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Executive Summary US Equity Drawdowns During Geopolitical Crises/Commodity Shocks​​​​​​ The most recent examples of geopolitical and commodity price shocks similar the current one include the Cuban missile crisis in 1962, the oil embargo of 1973 in response to the Yom Kippur War as well as the Gulf War of 1990. The magnitude of the S&P 500 selloff was 28% in 1962, 23% in 1973 and 20% in 1990 (Chart of the week). Neither of our capitulation indicators for the S&P 500 or for EM stocks have reached their previous lows. As for commodity prices, the only thing that is certain in the next couple of months is that volatility will remain very elevated. Having incurred considerable costs, Russia will push to maximize its gains and secure a new, more favorable agreement with NATO. This will keep geopolitical tension elevated.   Bottom Line: The drawdown in global and EM stocks in not over yet. The US dollar has more upside in the near term. This is consistent with the S&P500 outperforming and EM stocks underperforming. A rising US dollar bodes ill for EM fixed-income markets. Feature Chart 1US Equity Drawdowns During Geopolitical Crises/Commodity Shocks The world is experiencing geopolitical and commodity price shocks that have not been seen in over a generation. The most recent examples of this kind of shock include the Cuban missile crisis in 1962, the oil embargo of 1973 in response to the Yom Kippur War as well as the Gulf War of 1990. Chart 1 illustrates the current trajectory of the S&P 500 with selloffs that occurred during those three episodes. The magnitude of the S&P 500 selloff was 28% in 1962, 23% in 1973 and 20% in 1990. The S&P 500 is down only 11% from its peak. Based on the above three profiles, the current selloff in US stocks has further to go. This also means that non-US equities, including EM, will continue to suffer. What are the conditions needed for global stocks to bottom? In our opinion, a durable bottom in share prices will occur when measures of capitulation in equity markets reach their previous lows, commodity prices (particularly crude prices) decline and geopolitical tensions peak. We elaborate on each below. Equity Capitulation Neither of our capitulation indicators for the S&P 500 or for EM stocks have reached their previous lows. Chart 2 displays our capitulation indicator for US equities. Its construction is based on four equal-weighted components: the composite momentum indicator, the US equity sentiment indicator, industry group breadth and the advance-decline line (shown individually in Chart 7-8 below). Chart 2US Stocks Have Not Reached Their Selling Climax This indicator has not reached its lows of 2010, 2011, 2018 and 2020. In 2011 and 2018, the S&P500 selloffs were 19.5% and 19.8%, respectively. Hence, our best guess for the magnitude of an equity drawdown in this selloff is about 20%. This puts the potential S&P500 low at 3600-3700. The latter is consistent with the technical support (3-year moving average) that held up in 2011, 2016 and 2018 (Chart 2, top panel).  Chart 3 illustrates our EM equity capitulation indicator. Its four equal-weighted components are the composite momentum indicator, EM equity sentiment, industry group breadth and net EPS revisions (shown individually in Chart 9-10 below). We believe that EM share prices will drop until this capitulation indicator comes to the levels reached in the 2011, 2013 and 2018 selloffs. Chart 3The EM Equity Capitulation Has Further To Run Concerning the magnitude of further EM equity selloff, the next technical defense line for the MSCI EM stock index in USD is 10%, or in the worst-case scenario, 25% below current levels (Chart 3, top panel). The Commodity Shock Global share prices have become negatively correlated with commodity (primarily oil) prices and such an inverse relationship will likely persist for now. In fact, an important signal of the bottom in the S&P 500 during the 1990 oil spike was the peak in crude prices (the latter is shown inverted in Chart 4). In the case of the oil embargo of 1973-74, the oil market was not developed, and US share prices were negatively correlated with US 10-year Treasury yields (Chart 5). Chart 4The 1990 Oil Shock Chart 5The 1973 Oil Shock   Presently, given that US stocks were reacting negatively to rising US bond yields prior to the Ukraine crisis, it is reasonable to expect American share prices to bottom only when two conditions are satisfied: (1) oil prices start falling on a sustainable basis and (2) US bond yields do not rise much. How much will oil and other commodity prices rise? It is hard to know because multiple forces are in play. First, Russia is the second largest commodity exporter in the world (after the US). Russia’s crude oil exports account for 8.4% of global crude consumption, natural gas exports for 5.9% of global consumption and 3.4% for coal (Table 1). Across metals, Russia is a large producer too – 35.6% for palladium, 4.4% for nickel and 4.2% for copper (Table 1).  In turn, Russia and Ukraine production together accounts for 14% of global wheat consumption. Table 1Russia’s Global Share In Various Commodities The West’s official sanctions affect Russian exports of certain commodities but there is also a reluctance on the part of private companies to buy or ship Russian exports. This latter factor makes it nearly impossible to gauge just how much supply of each individual commodity will be curtailed. Assuming in the near term that a considerable share of Russia’s commodity exports will be blocked from global markets, the largest impact will be on oil, palladium, copper, nickel and fertilizer. While ratcheting sales of resources to China is a saving grace for Russia, it might take some time until shipments can be rerouted and reorganized. Second, the US is pressuring allied nations in the Gulf as well as other countries like Venezuela to produce and bring more oil to the