake up state-owned enterprises. Chart II-4Lower Impetus For Economic Support Due To Improvements In National Income? Chart II-5Has China's Stimulus Peaked?   An added headwind for the Chinese economy stems from the currency. The currency should track interest rate differentials. Beijing’s incremental monetary stimulus, in the form of cuts to bank reserve requirement ratios (RRRs), should also push the renminbi down over time (Chart II-6). However, an essential aspect of any trade deal with the Trump administration is the need to demonstrate that China is not competitively devaluing. Hence the CNY-USD could overshoot in the first half of the year. This is positive for global exports to China, but it tightens Chinese financial conditions at home. A stronger than otherwise justified renminbi would add to any negative economic surprises from less accommodative monetary and fiscal policy. Conventional wisdom says China will stimulate the economy ahead of two major political events: the centenary of the Communist Party in 2021 and the twentieth National Party Congress in 2022. The former is a highly symbolic anniversary, as Xi has reasserted the supremacy of the party in all things, while the latter is more significant for policy, as it is a leadership reshuffle that will usher in the sixth generation of China’s political elite. But conventional wisdom may be wrong – the Xi administration may aim only for stability, not acceleration, in the economy. It would make sense to save dry powder for the next US or global recession. The obvious implication is that China’s economic rebound may lose steam as early as H2 – but the black swan risk is that negative surprises could cause a vicious spiral inside of China. This is a country with massive financial and economic imbalances, a declining potential growth profile, and persistent political obstacles to growth both at home and abroad. Corporate defaults have spiked sharply. While the default rate is lower than elsewhere, the market may be sniffing out a bigger problem as it charges a much higher premium for onshore Chinese bonds (Chart II-7). Chart II-6CNY/USD Overshoot Would Tighten Chinese Financial Conditions Chart II-7Is China's Bond Market Sniffing Out A Problem?   Bottom Line: Our view is that China’s authorities will remain accommodative in 2020 in order to ensure that growth bottoms and the labor market continues to improve. But Beijing has compromised its domestic economic discipline since 2018 in order to fight trade war. The risk now, with a “phase one” deal in hand, is that Xi Jinping returns to his three-year battle plan and underestimates the downward pressures on the economy. The result would be a huge negative surprise for the Chinese and global economy in 2020. Black Swan 2: The US And China Go To War In 2013, we predicted that US-China conflict was “more likely than you think.” This was not just an argument for trade conflict or general enmity that raises the temperature in the Asia-Pacific region – we included military conflict. At the time, the notion that a Sino-American armed conflict was the world’s greatest geopolitical threat seemed ludicrous to many of our clients. We published this analysis in October of that year, months after the Islamic State “Soldier’s Harvest” offensive into Iraq. Trying to direct investors to the budding rivalry between American and Chinese naval forces in the South China Sea amidst the Islamic State hysteria was challenging, to say the least. Chart II-8Americans’ Attitudes Toward China Plunged… The suggestion that an accidental skirmish between the US and China could descend into a full-blown conflict involved a stretch of the imagination because China was not yet perceived by the American public as a major threat. In 2014, only 19%of the US public saw China as the “greatest threat to the US in the future.” This came between Russia, at 23%, and Iran, at 16%. Today, China and Russia share the top spot with 24%. Furthermore, the share of Americans with an unfavorable view of China has increased from 52% to 60% in the six intervening years (Chart II-8). The level of enmity expressed by the US public toward China is still lower than that toward the Soviet Union at the onset of the Cold War in the 1950s (Chart II-9). However, the trajectory of distrust is clearly mounting. We expect this trend to continue: anti-China sentiment is one of the few sources of bipartisan agreement remaining in Washington, DC (Chart II-10). Chinese sentiment toward the United States has also darkened dramatically. The geopolitical rivalry is deepening for structural reasons: as China advances in size and sophistication, it seeks to alter the regional status quo in its favor, while the US grows fearful and seeks to contain China. Chart II-9…But Not Yet To War-Inducing Levels Chart II-10Distrust Of China Is Bipartisan   Chart II-11Newfound American Concern For China’s Repression One example of rising enmity is the US public’s newfound concern for China’s domestic policies and human rights, specifically Beijing’s treatment of its Uyghur minority in Xinjiang. A Google Trends analysis of the term “Uyghur” or “Uyghur camps” shows a dramatic rise in mentions since Q2 of 2018, around the same time the trade war ramped up in a major way (Chart II-11). While startling revelations of re-education camps in Xinjiang emerged in recent years, the reality is that Beijing has used heavy-handed tactics against both militant groups and the wider Uyghur minority since at least 2008 – and much earlier than that. As such, the surge of interest by the general American public and legislators – culminating in the Uyghur Human Rights Policy Act of 2019 – is a product of the renewed strategic tension between the two countries. The same can be said for Hong Kong: the US did not pass a Hong Kong Human Rights and Democracy Act in 2014, during the first round of mass protests, which prompted Beijing to take heavy-handed legal, legislative, and censorship actions. It passed the bill in 2019, after the climate in Washington had changed. Why does this matter for investors? There are two general risks that come with a greater public engagement in foreign policy. First, the “phase one” trade deal between China and the US could fall victim to domestic politics. This deal envisions a large step up in Sino-American economic cooperation. But if China is to import around $200 billion of additional US goods and services over the next two years – an almost inconceivable figure – the US and China will have to tamp down on public vitriol. This is notably the case if the Democratic Party takes over the White House, given its likely greater focus on liberal concerns such as human rights. And yet the latest bills became law under President Trump and a Republican Senate, and we fully expect a second Trump term to involve a re-escalation of trade tensions to ensure compliance with phase one and to try to gain greater structural concessions in phase two. Second, mounting nationalist sentiment will make it more difficult for US and Chinese policymakers to reduce tensions following a potential future military skirmish, accidental or otherwise. While our scenario of a military conflict in 2013 was cogent, the public backlash in the United States was probably manageable.3 Today we can no longer guarantee that this is the case. The “phase one” trade deal risks falling victim to domestic politics due to greater public engagement in foreign policy. China has greater control over the domestic narrative and public discourse, but the rise of the middle class and the government’s efforts to rebuild support for the single-party regime have combined to create an increase in nationalism. Thus it is also more difficult for Chinese policymakers to contain the popular backlash if conflict erupts. In short, the probability of a quick tamping down of public enmity is actively being reduced as American public vilification of China is closing the gap with China’s burgeoning nationalism at an alarming pace. Another of our black swan risks – Taiwan island – is inextricably bound up in this dangerous US-China dynamic. To be clear, Washington will tread carefully, as a conflict over Taiwan could become a major war. Nevertheless Taiwan’s election, as we expected, has injected new vitality into this already underrated geopolitical risk. It is not only that a high-turnout election (Chart II-12) gave President Tsai Ing-wen a greater mandate (Chart II-13), or that her Democratic Progressive Party retained its legislative majority (Chart II-14). It is not only that the trigger for this resounding victory was the revolt in Hong Kong and the Taiwanese people’s rejection of the “one country, two systems” formula for Taiwan. It is also that Tsai followed up with a repudiation of the mainland by declaring, “We don’t have a need to declare ourselves an independent state. We are an independent country already and we call ourselves the Republic of China, Taiwan.” Chart II-12Tsai Ing-Wen Enjoys A Greater Mandate On Higher Turnout… Chart II-13…Popular Support… Chart II-14…And A Legislative Majority This statement is not a minor rhetorical flourish but will be received as a major provocation in Beijing: the crystallization of a long-brewing clash between Beijing and Taipei. Additional punitive economic measures against Taiwan are now guaranteed. Saber-rattling could easily ignite in the coming year and beyond. Taiwan is the epicenter of the US-China strategic conflict. First, Beijing cannot compromise on its security or its political legitimacy and considers the “one China principle” to be inviolable. Second, the US maintains defense relations with Taiwan (and is in the process of delivering on a relatively large new package of arms). Third, the US’s true willingness to fight a war on Taiwan’s behalf is in doubt, which means that deterrence has eroded and there is greater room for miscalculation. Bottom Line: A US-China military skirmish has been our biggest black swan risk since we began writing the BCA Geopolitical Strategy. The difference between then and now, however, is that the American public is actually paying attention. Political ideology – the question of democracy and human rights – is clearly merging with trade, security, and other differences to provoke Americans of all stripes. This makes any skirmish more than just a temporary risk-off event, as it could lead to a string of incidents or even protracted military conflict. Black Swan 3: Social Unrest Erupts In America There are numerous lessons that one can learn from the ongoing unrest in Hong Kong, but perhaps the most cogent one is that Millennials and Generation Z are not as docile and feckless as their elders think. Images of university students and even teenagers throwing flying kicks and Molotov cocktails while clad in black body armor have shocked the world. Perhaps all those violent video games did have a lasting impact on the youth! What is surprising is that so few commentators have made the cognitive leap from the ultra-first world streets of Hong Kong to other developed economies. Perhaps what is clouding analysts’ minds is the idiosyncratic nature of the dispute in Hong Kong, the “one China” angle. However, Hong Kong youth are confronted with similar socio-economic challenges that their peers in other advanced economies face: overpriced real estate and a bifurcated service-sector labor market with few mid-tier jobs that pay a decent wage. There is a risk of rebellion from Trump’s most ardent supporters if he loses the White House. In the US, Millennials and Gen Z are also facing challenges unique to the US. First, their debt burden is much more toxic than that of the older cohorts, given that it is made up of student loans and credit card debt (Chart II-15). Second, they find themselves at odds – demographically and ideologically – with the older cohorts (Chart II-16). Chart II-15Younger American Cohorts Plagued By Toxic Debt Chart II-16Younger And Older Cohorts At Odds Demographically   Chart II-17Massive Turnout To The 2016 Referendum On Trump The adage that the youth are apolitical and do not turn out to vote may have ended thanks to President Trump. The 2018 midterm election, which the Democratic Party successfully turned into a referendum on the president, saw the youth (18-29) turnout nearly double from 20% to 36% (the 30-44 year-old cohort also saw a jump in turnout from 35.6% to 48.8%). The election saw one of the highest turnouts in recent memory, with a 53.4% figure, just two points off the 2016 general election figure (Chart II-17). Despite the high turnout in 2018, the-most-definitely-not-Millennial Vice President Joe Biden continues to lead the Democratic Party in the polls. His probability of winning the nomination is not overwhelming, but it is the highest of any contender. In recent polls, Biden comes third place in Millennial/Gen-Z vote preferences (Chart II-18). Yet he is hardly out of contention, especially for the 30-44 year-old cohort. The view that “Uncle Joe” does not fit the Democratic Party zeitgeist has become so entrenched in the Democratic Party narrative that it became conventional wisdom last year, pulling oddsmakers and betting markets away from the clear frontrunner (Chart II-19). Chart II-18Biden Unpopular Among Young American Voters Chart II-19Bookies Pulled Down 'Uncle Joe’s' Odds, Capturing Democratic Party Zeitgeist     As such, a Biden victory at the Democratic National Convention in Milwaukee, Wisconsin on July 13-16 may come as an affront to the left-wing activists who will surely descend on the convention. This will particularly be the case if Biden wins despite the progressive candidates amassing a majority of overall delegates, which is possible judging by the combined progressive vote share in current polling (Chart II-20). He would arrive in Milwaukee without clearing the 1990 delegate count required to win on the first ballot. On the second ballot, his presidency would then receive a boost from “superdelegates” and those progressives who are unwilling to “rock the boat,” i.e. unify against an establishment candidate with the largest share of votes. This is also how Mayor Michael Bloomberg could pull off a surprise win. Chart II-20Progressives Come Closest To Victory Such a “brokered” – or contested – convention has not occurred since 1952. However, several Democratic Party conventions came close, including 1968, 1972, and 1984. The 1968 one in Chicago was notable for considerable violence and unrest. Even if the Milwaukee Democratic Party convention does not produce unrest, it could sow the seeds for unrest later in the year. First, a breakout Biden performance in the primaries is unlikely. As such, he will likely need to pledge a shift to the left at the convention, including by accepting a progressive vice-presidential candidate. Second, an actual progressive may win the primary. Chart II-21Zealots In Both Parties Perceive Each Other As A National Threat It is likely that either of the two options would be seen as an existential threat to many of Trump’s loyal supporters across the United States. President Trump’s rhetoric often paints the scenario of a Democratic takeover of the White House in apocalyptic terms. And data suggests that the zealots in both parties perceive each other as a “threat to the nation’s wellbeing” (Chart II-21). The American Civil War in the nineteenth century began with the election of a president. This is not just because Abraham Lincoln was a particularly reviled figure in the South, but because the states that ultimately formed the Confederacy saw in his election the demographic writing-on-the-wall. The election was an expression of a general will that, from that point onwards, was irreversible. Given demographic trends in the US today, it is possible that many would see in Trump’s loss a similar fait accompli. If one perceives progressive Democrats as an existential threat to the US constitution, rebellion is the obvious and rational response. Bottom Line: Year 2020 may be a particularly violent one for the US. First, left wing activists may be shocked and angered to learn that Joe Biden (or Bloomberg) is the nominee of the Democratic Party come July. With so much hype behind the progressive candidates throughout the campaign, Biden’s nomination could be seen as an affront to what was supposed to be “the big year” for left-wing candidates. Second, investors have to start thinking about what happens if Biden – or a progressive candidate – goes on to defeat President Trump