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Highlights Odds are that the recent improvement in Chinese manufacturing PMIs could be due to inventory re-stocking rather than a decisive turnaround in final demand. “Hard” data have not shown meaningful improvements in China’s final demand. Weighing the pros and cons, we are instituting a stop-buy on our EM strategy: We will turn tactically positive on EM risk assets if the MSCI EM equity index breaks above 1125, which is 4% above its current level. Keep Malaysia on an upgrade watch list. Downgrade Brazil to underweight. Feature The strong Chinese PMI prints released this week have challenged our negative view on EM assets and China plays. This week we take a deeper look at the underlying reasons behind the recent improvement in China’s PMI data. In addition, we elaborate on what it would take for us to alter our current strategy on EM risk assets. A Manufacturing Upturn The upturn in China’s manufacturing PMIs in March has been validated by improvement in Taiwanese PMI’s export orders (Chart I-1, top panel). The latter’s amelioration has been broad-based across all sectors: electronics and optical, electrical machinery and equipment, basic materials, and chemical/biological/medical (Chart I-1, bottom panel). China accounts for 30% of Taiwanese exports, making Taiwan’s manufacturing sector heavily exposed to China’s business cycle. Does this improvement in manufacturing PMIs reflect a final demand revival in China? Looking For Final Demand Revival China’s domestic and overseas orders remain weak, as exhibited in Chart I-2. These indicators give us the primary trajectory of the Chinese business cycle, while the PMI indexes exhibit considerable short-term volatility. Chart I-1One-Month Surge In China's And Taiwan's PMIs Chart I-2Noise And Business Cycle Trajectory   The domestic demand and overseas orders reflect quarterly data from 5,000 enterprises. The latest datapoints are from Q1 2019 and were released on March 22. To be sure, we are not suggesting an absence of bright spots, but at the moment “hard” data do not corroborate broad-based improvement in final demand. Consumer spending: There has been no improvement in households’ propensity to spend. Our proxy for households’ marginal propensity to spend has not turned up (Chart I-3). Consistently, China’s smartphone sales and passenger car sales are contracting at double-digit rates, while the growth rate in online sales of services has not improved (Chart I-4, top three panels). Chart I-3Chinese Consumers' Propensity To Spend Chart I-4China: No Improvement In "Hard" Data   The bottom panel of Chart I-4 demonstrates the retail sales of consumer goods during the Chinese New Year compared with the previous year’s spring festival. It is evident that as of mid-February, when this year’s spring festival took place, there was no improvement in Chinese consumer demand. Business spending / investment: Our proxy for enterprises’ propensity to spend continues to decline (Chart I-5). Companies’ propensity to spend has historically led the cyclical trajectory in industrial metals prices. Crucially, this has not corroborated the rebound in base metals prices over the past three months. Besides, China’s imports of capital goods, its total imports from Korea and its machinery and machine tool imports from Japan are all still contracting at a double-digit rate (Chart I-6). Chart I-5China: Enterprises' Propensity To Spend And Metals Chart I-6Contracting At A Double Digit Rate   China’s fixed asset investment in infrastructure has picked up of late and will continue to improve. However, this may not be sufficient to revive the mainland’s economy. China’s growth decelerated in 2014-2015 and industrial commodities prices dwindled, despite robust growth in infrastructure investment at the time (Chart I-7). The culprit was the decline in property construction in 2014-2015. As to the property market, the People’s Bank of China’s (PBoC) Pledged Supplementary Lending (PSL) financing points to further weakness in property demand in the coming months (Chart I-8). Chart I-7China's Infrastructure Investment And Base Metals Prices Chart I-8China: The Outlook For Residential Property Demand   Moreover, property starts have been surging, yet their completions have been tumbling. This suggests a ballooning amount of work-in-progress on real estate developers’ balance sheets. To be sure, we are not suggesting an absence of bright spots, but at the moment “hard” data do not corroborate broad-based improvement in final demand. It may well be that property developers do not have financing to complete work or that they are reluctant to bring new units to the market amid tame demand. Whatever the case, the mediocre pace of construction activity is negative for suppliers to the construction industry. Government spending: Aggregate government spending in China – including central and local government as well as government-managed funds (GMF) – has been very robust in the past year (Chart I-9). Hence, government