market. Finally, the surge in commodity prices is probably already destroying demand. Oil and wheat prices have risen to record highs in many EM currencies (Chart 36 and 37 below). This will push inflation higher and herald more rate hikes from central banks. High interest rates along with tight fiscal policy and eroding discretionary spending (due to high energy and food prices) entail weak demand in developing economies. Bottom Line: In the very short run, risks to many commodity prices are skewed to the upside due to supply constraints. Yet, enormous uncertainty over factors driving their demand and supply makes prices over the next three months impossible to forecast. During this period, individual commodity prices might be driven by idiosyncratic factors. The only thing that is certain in the next couple of months is that volatility in commodity prices will remain very elevated. Price surges might be followed by large drawdowns and vice versa. Geopolitical Tensions The Kremlin will continue its military assault until it establishes firm control over Kyiv and the Black Sea coast, including the city of Odessa. As we wrote in our March 2 report, Putin’s objective is to install a very loyal government in Kyiv and to control the territory east of the Dniepr river. It is not clear to us whether the Kremlin has the appetite to control the Ukraine territory west of the Dniepr river. Western Ukraine has always been very anti-Russian and Putin might realize that it will be too costly to capture and control it. We do not think Putin has ambitions to go beyond Ukraine (Moldova being an exception). That said, there is no doubt that the Kremlin will be presenting more demands to NATO and threatening if those demands are not met. Having incurred considerable costs, Russia will push to maximize its gains and secure a new, more favorable agreement with NATO. It is not clear how many geopolitical concessions or what security guarantees the US is willing to provide to Russia. On the whole, geopolitical tensions between Russia and NATO/the US will continue until there is a new deal between the parties. Investment Strategy Chart 6No Trend Change In EM And US Relative Equity Performance The drawdown in global and EM stocks in not over yet. Within a global equity portfolio, we continue to recommend underweighting EM and Europe and overweighting the US. Interestingly, the EM relative equity performance versus the global stock index has rolled over at its 200-day moving average, while the US’s relative performance has found a support at its 200-day moving average (Chart 6). Such a technical configuration suggests that EM stocks will continue underperforming for now while US equities will have another upleg in relative terms. The US dollar has more upside in the near term. This is consistent with the S&P500 outperforming and EM stocks underperforming. A rising US dollar bodes ill for EM fixed-income markets. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Components Of Our US Equity Capitulation Indicator Not all components of our US Equity Capitulation Indicator have reached their previous lows. Given the backdrop of still expensive US equity valuations, heightened geopolitical risks, very elevated inflation and high inflation expectations as well as the little maneuvering room that the Fed has, odds are that US share prices will drop further. Chart 7Components Of Our US Equity Capitulation Indicator Chart 8Components Of Our US Equity Capitulation Indicator Components Of Our EM Equity Capitulation Indicator Not all components of our EM Equity Capitulation Indicator have reached their previous lows either. The share of industry groups above their 200-day moving average, analysts’ net EPS revisions as well as the momentum and equity sentiment indicators remain above their lows. Further downside in EM share prices is likely. Chart 9Components Of Our EM Equity Capitulation Indicator Chart 10Components Of Our EM Equity Capitulation Indicator US Stocks Have Not Yet Reached Their Selling Climax The NYSE’s advance/decline line has broken down and is dropping, signifying a broadening equity rout. Yet, we doubt the US equity indexes will bottom when 35% of NYSE listed stocks are above their 200-day moving average. Finally, the US median stock has broken below its 200-day moving average. Given the fundamental backdrop, all of these technical signposts point to a larger than 10% correction in the S&P 500. Chart 11US Stocks Have Not Yet Reached Their Selling Climax Chart 12US Stocks Have Not Yet Reached Their Selling Climax Chart 13US Stocks Have Not Yet Reached Their Selling Climax Chart 14US Stocks Have Not Yet Reached Their Selling Climax Global Overall And Global ex-US Equities Although Global ex-US stocks are much more oversold than US stocks, their growth and profit backdrops are worse. As we argued in the front section of this report (Chart 6 above), odds are that US stocks will continue outperforming non-US stocks in the near term. Despite crashing, European stocks might not have found a support yet. Chart 15Global Overall And Global ex-US Equities Chart 16Global Overall And Global ex-US Equities Chart 17Global Overall And Global ex-US Equities Chart 18Global Overall And Global ex-US Equities European Stocks: Is A Support At Hand? Investor sentiment on European stocks has become depressed. Yet, European economies will decelerate due to the energy shock (natural gas prices have shot up two-fold since October 1) as well as falling consumer and business confidence. A bottom for euro area stocks might be lower than current prices. Chart 19European Stocks: Is A Support At Hand? Chart 20European Stocks: Is A Support At Hand? Chart 21European Stocks: Is A Support At Hand? EM Equities: Cheap But Mind The Profit Outlook According to our cyclically adjusted P/E ratio, EM stocks are slightly cheap in absolute terms and are very attractive versus US equities. However, this valuation indicator should be used by long-term