in the general election. While liberal America took Trump’s election badly, it has demographics – and thus time – on its side. Trump’s most ardent supporters may conclude that his defeat means the end of America as they know it. Black Swan 4: Europe’s Migration Crisis Restarts It is a testament to Europe’s resilience that we do not have a Black Swan scenario based on an election or a political crisis set on the continent in 2020. Support for the common currency and the EU as a whole has rebounded to its highest since 2013. Even early elections in Germany and Italy are unlikely to produce geopolitical risk. The populists in the former are in no danger of outperforming whereas the populists in the latter barely deserve the designation. But what if one of the reasons for the surge in populism – unchecked illegal immigration – were to return in 2020? Chart II-22Decline In Illegal Immigration Dampened European Populism The data suggests that the risk of migrant flows has massively subsided. From its peak of over a million arrivals in 2015, the data shows that only 125,472 migrants crossed into Europe via land and sea routes in the Mediterranean last year (Chart II-22). Why? There are five reasons that we believe have checked the flow of migrants: Supply: The civil wars in Syria, Iraq, and Libya have largely subsided. Heterogenous regions, cities, and neighborhoods have been ethnically cleansed and internal boundaries have largely ossified. It is unlikely that any future conflict will produce massive outflows of refugees as the displacement has already taken place. These countries are now largely divided into armed, ethnically homogenous, camps. Enforcement: The EU has stepped up border enforcement since 2015, pouring resources into the land border with Turkey and naval patrols across the Mediterranean. Individual member states – particularly Italy and Hungary – have also stepped up border enforcement policy. While most EU member states have publicly chided both for “draconian” policies, there is no impetus to force Rome and Budapest to change policy. Libyan Imbroglio: Conflict in Libya has flared up in 2019 with military warlord Khalifa Haftar looking to wrest control from the UN-backed Government of National Accord led by Fayez al-Serraj. The Islamic State has regrouped in the country as well. Ironically, the conflict is helping stem the flow of migrants as African migrants from sub-Saharan countries dare not cross into Libya as they did in 2015 when there was a brief lull in fighting. Turkish benevolence: Ankara is quick to point out that it is the only thing standing between Europe and a massive deluge of migrants. Turkey is said to host somewhere between two and four million refugees from various conflicts in the Middle East. Fear of the crossing: If crossing the Mediterranean was easy, Europe would have experienced a massive influx of migrants throughout the twentieth century. Not only is it not easy, it is costly and quite deadly, with thousands lost each year. Furthermore, most migrants are not welcomed when they arrive to Europe, many are held in terrible conditions in holding camps in Italy and Greece. Over time, migrants who made it into Europe have reported these dangers and conditions, reducing the overall demand for illegal migration. We do not foresee these five factors changing, at least not all at once. However, there are several reasons to worry about the flow of migrants in 2020. US-Iran tensions have sparked outright military action, while unrest is flaring up across Iran’s sphere of influence. Going forward, Iran could destabilize Iraq or fuel Shia unrest against US-backed regimes. Second, Afghanistan has been the source of most migrants to Europe via sea and land Mediterranean routes – 19.2%. The conflict in the country continues and may flare up with President Trump’s decision to formally withdraw most US troops from the country in 2020. Third, a break in fighting in Libya may encourage sub-Saharan migrants to revisit routes to Europe. Migrants from Guinea, Cote d’Ivoire, and the Democratic Republic of Congo make up over 10% of migrants to Europe. Finally, Turkish relationship with the West could break up further in 2020, causing Ankara to ship migrants northward. We highly doubt that President Erdogan will risk such a break, given that 50% of Turkish exports go to Europe. A European embargo on Turkish exports – which would be a highly likely response to such an act – would crush the already decimated Turkish economy. Bottom Line: While we do not see a return to the 2015 level of migration in 2020, we flag this risk because it would fundamentally undermine political stability in Europe. Black Swan 5: Russia Faces A “Peasant Revolt” Our fifth and final black swan risk for the year stems from Russia. This risk may seem obvious, since the US election creates a dynamic that revives the inherent conflict in US-Russian relations. Russia could seek to accomplish foreign policy objectives – interfering in US elections, punishing regional adversaries. The Trump administration may be friendly toward Russia but Trump is unlikely to veto any sanctions passed by the House and Senate in an election year, should an occasion for new sanctions arise. Conversely Russia could anticipate greater US pressure if the Democrats win in November. Yet it is Russia’s domestic affairs that represent the real underrated risk. Putin’s fourth term as president has been characterized by increased focus on domestic political control and stability as opposed to foreign adventurism. The creation of a special National Guard in 2016, reporting directly to Putin and responsible for quelling domestic unrest, symbolizes the shift in focus. So too does Russia’s adherence to the OPEC 2.0 regime of production control to keep oil prices above their budget breakeven level. Meanwhile Putin’s courting of Europe for the Nordstream II pipeline, and his slight peacemaking efforts with Ukraine, has suggested a slightly more restrained international posture. Strategically it makes little sense for Russia to court negative attention at a time when the US and Europe are at odds over trade and the Middle East, the US is preoccupied with China and Iran, and Russia itself faces mounting domestic problems. The domestic problems are long in coming. The central bank has maintained a stringent monetary policy for the better part of the decade. Despite cutting interest rates recently, monetary and credit conditions are still tight, hurting domestic demand. Moscow has also imposed fiscal austerity, namely by cutting back on state pensions and hiking the value added tax. Real wage growth is weak (Chart II-23), retail sales are falling, and domestic demand looks to weaken further, as Andrija Vesic of BCA Emerging Markets Strategy observes in a recent Special Report. The effect of Russia’s policy austerity has been a drop in public approval of the administration (Chart II-24). Protests erupted in 2019 but were largely drowned out by the larger and more globally significant protests in Hong Kong. These were met by police suppression that has not removed their underlying cause. Putin’s first major decision of the new year was to reshuffle the government, entailing Prime Minister Dmitri Medvedev’s transfer to a new post and the appointment of a new cabinet. This move reveals the need to show some accountability to reduce popular pressure. While Moscow now has room to cut interest rates and ease fiscal policy, it is behind the curve and the weak economy will add fuel to domestic unrest. Chart II-23Sluggish Wage Growth Threatens Russian Stability Chart II-24Austerity Weighed On The Administration's Popularity In Russia   Meanwhile Putin’s efforts to alter the Russian constitution so he can stay in power beyond current term limits, effectively becoming emperor for life, like Xi Jinping, should not be dismissed merely because they are expected. They reflect a need to take advantage of Putin’s popular standing to consolidate domestic political power at a time when the ruling United Russia party and the federal government face discontent. They also ensure that strategic conflict with the United States will take on an ideological dimension. Russia's recent cabinet shakeup is positive from the point of view of economic reform. And the country's monetary and fiscal room provide a basis for remaining overweight equities within EM, as our Emerging Markets Strategy recommends. However, Russian equities have rallied hard and the political risk is understated. Chart II-25Russian Political Risk Is Unsustainably Low Bottom Line: It is never easy predicting Putin’s next international move. Our market-based indicators of Russian political risk have hit multi-year lows, but both the domestic and international context suggest that these lows will not be sustained (Chart II-25). A new bout of risk can emanate from Putin, or from changes in Washington, or from the Russian people themselves. What would take the world by surprise would be domestic unrest on a larger scale than Russia can easily suppress through the police force. Housekeeping We are closing our long European Union / short Chinese equities strategic trade with a 1.61% loss since inception on May 10, 2019. Dhaval Joshi of BCA’s European Investment Strategy downgraded the Eurostoxx 50 to underweight versus the S&P 500 and the Nikkei 225 this week. He makes the point that the Euro Area bond yield 6-month impulse hit 100 bps – a critical technical level – and will be a strong headwind to growth. We will look to reopen this trade at a later date when the euphoria over the “phase one” trade deal subsides, as we still favor European equities and DM bourses over EM. We will reinstitute our long Brent crude H2 2020 versus H2 2021 tactical position, which was stopped out on January 9, 2020. We remain bullish on oil fundamentals and expect Middle East instability to add a political risk premium. China's stimulus and the oil view also give reason for us to reinitiate our long Malaysian equities relative to EM as a tactical position. The Malaysian ringgit will benefit as oil prices move higher, helping Malaysian companies make payments on their large pile of dollar-denominated debt and improving household purchasing power. Higher oil prices also correlate with higher equity prices, while China's stimulus and the US trade ceasefire will push the US dollar lower and help trade revive in the region. Marko Papic Chief Strategist, Clocktower Group Matt Gertken Geopolitical Strategist   III. Indicators And Reference Charts The S&P 500 rally looks increasingly vulnerable from a tactical perspective. The US benchmark is overbought, and the percentage of NYSE stocks above their 30-week and 10-week moving averages is rolling over at elevated levels. Additionally, the number of NYSE new highs minus new lows has moved in a parabolic fashion and has hit levels that in previous years have warned of an imminent correction. The spread of nCoV-2019 is likely to be the catalyst to a pullback that could cause the S&P 500 to retest its October 2019 breakout. An improving outlook for global growth, limited inflationary pressures and global central banks who maintain an accommodative monetary stance bode well for stocks. Therefore, the anticipated equity correction will not morph into a bear market. For now, our Monetary Indicator remains at extremely elevated levels. Furthermore, our Composite Technical Indicator has strengthened. Additionally, our BCA Composite Valuation index suggests that stocks are expensive, but not so much as to cancel out the supportive monetary and technical backdrop. Finally, our Speculation Indicator is elevated, but is not so high as to warn of an imminent market top. This somewhat muted level of speculation is congruent with the expectation of low long-term growth rates for profits embedded in equity prices. In contrast to our Revealed Preference Indicator, our Willingness-to-Pay (WTP) is moving in accordance with our constructive cyclical stance for stocks. Indeed, the WTP for the US, Japan and Europe continues to improve. The WTP indicator tracks flows, and thus provides information on what investors are actually doing, as opposed to sentiment indexes that track how investors are feeling. This broad-based improvement therefore bodes well for equities. Meanwhile, net earnings revisions appear to be forming a trough. 10-year Treasury yields remain extremely expensive. Moreover, according to our Composite Technical Indicator, T-Note prices are losing momentum. The fear surrounding the spread of the new coronavirus has cause bonds to rally again, but this is likely to be the last hurrah for the Treasury markets before a major reversal takes hold. The rising risk premia linked to the coronavirus is also helping the dollar right now, but signs that global growth is bottoming, such as the stabilization in the global PMIs, the pick-up in the German ZEW and Belgium’s Business Confidence surveys, or the improvement in Asia’s export growth, point to a worsening outlook for the counter-cyclical US dollar. Moreover, the dollar trades at a large premium of 24.5% relative to its purchasing-power parity equilibrium. Additionally, the negative divergence between the dollar and our Composite Momentum Indicator suggests that the dollar is technically vulnerable. In fact, the very modest pick-up in the dollar in response to the severe fears created by the spreading illness in China argues that dollar buying might have become exhausted. Finally, commodity prices have corrected meaningfully in response to the stronger dollar and the growth fears created by the spread of the coronavirus. However, they have not pulled back below the levels where they traded when they broke out in late 2019. Moreover, the advance/decline line of the Continuous Commodity Index remains at an elevated level, indicating underlying strength in the commodity complex. Natural resources prices will likely become the key beneficiaries of both the eventual pullback in virus-related fears and the weaker dollar.   EQUITIES: Chart III-1US Equity Indicators Chart III-2Willingness To Pay For Risk Chart III-3US Equity Sentiment Indicators   Chart III-4Revealed Preference Indicator Chart III-5US Stock Market Valuation Chart III-6US Earnings Chart III-7Global Stock Market And Earnings: Relative Performance Chart III-8Global Stock Market And Earnings: Relative Performance   FIXED INCOME: Chart III-9US Treasurys And Valuations Chart III-10Yield Curve Slopes Chart III-11Selected US Bond Yields Chart III-1210-Year Treasury Yield ComponentsChart III-13US Corporate Bonds And Health Monitor Chart III-14Global Bonds: Developed Markets Chart III-15Global Bonds: Emerging Markets   CURRENCIES: Chart III-16US Dollar And PPP Chart III-17US Dollar And Indicator Chart III-18US Dollar Fundamentals Chart III-19Japanese Yen Technicals Chart III-20Euro Technicals Chart III-21Euro/Yen Technicals Chart III-22Euro/Pound Technicals   COMMODITIES: Chart III-23Broad Commodity Indicators Chart III-24Commodity Prices Chart III-25Commodity Prices Chart III-26Commodity Sentiment Chart III-27Speculative Positioning   ECONOMY: Chart III-28US And Global Macro Backdrop Chart III-29US Macro Snapshot Chart III-30US Growth Outlook Chart III-31US Cyclical Spending Chart III-32US Labor Market Chart III-33US Consumption Chart III-34US Housing Chart III-35US Debt And Deleveraging   Chart III-36US Financial Conditions Chart III-37Global Economic Snapshot: Europe Chart III-38Global Economic Snapshot: China   Mathieu Savary Vice President The Bank Credit Analyst   Footnotes 1 Please see US Equity Strategy Weekly Report "Three EPS Scenarios," dated January 13, 2020, available at uses.bcaresearch.com; US Equity Strategy Insight Report "Bombed Out Energy," dated January 8, 2020, available at uses.bcaresearch.com; US Equity Strategy Special Report "Industrials: Start Your Engines," dated January 21, 2020, available at uses.bcaresearch.com 2  Please see The Bank Credit Analyst Monthly Report "January 2020," dated December 20, 2019 available at bca.bcaresearch.com; The Bank Credit Analyst Monthly Report "OUTLOOK 2020: Heading Into The End Game," dated November 22, 2019 available at bca.bcaresearch.com 3 Please see Geopolitical Strategy "A Reprieve Amid The Bull Market In Iran Tensions," dated January 8, 2020, available at gps.bcaresearch.com 4 Observe how little attention the public paid to US-China saber-rattling around China’s announcement of an Air Defense Identification Zone in the East China Sea that year.