spending has not been the reason behind the economic slowdown. Chart I-9China's Aggregate Fiscal Spending For 2019, overall government spending is projected to expand by 11% in nominal terms from a year ago, down from 17% in 2018. The key fiscal risk is shrinking land sales, which account for 86% of GMF revenues. The latter have substantially increased in size and now makeup 27% of aggregate fiscal spending. Local and central government expenditures account for 62% and 11% of aggregate fiscal spending, respectively. If land revenues undershoot, GMF and local governments will not be able to meet their expenditure targets without Beijing altering the former’s borrowing quotas. In brief, fiscal policy may be involuntarily tightened due to a shortfall in land sales revenues before the central government permits local governments to borrow more. Exports: Chinese shipments to the U.S. will recover as China and the U.S. finalize their trade deal. The media is extremely focused on the trade negotiations, and markets have been trading off the headlines. Nevertheless, it is essential to realize that China’s exports to the U.S. make up only 3.6% of the country’s total GDP (Chart I-10). This contrasts with capital spending that accounts for 42% of the mainland’s GDP.  Consequently, we believe the credit cycle that drives construction and capital spending is more important to China’s growth than its shipments to the U.S. Global ex-China Demand: The areas of global final demand that weighed on global growth last year remain depressed. Global semiconductors and auto sales have been shrinking at a rapid pace and have so far not experienced a reversal (Chart I-11). Chart I-10China Is Not Reliant On Exports To The U.S. Chart I-11Global "Hard" Data Are Still Bad   Bottom Line: There is a lack of pertinent “hard” business cycle data in China that have improved. What Does It All Mean Having reviewed final demand conditions in China, it is reasonable to argue that the improvement in the Chinese and Taiwanese manufacturing PMIs could be due to inventory re-stocking. Unfortunately, in China, there is limited reliable data that quantifies inventory levels well in various industries. Having reviewed final demand conditions in China, it is reasonable to argue that the improvement in the Chinese and Taiwanese manufacturing PMIs could be due to inventory re-stocking. The consensus view in the investment community is that China’s credit stimulus has boosted the economy since the beginning of this year. Business conditions have certainly improved. The rally in Chinese stocks has in turn mirrored this improvement. Yet it is not clear that this revival in the business cycle is due to the credit stimulus. Chart I-12 plots the credit impulse, including local government general and special bonds issuance, with the three typical business cycle variables: manufacturing PMI and nominal manufacturing production growth. Chart I-12China: Credit Impulse Leads "Hard" Data As can be seen from the chart, the manufacturing PMI is very volatile. In the short term, there is little correlation between it and the credit impulse (Chart I-12, top panel). Meanwhile, the credit impulse leads nominal manufacturing output growth by nine months (Chart I-12, bottom panel). Based on the past time lag relationships, the mainland’s business cycle should not have bottomed until the third quarter of this year. Hence, the bottom in the manufacturing PMIs in January does not fit the historical pattern of the relationship between the credit impulse and the mainland’s business cycle. Bottom Line: Presently, it is hard to make a definite conclusion on the reasons behind the pick-up in Chinese manufacturing. That said, business cycles do not always evolve in a common-sense manner that can be both rationalized and forecast by indicators. Therefore, it is essential for investors, to have confirmation signals from financial markets on the direction of the business cycle. Financial Markets As A Litmus Test We continuously monitor numerous financial markets that are sensitive to both the global and Chinese business cycles. These financial market-based indicators are often coincident with EM asset prices. Hence, they can be used to confirm or refute EM market direction. Our Risk-On-to-Safe-Haven (ROSH) currency ratio has recently softened, flashing a warning signal for EM share prices (Chart I-13). Chart I-13Currency Markets Are Flashing Amber For EM Stocks The ROSH ratio is the relative total return (including carry) of six commodities currencies (AUD, NZD, CAD, CLP, BRL and ZAR) versus two safe-haven currencies: the yen and Swiss franc. Hence, this currency ratio is agnostic to U.S. dollar trends, making its signals especially valuable. Our Reflation Confirming Indicator has retreated, also signaling a pullback in the EM equity index (Chart I-14). This indicator is composed of an equal-weighted average of industrial metals prices (a play on Chinese growth), platinum prices (a play on global reflation) and U.S. lumber prices (a