investors. In the short run and even from a cyclical perspective, this valuation indicator is not very useful. Besides, investor sentiment on EM equities was neutral in the middle of February. It might take more weakness before bad news get priced in EM share prices. Chart 22EM Equities: Cheap But Mind The Profit Outlook Chart 23EM Equities: Cheap But Mind The Profit Outlook Chart 24EM Equities: Cheap But Mind The Profit Outlook EM Profits In A Soft Spot As projected by our EM narrow money (M1) aggregate, EM corporate earnings will continue to disappoint. This is the key risk to EM share prices. In fact, EM EPS has been broadly flat over the past 15 years. That is why EM stocks appear cheap. Plus, EM ex-TMT stocks have not yet fallen much and downside risks remain. Chart 25EM Profits In A Soft Spot Chart 26EM Profits In A Soft Spot Chart 27EM Profits In A Soft Spot Chinese Investable Stocks Are At Their March 2020 Lows Offshore and onshore Chinese shares prices have been falling hard. Not only have Chinese corporate profit expectations been downshifting but also Chinese Investable stocks have been derating (their multiples have been compressing). This has been due to foreign investors projecting/extrapolating the US-Russia confrontation to a possible future US-China geopolitical standoff, and therefore possible sanctions the West can impose on China. Chart 28Chinese Investable Stocks Are At Their March 2020 Lows Chart 29Chinese Investable Stocks Are At Their March 2020 Lows Chart 30Chinese Investable Stocks Are At Their March 2020 Lows Chart 31Chinese Investable Stocks Are At Their March 2020 Lows China: No "All-In" Stimulus Yet The improvement in China’s total social financing has been entirely due to local government bond issuance. Corporate and household credit have not improved at all. Consistently, traditional infrastructure investment has probably bottomed. Yet, outside this sector the outlook is uninspiring. Property construction remains at risk, consumer spending is very sluggish and private business sentiment is downbeat. Chart 32China: No "All-In" Stimulus Yet Chart 33China: No "All-In" Stimulus Yet Chart 34China: No "All-In" Stimulus Yet Chart 35China: No "All-In" Stimulus Yet EM Woes: Energy And Food Prices Many low-income developing countries will be suffering from elevated food and energy prices. Oil and wheat prices in EM currencies have surged to all-time highs. This will lift headline inflation in many emerging economies, lead to monetary tightening and reduce household income available for discretionary spending. All of these and the lack of fiscal easing in many developing countries entail growth disappointments this year. Chart 36EM Woes: Energy And Food Prices Chart 37EM Woes: Energy And Food Prices Chart 38EM Woes: Energy And Food Prices Chart 39EM Woes: Energy And Food Prices EM Credit Spreads Are Widening Rapidly EM sovereign and corporate spreads have broken out. Such spread widening is not simply due to Russian credit. The pace of spread widening differs among countries. However, directionally, credit spreads seem to have embarked on a widening path. In a nutshell, Chinese USD corporate in general and property bond prices in particular are tanking (see below). This foreshadows the poor outlook for Chinese housing. Chart 40EM Credit Spreads Are Widening Rapidly Chart 41EM Credit Spreads Are Widening Rapidly Chart 42EM Credit Spreads Are Widening Rapidly Chart 43EM Credit Spreads Are Widening Rapidly EM Credit Markets And EM Equities Historically, rising EM corporate USD bond yields led to a selloff in EM share prices. This is the cost of capital that matters for EM equities. Unless EM sovereign and corporate bonds yields start falling on a sustainable basis, EM equities will continue to struggle. Chart 44EM Credit Markets And EM Equities Chart 45EM Credit Markets And EM Equities Chart 46EM Credit Markets And EM Equities Global Resource Stocks The relative performance of global energy and basic materials versus the global equity index has bottomed. In the medium term, odds are that TMT stocks will underperform while resource companies outperform. Yet, the outlook for energy stocks and basic materials in absolute terms is complicated (in line with the elevated volatility in commodity prices we discussed in the front section). Notably, even though commodity prices have skyrocketed, basic materials and energy share prices have not yet broken out. It seems the market is doubting the sustainability of high commodity prices. Chart 47Global Resource Stocks Footnotes

Executive Summary Euro Natgas Soars; LME Nickel Squeezed Russian Energy Minister Alexander Novak's threat to halt shipmentsof natgas on Nord Stream 1 to Europe lifted European gas prices 25% overnight, and will reverberate for years. We make the odds of a cut-off of Russian natgas exports to the EU low but not extremely low. Russia’s war is about the status of Ukraine. Russia needs the EU markets, and the EU needs Russia's gas. However, if Russia follows through on Novak's threat, it would be a major disruption for gas markets in the short term. Over the medium to long term, US shale gas producers, LNG terminal operators and exporters will benefit from new demand. On the import side, China likely benefits most from Russia's need to re-route gas. But this will require substantial infrastructure investment to monetize Russia's gas supplies and as such will take years to realize. Separately, the LME has shut down its nickel markets following an explosive 250% rally over two days that took prices above $100,000/MT. Nickel settled at ~ $80,000/MT before the LME closed the market today for margin calls on shorts squeezed by the surge in prices to make margin calls. Bottom Line: We remain long commodity-index exposure (S&P GSCI and the COMT ETF), along with equity exposure to oil and gas producers via the XOP ETF. We also remain long the XME and PICK ETFs to retain exposure to base metals and bulks.