Highlights The coronavirus scare is the catalyst for the recent correction, not the cause. The true cause is that the stock market had reached a point of groupthink-triggered instability and therefore needed the slightest catalyst to correct. Bond yields will stay depressed for (at least) the first half of 2020. Long-term investors should use corrections to overweight equities versus bonds, provided bond yields stay near or below current levels. The pound and UK-exposed investments will come under near-term pressure as UK/EU trade deal tensions ratchet up. But ultimately, UK-exposed investments will enjoy a major leg up later this year if both the UK and EU blink. Feature Chart of the WeekThe Next Up-Leg In The Pound And UK-Exposed Investments Will Occur Later In 2020 Corrections, Catalysts, And Coronavirus Markets have suffered a correction, begging the question: what caused it? The question is a good one, because identifying the cause can help to inform our response. Yet the danger is that the knee-jerk narrative pinpoints the catalyst rather than the true cause. In which case our response will be wrong too. For example, consider the following two narratives: Tree foliage collapses because of 40 mph winds. Tree foliage collapses because it is autumn. The first narrative is exciting, satisfying, and headline grabbing, but it only pinpoints the catalyst for the foliage collapse: the puff of wind. The second explanation is dull and less newsworthy, but it pinpoints the true cause: in autumn, tree foliage is unstable. Likewise, the coronavirus scare is the catalyst for the recent correction. The true cause is that the stock market had reached a point of groupthink-triggered instability and therefore needed the slightest catalyst to correct. The catalyst could have come from anywhere at any time. If it hadn’t been the coronavirus scare, it would have been the next worry… or the one after that. On January 9 in Markets Are Fractally Fragile we warned that usually cautious value investors had become momentum traders – undermining market liquidity and stability. When this happens, there is a two in three chance of a tactical reversal (Chart I-2). Chart I-2When Markets Are Fractally Fragile, There Is A 2 In 3 Chance Of A Tactical Reversal We also warned that the bond yield 6-month impulse – the change in the change – had recently become a severe 100 bps headwind to growth. At this severity of headwind, there is a nine in ten chance that bond yields have reached a near-term peak (Chart I-3). Chart I-3When The Bond Yield 6-Month Impulse Becomes A Severe Headwind, There Is A 9 In 10 Chance Of A Near-Term Peak In Yields In combination, we warned that equities would underperform bonds by about 4 percent on a tactical horizon. Now that this anticipated correction has happened, what next? Long-term investors should use corrections to overweight equities versus bonds.  First, irrespective of coronavirus – or any other catalyst – the recent severe headwind to growth from the bond yield impulse suggests that bond yields will stay depressed for (at least) the first half of 2020. Second, the good news is that the ultra-low bond yields justify and underpin the valuation of equities. Hence, at the current level of bond yields, long-term investors should use corrections to overweight equities versus bonds. Brexit Is “Done”. Or Is It? Rumour has it that Boris Johnson will banish the word Brexit from the UK government lexicon after January 31, because Brexit is now “done”. Good luck with that. When Britain wakes up bleary-eyed on Saturday February 1, what will have changed? Not a lot. The UK will have lost its voice and votes in the EU decision making institutions. Yet in practical terms nothing will have changed, because the UK and EU will enter an 11-month ‘standstill’ transition period in which existing arrangements will continue: the free movement of people, financial contributions, and full access to the single market without tariffs or customs checks. The Conservative government made a manifesto pledge not to extend the 11-month transition, so the more important question is: what will change when the standstill period ends on December 31? The answer depends on what sort of trade deal the UK and EU can negotiate in the limited space of 11 months. Or indeed whether they can negotiate a trade deal at all. Therein lies the problem. A free trade deal with the EU will require a mutual commitment to a ‘level playing field’. If the UK wants to diverge on food standards, environmental protection, labour rights, and state aid – as the Brexit purists yearn – then there is zero chance that the EU will agree to a free trade deal.  This leaves two options, neither of which is appealing. The first is for the UK to end the 11-month standstill period without a trade deal. Technically, this would not be ‘no deal’ because the withdrawal agreement would still bind both sides on citizens’ rights, financial contributions, and arrangements for Northern Ireland. A free trade deal with the EU will require a mutual commitment to a ‘level playing field’.  However, for UK companies, the option of ending the standstill period without a trade deal would constitute a painful dislocation from the single market involving tariffs and customs checks. It would also hurt the EU economies most exposed to the UK, notably Ireland and the Netherlands. Moreover, a full customs and tariff border in the Irish Sea would endanger the very existence of a ‘United’ Kingdom which included Northern Ireland.   The second option is for the UK to accept a trade deal on EU terms, recognising that the EU is the larger and more economically powerful party in the negotiation. The EU will offer the UK a tariff-free and quota-free trade deal conditional on strict level playing field conditions where the UK chooses to diverge from EU standards, combined with a mechanism to adjudicate on any level playing field disputes. Though economically better than no trade deal at all, the Brexit purists would claim it isn’t Brexit. Meanwhile, even without tariffs and quotas, UK companies whose just-in-time supply chains depended on the EU would still suffer disruption, as the level playing field was policed at every border crossing. So this option would satisfy nobody in the UK. The bigger practical problem is a lack of time to leave the EU regulatory orbit smoothly. Nobody believes that eleven months is enough time to implement a system in Northern Ireland that prevent a hard border in the Irish Sea; or indeed to implement a new UK immigration system if free movement were to end at the end of 2020. So what’s the resolution? The answer is the same as it has always been for Brexit – a gradual ratcheting up of tension ahead of a hard deadline to focus minds and force progress. Followed by a ‘fudged resolution’ at the eleventh hour in which both sides blink – because neither side is prepared to go over the cliff-edge. Recall that to get the withdrawal agreement over the line, the UK blinked by allowing Northern Ireland to be treated differently; but the EU also blinked by allowing the withdrawal agreement to be reopened. And once this happened, the pound and UK-exposed investments enjoyed a major leg up (Chart I-1 and Chart I-4-Chart I-7). Chart I-4The FTSE 250 Is A UK-Exposed ##br##Investment Chart I-5The FTSE 100 Is Not A UK-Exposed Investment Chart I-6UK General Retail Is A UK-Exposed Investment Chart I-7UK Clothing And Accessories Is Not A ##br##UK-Exposed Investment In the next fudged resolution, the UK could blink by retaining full regulatory alignment with the EU in most areas for a little while longer, and where it doesn’t the EU could blink by becoming flexible in its interpretation of ‘level playing field’. Obviously, nobody would call this an extension to the transition, but the UK would, in most practical terms, still be in the single market on January 1 2021. UK-exposed investments will enjoy their next major leg up later this year In this playbook, the pound and UK-exposed investments will come under near-term pressure, as UK/EU trade deal tensions ratchet up. But ultimately, UK-exposed investments will enjoy their next major leg up later this year if both the UK and the EU blink (Chart I-8). Chart I-8The Pound Still Has A Brexit Discount Fractal Trading System* There are no new trades this week. The rolling 1-year win ratio now stands at 62 percent. Chart I-9EUR/GBP When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated   December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System   Cyclical Recommendations Structural Recommendations Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

ハイライト ほとんどの中央銀行は依然として経済リスクを下方リスクに偏ったものと見なしている。 これは、世界的な成長が本格的に回復したとしても、今後3〜6か月は政策が据え置かれる可能性が高いことを意味する。 結論としては、今後数か月の為替の値動きは中央銀行の政策というよりも相対的な成長ファンダメンタルズが主導する可能性が高い。 我々のバイアスは、今年前半は米国以外で成長の勢いが最も強くなるというものだ。DXY指数はショートで構える。 今週の日銀の不作為は、為替ボラティリティの上昇に対する円ロングを安価な保険にしている。USD/JPYはショートを維持し、CHF/JPYはショートを取る。 ポンドは押し目買いだが、今後数か月はユーロに対してやや劣後する公算が大きい。EUR/GBPは0.88に達するはずだ。 カナダ銀行は利率を据え置いたが、我々の期待通りタカ派寄りではなくハト派寄りの判断を示した。CAD/NOKはショート、AUD/CADはロングを維持する。 我々のロングNOK/SEKポジションは1.8%の利益でストップにかかって決済された。より低い水準でこのクロスを買い戻すことを検討する。 特集 チャート I-1 為替市場は穏やかな回復を織り込んでいる 為替市場は穏やかな回復を織り込んでいる 為替市場は穏やかな回復を織り込んでいる 8月の安値以降の世界株式市場の強い反発は、多くの株価指数を買われ過ぎ領域に押し上げた。チャート I-1 は、世界株の上昇が既にグローバル製造業の改善を2012年や2016年の局面と同程度の規模で織り込んでいることを示している。一方で為替市場ははるかに穏やかな結果を織り込んでいる（下段）。 為替と株式のパフォーマンスの乖離は、過去のサイクルで見られたものとは大きく異なる。例えば、ボトムからピークにかけて、為替市場における強欲と恐怖の重要なバロメーターであるAUD/JPYは2012年の局面で40％、2016〜2017年で25％上昇し、株価も上昇した。RUB/JPY、ZAR/JPY、BRL/JPYのようなよりハイオクタンな通貨ペアのパフォーマンスは爆発的だった。今回のように通貨の動きが抑制されていることは、この回復の持続性に疑問符を付ける。 株式は長期資産であるため、2019年の金利低下が相対的な魅力を高め名目価値を押し上げたというのはもっともらしい説明だ。しかし、多くの債券市場でもここ数か月で利回りが上昇しており、この説明だけでは不十分とも言える。別の可能性としては、貿易緊張の緩和やFRBの流動性注入が国内投資家の動物的精神を呼び起こしたのかもしれない。あるいは、世界的な同期化した回復がG10の成長差を縮め、通貨の動きを抑えつつ株価を押し上げたのかもしれない。 世界株の上昇は既にグローバル製造業の改善を織り込んでいる。しかし、為替市場ははるかに穏やかな結末を織り込んでいる。 いずれにせよ、この不協和音の解決は、今後数か月で世界の経済データが著しく改善してプロシクリカル通貨を支持するか、株式市場の消化不良期（ボラティリティ上昇）を迎えるか、あるいはその両方の組み合わせによってもたらされるだろう。少なくとも、これらのダイナミクスを見越して通貨ポートフォリオを調整することを示唆している。 ボラティリティとドルについて 為替市場は相対的なトレンドに関するものだということは誰もが理解している。したがって、世界成長が加速すればドルが弱くなるという暗黙の前提は、この回復の震源地が米国外にあるということを意味する。チャート I-2 は、米国外で経済指標がまだ上振れを示しているわけではないことを示しているが、変化率ベースでは著しい改善が見られる。表面下では、最も強いデータサプライズはユーロ圏、スイス、ニュージーランド、オーストラリアで見られ、カナダと英国は予想外の失望があった。振り返れば、このチャートはカナダドルが2019年にG10で最も好調だった理由、スウェーデンクローナが最も弱かった理由も浮き彫りにしている。 チャート I-2 成長のばらつきは縮小した グロースの分散が減少した グロースの分散が減少した 経済の分散の低下は通貨ボラティリティをほぼ史上最低水準に押し下げている（チャート I-3）。経験豊富な投資家は低ボラティリティに注目し、注目すべきだ。なぜなら、ポートフォリオを破壊するのは熱狂ではなく慢心だからである。これは自明の理に聞こえるかもしれないが、過去3回ボラティリティがこれほど低下した局面ではドルは急騰し、プロシクリカル通貨は大きな損失を被った。誰もが1997〜1998年、2007〜2008年、2014〜2015年を覚えている。今回は同じだろうか？ 通常、ボラティリティの上昇はドル高と結びつくが、今回は3つの重要な相違点がある。 第一に、実質金利は2014年に米国がG10の同業国に対してプラスに転じた（チャート I-4）。これは、通常は資金調達通貨であった米ドル（準備通貨でもある）がキャリートレードの対象になったことを意味する。米国債に資金を振り向けたい資本は5年以上にわたり正の実質キャリーを享受してきたと言ってよい。現在米国の実質相対利回りが頭打ちになっている中で、資本はどちらに向かうだろうか？ チャート I-3 ボラティリティは史上最低水準付近 ボラティリティが記録的低水準に近い ボラティリティが記録的低水準に近い チャート I-4 米国の実質金利は低下 米国で実質金利が低下 米国で実質金利が低下 ドルは2011年以降ブル相場にあり、評価は高い四分位にシフトしている。これは、ドルが前の低ボラティリティ局面でより早い段階でブル相場にあった時とは大きく異なる（チャート I-5）。ドルは長いサイクルで動く傾向があり、ボラティリティの急騰はサイクルの始まりか終わりのいずれかを示すことがある。 以前のレポートで繰り返し強調してきたように、米ドルロングはコンセンサストレードである。我々の主な根拠はCFTCのポジショニングデータだ。しかし、よりタイムリーな先行指標として注視すべきは金と債券の比率だ。通貨は信認に関するものであり、米ドルへの信認の重要な尺度は米10年国債の総リターンと金地金の比率であり、これは崩れている（チャート I-6）。米国の財政赤字はこれから急拡大する見込みであり、過去のドル高の局面では赤字は低く減少傾向にあった。 チャート I-5 ドルは割高である ドルは高い ドルは高い チャート I-6 米国債と金の綱引き 米国債と金の綱引き 米国債と金の綱引き より重要なのは、通貨市場は相対的なファンダメンタルズに合わせて変動する可能性が高いということだ。世界経済の減速は製造業が主因であったため、平均回帰が期待できるのはこの分野だと考えるのが妥当だ。歴史的に見て、多くの経済における景気循環の振幅はサービス（消費）よりも製造業や輸出に牽引される傾向がある。 より具体的には、製造業の減速で最も痛手を被った通貨が最も早いリバーサルを経験する論理的な候補となる。これは既に、対米国での債券利回りの急上昇として現れているvis-à-vis 米国の利回りに対してである。例えば、ノルウェー、スウェーデン、スイス、日本の利回りはボトム以降、対米で大幅に上昇している。世界的な成長の同期回復は米国の利回り優位をさらに削ぐだろう。 通貨は信認に関するものであり、米ドルへの信認の重要な尺度は米10年国債の総リターンと金地金の比較である。 結論： DXY指数はショートを維持、当面のターゲットを90、ストップロスを100に設定する。 ポートフォリオ保険としての円 もし我々の2020年のドルに対する下落トレンドという仮説が正しければ、それは一直線には進まないだろう。したがって、ポートフォリオ保険を持つことが理にかなっている。 今週の日銀の不作為は気を逸らすためのものだった可能性がある。なぜなら近月の資産市場で最も強力な動きの一つは日本の利回りに有利な+130ベーシスポイントの動きだったからだ（チャート I-7）。USD/JPYと実質金利のギャップは希少な裁定機会を生んでいる。世界的なリスク資産の売りが顕在化すれば円は強くなるだろう。一方で、世界成長が最終的に加速すれば円は通貨クロスで弱含む可能性があるが、対ドルでは強まる可能性がある。これによりUSD/JPYのショートは「勝てば大きく勝つ、負けてもそれほど失わない」という好ましい構図になる。 日本の利回り上昇は、次の3つの重要な転換点で駆動されている： 過去5年間の大半で、日銀は資産買入れの点で最も積極的な中央銀行の一つだった。これは貿易加重の円安の大きな要因だった（チャート I-8）。FRBのバランスシートの再拡大により、日本との相対的な金融政策は引き締まりつつある。日銀の年間総資産買入れは現在約20兆円、JGB買入れは約15兆円の水準で推移している。これは目標の80兆円という緩やかな目標からはほど遠く、当面変わる見込みはない。 チャート I-7 日本の国債利回りは急騰した 日本の債券利回りが急騰している 日本の債券利回りが急騰している チャート I-8 円と量的緩和（QE） 円と量的緩和 円と量的緩和 円の動きは日本の巨大小売輸出セクターを考慮すると、国内要因と同様に外部環境の影響も大きい。景気循環的なセクターのクレジット・デフォルト・スワップスプレッドは新たな安値へと収縮しており、収益見通しの改善を示唆している（チャート I-9）。これは成長要因が日本の利回りを押し上げていることを示唆する（日本のCPIスワップは実際には横ばい）。これはアジアの景気循環セクターが防御的セクターに対して最近アウトパフォームしている動きとも一致する。 安倍政権は昨年、大規模な財政パッケージを発表した。これは壊滅的だった台風被害と来たる五輪に部分的に起因する。これにより日銀は最新の政策分科会で成長見通しを上方修正した。建設・エンジニアリング株の相対パフォーマンスは、資金が経済に流入しているかどうかの重要なバロメーターである（チャート I-10）。 チャート I-9 日本のデフォルトリスク緩和 日本でデフォルト・リスクが緩和 日本でデフォルト・リスクが緩和 チャート I-10 財政刺激と建設株 財政刺激策と建設株 財政刺激策と建設株 防御通貨としての円は、グローバル成長が改善すると資金調達通貨として使われるため通常は弱含む傾向がある。とはいえ我々の主張は、円はクロスでは確かに弱まるだろうが、対ドルではなお強くなり得るということだ。前述したように、その触媒の一つは実質金利との従来の関係からの乖離である。 より重要なのは、USD/JPYとDXYは正の相関を持つ傾向があることで、なぜならドルが多くの場合円を動かすからだ。一方で、円に対するネットショートポジションは逆張りの観点から魅力的に見える（チャート I-11）。極めて低いボラティリティを考えると、USD/JPYのショートはボラティリティ上昇をプレイする魅力的な手段となる。 