proxy play on U.S. growth). Chart I-14Commodities Markets Are Flashing Amber For EM Stocks Within EM credit markets, corporate investment-grade spreads have begun narrowing versus high-yield spreads (Chart I-15). This typically coincides with lower EM share prices. Finally, EM share prices have been underperforming DM since late December. Relative performance of EM ex-China stocks against the global equity index has been even more underwhelming. In short, these markets are at a critical juncture. A decisive breakout will entail a lasting rally, while a failure to break out will signal imminent downside risk. Bottom Line: These financial market signals are not consistent with a durable China-led recovery in the global business cycle. Investment Strategy A number of financial markets are currently at a critical juncture. These markets will either break out or break down, with subsequently significant moves. The broad U.S. trade-weighted dollar has been flattish in the past nine months despite falling interest rate expectations in the U.S. and the risk-on market environment. We read this as a sign of underlying strength. The trade-weighted dollar is presently sitting on its 200-day moving average (Chart I-16). Consistent with a flattish trend in the greenback, the U.S. dollar volatility has dropped to very low levels. Exchange rates usually do not trade sideways much longer than that. Hence, the dollar is about to break out or break down and any move will be lasting and large. Chart I-15A Message From EM Corporate Credit Market Chart I-16The U.S. Dollar Is About To Make A Big Move   The Korean won has been forming a tapering wedge pattern from both short-term and long-term perspectives (Chart I-17, top and middle panels). Its volatility has also plunged to a record low (Chart I-17, bottom panel). Chart I-17The Korean Won Is At Crossroads Chart I-18A Stop-Buy On EM Stocks Finally, emerging Asian equities’ relative performance to global stocks is facing an important technical resistance as are copper and oil prices. In short, these markets are at a critical juncture. A decisive breakout will entail a lasting rally, while a failure to break out will signal imminent downside risk. Consistently, China’s “soft” data that has improved markedly yet there is no “hard” data confirmation. Moreover, there is some evidence to suggest that the pickup in the soft data may simply reflect inventory building.   Weighing the pros and cons, we are instituting a stop-buy on our EM strategy: We will turn tactically positive on EM risk assets if the MSCI EM equity index in U.S. dollar terms breaks above 1125, which is 4% above its current level (Chart I-18). Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Malaysia: Keep On Upgrade Watch List Malaysian equities have been underperforming their EM counterparts since 2013 and are now resting around their 2017 lows (Chart II-1). The odds are high that this market’s underperformance is late. Chart II-1Malaysian Stocks Relative to EM Investors should keep Malaysian equities on an upgrade watch list. We upgraded the Malaysian bourse from underweight to neutral in December 2018. In a Special Report published at that time, we argued that the structural outlook for Malaysia had improved, yet the cyclical downturn would persist. The latter did not warrant moving the bourse to overweight. This view is still at play. Economic Slowdown Is Advanced The Malaysian economy has been digesting credit and property market excesses. Property sector: Property sales have declined by 37% since 2010, and prices for some property segments are beginning to deflate (Chart II-2). Similarly, housing construction approvals have slumped severely since 2012. Consumers: Passenger vehicle sales have been falling since 2012 along with households' declining marginal propensity to consume, and retail trade has been very weak (Chart II-3). Chart II-2Property Sector Is Depressed Chart II-3Consumer Sector Is Weak   An ongoing purge of excesses by companies entails lower wage growth and weaker employment, resulting in subdued household income growth. The latter could extend the consumer slump. Business sector: Capital spending growth in real terms has decelerated and may contract. Both profit margins and return-on-equity (ROE) for non-financial publicly listed companies have slumped and are currently resting below their 2008 levels (Chart II-4). This warrants cost-cutting and reduced corporate spending/capital expenditures for now. Chart II-4Corporate Restructuring On The Way? Reduced employment and weak wage growth are negative dynamics for households but positive for companies’ profit margins. Commercial Banks: Malaysian banks remain unhealthy. At 1.5%, their NPLs remain low relative to the credit boom that occurred over the past decade. Moreover, Malaysian banks have been lowering their provisions levels to boost profits. This is an unsustainable strategy. Provided economic growth will remain weak, both NPLs and provisions will rise, hurting banks’ profits and share prices. Banks