Highlights Chart 1A Tough Balancing Act For The Fed In last week’s Congressional testimony, Fed Chair Jay Powell talked about his goal of achieving a “soft landing”. That is, the Fed will tighten enough to slow inflation but not so much that the economy tips into recession. This balancing act was always going to be difficult, and recent world events have only complicated it. On the one hand, the US labor market has essentially returned to full employment. The prime-age employment-to-population ratio is just 1% below its pre-COVID level, a gap that will soon be filled by the 1.2 million people being kept out of the labor force by the pandemic (Chart 1). On the other hand, risk-off market moves driven by the war in Ukraine have caused the yield curve to flatten (Chart 1, bottom panel). The Fed’s task is to respond to the strong US economy by lifting rates, but to also avoid inverting the yield curve. To split the difference, the Fed will proceed with a 25 bps rate hike at each FOMC meeting, but will slow down if the curve inverts. Our recommended strategy is to keep portfolio duration close to benchmark for the time being given the uncertainty in Ukraine. However, the Treasury curve is now priced for too shallow a path for rate hikes. We are actively looking for a good time to re-initiate duration shorts. Feature   Table 1Recommended Portfolio Specification Table 2Fixed Income Sector Performance Investment Grade: Neutral Chart 2Investment Grade Market Overview Investment grade corporate bonds underperformed the duration-equivalent Treasury index by 124 basis points in February, dragging year-to-date excess returns down to -238 bps. The index option-adjusted spread widened 16 bps on the month and it currently sits at 130 bps. Our quality-adjusted 12-month breakeven spread has moved up to its 36th percentile since 1995 (Chart 2). The corporate bond sell-off that began late last year on heightened expectations of Fed tightening has accelerated in recent weeks, this time driven by the war in Ukraine. The result of the turmoil is that a significant amount of value has returned to the corporate bond market. In fact, spreads have not been this wide since early 2021. Continued uncertainty about how the Ukrainian situation will evolve causes us to recommend a neutral stance on investment grade corporate bonds in the near term. However, enough value has been created that a buying opportunity could soon emerge. Corporate balance sheets remain healthy. In fact, the ratio of total debt to net worth on nonfinancial corporate balance sheets is at its lowest level since 2010 (bottom panel). Further, the most likely scenario is that the economic contagion from Russia/Ukraine to the United States will be limited. While Fed tightening is set to begin this month, spreads are now wide enough that a flat but positively sloped yield curve is not sufficient to justify an underweight stance on corporate bonds. Investors should stay neutral for now but look for an opportunity to turn more bullish. Table 3ACorporate Sector Relative Valuation And Recommended Allocation* Table 3BCorporate Sector Risk Vs. Reward* High-Yield: Overweight Chart 3High-Yield Market Overview High-Yield underperformed the duration-equivalent Treasury index by 56 basis points in February, dragging year-to-date excess returns down to -213 bps. The index option-adjusted spread widened 17 bps on the month and it currently sits at 376 bps. The 12-month spread-implied default rate – the default rate that is priced into the junk index assuming a 40% recovery rate on defaulted debt and an excess spread of 100 bps – also moved up to 4.6% (Chart 3). The odds are good that defaults will come in below 4.6% during the next 12 months, and as such, we expect high-yield bonds to outperform a duration-matched position in Treasuries. This warrants a continued overweight allocation to High-Yield on a cyclical (6-12 month) horizon, though we acknowledge that further spread widening is likely until the situation in Ukraine reaches a place of greater stability. High-Yield valuations continue to be more favorable than for investment grade corporates (panel 3). We therefore maintain a preference for high-yield corporate bonds over investment grade.       MBS: Underweight Chart 4MBS Market Overview Mortgage-Backed Securities underperformed the duration-equivalent Treasury index by 48 basis points in February, dragging year-to-date excess returns down to -60 bps. The zero-volatility spread for conventional 30-year agency MBS widened 12 bps on the month, driven by an 11 bps widening of the option-adjusted spread (OAS). The compensation for prepayment risk (option cost) increased by 1 bp on the month (Chart 4). We wrote in a recent report that MBS’ poor performance in 2021 was attributable to an option cost that was too low relative to the pace of mortgage refinancings, noting that the MBA Refinance Index was slow to fall in 2021 despite the back-up in yields.1 This valuation picture is starting to change. The option cost is now up to 44 bps, its highest level since 2016 and refi activity is slowing as the Fed moves toward rate hikes. At 30 bps, the index OAS remains unattractive. However, the elevated option cost raises the possibility that the OAS may be over-estimating the pace of mortgage refinancings for the first time in a while. If these trends continue, it may soon make sense to increase exposure to agency MBS. We closed our recommendation to favor high coupon over low coupon securities on February 15th, concurrent with our decision to increase portfolio duration. We will likely re-establish this position when we move portfolio duration back to below benchmark. Emerging Market Bonds (USD): Underweight Chart 5Emerging Markets Overview Emerging Market bonds underperformed the duration-equivalent Treasury index by 399 basis points in February, dragging year-to-date excess returns down to -483 bps. EM Sovereigns underperformed the Treasury benchmark by 519 bps on the month, dragging year-to-date excess returns down to -646 bps. The EM Corporate & Quasi-Sovereign Index underperformed by 323 bps on the month, dragging year-to-date excess returns down to -379 bps. Russian sovereign bonds were recently downgraded to below investment grade, but before they were removed from the index they contributed -367 bps to Sovereign excess returns in February. In other words, if Russian securities are excluded, the EM Sovereign index only lagged Treasuries by 152 bps in February and actually outperformed a duration-matched position in US corporate bonds. As a result, the EM Sovereign index now offers less yield than a credit rating and duration-matched position in US corporate bonds (Chart 5). This recent shift in valuation leads us to reduce our recommended exposure to EM Sovereigns from overweight to underweight. Russian securities also negatively influenced EM Corporate & Quasi-Sovereign returns in February, but that index still offers a significant yield premium over US corporates whether Russian bonds are included or not (bottom panel). The turmoil overseas causes us to reduce exposure to this sector as well, but we will retain a neutral allocation instead of underweight because of still-attractive valuations. Municipal Bonds: Overweight Chart 6Municipal Market Overview Municipal bonds underperformed the duration-equivalent Treasury index by 5 basis points in February, dragging year-to-date excess returns down to -126 bps (before adjusting for the tax advantage). While the war in Ukraine introduces a great deal of uncertainty into the economic outlook, the municipal bond sector should be better placed than most to deal with the fallout. Trailing 4-quarter net state & local government savings are incredibly high (Chart 6) and 2021’s federal spending splurge will continue to support state & local government coffers for some time. That said, relative muni valuations have tightened significantly during the past few months and the recent back-up in corporate spreads will eventually give us an opportunity to increase exposure to that sector. With that in mind, this week we downgrade our municipal bond allocation from “maximum overweight” (5 out of 5) to “overweight” (4 out of 5). We calculate that 12-17 year maturity Revenue munis offer a breakeven tax rate of 5% relative to credit rating and duration matched US corporate bonds. 12-17 year General Obligation Munis offer a breakeven tax rate of 11% versus corporates (panel 2). Both figures are down considerably from their 2020 peaks. For their part, high-yield muni spreads have also not kept pace with the recent widening in high-yield corporate spreads (bottom panel). Treasury Curve: Buy 2-Year Bullet Versus Cash/10 Barbell Chart 7Treasury Yield Curve Overview The Treasury curve flattened dramatically In February, driven by a re-pricing of Fed expectations in the first half of the month and then later by flight-to-quality flows spurred by the war in Ukraine. The 2/10 and 5/30 Treasury slopes flattened by 22 bps and 3 bps in February. They currently sit at 24 bps and 51 bps, respectively (Chart 7). As noted on the first page of this report, during the next few months the Fed will be forced to strike a balance between tightening policy fast enough to prevent a de-stabilizing increase in inflation expectations and slow enough to prevent an inversion of the yield curve. The latter would likely signal an unacceptable increase in recession risk. In the near-term, we view the risks as clearly tilted toward further curve flattening as the Fed initiates a rate hike cycle while geopolitical uncertainties keep a lid on long-dated yields. However, this dynamic will eventually give way when political uncertainties abate and/or the Fed is forced to move more slowly in response to an inverted (or almost inverted) curve. With that in mind, a position in curve steepeners continues to make sense on a 6-12 month investment horizon. We also maintain our recommendation to favor the 20-year bond over a duration-matched barbell consisting of the 10-year note and 30-year bond. This position offers an enticing 26 bps of duration-neutral carry. TIPS: Neutral Chart 8TIPS Market Overview TIPS outperformed the duration-equivalent nominal Treasury index by 150 basis points in February, bringing year-to-date excess returns up to +127 bps. The 10-year TIPS breakeven inflation rate rose 19 bps on the month and the 5-year/5-year forward TIPS breakeven inflation rate rose 7 bps. Perhaps the most interesting recent market move is that TIPS breakeven inflation rates rose during the past month, even as flight-to-safety flows surged into the US bond market. That is, while nominal Treasury yields declined, TIPS yields fell even more, and the cost of inflation compensation embedded in US bond prices increased. At present, the 10-year TIPS breakeven inflation rate is 2.70%, above the Fed’s 2.3% to 2.5% target range (Chart 8). The 5-year/5-year forward TIPS breakeven inflation rate is 2.16%, still below the Fed’s target range but significantly higher than where it was in January. The bond market has responded to the war in Ukraine and resultant surge in commodity prices by bidding up the cost of inflation compensation. While we agree that higher commodity prices increase the risk that inflation will remain elevated in the second half of the year, we still think the most likely outcome is that core inflation starts to moderate in the coming months as supply chain pressures ease and the pandemic exerts less of an impact on daily life. Upcoming Fed rate hikes will also apply downward pressure to long-maturity TIPS breakeven inflation rates. As a result, we maintain our recommended neutral allocation to TIPS versus nominal Treasuries at the long-end of the curve and re-iterate our recommendation to underweight TIPS versus nominal Treasuries at the front-end of the curve.  ABS: Overweight Chart 9ABS Market Overview Asset-Backed Securities underperformed the duration-equivalent Treasury index by 25 basis points in February, dragging year-to-date excess returns down to -5 bps. Aaa-rated ABS underperformed by 25 bps on the month, dragging year-to-date excess returns down to -6 bps. Non-Aaa ABS underperformed by 22 bps on the month, dragging year-to-date excess returns down to -1 bp. During the past two years, substantial federal government support for household incomes has caused US households to build up an extremely large buffer of excess savings. During this period, many households have used their windfalls to pay down consumer debt and credit card debt levels have fallen to well below pre-COVID levels (Chart 9). Though consumer credit growth has rebounded, debt levels are still low. This indicates that the collateral quality backing consumer ABS remains exceptionally strong. This also indicates that while surging gasoline prices will weigh on consumer activity in the coming months, household balance sheets are starting from such a good place that we don’t expect a meaningful increase in consumer credit delinquencies. Investors should remain overweight consumer ABS and should take advantage of the high quality of household balance sheets by moving down the quality spectrum, favoring non-Aaa rated securities over Aaa-rated ones. Non-Agency CMBS: Neutral Chart 10CMBS Market Overview Non-Agency Commercial Mortgage-Backed Securities underperformed the duration-equivalent Treasury index by 95 basis points in February, dragging year-to-date excess returns down to -98 bps. Aaa Non-Agency CMBS underperformed Treasuries by 90 bps on the month, dragging year-to-date excess returns down to -92 bps. Non-Aaa Non-Agency CMBS underperformed by 108 bps on the month, dragging year-to-date excess returns down to -105 bps (Chart 10). Though CMBS spreads remain wide compared to other similarly risky spread products, we continue to recommend only a neutral allocation to the sector because of the structurally challenging environment for commercial real estate. Agency CMBS: Overweight Agency CMBS underperformed the duration-equivalent Treasury index by 24 basis points in February, dragging year-to-date excess returns down to -21 bps. The average index option-adjusted spread widened 6 bps on the month. It currently sits at 46 bps (bottom panel). The average Agency CMBS spread remains below its pre-COVID level, but it continues to look attractive compared to other similarly risky spread products. Stay overweight. Appendix A: The Golden Rule Of Bond Investing We follow a two-step process to