チャート I-11 投資家は円をショートしている 投資家は円をショートしている 投資家は円をショートしている より保守的な投資家はCHF/JPYをショートすることもできる。最近のスイスフラン高はインフレ回復の芽を脅かしており（チャート I-12）、一方で円安は国内でのトレード可能財の価格を押し上げるだろう。これにより日銀よりもスイス国立銀行に対するプレッシャーが強まる。また、セーフヘイブンとして円はフランよりも割安である。これは当社の多数の社内モデルでも確認されている。 簡単に言えば、過去数十年で米国に対する相対的インフレは日本の方が低かったが、フランの方が強かった。 簡単に言えば、過去数十年で米国に対する相対的インフレは日本の方が低かったが、フランの方が強かった（チャート I-13）。一方で、過去2年間ではボラティリティ上昇はフランよりも円に有利に働いている。 チャート I-12 強いフランはスイスのインフレにとって逆風である 強いスイスフランはスイスのインフレにとって逆風だ 強いスイスフランはスイスのインフレにとって逆風だ チャート I-13 円はより割安 ##br##保険 円はより安い保険 円はより安い保険 結論： 現時点では円が最も魅力的なセーフヘイブン通貨である。USD/JPYはショートを維持し、CHF/JPYを売る。 ハウスキーピング 我々のロングNOK/SEKポジションは1.8%の利益でストップにかかって決済された。より低い水準でこのクロスを買い戻すつもりだ。このトレードは主にキャリーに関するものであり、我々はNOKとSEKの両方に対してポジティブである。したがってマーケットタイミングが重要になる。NOK/SEKが1.04なら魅力的だ。今週の各中央銀行会合の文脈ではノルゲス銀行からの新たな示唆はなかった。 我々はポンドを押し目買いで仕込む機会も探るが、EURまたはGBPのボラティリティを買う方が良い賭けかもしれない。今のところ、堅調な雇用報告にもかかわらず英国の経済サプライズは依然としてマイナスである（チャート I-14）。続報を注目してほしい。 チャート I-14 GBPは脆弱である 英ポンドは弱含み 英ポンドは弱含み Chester Ntonifor 外国為替ストラテジスト chestern@bcaresearch.com 通貨 米ドル チャート II-1 USD テクニカル 1 米ドルのテクニカル（1） 米ドルのテクニカル（1） チャート II-2 USD テクニカル 2 米ドルのテクニカル分析 2 米ドルのテクニカル分析 2 最近の米国のデータは混在している： 鉱工業生産は12月に前年同月比で1%減少した。 ミシガン大学消費者信頼感の速報値は1月に99.1へやや低下した。 MBA住宅ローン申請件数は1月17日までの週で1.2%減少した。しかし既存住宅販売は12月に月次で3.6%増加し予想を上回った。 シカゴ地区連銀の全国活動指数は12月に0.41から-0.35へ低下した。 新規失業保険申請件数は1月17日までの週で211Kに増加し、予想より良かった。 DXY指数は今週0.4%上昇した。中国のコロナウイルスが世界成長を大幅に押し下げるのではないかという懸念が高まっている。これは短期的にはつまずきに過ぎないが、我々は依然としてポジティブで、金融条件の緩和と貿易戦争リスクの後退により今年は世界成長が加速すると考えている。 レポートリンク： On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 ユーロ チャート II-3 EUR テクニカル 1 EURのテクニカル指標 1 EURのテクニカル指標 1 チャート II-4 EUR テクニカル 2 EURのテクニカル分析 2 EURのテクニカル分析 2 ユーロ圏の最近のデータは概ねポジティブである： 経常収支は11月に339億ユーロとなった。 ヘッドラインとコアのインフレ率はともに12月に前年比1.3%で横ばいだった。 ZEW景況感調査は1月に11.2から25.6へ急上昇した。 ユーロは今週対米ドルで0.8%下落した。木曜日にECBは政策金利を-0.5%で据え置いた。ECBの最大の示唆は、彼らが金融政策目標の見直しに取り組んでおり、それがより緩和的な姿勢の増加につながる可能性があるという点だ。明示的な2%インフレ目標への切り替えや量的緩和の判断に気候変動目標を組み入れることは、はるかにハト派的なECBの到来を告げる。長期のEUR/CADのストップを1.42へ引き締めている。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 On Money Velocity, EUR/USD And Silver - October 11, 2019 A Few Trade Ideas - Sept. 27, 2019 日本円 チャート II-5 JPY テクニカル 1 JPYのテクニカル1 JPYのテクニカル1 チャート II-6 JPY テクニカル 2 JPY テクニカル分析 2 JPY テクニカル分析 2 日本の最近のデータは軟調である： 鉱工業生産は11月に前年同月比で8.2%減少した。 貿易収支は12月に1525億円の赤字に拡大した。輸出入はそれぞれ前年同月比で4.9%および6.3%減少した。 全産業活動指数は11月に前月比0.9%上昇した。 一致指数と先行指数は11月にそれぞれ94.7と90.8に低下した。 日本円は今週対米ドルで0.3%上昇した。日銀は予想通り政策金利を据え置いた。より重要なのは、見通し報告が2020会計年度の成長見通しを0.7%から0.9%に上方修正したことだ。さらに日銀は原油安を受けてインフレ見通しを10ベーシスポイント下方修正した。日本円に関する詳しい分析は本号の前半を参照されたい。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 Signposts For A Reversal In The Dollar Bull Market - November 1, 2019 A Few Trade Ideas - Sept. 27, 2019 英ポンド チャート II-7 GBP テクニカル 1 GBP テクニカル 1 GBP テクニカル 1 チャート II-8 GBP テクニカル 2 GBP テクニカル分析 2 GBP テクニカル分析 2 英国の最近のデータはポジティブである： 小売売上高は12月に前年同月比で0.9%増加した。 Rightmoveの住宅価格指数は1月に前年同月比で2.7%上昇した。 ILO方式の失業率は11月に3.8%で横ばいだった。 平均賃金は11月に前年同月比で3.2%増加した。これは2019年の大半で低迷していた雇用報告の後、3か月で就業者が20.8万人改善したことに続く。 英ポンドは今週対米ドルで0.7%上昇した。今後数週間で欧州通貨の最大のボラティリティはEUR/GBPクロスで生じる可能性が高い。欧州の経済データはベース効果もあってここ数週間で最も良いポジティブサプライズを示している。しかし今週のECB議事録は通貨の強さに対して牽制する姿勢を示唆している。英国では当面ポンドは政治の影響を部分的に受けるだろう。GBPおよびEURのボラティリティを買うのは良い賭けに見える。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 A Few Trade Ideas - Sept. 27, 2019 United Kingdom: Cyclical Slowdown Or Structural Malaise? - Sept. 20, 2019 オーストラリアドル チャート II-9 AUD テクニカル 1 AUD テクニカル分析 1 AUD テクニカル分析 1 チャート II-10 AUD テクニカル 2 AUDのテクニカル分析 2 AUDのテクニカル分析 2 オーストラリアの最近のデータはポジティブである： Westpac消費者信頼感指数は1月に1.8%低下した。 消費者のインフレ期待は1月に4%から4.7%へ上昇した。 12月には28.9Kの雇用が創出され、コンセンサスを上回った。これは29.2Kのパートタイム雇用増だがフルタイムは0.3K減少した。 参加率は12月に66%で横ばい、失業率はさらに低下して5.1%となった。 オーストラリアドルは今週対米ドルで0.6%下落した。ポジティブな雇用報告はAUDを支えたが、コロナウイルスの懸念がヘッドラインを支配し始めるとすぐに薄れた。我々は先週AUDを詳述し、68セントで買い手だ。主な根拠は強力な逆張りの賭けであるためだ。 レポートリンク： On AUD And CNY - January 17, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 ニュージーランドドル チャート II-11 NZD テクニカル 1 NZDテクニカル 1 NZDテクニカル 1 チャート II-12 NZD テクニカル 2 NZDテクニカル分析 2 NZDテクニカル分析 2 ニュージーランドの最近のデータは弱含みである： 訪問者数は11月に前年同月比で3.5%減少した。 純移民は11月に3400から2610へ減少した。 パフォーマンスサービス指数は12月に52.9から51.9へ低下した。 ニュージーランドドルは今週対米ドルで0.5%下落した。我々はキウイが世界成長の改善の中で今年は米ドルをアウトパフォームすると考えているが、純移民の減少など国内制約が上昇余地を制限する可能性がある。AUD/NZDとSEK/NZDはロングを維持する。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 Place A Limit Sell On DXY At 100 - November 15, 2019 USD/CNY And Market Turbulence - August 9, 2019 カナダドル チャート II-13 CAD テクニカル 1 CADのテクニカル分析 1 CADのテクニカル分析 1 チャート II-14 CAD テクニカル 2 CADのテクニカル指標 2 CADのテクニカル指標 2 カナダの最近のデータは軟調である： 製造業売上高は11月に前月比で0.6%減少した。 ヘッドラインのインフレ率は12月に前年比2.2%で横ばいだった。コアインフレは12月に1.9%から1.7%へ低下した。 新築住宅価格は12月に前年同月比で0.1%上昇した。 カナダドルは今週対米ドルで0.8%下落した。水曜日にカナダ銀行は利率を据え置くことを決めたが、カナダのデータが失望すれば今年後半に利下げの可能性を開く余地を残した。要するに他の多くの中央銀行と同様に、カナダ銀行もデータ依存だ。我々のCADに関するストーリーは単純で、成長リバウンドの震源地が米国外にあるならCADは対極の通貨に対して下振れするということだ。AUD/CADはロングを維持する。 レポートリンク： The Loonie: Upside Versus The Dollar, But Downside At The Crosses Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 スイスフラン チャート II-15 CHF テクニカル 1 CHF テクニカル 1 CHF テクニカル 1 チャート II-16 CHF テクニカル 2 CHF テクニカルズ 2 CHF テクニカルズ 2 今週スイスからのデータは乏しかった： 生産者物価は12月に前年同月比で1.7%下落し、前月の2.5%減から改善した。 マネーサプライ（M3）は12月に前年同月比で0.7%増加した。 スイスフランは今週対米ドルでほぼ横ばいだった。我々は世界的リスクが持続する限りスイスフランを支持し続ける、コロナウイルスへの懸念を含めて。しかし、本レポート前半で議論したように、現時点では円の方がフランよりも優れたヘッジである。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 Notes On The SNB - October 4, 2019 What To Do About The Swiss Franc? - May 17, 2019 ノルウェークローネ チャート II-17 NOK テクニカル 1 NOK テクニカル指標 1 NOK テクニカル指標 1 チャート II-18 NOK テクニカル 2 NOK テクニカルズ 2 NOK テクニカルズ 2 今週ノルウェーからのデータは乏しかった： 労働力調査は11月に失業率が4%に上昇したと記録した。 ノルウェークローネは今週エネルギー価格の下落を受けて対米ドルで1.3%下落した。木曜日にノルゲス銀行は政策金利を1.5%で据え置き、広く予想されていたとおりだった。さらにオイステイン・オルセン総裁は「委員会の現在の見通しとリスクのバランス評価は、政策金利が当面現在の水準のままである可能性が高いことを示している」と述べ、短期的な政策変更の可能性を示唆しなかった。これは今後は政策決定よりも相対的なファンダメンタルズがNOKの進路を決めることを示唆している。我々のバイアスはバリュエーションのクッションがロングNOKの安全マージンを提供しているというものだ。USD/NOKとCAD/NOKはショートを維持する。 レポートリンク： On Oil, Growth And The Dollar - January 10, 2020 Updating Our Balance Of Payments Monitor - November 29, 2019 Making Money With Petrocurrencies - November 8, 2019 スウェーデンクローナ チャート II-19 SEK テクニカル 1 SEKのテクニカル1 SEKのテクニカル1 チャート II-20 SEK テクニカル 2 SEK テクニカル指標 2 SEK テクニカル指標 2 今週スウェーデンからのデータは乏しかった： 11月に6%から6.8%へ上昇した後、失業率は12月に6%へ戻った。 スウェーデンクローナは今週対米ドルで0.2%下落した。今後は世界成長の改善、貿易緊張の緩和、短期的な景気後退懸念の後退がスウェーデン経済とクローナを下支えする。SEKは世界的な製造業のリバウンドをプレイするための最も有力なG10クロスである。 レポートリンク： Updating Our Balance Of Payments Monitor - November 29, 2019 Where To Next For The US Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 トレードと予想 予想サマリー コアポートフォリオ タクティカルトレード 指値注文 決済済みトレード

Highlights The bank credit 6-month impulse is likely to drop sharply in Europe, drop modestly in the US, but remain positive in China. Hence, the momentum of first-half economic data is likely to be worse in Europe than in China – albeit the Wuhan coronavirus scare is an unknown risk to this view. Initiate long CNY/GBP on a 6-month horizon. Underweight banks and the cyclical-heavy Eurostoxx 50 versus other markets, again on a 6-month horizon. There will be a better time to enter these positions later in the year when 6-month impulses are improving. Long-term investors seeking value in Europe should focus on the main currencies and not on the main equity indexes. Fractal trade: long EUR/GBP. Europe And China Play A Role-Reversal In recent dispatches we have highlighted that the euro area bond yield 6-month impulse stands near +100 bps, posing the strongest headwind to growth for three years. To make matters worse, the impulse has flipped from a strong -100 bps tailwind last summer into the current strong headwind, equating to a marked deterioration in the weather. But in China, it is the opposite story. Last summer, the China bond yield 6-month impulse constituted a strong +80 bps headwind; today the headwind has disappeared. Indeed, it has morphed into a tailwind, albeit a very mild tailwind at just -10 bps. In this sense, Europe and China are now playing a role-reversal. The momentum of first-half economic data is likely to be worse in Europe than in China – albeit with the caveat that the Wuhan coronavirus scare is an unknown risk to this view (Chart of the Week). Chart of the WeekBond Yields In Europe And China Play A Role-Reversal For the sake of completeness, we should address the world’s other large economy, the United States. Just as in the euro area, the US bond yield 6-month impulse has flipped from a strong -100 bps tailwind last summer into a current headwind. But the headwind, at +50 bps, is not as strong as it is in the euro area (Chart I-2). Chart I-2Headwind Impulses In The Euro Area And The US, But Not In China The Four Impulse Framework For Short-Term Growth The bond yield 6-month impulse is the first component of our proprietary ‘four impulse framework’ for short-term growth. The bond yield 6-month impulse is important because it usually leads the framework’s second component, the bank credit 6-month impulse, by a few months. This relationship makes perfect sense as, at the margin, it is the price of credit that drives credit demand. Indeed, to the extent that monetary policy drives growth, this is the main mechanism by which it operates, albeit with a slight delay. The bond yield impulse usually leads the credit impulse. On this compelling theoretical and empirical evidence, the bank credit impulse is now likely to drop sharply in the euro area (Chart I-3), drop modestly in the US (Chart I-4), but remain positive in China (Chart I-5). Chart I-3The Credit 6-Month Impulse Is Likely To Drop Sharply In The Euro Area... Chart I-4...Drop Modestly In ##br##The US...   Chart I-5...But Remain Positive In China But we must also consider the other two impulses in our four impulse framework. In the case of the euro area, the third important impulse is the oil price 6-month impulse. This is because the euro area relies on oil imports whose volumes tend to be price inelastic. Hence, when the oil price falls it subtracts from imports, thereby adding to net exports and growth – and vice-versa when the oil price rises. In the middle of 2019, the oil price impulse constituted a very strong headwind which helps to explain the midyear sharp slowdown in Germany. Subsequently, the headwind eased, even reversing into a modest tailwind which facilitated a recovery. But the tailwind is now fading (Chart I-6).  Chart I-6A Fading Tailwind From The Oil Price 6-Month Impulse The fourth and final component of our four impulse framework is geopolitical risk. This is not an impulse in the strict mathematical sense, but it is the same broad idea applied to the flow of geopolitical tail-events, both negative and positive. Europe’s positive events came several months ago: first in early-August when Italy ousted the firebrand Matteo Salvini from government; then in early-October when the UK parliament legislated against a no-deal Halloween Brexit. The tailwind from these positive events has now likely faded. For China, a positive geopolitical event and potential mild tailwind has come more recently, with the signing of the phase one trade deal with the US. Against this, the Wuhan coronavirus scare is a new risk – though based on the latest information it is unlikely to impact a 6-month view. The tailwind from the oil price impulse is now fading. On the four impulse framework, the momentum of first-half economic data is likely to favour China over Europe. We have found that the best way of playing this is through the exchange rate (Chart I-7), though given recent moves our preferred expression is versus the pound rather than the euro. Hence, on a 6-month horizon, initiate long CNY/GBP. Chart I-7Play Relative Impulses Through Currencies More generally, can the mild tailwind in China counter the headwinds in the West? No. Despite the improvement in China, the aggregate global bond yield impulse still constitutes a +50 bps headwind, which is almost certain to weigh down the global credit impulse through the early months of 2020 (Chart I-8). Chart I-8The Global Credit 6-Month Impulse Will Weaken In Early 2020 Therefore, as discussed last week in Strong Headwind Warrants Caution In H1, we recommend an underweight stance to banks and to the cyclical-heavy Eurostoxx 50 versus other markets, again on a 6-month horizon. This is not to say that these positions cannot do better on a 12-month view, as per the BCA house view. But if so, any outperformance will be back-end loaded, and there will be a better time to enter these positions later in the year when 6-month impulses are improving. Where Is The Value In Europe? One of the most common questions we get is: are European equities cheaper than US equities? Usually, this question comes from our US clients who are aware that their own stock market is expensive and wish that Europe might be less so. Unfortunately, the wishful thinking won’t make it come true! Major stock market indexes comprise multinational companies with global footprints. For these multinationals, there is no such thing as a ‘European’ company or a ‘US’ company. They are simply global companies that could list their shares on any major stock market. Now ask yourself this: is it really plausible that such a multinational would be cheaper if its primary listing was in Frankfurt as opposed to New York? Of course not. The valuation depends on the industry and company specifics, but it is highly unlikely to depend on whether the company