hold a very large market-cap weighting in this bourse, and the negative outlook for banks’ profits deters us from upgrading this equity market. Purging Excesses: Implications For The Exchange Rate Purging of economic excesses is painful in the short- and medium-term, as it instills deflation. A currency often depreciates during this phase to mitigate the deflationary forces in the economy. However, purging excesses, deleveraging and corporate restructuring are ultimately structurally bullish for a currency. First, corporate restructuring and improved capital allocation lift productivity growth in the long run. The Malaysian economy has been digesting credit and property market excesses. Second, low inflation or outright deflation allow the currency to depreciate in real terms. The Malaysian ringgit is already cheap based on the real effective exchange rate (Chart II-5). Finally, amid deflation and in the absence of widespread bailout of debtors funded by bank loans or excessive government borrowing, cash becomes “king”. Hence, deleveraging is ultimately currency positive. In contrast, pervasive bailouts funded by money creation – i.e., mushrooming money growth – usually undermine residents’ and foreigners’ willingness to hold the currency. A capital flight ensues and the currency plunges. Malaysia in 2015 was the latter case, with the ringgit plummeting as residents converted their ringgits to U.S. dollars (Chart II-6, top panel). Chart II-5The Ringgit Is Cheap Chart II-6Malaysia: 2015 Vs. Now   Presently, the opposite dynamics are at play. The central bank is reducing commercial banks’ excess reserves, domestic private credit growth is weak and residents are not fleeing the ringgit (Chart II-6). In addition, the structural reorientation of the economy from commodities to semiconductors/technology is beginning to bear fruit. As a result, overall trade balance has significantly improved, despite weak commodities prices. This is also positive for the currency. Finally, a more stable (i.e., modestly weaker) exchange rate amid both a global and domestic downturn will allow Malaysia’s central bank to reduce interest rates and smooth the growth slump. This is in contrast to 2015 when capital outflows and the plunging currency did not allow the central bank to reduce borrowing costs. Investment Conclusions We recommend keeping Malaysian stocks on an upgrade watch list for now. We recommend upgrading Malaysian sovereign credit and local currency government bonds from underweight to neutral relative to their respective EM benchmarks A relatively stable ringgit will benefit Malaysia’s local and U.S. dollar bonds. Furthermore, foreign ownership of local bonds has fallen meaningfully, diminishing the risk of future outflows. Ayman Kawtharani, Associate Editor ayman@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Downgrading Brazil: The Honeymoon Is Over In our October 9 report, we upgraded Brazil following the outcome of the first round of presidential elections. We, like the market, gave a benefit of the doubt to the new president. However, the honeymoon is over for President Bolsonaro. The markets are becoming increasingly pessimistic because of the lack of progress on the social security reforms front. It is no secret that Brazil needs bold pension reform to make its public debt sustainable. As things stand now, the public debt dynamic in Brazil is precarious. Two prerequisites for public debt sustainability are (1) for interest rates to be below nominal GDP growth or (2) continuous robust primary fiscal surpluses. Hence, a government can stabilize its debt-to-GDP ratio by either having nominal GDP above its borrowing costs, or by running persistent and sizable primary fiscal surpluses. Neither of these two stipulations are presently satisfied in Brazil. The gap between government local currency bond yields and nominal GDP growth is still very wide (Chart III-1). Meanwhile, the primary fiscal deficit is 1.5% of GDP (Chart III-2). Chart III-1Brazil: An Unsustainable Gap Chart III-2Brazil: Public Debt Dynamics Are Precarious     In the early 2000s, the government stabilized its public debt dynamics by running persistent primary surpluses of about 4% of GDP (Chart III-2, top panel). Will Brazil achieve primary fiscal surpluses in the coming years assuming some form of the pension reform is adopted? It is doubtful. According to the government’s own forecasts, the submitted draft of social security reforms, including the one for the army, will save only BRL190 billion in next four years or 0.7% of GDP per year. The current primary deficit is 1.5% of GDP (Chart III-2). Unless nominal GDP growth and government revenue growth shoot up, the primary deficit will not be eliminated or the primary surplus will be very small. Overall, it seems unlikely that the government’s proposed pension reforms will be sufficient to turn around Brazil’s public debt dynamics in the next several years - barring very strong economic growth that will fill in government coffers. Bottom Line: We are