formulate recommendations for bond portfolio duration. First, we determine the change in the federal funds rate that is priced into the yield curve for the next 12 months. Second, we decide – based on our assessments of the economy and Fed policy – whether the change in the fed funds rate will exceed or fall short of what is priced into the curve. Most of the time, a correct answer to this question leads to the appropriate duration call. We call this framework the Golden Rule Of Bond Investing, and we demonstrated its effectiveness in the US Bond Strategy Special Report, “The Golden Rule Of Bond Investing”, dated July 24, 2018. Chart 11 illustrates the Golden Rule’s track record by showing that the Bloomberg Barclays Treasury Master Index tends to outperform cash when rate hikes fall short of 12-month expectations, and vice-versa. At present, the market is priced for 172 basis points of rate hikes during the next 12 months. Chart 11The Golden Rule's Track Record Appendix A: The Golden Rule Of Bond Investing We can also use our Golden Rule framework to make 12-month total return and excess return forecasts for the Bloomberg Barclays Treasury index under different scenarios for the fed funds rate. Excess returns are relative to the Bloomberg Barclays Cash index. To forecast total returns we first calculate the 12-month fed funds rate surprise in each scenario by comparing the assumed change in the fed funds rate to the current value of our 12-month discounter. This rate hike surprise is then mapped to an expected change in the Treasury index yield using a regression based on the historical relationship between those two variables. Finally, we apply the expected change in index yield to the current characteristics (yield, duration and convexity) of the Treasury index to estimate total returns on a 12-month horizon. The below tables present those results, along with excess returns for a front-loaded and a back-loaded rate hike scenario. Excess returns are calculated by subtracting assumed cash returns in each scenario from our total return projections. Appendix B: Butterfly Strategy Valuations The following tables present the current read-outs from our butterfly spread models. We use these models to identify opportunities to take duration-neutral positions across the Treasury curve. The following two Special Reports explain the models in more detail: US Bond Strategy Special Report, “Bullets, Barbells And Butterflies”, dated July 25, 2017, available at usbs.bcaresearch.com US Bond Strategy Special Report, “More Bullets, Barbells And Butterflies”, dated May 15, 2018, available at usbs.bcaresearch.com Table 4 shows the raw residuals from each model. A positive value indicates that the bullet is cheap relative to the duration-matched barbell. A negative value indicates that the barbell is cheap relative to the bullet. Table 4Butterfly Strategy Valuation: Raw Residuals In Basis Points (As Of February 28, 2022) Table 5 scales the raw residuals in Table 4 by their historical means and standard deviations. This facilitates comparison between the different butterfly spreads. Table 5Butterfly Strategy Valuation: Standardized Residuals (As Of February 28, 2022) Table 6 flips the models on their heads. It shows the change in the slope between the two barbell maturities that must be realized during the next six months to make returns between the bullet and barbell equal. For example, a reading of -29 bps in the 5 over 2/10 cell means that we would expect the 5-year to outperform the 2/10 if the 2/10 slope flattens by less than 29 bps during the next six months. Otherwise, we would expect the 2/10 barbell to outperform the 5-year bullet. Table 6Discounted Slope Change During Next 6 Months (BPs) Appendix C: Excess Return Bond Map The Excess Return Bond Map is used to assess the relative risk/reward trade-off between different sectors of the US bond market. It is a purely computational exercise and does not impose any macroeconomic view. The Map’s vertical axis shows 12-month expected excess returns. These are proxied by each sector’s option-adjusted spread. Sectors plotting further toward the top of the Map have higher expected returns and vice-versa. Our novel risk measure called the “Risk Of Losing 100 bps” is shown on the Map’s horizontal axis. To calculate it, we first compute the spread widening required on a 12-month horizon for each sector to lose 100 bps or more relative to a duration-matched position in Treasury securities. Then, we divide that amount of spread widening by each sector’s historical spread volatility. The end result is the number of standard deviations of 12-month spread widening required for each sector to lose 100 bps or more versus a position in Treasuries. Lower risk sectors plot further to the right of the Map, and higher risk sectors plot further to the left. Chart 12Excess Return Bond Map (As Of February 28, 2022) Recommended Portfolio Specification Other Recommendations Ryan Swift US Bond Strategist rswift@bcaresearch.com Footnotes 1 Please see US Bond Strategy Weekly Report, “The Omicron Impact”, dated November 30, 2021. Treasury Index Returns Spread Product Returns

Executive Summary US Can Do Without Russia's Oil, EU, NATO … Not So Much The US will ban Russian oil imports shortly.  This is not as big a deal markets had feared over the weekend, when news of a possible ban of Russian oil and refined products into the US and Europe was telegraphed by US officials, powering prices to $140/bbl.1 The US imported a combined 400k b/d of Russian crude oil and refined products in December 2021, the EIA reports, which accounted for less than 5% of the 8.6mm b/d of imports. Europe is another story.  Roughly 60% of Russia's 11.3mm b/d of crude oil and refined-products output goes to OECD Europe, according to the IEA. Russia considers Western sanctions to be on an equal footing with a declaration of war.2  President Putin has threatened a nuclear response if the West interferes with invasion of Ukraine, which could elicit a similar response from the West.3  US shale producers will be highly incentivized to increase output given high prices.  Our view continues to include a production increase from core OPEC 2.0 – Saudi Arabia, UAE and Kuwait.  We also anticipate a return of 1mm b/d from Iran, following a nuclear deal with the US. Bottom Line: We remain long commodity-index exposure (S&P GSCI and the COMT ETF), along with equity exposure to oil and gas producers via the XOP ETF. Footnotes 1     Please see Crude price jumps on talk of US oil ban as Russia steps up shelling of civilian areas, published by the Financial Times on March 6, 2022. 2     Please see Putin says Western sanctions are akin to declaration of war, published on March 5, 2022. 3    Please see How likely is the use of nuclear weapons by Russia?, published by Chatham House on March 1, 2022.  The report notes, " If Russia were to attack Ukraine with nuclear weapons, NATO countries would most likely respond on the grounds that the impact of nuclear weapons crosses borders and affects the countries surrounding Ukraine. NATO could respond either by using conventional forces on Russian strategic assets, or respond in kind using nuclear weapons as it has several options available."