is listed in Frankfurt or New York. It is not European equities that are cheap, it is European currencies that are cheap. But then why do companies with dual listings in Europe and outside Europe trade at a valuation discount in their European listing? For example, Carnival Cruises trades around 8 percent dearer in New York than in London (Chart I-9); and BHP Billiton trades around 15 percent dearer in Sydney than in London (Chart I-10). The answer is that the London listing is quoted in pounds, the New York listing is quoted in US dollars, the Sydney listing is quoted in Australian dollars, but Carnival’s and BHP’s sales and profits are denominated in a mix of international currencies. Chart I-9Carnival Cruises Trades Dearer In New York Than In London Chart I-10BHP Trades Dearer In Sydney ##br##Than In London Hence, Carnival and BHP are trading dearer in New York and Sydney because the market is expecting their mixed currency earnings to appreciate more in US dollar and Australian dollar terms respectively than in pound terms. Put another way, the market is expecting the pound to appreciate structurally versus the major non-European currencies. Therein lies the important message. It is not European equities that are cheap, it is European currencies that are cheap. For those of you still in doubt, just visit the ECB website. The central bank’s own currency valuation indicator admits that the trade-weighted euro is 10 percent undervalued (Chart I-11). Chart I-11The ECB Admits That The Euro Is 10 Percent Undervalued Hence, investors seeking value in Europe should not focus on the main equity indexes. Instead, they should focus on the main currencies. That said, valuation based investing only works if you have a long enough time horizon, meaning at least two years. For shorter horizons, economic momentum and technical factors dominate. In this regard, the pound’s strong rally faces resistance once post-Brexit trade deal negotiations begin in earnest after January 31. As a tactical trade, go long EUR/GBP (see next section). Fractal Trading System* The Brexit deal unleashed a strong rally in the pound, but this is vulnerable to a countertrend setback once the trade deal negotiations begin in earnest. Accordingly, this week's recommendation is long EUR/GBP. Set a profit target at 2 percent with a symmetrical stop-loss. In other trades, long tin achieved its 5 percent profit target at which it was closed. The rolling 1-year win ratio stands at 62 percent. Chart I-12EUR/GBP When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated   December 11, 2014, available at eis.bcaresearch.com.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System   Cyclical Recommendations Structural Recommendations Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

特別レポート

Highlights Global Corporates: The cyclical backdrop – accommodative monetary policies, improving global growth momentum, moderate inflation and subdued volatility – is supportive for the continued outperformance of global corporate bonds over sovereign debt in 2020. Corporate Bond Valuation: Extending a valuation framework we’ve introduced for US corporates to non-US credit – looking at volatility-adjusted spreads relative to both their own history and the “phase” of the monetary policy cycle - we calculate spread targets for non-US corporates in the euro area, UK and Canada. 2020 Opportunities: Current corporate spread levels are furthest above our targets (i.e. cheap) for US high-yield (most notably for Ba- and Caa-rated credit), UK high-yield and UK investment grade. Spreads are furthest below our targets (i.e. expensive) for euro area high-yield (mostly Ba-rated), US investment grade (all credit tiers) and Canadian investment grade. Feature Chart 1Deviations From Corporate Spread Targets One of our main investment themes for 2020 is that accommodative monetary policies and faster economic growth will delay the peak in the aging global credit cycle, giving investors another year of corporate bond outperformance versus sovereign debt in the developed economies. Returns this year will be nowhere near as robust as in 2019, however, given rich valuation starting points for much of the global corporate universe. Against this backdrop, fixed income investors will have to be more selective in allocations by country, sector and credit quality in order to outperform. To that end, in this Special Report we extend a valuation framework for corporate bond spreads first introduced for US corporates by our sister service, US Bond Strategy, to non-US credit. This methodology looks at spreads on a volatility-adjusted basis, allowing comparison of valuations versus their own history and relative to similar stages of past monetary policy cycles. Chart 1 shows the deviations of current benchmark index option-adjusted spreads (OAS) from spread targets derived from our methodology for different countries (the US, euro area, the UK and Canada) and credit quality tiers (investment grade vs. high-yield). Positive deviations imply current spreads are above the targets derived from our framework – in other words, relatively undervalued - and vice-versa. Returns this year will be nowhere near as robust as in 2019, however, given rich valuation starting points for much of the global corporate universe. Against this backdrop, fixed income investors will have to be more selective in allocations by country, sector and credit quality in order to outperform. The conclusions are that there are still opportunities for additional spread tightening from current levels for lower-rated US high-yield and both UK investment grade and high-yield corporates. At the same time, valuations are looking most stretched for euro area high-yield, US investment grade (all credit tiers) and Canadian investment grade. A Brief Word On The Outlook For Global Corporate Credit In 2020 Chart 2Positive Backdrop For Corporate Bonds The backdrop for global corporate bond markets will remain positive in 2020 for three main reasons: Global monetary policies will remain accommodative. Central bankers are now focusing more on boosting soft growth and low inflation expectations. Real policy interest rates in the US, euro area, UK and Canada are already below estimates of neutral like r-star (Chart 2, top panel), and will likely remain so throughout 2020. In the past, periods of credit market underperformance have occurred when monetary policy was restrictive, with real rates above neutral or government bond yield curves that were very flat or inverted (more on that later). Global growth momentum will improve. Recent data releases (global manufacturing PMIs, sentiment surveys like the global ZEW and German IFO) have shown that the 2019 global industrial downturn was in the process of bottoming out during the 4th quarter of the year. Additional improvement is likely in the coming months, based on the steady gains of the BCA Global Leading Economic Indicator (LEI). The elevated level of our global LEI diffusion index – measuring the share of individual country LEIs that are rising and which is itself a leading indicator of both the global LEI and corporate bond returns - suggests that additional outperformance of global corporates versus sovereign bonds is likely within the next 12 months (Chart 2, middle panel). Financial conditions are stimulative. Global equities and credit are off to a strong start in 2020, while market volatility is subdued across a variety of asset classes. For example, the US VIX index is now just above its 2019 low, which is consistent with narrow global corporate bond spreads (Chart 2, bottom panel). That low volatility backdrop – supported by market-friendly central bank policies - is helping keep financial conditions easy enough to lift economic growth, while also boosting investor risk appetite for corporate credit. The overall outlook for global corporate credit is still positive and investors should expect another year of corporate bond outperformance versus sovereign debt in the developed economies. Nonetheless, returns will be lower in 2020 than in 2019 due to expensive valuation starting points. As can be seen from Chart 3, global corporate bond spreads are already fairly tight relative to their long-term historical range. Also, outright index yields in many asset classes, like US high-yield, are now at new all-time lows. We interpret this as a sign that the “easy money” has already been made in being generally long corporate credit versus government bonds. Having the right tools to assess the relative values among differing credit markets will be critical to finding the best investment opportunities in this environment. Chart 3Rich Valuation Starting Points In Corporate Credit We can use the breakeven spread as a valuation tool by looking at the percentile rank relative to its own history, effectively showing the percentage of time that the breakeven spread has been lower in the past. Bottom Line: The cyclical backdrop – accommodative monetary policies, improving global growth momentum, moderate inflation and subdued volatility – is supportive for the continued outperformance of global corporate bonds over sovereign debt in 2020. Valuations are likely to be more of a headwind for corporate bond returns, though. Using Breakeven Spreads As A Credit Valuation Tool As a reminder to existing readers (and to new clients), one of our main valuation tools for credit instruments is the 12-month breakeven spread. That is, the amount of spread widening required for corporate bond returns to break even with a duration-matched position in government bond securities over a 12-month horizon. It can be approximated by dividing the OAS of a bond (or a benchmark bond index) by its duration. More specifically, we can use the breakeven spread as a valuation tool by looking at the percentile rank relative to its own history, effectively showing the percentage of time that the breakeven spread has been lower in the past. We find this valuation tool to be superior to others for two main reasons: (i) using the breakeven spread rather than the average index OAS allows us to control for the changing average duration of the benchmark bond indices; and (ii) the percentile rank is often a better representation of credit spreads than the spread itself.1 BCA Research US Bond Strategy and Global Fixed Income Strategy have both regularly shown the percentile rankings of US investment grade and high-yield breakeven spreads as part of our discussion of US corporate bond markets. We have never produced such rankings for non-US credit, until now. InCharts 4- 7, we show those percentile ranks relative to history for credit in the US and, for the first time, the euro area, UK, Canada, Japan, Australia and Emerging Markets US dollar denominated corporates. We also provide the breakeven spread historical percentile ranks for each individual credit tier in the Appendix charts on pages 13-16. Chart 4US: Corporate Bond Breakeven Spreads Chart 5Euro Area: Corporate Bond Breakeven Spreads Chart 6UK: Corporate Bond Breakeven Spreads Using these charts, we can gauge which markets offer the best (or worst) level of spread, adjusted by its own volatility and compared to its own history. The most attractive corporate credit spreads on a volatility-adjusted basis are: US high-yield (mostly Caa-rated and B-rated) Japan investment grade (mostly Baa-rated and A-rated) Canada Aaa-rated UK high-yield (excluding financials) Chart 7Other Countries: Corporate Bond Breakeven Spreads The least attractive corporate credit spreads on a volatility-adjusted basis are: US investment grade (all credit tiers) UK Aaa-rated Canada Baa-rated Euro Area high-yield Using this metric, US Caa-rated junk bonds look most “undervalued”, with a volatility-adjusted spread in the upper 20% of all observations. Chart 8 displays the current breakeven spread historical percentile ranks across countries and credit quality, with high-yield markets shown in red. Using this metric, US Caa-rated junk bonds look most “undervalued”, with a volatility-adjusted spread in the upper 20% of all observations. While this chart provides a quick overview of which corporate bond markets are cheap/expensive with respect to their own history, it does not allow for comparisons of the relative cheapness between markets. To do this, we need to find a way to convert the percentile rankings into some measure of a “fair value” credit spread. Chart 8Global Corporate Bond 12-Month Breakeven Spreads By Percentile Rank (%) Using Monetary Policy Cycles To Determine Corporate Spread Targets Our colleagues at BCA Research US Bond Strategy have come up with a novel approach for determining spread targets for US corporate credit, based on the breakeven spread percentile rankings.2 Essentially, the stance of US monetary policy, as measured by the slope of the US Treasury curve, is used to predict changes in the US credit cycle, helping to determine “cyclical” spread targets relative to the stance of monetary policy. The first step of this process is to group corporate bond excess returns (vs government debt) into buckets defined by the following “phases” of the US monetary policy cycle, measured by the yield differential between 