downgrading Brazil from overweight to underweight within EM equity, local currency bonds and sovereign credit benchmarks. Andrija Vesic, Research Analyst andrijav@bcaresearch.com Footnotes Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Overweight (Downgrade Alert) Last fall we felt all of the shoes had dropped in the S&P industrial conglomerates index: industrial conglomerate stalwart GE had cut their dividend to a token to $0.01 per share following awful guidance and the other key constituent members, MMM and HON, noted tariffs and trade wars factoring heavily in their own respective guidance cuts. The market had moved to a deeply negative position with valuations at post-GFC lows which we took as a contrarily positive signal that sentiment had moved too far and we upgraded the index to overweight based on valuations. Our call was somewhat early; GE took another month to reach a 20-yr low. However, since then the index has been smartly outperforming the broad market as GE has surged nearly 50% from the bottom and our expectation of a rerating has largely panned out (second and bottom panels). Bottom Line: With a valuation rerating underway, our contrarian thesis is weakening and we are compelled to add a downgrade alert. We believe this heavily international index would be a key beneficiary of easing in the U.S./China trade tussle which we anticipate to be the catalyst to execute our downgrade alert. The ticker symbols for the stocks in this index are: BLBG: S5INDCX - GE, MMM, HON, ROP.  

Highlights The meaningful improvement in the March manufacturing PMIs (both Caixin and official) all but confirms that a rebound in Chinese economic activity is forthcoming. The odds that investors will look through any near-term economic and/or earnings weakness are directly related to the likely magnitude of the expansion in credit over the coming year, and our research points to the need for the recent pace of credit growth to be sustained in order to stabilize the outlook for earnings. Barring a substantial breakdown in trade talks between China and the U.S., a strong March total social financing release would likely tip the scales in favor of a recommendation to increase Chinese investable stock exposure within a global equity portfolio to overweight. Feature Tables 1 and 2 highlight key developments in China’s economy and its financial markets over the past month. On the growth front, coincident economic activity has sharply converged with our leading indicator for China’s economy, which we highlighted was likely to occur. Looking forward, while we await the March total social financing release later this month for a better sense of the likely magnitude in credit growth over the coming year, the meaningful improvement in the March manufacturing PMIs (both Caixin and official) all but confirms that a rebound in Chinese economic activity is forthcoming. Table 1China Macro Data Summary Table 2China Financial Market Performance Summary​​​​​​​ The likely magnitude of the uptrend in credit is important from an investment strategy perspective, as we have highlighted that weak coincident activity raises the risk of a lagged but meaningful further decline in Chinese earnings per share over the coming few months. The odds that investors will look through any near-term economic and/or earnings weakness are directly related to the ultimate size of the expansion in credit, and our research points to the need for the recent pace of credit growth to be sustained in order to stabilize the outlook for earnings. But the bottom line for investors is that we recently placed Chinese investable stocks (i.e. the MSCI China Index) on upgrade watch, and the March PMI is a step in the direction of a recommendation to increase equity allocation to overweight within a global stock portfolio. Investors should closely watch the March total social financing data (due to be released in mid-April); a strong release, barring a substantial breakdown in trade talks between China and the U.S., would likely tip the scales in favor of a move to overweight. In reference to Tables 1 and 2, we provide several detailed observations concerning developments in China’s macro and financial market data below: Chart 1 shows that coincident economic activity sharply converged in January and February with our leading indicator for China’s economy, as we had argued many times over the past several months was likely to occur. In our view, most if not all of the previously beneficial tariff front-running effect has probably washed out of the data, implying that future changes in activity measures are now more likely to reflect actual changes in underlying economic circumstances. Chart 1A Convergence That We Predicted The components of our LKI leading indicator continue to point to divergent outcomes for the Chinese economy (Chart 2). Monetary conditions have weakened somewhat over the past few months, but remain quite easy relative to history. The credit components bounced in January but are still weak relative to their