Executive Summary Nuclear Worries Take Center Stage Vladimir Putin has now committed himself to orchestrating a regime change in Kyiv. Anything less would be seen as a defeat for him. Assuming he succeeds, and it is far from obvious that he will, the resulting insurgency will drain Russian resources. Along with continued sanctions, this will lead to a further deterioration in Russian living standards and growing domestic discontent. If Putin concludes that he has no future, the risk is that he will decide that no one else should have a future either. Although there is a huge margin of error around any estimate, subjectively, we would assign an uncomfortably high 10% chance of a civilization-ending global nuclear war over the next 12 months. These odds place some credence on Brandon Carter’s highly controversial Doomsday Argument. Even if World War III is ultimately averted, markets could experience a freak-out moment over the next few weeks, similar to what happened at the outset of the pandemic. Google searches for nuclear war are already spiking. Despite the risk of nuclear war, it makes sense to stay constructive on stocks over the next 12 months. If an ICBM is heading your way, the size and composition of your portfolio becomes irrelevant. Thus, from a purely financial perspective, you should largely ignore existential risk, even if you do care about it greatly from a personal perspective. Bottom Line: The risk of Armageddon has risen dramatically. Stay bullish on stocks over a 12-month horizon. All In on Sanctions In the criminal justice system, there is a reason why the punishment for armed robbery is lower than for murder. If the punishment were the same, an armed robber would have a perverse incentive to kill his victim in order to better conceal his crime. The same logic applies, or at least used to apply, to geopolitics: You do not impose maximum sanctions from the get-go because that removes your ability to influence your enemy with the threat of further sanctions. Following Russia’s invasion of Ukraine, the West chose to go all in on sanctions, levying every type imaginable with the exception of those entailing a big cost to the West (such as cutting off Russian energy exports). Most notably, many Russian banks have been blocked from the SWIFT messaging system while the Russian central bank’s foreign exchange reserves have been frozen. Even FIFA has barred Russia from international competition, just weeks before it was set to participate in the qualifying rounds of the 2022 World Cup. At this point, there is not much more that can be done on the sanctions front. This leaves military intervention as the only avenue available to further pressure Russia. A growing chorus of Western pundits, some of whom could not have picked out Ukraine on a map two weeks ago, have begun clamoring for regime change… this time, in Moscow. As one might imagine, this is not something that sits well with Putin. Last week, he declared that “No matter who tries to stand in our way or … create threats for our country and our people, they must know that Russia will respond immediately, and the consequences will be such as you have never seen in your entire history.” To ensure there was no uncertainty about what he was talking about, he proceeded to place Russia’s nuclear forces on “special regime of combat duty.” Yes, It’s Possible The Putin regime has used nuclear weapons of a sort in the past. The FSB likely orchestrated the poisoning of Alexander Litvinenko with polonium-210 in 2006, leaving traces of the radioactive substance scattered in dozens of places across London. As former US presidential advisor and Putin biographer Fiona Hill said in a recent interview with Politico, “Every time you think, “No, he wouldn’t, would he?” Well, yes, he would.” Admittedly, there is a big difference between dropping polonium into a cup of tea at the Millennium hotel in Mayfair and dropping a 10-megaton nuclear bomb on London or any other major Western city. Still, if Putin feels that he has no future, he may try to take everyone down with him. The collapse in the ruble, and what is sure to be a major plunge of living standards across Russia, could foment internal opposition to Putin. A quiet retirement is not an option for him. Based on the latest exchange rates, Russia’s GDP is smaller than Mexico’s and barely higher than that of Illinois (Chart 1). While denying gas to Europe is a very real threat, it has a limited shelf life. Europe will aggressively build out infrastructure to process LNG imports. Chart 1Russia's Economic Power Has Faded In a few years, the one viable weapon that Russia will have at its disposal is its nuclear arsenal. As Dutch historian Jolle Demmers has said, “It is precisely the decline and contraction of Russian power, coupled with the possession of nuclear weapons and a tormented repressive president, that poses great risks.” Some of the world’s most prominent strategic thinkers flagged these risks before the invasion, but with little effect. The Mother of All Risks In simulated war games, it is generally difficult to get participants to cross the nuclear threshold, but once they do, a full-blown nuclear exchange usually ensues.1 The idea of “limited” nuclear war is a mirage.  