10-year and 3-year Treasuries: Phase 1: from the end of the previous recession until the slope goes below 50 bps. Phase 2: from the time that the slope crosses below 50 bps until it inverts. Phase 3: from the time that the yield curve first inverts to the start of the next recession. Recessionary periods are not included in these phases, as all corporate credit exhibits the worst returns during those episodes. That is because economic growth and downgrade/default risks, and not the state of monetary policy, are the driving factor behind credit spread moves during recessions. Chart 9 shows the history of the US corporate bond markets broken down into “curve-defined” cycles.3 Dating back to 1974, the earliest date for investment grade bond index data, there have been five such cycles. Chart 9US Corporate Bond Performance And The Yield Curve In Charts 10-12, we show the same phases for the euro area, the UK and Canada, using their own government bond yield curves to determine the phase of the monetary policy cycle in the same fashion as was done for the US.4 Once the phases of the monetary policy cycle are defined, we can then calculate corporate bond excess returns during each phase. Chart 10Euro Area: Corporate Bond Performance And The Yield Curve Chart 11UK: Corporate Bond Performance And The Yield Curve Chart 12Canada: Corporate Bond Performance And The Yield Curve Table 1 shows the average corporate bond annualized excess returns under each phase across every cycle that can be defined with available data. Excess returns tend to be highest in Phase 1, quite low but still positive in Phase 2, and usually turn negative during Phase 3, once the yield curve has inverted. Table 1Corporate Bond Annualized Excess Returns* (%) Under Each Phase Of The Cycle Currently, we are in Phase 2 in the US, euro area and UK, with yield curves that are relatively flat but still positively sloped. Historically, such periods have generated positive excess returns for corporate debt versus duration-matched government bonds, although of far smaller magnitudes compared to Phase 1 periods. Given our expectation that the Fed, ECB and Bank of England will maintain a dovish bias throughout 2020, we expect the no shift from Phase 2 for the US, euro area and the UK that would hurt corporate bond excess returns in those countries. With the Canadian yield curve now slightly inverted, however, Canada is now in Phase 3. This raises the risk that the recent strong outperformance of Canadian investment grade corporate bonds could end if the Bank of Canada does not deliver the monetary easing currently discounted in the Canadian yield curve. How We Determine Corporate Spread Targets Having defined the three phases of the monetary policy cycle, we then re-calculate our corporate bond breakeven spread percentile ranks within each phase. We then back-out a spread target for each credit tier by taking the median 12-month breakeven spread seen in similar monetary policy environments, as determined by the slope of the yield curve.5 Finally, we convert those “median” breakeven spreads into OAS targets using the current benchmark index duration and credit rating distribution. We are assuming that a reasonable spread target for any corporate bond market is determined by adjusting for both spread volatility AND the monetary policy cycle. So, essentially, we are assuming that a reasonable spread target for any corporate bond market is determined by adjusting for both spread volatility AND the monetary policy cycle. Charts 13-16 show the index OAS and their respective targets for the US (both investment grade and high-yield), euro area (both investment grade and high-yield), the UK (both investment grade and high-yield excluding financials), and Canada (only investment grade). Further, the spread targets for each individual credit tier are provided in the Appendix on pages 17-19. Chart 13US: Corporate Bond Spread Targets Chart 14Euro Area: Corporate Bond Spread Targets Chart 15UK: Corporate Bond Spread Targets Chart 16Canada: Corporate Bond Spread Targets For example, our spread target for US B-rated high-yield is 227bps, which is 80bps below the current index OAS. From the charts, we can make the following conclusions about the relative attractiveness of current spread levels: The largest deviations from our spread target (i.e. potentially most undervalued) are: US high-yield (mostly Caa-rated and B-rated) UK high-yield (excluding financials) The lowest deviations from our spread target (i.e. potentially most overvalued) are: Euro Area high-yield (mostly Ba-rated) Canada investment grade US investment grade (all credit tiers) This framework is an interesting way to derive corporate bond value, by adjusting for both the volatility and monetary policy backdrop. Of course, there are other factors that are more difficult to quantify that can keep spreads too tight or too wide versus these fair value levels, like investor risk tolerance or risk premia for political uncertainty. In terms of factors that are quantifiable, however, this spread target methodology is a useful way to get a sense of the richness or cheapness of global corporate debt. In terms of factors that are quantifiable, however, this spread target methodology is a useful way to get a sense of the richness or cheapness of global corporate debt. We will regularly update these targets in future BCA Research Global Fixed Income Strategy reports. Bottom Line: Current corporate spread levels are furthest above our targets (i.e. cheap) for US high-yield (most notably for Ba- and Caa-rated credit), UK high-yield and UK investment grade. Spreads are furthest below our targets (i.e. expensive) for euro area high-yield (mostly Ba-rated), US investment grade (all credit tiers) and Canadian investment grade.   Jeremie Peloso Research Analyst jeremiep@bcaresearch.com Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1 This is because credit spreads often tighten to very low levels and then remain tight for an extended period. Thus, by showing the percentage of time that a given spread has been tighter than its current level, the percentile rank gives a better sense of this pattern than the actual spread. 2 Please see US Bond Strategy Special Report, “2019 Key Views: Implications For US Fixed Income”, dated December 11, 2018, available at usbs.bcaresearch.com. 3 Note that the Treasury curve used for this analysis is the spread between the 10-year Treasury and the 3-year Treasury yield. The more widely-followed 2-year Treasury was not used as there was more historical data available for the 3-year maturity. 4 Note that there are fewer cycles to analyze for these countries due to the shorter available history of corporate bond market data outside the US. 5 For more details on the spread targets please see US Bond Strategy Weekly Report, “Paid To Wait”, dated February 26, 2019, available at usbs.bcaresearch.com. Appendix Chart 1AUS: Investment Grade Breakeven Spreads Chart 1BUS: High-Yield Breakeven Spreads Chart 1CEuro Area: Investment Grade Breakeven Spreads By Credit Tiers Chart 1DEuro Area: High-Yield Breakeven Spreads By Credit Tiers Chart 1EUK: Investment Grade Breakeven Spreads Chart 1FCanada: Investment Grade Breakeven Spreads Chart 1GJapan: Investment Grade Breakeven Spreads Chart 2AUS: Investment Grade Spread Targets Chart 2BUS: High-Yield Spread Targets Chart 2CEuro Area: Investment Grade Spread Targets By Credit Tiers Chart 2DEuro Area: High-Yield Spread Targets By Credit Tiers Chart 2EUK: Investment Grade Spread Targets By Credit Tiers Chart 2FCanada: Investment Grade Spread Targets By Credit Tiers

Highlights Our top five geopolitical “Black Swans” are risks that the market is seriously underpricing. With the “phase one” trade deal signed, Chinese policy could become less accommodative, resulting in a negative economic surprise. The trade deal may fall victim to domestic politics, raising the risk of a US-China military skirmish. A Biden victory at the Democratic National Convention or a Democratic takeover of the White House could trigger social unrest and violence in the US. A pickup in the flow of migrants to Europe would fundamentally undermine political stability there. Russia’s weak economy will add fuel to domestic unrest, risking an escalation beyond the point of containment. Feature Over the past four years, we have started off the year with our top five geopolitical “Black Swans.” These are low-probability events whose market impact would be significant enough to matter for global investors. Unlike the great Byron Wien’s perennial list of market surprises, we do not assign these events a “better than 50% likelihood of happening.” We offer risks that the market is seriously underpricing by assigning them only single-digit probabilities when we think the reality is closer to 10%-15%, a level at which a risk premium ought to be assigned. Some of our risks below are so obscure that it is not clear how exactly to price them. We exclude issues that are fairly probable, such as flare-ups in Indo-Pakistani conflict. The two major risks of the year – discussed in our annual outlook – are that either US President Donald Trump or Chinese President Xi Jinping overreaches in a major way. But what would truly surprise the market would be a policy-induced relapse in Chinese growth or a direct military clash between the two great powers. That is how we begin. Other risks stem from domestic affairs in the US, Europe, and Russia. Black Swan 1: China’s Financial Crisis Begins The risk of Xi Jinping’s concentration of power in his own person is that individuals can easily make mistakes, especially if unchecked by advisors or institutions. Lower officials will fear correcting or admonishing an all-powerful leader. Inconvenient information may not be relayed up the hierarchy. Such behavior was rampant in Chairman Mao Zedong’s time, leading to famine among other ills. Insofar as President Xi’s cult of personality successfully imitates Mao’s, it will be subject to similar errors. If President Xi overreaches and makes a policy mistake this year, it could occur in economic policy or other policies. We begin with economic policy, as we have charted the risks of Xi’s crackdown on the financial system since early 2017 (Chart 1). Chart 1A Crackdown On Financial Risk Could Cause China's Economy To Derail Chart 2Easing Of Trade Tensions May Re-Incentivize Tighter Policy This year is supposed to be the third and final year of Xi Jinping’s “three battles” against systemic risk, pollution, and poverty. The first battle actually focuses on financial risk, i.e. China’s money and credit bubble. The regime has compromised on this goal since mid-2018, allowing monetary easing to stabilize the economy amid the trade war. But with a “phase one” trade deal having been signed, there is an underrated risk that economic policy will return to its prior setting, i.e. become less accommodative (Chart 2). When Xi launched the “deleveraging campaign” in 2017, we posited that the authorities would be willing to tolerate an annual GDP growth rate below 6%. This would not only cull excesses in the economy but also demonstrate that the administration means business when it says that China must prioritize quality rather than quantity of growth. While Chinese authorities are most likely targeting “around 6%” in 2020, it is entirely possible that the authorities will allow an undershoot in the 5.5%-5.9% range. They will argue that the GDP target for 2020 has already been met on a compound growth rate basis (Chart 3), as astute clients have pointed out. They may see less need for stimulus than the market expects. Chart 3Chinese Authorities Might Tolerate A Growth Undershoot In 2020 Similarly, while urban disposable income is ostensibly lagging its target of doubling 2010 levels by 2020, China’s 13th Five Year Plan, which concludes in 2020, conspicuously avoided treating urban and rural income targets separately. Chart 4Lower Impetus For Economic Support Due To Improvements In National Income? Chart 5Has China's Stimulus Peaked? If the authorities focus only on general disposable income, then they are on track to meet their target (Chart 4). This would reduce the impetus for greater economic support. There are already tentative signs that Chinese authorities are “satisfied” with the amount of stimulus they have injected: some indicators of money and credit have already peaked (Chart 5). The crackdown on shadow banking has eased, but informal lending is still contracting. The regime is still pushing reforms that shake up state-owned enterprises. The Xi administration may aim only for stability, not acceleration, in the economy. An added headwind for the Chinese economy stems from the currency. The currency should track interest rate differentials. Beijing’s incremental monetary stimulus, in the form of cuts to bank reserve requirement ratios (RRRs), should also push the renminbi down over time (Chart 6). However, an essential aspect of any trade deal with the Trump administration is the need to demonstrate that China is not competitively devaluing. Hence the CNY-USD could overshoot in the first half of the year. This is positive for global exports to China, but it