history, whereas money growth is extremely weak and has shown no sign of improvement. Barring a major rise in the RMB, a continuation in the recent pace of credit growth would likely be enough to cause our leading indicator to trend higher, particularly if money growth begins to pick up. Chart 2An Uptrend In Credit Growth Will Push Our Leading Indicator Higher We noted in our March 13 Weekly Report that growth in residential floor space started was unsustainably strong,1 and the January/February data update confirmed this view. Growth in starts has decelerated by 10 percentage points from December to February, highlighting that housing construction cannot permanently decouple from sales volume and that a further deceleration is possible unless sales growth (which is currently negative) begins to pick up. The PMI rebound in March registers as one of the most important macro developments since the release of the January total social financing data. Both the Caixin and official manufacturing PMI data came in solidly positive for March, rising relative to their February values and surprising consensus expectations to the upside. Chart 3 highlights that the March Caixin data has pushed the series above its post-2010 median, whereas the official PMI has risen to its 40th percentile from essentially its lowest point in the past decade. In our view, the PMI rebound registers as one of the most important macro developments since the release of the January total social financing data, in that it all but confirms that a rebound in (still depressed) Chinese economic activity is forthcoming. Chart 3A Very Sharp Rebound In Both Manufacturing PMIs Despite having rallied significantly from their low, Chinese stocks (both investable and domestic) remain approximately 20% below their early-2018 high in US$ terms. This is in contrast to global stocks, which are only 7% shy of their 2018 high. If Chinese equities can avoid a major earnings recession, this discrepancy underscores that there is further upside for stock prices in relative terms over the coming 6-12 months. For the A-share market, however, Chart 4 highlights a potential near-term roadblock for continued outperformance versus global stocks. The chart highlights that the relative performance trend is now bumping up against the upper end of a declining trend channel that has been in place for almost 4 years, a bearish pattern that is in stark contrast to that of the investable market. Conversely, a break outside of this channel would warrant attention, as it could signal a secular change in trend for the domestic equity market. Chart 4Is The Four Year Downtrend In A-Share Relative Performance Over? Chart 5 highlights that the strange combination of consumer staples and real estate stocks have been the clear sector winners over the past month, both in the investable and domestic markets. Signs of stabilization in consumer spending explains staples outperformance, but the rally in real estate stocks is more difficult to explain given the weakness in housing fundamentals referenced above. For now, our bias is to believe that real estate stocks are benefitting as a value play, given their deep discount relative to both their respective broad markets and their global peers. Chart 5A Sharp Rebound In Staples And Real Estate Stocks China’s 7-day interbank repo rate has increased somewhat over the past month, raising speculation that the PBOC may soon proceed with a generalized cut to the reserve requirement ratio. In our view, the trend in the 3-month interbank repo rate has been more important over the past few years, as it has closely correlated since late-2016 with average interest rates in the economy and sharp declines in the rate last year preceded the pickup in credit growth observed in January. Still, additional easing from the PBOC could be significant for market participants, as it would likely be greeted positively by investors and could further stoke the belief that Chinese credit growth may overshoot to the upside over the coming 6-12 months. A stronger RMB versus the euro will be welcome news for European exporters. In contrast to a significant improvement in domestic equity prices and investor sentiment, Chinese onshore corporate bond spreads have actually inched higher over the past month. While the rise has been comparatively small (8 basis points), spreads now stand at roughly a third of their 12-month range. A rising trend in onshore corporate bond spreads is not consistent with a slower pace of defaults over the coming 6-12 months, suggesting that at least some headwinds facing the Chinese economy will remain over the coming year if the recent trend in spreads continues. While CNY-USD has been largely flat over the past month, CNY-EUR has continued to rise and is now within striking distance of its 2018 high (Chart 6). This is not likely welcome news for Chinese exporters with close ties to Europe, but it may help provide a much-needed trade boost to the European economy over the coming year, whose manufacturing PMI has recently fallen to a six-year low. Chart 6A Stronger CNY-EUR Cross Will Help Boost Chinese Imports From Europe   Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com Footnotes 1 Please see China Investment Strategy Weekly Report, “China Macro And Market Review”, dated March 13, 2019, available at cis.bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations

Two weeks ago, we highlighted that S&P 500 profit margins have likely peaked for the cycle and that our margin proxy, weighed down by mounting concerns over wage growth and nil pricing power, was pointing to a further decline (top panel). We are updating this today to show BCA’s Monetary Indicator (MI) and its confirming negative signal for SPX margins (MI shown inverted, second panel) These profit headwinds have been likely reflected in sell-side estimates that have forward EPS growth rates trailing forward revenue growth rates according to IBES data, implying contracting margins through the first nine months of the year. Including the slight year over year margin contraction in Q4/18, this means a full calendar year of falling margins. Grinding lower margins are a cause for short-term concern. Nevertheless, from a cyclical perspective we reiterate two important points: first, unit labor costs – the best measure of wage growth – remain muted as productivity growth has ramped up recently. Second, using empirical evidence dating back to the 1960s, the ultimate SPX profit margin mean reversion occurs during recessions, when EPS suffer a major setback; as a reminder, BCA’s review remains that the U.S. will avoid recession in the next 12 months. Thus, despite a near-term margin soft patch, we expect a mid-year margin inflection point courtesy of EPS growth green-shoots (please refer to Chart 3 from the March 18th Weekly Report). ​​​​​​​

Feature GAA DM Equity Country Allocation Model Update The GAA DM Equity Country Allocation model is updated as of March 29, 2019. The quant model has not made changes in the direction of underweights and overweights compared to last month. However, the magnitude of the U.S underweight was reduced, so was that of the overweights in Spain and Germany, as shown in Table 1. Table 1Model Allocation Vs. Benchmark Weights As shown in Table 2 and Charts 1 - 3, the overall model underperformed the MSCI world benchmark by 44 bps in March, with a 45 bps of underperformance from the Level 2 model and a 20 bps of underperformance from Level 1. What has contributed to such an underperformance? As shown in Chart 4, directionally, 7 out of the 12 country allocations generated positive alpha, however, the negative value added from the overweights in Germany and Spain overwhelmed all the positives. This shows again that quant models with a “systematic” approach cannot fully capture “atypical” conditions in the market place. This is one of the reasons that we use (and also have suggested our clients to use) our quant models as a starting point in the decision-making process, but to use them together with human judgement. Table 2Performance (Total Returns In USD %) Chart 1GAA DM Model Vs. MSCI World   Chart 2GAA U.S. Vs. Non U.S. Model (Level 1)     Chart 3GAA Non U.S. Model (Level 2) Please see also the website http://gaa.bcaresearch.com/trades/allocation_performance. For more details on the models, please see Special Report, “Global Equity Allocation: Introducing The Developed Markets Country Allocation Model,” dated January 29, 2016, available at https://gaa.bcaresearch.com. Please note that the overall country and sector recommendations published in our Monthly Portfolio Update and Quarterly Portfolio Outlook use the results of these quantitative models as one input, but do not stick slavishly to them. We believe that models are a useful check, but structural changes and unquantifiable factors need to be considered too in making overall recommendations.   GAA Equity Sector Selection Model The GAA Equity Sector Model (Chart 5) is updated as of March 29, 2019. Chart 5Overall Model Performance Table 3Model’s Performance (March 1, 2019 - Current) Table 4Current Model Allocations   Following the changes implemented and the model relaunch last month, the model continues to maintain a slightly cyclical stance by overweighting Industrials and Materials. The relative tilts within cyclicals and defensives remains the same as the previous month. Global growth concerns still prevent the model from being outright bullish on cyclicals. The valuation component remains muted across all sectors. The model is still overweight Utilities due to positive inputs from its momentum and liquidity components. For more details on the model, please see the Special Report “Introducing the GAA Equity Sector Selection Model,” dated July 27, 2016, as well as the Sector Selection Model section in the Special Alert “GAA Quant Model Updates,” dated March 1, 2019 available at https://gaa.bcaresearch.com.   Xiaoli Tang, Associate Vice President xiaoliT@bcaresearch.com Amr Hanafy, Research Associate amrh@bcaresearch.com