How high are the odds of such a full-blown war? I must confess that my own feelings on the matter are heavily colored by my writings on existential risk. As I argued in Section XII of my special report, “Life, Death, and Finance in the Cosmic Multiverse,” we are probably greatly understating existential risk, especially when we look prospectively into the future. Although there is a huge margin of error around any estimate, subjectively, we would assign an uncomfortably high 10% chance of a civilization-ending global nuclear war over the next 12 months. These odds place some credence on Brandon Carter’s highly controversial Doomsday argument (See Box 1). A Paradox for Investors For investors, existential risk represents a paradoxical concept. If an ICBM is heading your way, the question of whether you are overweight or underweight stocks would be pretty far down on your list of priorities. And even if you were inclined to think about your portfolio, how would you alter it? In a full-blown global nuclear war, most stocks would go to zero while governments would probably be forced to default or inflate away their debt. Gold might retain some value – provided that you kept it in your physical possession – but even then, you would still have trouble exchanging it for anything of value if nothing of value were available to purchase. This means that from a purely financial perspective, you should largely ignore existential risk, even if you do care greatly about it from a personal perspective. What, then, can we say about the current market environment? I touched on many of the key issues in Monday’s Special Alert, in which we tactically downgraded global equities from overweight to neutral. I encourage readers to consult that report for our latest market views. In the remainder of today’s report, allow me to elaborate on a couple of key themes. A Freak-Out Moment Is Coming Chart 2Nuclear Worries Take Center Stage The market today reminds me of early 2020. We wrote a report on February 21 of that year entitled “Markets Too Complacent About The Coronavirus,” in which we noted that a full-blown pandemic “could lead to 20 million deaths worldwide,” and that “This would likely trigger a global downturn as deep as the Great Recession of 2008/09, with the only consolation being that the recovery would be much more rapid than the one following the financial crisis.” Many saw that report as alarmist, just as they saw our subsequent decision to upgrade stocks in March as cavalier.  Even if you knew in February 2020 that the S&P 500 would reach an all-time high later that year, you should have still shorted equities aggressively on a tactical basis. I feel the same way about the present. Google searches for nuclear war are spiking (Chart 2). A freak-out moment is coming, which will present a good buying opportunity for investors. Just to be on the safe side, I picked up a couple of bottles of Potassium Iodide earlier this week. When I checked the pharmacy again yesterday, all the bottles were sold out. They are now being hawked on Amazon for ten times the regular price. From Cold War to Hot Economy? The spike in commodity prices – especially energy prices – will have a negative near-term impact on global growth, while also limiting the ability of central banks to slow the pace of planned rate hikes (Chart 3). In general, inflation expectations and oil prices move together (Chart 4).   Chart 3Central Banks: Caught Between A Rock And A Hard Place   Chart 4Inflation Expectations And Oil Prices Go Hand-In-Hand Assuming the geopolitical situation stabilizes in a few months, oil prices should come down. The forward curve for oil is heavily backwardated now: The spot price for Brent is $111/bbl while the December 2022 price is $93/bbl (Chart 5). BCA’s commodity strategists expect the price of Brent oil to fall to $88/bbl by year-end. The decline in energy prices should provide some relief to global growth and risk assets in the back half of the year, which is one reason we are more constructive on equities over a 12-month horizon than a 3-month horizon. Looking out beyond the next year or two, the new cold war will lead to higher, not lower, interest rates. Increased spending on defense and alternative energy sources will prop up aggregate demand, especially in Europe where the need to diversify away from Russian gas is greatest. As Chart 6 shows, capex in the euro area cratered following the euro debt crisis. Capital spending via the Recovery Fund and other sources will rise significantly over the next few years. Chart 5The Brent Curve Is Heavily Backwardated Chart 6European Capex Is Poised To Increase In addition, the shift to a multipolar world will expedite the retreat from globalization. Rising globalization was an important force restraining inflation – and interest rates – over the past few decades. Lastly, the ever-present danger of war could prompt households to reduce savings. It does not make sense to save for a rainy day if that day never arrives. Lower savings implies a higher equilibrium rate of interest. As we discussed in our recent report entitled “A Two-Stage Fed Tightening Cycle,” after raising rates modesty this year, the Fed will resume hiking rates towards the end of 2023 or in 2024, as it becomes clear that the neutral rate in nominal terms is closer to 3%-to-4% rather than the 2% that the market assumes. The secular bull market in equities will likely end at that point. In summary, equity investors should be somewhat cautious over the next three months, more optimistic over a 12-month horizon, but more cautious again over a longer-term horizon of 2-to-5 years. Box 1The Doomsday Argument In A Nutshell Peter Berezin Chief Global Strategist peterb@bcaresearch.com Footnotes 1     For example, an article from the Center for Arms Control and Non-Proliferation discusses a Reagan administration war game called “Proud Prophet,” an exercise the Americans hatched to test the theory of limited nuclear strikes. The result of this exercise was that the “Soviet Union perceived even a low-yield nuclear strike as an attack, and responded with a massive missile salvo.” Global Investment Strategy View Matrix Special Trade Recommendations Current MacroQuant Model Scores