tightens Chinese financial conditions at home. A stronger than otherwise justified renminbi would add to any negative economic surprises from less accommodative monetary and fiscal policy. Conventional wisdom says China will stimulate the economy ahead of two major political events: the centenary of the Communist Party in 2021 and the twentieth National Party Congress in 2022. The former is a highly symbolic anniversary, as Xi has reasserted the supremacy of the party in all things, while the latter is more significant for policy, as it is a leadership reshuffle that will usher in the sixth generation of China’s political elite. But conventional wisdom may be wrong – the Xi administration may aim only for stability, not acceleration, in the economy. It would make sense to save dry powder for the next US or global recession. The obvious implication is that China’s economic rebound may lose steam as early as H2 – but the black swan risk is that negative surprises could cause a vicious spiral inside of China. This is a country with massive financial and economic imbalances, a declining potential growth profile, and persistent political obstacles to growth both at home and abroad. Corporate defaults have spiked sharply. While the default rate is lower than elsewhere, the market may be sniffing out a bigger problem as it charges a much higher premium for onshore Chinese bonds (Chart 7). Chart 6CNY-USD Overshoot Would Tighten Chinese Financial Conditions Chart 7Is China's Bond Market Sniffing Out A Problem? Bottom Line: Our view is that China’s authorities will remain accommodative in 2020 in order to ensure that growth bottoms and the labor market continues to improve. But Beijing has compromised its domestic economic discipline since 2018 in order to fight trade war. The risk now, with a “phase one” deal in hand, is that Xi Jinping returns to his three-year battle plan and underestimates the downward pressures on the economy. The result would be a huge negative surprise for the Chinese and global economy in 2020. Black Swan 2: The US And China Go To War In 2013, we predicted that US-China conflict was “more likely than you think.” This was not just an argument for trade conflict or general enmity that raises the temperature in the Asia-Pacific region – we included military conflict. Chart 8Americans' Attitudes Toward China Plunged … At the time, the notion that a Sino-American armed conflict was the world’s greatest geopolitical threat seemed ludicrous to many of our clients. We published this analysis in October of that year, months after the Islamic State “Soldier’s Harvest” offensive into Iraq. Trying to direct investors to the budding rivalry between American and Chinese naval forces in the South China Sea amidst the Islamic State hysteria was challenging, to say the least. The suggestion that an accidental skirmish between the US and China could descend into a full-blown conflict involved a stretch of the imagination because China was not yet perceived by the American public as a major threat. In 2014, only 19%of the US public saw China as the “greatest threat to the US in the future.” This came between Russia, at 23%, and Iran, at 16%. Today, China and Russia share the top spot with 24%. Furthermore, the share of Americans with an unfavorable view of China has increased from 52% to 60% in the six intervening years (Chart 8). The level of enmity expressed by the US public toward China is still lower than that toward the Soviet Union at the onset of the Cold War in the 1950s (Chart 9). However, the trajectory of distrust is clearly mounting. We expect this trend to continue: anti-China sentiment is one of the few sources of bipartisan agreement remaining in Washington, DC (Chart 10). Chinese sentiment toward the United States has also darkened dramatically. The geopolitical rivalry is deepening for structural reasons: as China advances in size and sophistication, it seeks to alter the regional status quo in its favor, while the US grows fearful and seeks to contain China. Chart 9… But Not Yet To War-Inducing Levels Chart 10Distrust Of China Is Bipartisan Chart 11Newfound American Concern For China’s Repression One example of rising enmity is the US public’s newfound concern for China’s domestic policies and human rights, specifically Beijing’s treatment of its Uyghur minority in Xinjiang. A Google Trends analysis of the term “Uyghur” or “Uyghur camps” shows a dramatic rise in mentions since Q2 of 2018, around the same time the trade war ramped up in a major way (Chart 11). While startling revelations of re-education camps in Xinjiang emerged in recent years, the reality is that Beijing has used heavy-handed tactics against both militant groups and the wider Uyghur minority since at least 2008 – and much earlier than that. As such, the surge of interest by the general American public and legislators – culminating in the Uyghur Human Rights Policy Act of 2019 – is a product of the renewed strategic tension between the two countries. The “phase one” trade deal risks falling victim to domestic politics due to greater public engagement in foreign policy. The same can be said for Hong Kong: the US did not pass a Hong Kong Human Rights and Democracy Act in 2014, during the first round of mass protests, which prompted Beijing to take heavy-handed legal, legislative, and censorship actions. It passed the bill in 2019, after the climate in Washington had changed. Why does this matter for investors? There are two general risks that come with a greater public engagement in foreign policy. First, the “phase one” trade deal between China and the US could fall victim to domestic politics. This deal envisions a large step up in Sino-American economic cooperation. But if China is to import around $200 billion of additional US goods and services over the next two years – an almost inconceivable figure – the US and China will have to tamp down on public vitriol. This is notably the case if the Democratic Party takes over the White House, given its likely greater focus on liberal concerns such as human rights. And yet the latest bills became law under President Trump and a Republican Senate, and we fully expect a second Trump term to involve a re-escalation of trade tensions to ensure compliance with phase one and to try to gain greater structural concessions in phase two. Second, mounting nationalist sentiment will make it more difficult for US and Chinese policymakers to reduce tensions following a potential future military skirmish, accidental or otherwise. While our scenario of a military conflict in 2013 was cogent, the public backlash in the United States was probably manageable.1 Today we can no longer guarantee that this is the case. China has greater control over the domestic narrative and public discourse, but the rise of the middle class and the government’s efforts to rebuild support for the single-party regime have combined to create an increase in nationalism. Thus it is also more difficult for Chinese policymakers to contain the popular backlash if conflict erupts. In short, the probability of a quick tamping down of public enmity is actively being reduced as American public vilification of China is closing the gap with China’s burgeoning nationalism at an alarming pace. Chart 12Tsai Ing-Wen Enjoys A Greater Mandate On Higher Turnout … Another of our black swan risks – Taiwan island – is inextricably bound up in this dangerous US-China dynamic. To be clear, Washington will tread carefully, as a conflict over Taiwan could become a major war. Nevertheless Taiwan’s election, as we expected, has injected new vitality into this already underrated geopolitical risk. It is not only that a high-turnout election (Chart 12) gave President Tsai Ing-wen a greater mandate (Chart 13), or that her Democratic Progressive Party retained its legislative majority (Chart 14). It is not only that the trigger for this resounding victory was the revolt in Hong Kong and the Taiwanese people’s rejection of the “one country, two systems” formula for Taiwan. It is also that Tsai followed up with a repudiation of the mainland by declaring, “We don’t have a need to declare ourselves an independent state. We are an independent country already and we call ourselves the Republic of China, Taiwan.” Chart 13… Popular Support … Chart 14… And A Legislative Majority This statement is not a minor rhetorical flourish but will be received as a major provocation in Beijing: the crystallization of a long-brewing clash between Beijing and Taipei. Additional punitive economic measures against Taiwan are now guaranteed. Saber-rattling could easily ignite in the coming year and beyond. Taiwan is the epicenter of the US-China strategic conflict. First, Beijing cannot compromise on its security or its political legitimacy and considers the “one China principle” to be inviolable. Second, the US maintains defense relations with Taiwan (and is in the process of delivering on a relatively large new package of arms). Third, the US’s true willingness to fight a war on Taiwan’s behalf is in doubt, which means that deterrence has eroded and there is greater room for miscalculation. Bottom Line: A US-China military skirmish has been our biggest black swan risk since we began writing the BCA Geopolitical Strategy. The difference between then and now, however, is that the American public is actually paying attention. Political ideology – the question of democracy and human rights – is clearly merging with trade, security, and other differences to provoke Americans of all stripes. This makes any skirmish more than just a temporary risk-off event, as it could lead to a string of incidents or even protracted military conflict. Black Swan 3: Social Unrest Erupts In America There are numerous lessons that one can learn from the ongoing unrest in Hong Kong, but perhaps the most cogent one is that Millennials and Generation Z are not as docile and feckless as their elders think. Images of university students and even teenagers throwing flying kicks and Molotov cocktails while clad in black body armor have shocked the world. Perhaps all those violent video games did have a lasting impact on the youth! What is surprising is that so few commentators have made the cognitive leap from the ultra-first world streets of Hong Kong to other developed economies. Perhaps what is clouding analysts’ minds is the idiosyncratic nature of the dispute in Hong Kong, the “one China” angle. However, Hong Kong youth are confronted with similar socio-economic challenges that their peers in other advanced economies face: overpriced real estate and a bifurcated service-sector labor market with few mid-tier jobs that pay a decent wage. In the US, Millennials and Gen Z are also facing challenges unique to the US. First, their debt burden is much more toxic than that of the older cohorts, given that it is made up of student loans and credit card debt (Chart 15). Second, they find themselves at odds – demographically and ideologically – with the older cohorts (Chart 16). Chart 15Younger American Cohorts Plagued By Toxic Debt Chart 16Younger And Older Cohorts At Odds Demographically The adage that the youth are apolitical and do not turn out to vote may have ended thanks to President Trump. The 2018 midterm election, which the Democratic Party successfully turned into a referendum on the president, saw the youth (18-29) turnout nearly double from 20% to 36% (the 30-44 year-old cohort also saw a jump in turnout from 35.6% to 48.8%). The election saw one of the highest turnouts in recent memory, with a 53.4% figure, just two points off the 2016 general election figure (Chart 17). Chart 17Massive Turnout To The 2016 Referendum On Trump Despite the high turnout in 2018, the-most-definitely-not-Millennial Vice President Joe Biden continues to lead the Democratic Party in the polls. Chart 18Biden Unpopular Among Young American Voters Chart 19Bookies Pulled Down "Uncle Joe's" Odds, Capturing Democratic Party Zeitgeist His probability of winning the nomination is not overwhelming, but it is the highest of any contender. In recent polls, Biden comes third place in Millennial/Gen-Z vote preferences (Chart 18). Yet he is hardly out of contention, especially for the 30-44 year-old cohort. The view that “Uncle Joe” does not fit the Democratic Party zeitgeist has become so entrenched in the Democratic Party narrative that it became conventional wisdom last year, pulling oddsmakers and betting markets away from the clear frontrunner (Chart 19). As such, a Biden victory at the Democratic National Convention in Milwaukee, Wisconsin on July 13-16 may come as an affront to the left-wing activists who will surely descend on the convention. This will particularly be the case if Biden wins despite the progressive candidates amassing a majority of overall delegates, which is possible judging by the combined progressive vote share in current polling (Chart 20). He would arrive in Milwaukee without clearing the 1990 delegate count required to win on the first ballot. On the second ballot, his presidency would then receive a boost from “superdelegates” and those progressives who are unwilling to “rock the boat,” i.e. unify against an establishment candidate with the largest share of votes. This is also how Mayor Michael Bloomberg could pull off a surprise win. Chart 20Progressives Come Closest To Victory Such a “brokered” – or contested – convention has not occurred since 1952. However, several Democratic Party conventions came close, including 1968, 1972, and 1984. The 1968 one in Chicago was notable for considerable violence and unrest. Even if the Milwaukee Democratic Party convention does not produce unrest, it could sow the seeds for unrest later in the year. First, a breakout Biden performance in the primaries is unlikely. As such, he will likely need to pledge a shift to the left at the convention, including by accepting a progressive vice-presidential candidate. Second, an actual progressive may win the primary. Chart 21Zealots In Both Parties Perceive Each Other As A National Threat It is likely that either of the two options would be seen as an existential threat to many of Trump’s loyal supporters across the United States. President Trump’s rhetoric often paints the scenario of a Democratic takeover of the White House in apocalyptic terms. And data suggests that the zealots in both parties perceive each other as a “threat to the nation’s wellbeing” (Chart 21). The American Civil War in the nineteenth century began with the election of a president. This is not just because Abraham Lincoln was a particularly reviled figure in the South, but because the states that ultimately formed the Confederacy saw in his election the demographic writing-on-the-wall. The election was an expression of a general will that, from that point onwards, was irreversible. Given demographic trends in the US today, it is possible that many would see in Trump’s loss a similar fait accompli. If one perceives progressive Democrats as an existential threat to the US constitution, rebellion is the obvious and rational response. There is a risk of rebellion from Trump’s most ardent supporters if he loses the White House. Bottom Line: Year 2020 may be a particularly violent one for the US. First, left wing activists may be shocked and angered to learn that Joe Biden (or Bloomberg) is the nominee of the Democratic Party come July. With so much hype behind the progressive candidates throughout the campaign, Biden’s nomination could be seen as an affront to what was supposed to be “the big year” for left-wing candidates. Second, investors have to start thinking about what happens if Biden – or a progressive candidate – goes on to defeat President Trump in the general election. While liberal America took Trump’s election badly, it has demographics – and thus time – on its side. Trump’s most ardent supporters may conclude that his defeat means the end of America as they know it. Black Swan 4: Europe’s Migration Crisis Restarts Chart 22Decline In Illegal Immigration Dampened European Populism It is a testament to Europe’s resilience that we do not have a Black Swan scenario based on an election or a political crisis set on the continent in 2020. Support for the common currency and the EU as a whole has rebounded to its highest since 2013. Even early elections in Germany and Italy are unlikely to produce geopolitical risk. The populists in the former are in no danger of outperforming whereas the populists in the latter barely deserve the designation. But what if one of the reasons for the surge in populism – unchecked illegal immigration – were to return in 2020? The data suggests that the risk of migrant flows has massively subsided. From its peak of over a million arrivals in 2015, the data shows that only 125,472 migrants crossed into Europe via land and sea routes in the Mediterranean last year (Chart 22). Why? There are five reasons that we believe have checked the flow of migrants: Supply: The civil wars in Syria, Iraq, and Libya have largely subsided. Heterogenous regions, cities, and neighborhoods have been ethnically cleansed and internal boundaries have largely ossified. It is unlikely that any future conflict will produce massive outflows of refugees as the displacement has already taken place. These countries are now largely divided into armed, ethnically homogenous, camps. Enforcement: The EU has stepped up border enforcement since 2015, pouring resources into the land border with Turkey and naval patrols across the Mediterranean. Individual member states – particularly Italy and Hungary – have also stepped up border enforcement policy. While most EU member states have publicly chided both for “draconian” policies, there is no impetus to force Rome and Budapest to change policy. Libyan Imbroglio: Conflict in Libya has flared up in 2019 with military warlord Khalifa Haftar looking to wrest control from the UN-backed Government of National Accord led by Fayez al-Serraj. The Islamic State has regrouped in the country as well. Ironically, the conflict is helping stem the flow of migrants as African migrants from sub-Saharan countries dare not cross into Libya as they did in 2015 when there was a brief lull in fighting. Turkish benevolence: Ankara is quick to point out that it is the only thing standing between Europe and a massive deluge of migrants. Turkey is said to host somewhere between two and four million refugees from various conflicts in the Middle East. Fear of the crossing: If crossing the Mediterranean was easy, Europe would have experienced a massive influx of migrants throughout the twentieth century. Not only is it not easy, it is costly and quite deadly, with thousands lost each year. Furthermore, most migrants are not welcomed when they arrive to Europe, many are held in terrible conditions in holding camps in Italy and Greece. Over time, migrants who made it into Europe have reported these dangers and conditions, reducing the overall demand for illegal migration. We do not foresee these five factors changing, at least not all at once. However, there are several reasons to worry about the flow of migrants in 2020. US-Iran tensions have sparked outright military action, while unrest is flaring up across Iran’s sphere of influence. Going forward, Iran could destabilize Iraq or fuel Shia unrest against US-backed regimes. Second, Afghanistan has been the source of most migrants to Europe via sea and land Mediterranean routes – 19.2%. The conflict in the country continues and may flare up with President Trump’s decision to formally withdraw most US troops from the country in 2020. Third, a break in fighting in Libya may encourage sub-Saharan migrants to revisit routes to Europe. Migrants from Guinea, Cote d’Ivoire, and the Democratic Republic of Congo make up over 10% of migrants to Europe. Finally, Turkish relationship with the West could break up further in 2020, causing Ankara to ship migrants northward. We highly doubt that President Erdogan will risk such a break, given that 50% of Turkish exports go to Europe. A European embargo on Turkish exports – which would be a highly likely response to such an act – would crush the already decimated Turkish economy. Bottom Line: While we do not see a return to the 2015 level of migration in 2020, we flag this risk because it would fundamentally undermine political stability in Europe. Black Swan 5: Russia Faces A “Peasant Revolt” Our fifth and final black swan risk for the year stems from Russia. This risk may seem obvious, since the US election creates a dynamic that revives the inherent conflict in US-Russian relations. Russia could seek to accomplish foreign policy objectives – interfering in US elections, punishing regional adversaries. The Trump administration may be friendly toward Russia but Trump is unlikely to veto any sanctions passed by the House and Senate in an election year, should an occasion for new sanctions arise. Conversely Russia could anticipate greater US pressure if the Democrats win in November. Yet it is Russia’s domestic affairs that represent the real underrated risk. Putin’s fourth term as president has been characterized by increased focus on domestic political control and stability as opposed to foreign adventurism. The creation of a special National Guard in 2016, reporting directly to Putin and responsible for quelling domestic unrest, symbolizes the shift in focus. So too does Russia’s adherence to the OPEC 2.0 regime of production control to keep oil prices above their budget breakeven level. Meanwhile Putin’s courting of Europe for the Nordstream II pipeline, and his slight peacemaking efforts with Ukraine, has suggested a slightly more restrained international posture. Chart 23Sluggish Wage Growth Threatens Russian Stability Strategically it makes little sense for Russia to court negative attention at a time when the US and Europe are at odds over trade and the Middle East, the US is preoccupied with China and Iran, and Russia itself faces mounting domestic problems. The domestic problems are long in coming. The central bank has maintained a stringent monetary policy for the better part of the decade. Despite cutting interest rates recently, monetary and credit conditions are still tight, hurting domestic demand. Moscow has also imposed fiscal austerity, namely by cutting back on state pensions and hiking the value added tax. Real wage growth is weak (Chart 23), retail sales are falling, and domestic demand looks to weaken further, as Andrija Vesic of BCA Emerging Markets Strategy observes in a recent Special Report. The effect of Russia’s policy austerity has been a drop in public approval of the administration (Chart 24). Protests erupted in 2019 but were largely drowned out by the larger and more globally significant protests in Hong Kong. These were met by police suppression that has not removed their underlying cause. Putin’s first major decision of the new year was to reshuffle the government, entailing Prime Minister Dmitri Medvedev’s transfer to a new post and the appointment of a new cabinet. This move reveals the need to show some accountability to reduce popular pressure. While Moscow now has room to cut interest rates and ease fiscal policy, it is behind the curve and the weak economy will add fuel to domestic unrest. Meanwhile Putin’s efforts to alter the Russian constitution so he can stay in power beyond current term limits, effectively becoming emperor for life, like Xi Jinping, should not be dismissed merely because they are expected. They reflect a need to take advantage of Putin’s popular standing to consolidate domestic political power at a time when the ruling United Russia party and the federal government face discontent. They also ensure that strategic conflict with the United States will take on an ideological dimension. Chart 24Austerity Weighed On The Administration's Popularity In Russia Chart 25Russian Political Risk Is Unsustainably Low Russia's recent cabinet shakeup is positive from the point of view of economic reform. And the country's monetary and fiscal room provide a basis for remaining overweight equities within EM, as our Emerging Markets Strategy recommends. However, Russian equities have rallied hard and the political risk is understated. Bottom Line: It is never easy predicting Putin’s next international move. Our market-based indicators of Russian political risk have hit multi-year lows, but both the domestic and international context suggest that these lows will not be sustained (Chart 25). A new bout of risk can emanate from Putin, or from changes in Washington, or from the Russian people themselves. What would take the world by surprise would be domestic unrest on a larger scale than Russia can easily suppress through the police force. Housekeeping We are closing our long European Union / short Chinese equities strategic trade with a 1.61% loss since inception on May 10, 2019. Dhaval Joshi of BCA’s European Investment Strategy downgraded the Eurostoxx 50 to underweight versus the S&P 500 and the Nikkei 225 this week. He makes the point that the Euro Area bond yield 6-month impulse hit 100 bps – a critical technical level – and will be a strong headwind to growth. We will look to reopen this trade at a later date when the euphoria over the “phase one” trade deal subsides, as we still favor European equities and DM bourses over EM. We will reinstitute our long Brent crude H2 2020 versus H2 2021 tactical position, which was stopped out on January 9, 2020. We remain bullish on oil fundamentals and expect Middle East instability to add a political risk premium. China's stimulus and the oil view also give reason for us to reinitiate our long Malaysian equities relative to EM as a tactical position. The Malaysian ringgit will benefit as oil prices move higher, helping Malaysian companies make payments on their large pile of dollar-denominated debt and improving household purchasing power. Higher oil prices also correlate with higher equity prices, while China's stimulus and the US trade ceasefire will push the US dollar lower and help trade revive in the region. Marko Papic Consulting Editor marko@bcaresearch.com Matt Gertken Vice President Geopolitical Strategist mattg@bcaresearch.com   Footnotes 1 Observe how little attention the public paid to US-China saber-rattling around China’s announcement of an Air Defense Identification Zone in the East China Sea that year.