Asia

Feature Chinese stocks remain in limbo despite robust economic data in April and early May (Chart 1).  Onshore equities are pricing in policy tightening risks and a peak in the domestic economic cycle. Meanwhile, a regulatory clampdown on the tech sector continues to curb global investors’ enthusiasm towards Chinese investable stocks.  The PBoC has not changed its course of policy normalization. The falling 3-month SHIBOR since March likely reflects softening demand for interbank liquidity rather than monetary easing (Chart 2). Chart 1Stay Underweight Chinese Stocks Stay Underweight Chinese Stocks Stay Underweight Chinese Stocks Chart 2No Easing In Monetary Policy No Easing In Monetary Policy No Easing In Monetary Policy Fiscal policy has also been consolidating with a renewed focus on reducing local government debt load and financial risks. A delay in local government bond issuance in Q1 could potentially boost bond sales in the second half of the year. However, as we noted late last month, without a synchronized policy push for more bank loans and loosened regulations on provincial government spending, an increase in special-purpose bond issuance alone will not make a significant difference in infrastructure investment nor economic growth. We still expect China's economy, which lags the credit cycle by six to nine months, to start weakening by mid-2021 (Chart 3A & 3B). Chart 3ADomestic Economic Growth Set To Slow Domestic Economic Growth Set To Slow Domestic Economic Growth Set To Slow Chart 3BPolicy Tightening Will Weigh On Earnings Growth In 2H21 Policy Tightening Will Weigh On Earnings Growth In 2H21 Policy Tightening Will Weigh On Earnings Growth In 2H21   Qingyun Xu, CFA Associate Editor qingyunx@bcaresearch.com   Our BCA Li Keqiang Leading Indicator continues to fall despite a marginal improvement in the Monetary Conditions Index (MCI) component. The deceleration in both money supply and credit growth has more than offset a small uptick in the MCI (Chart 4). Furthermore, a rising RMB in trade-weighted and real terms will not help the profit outlook for China’s exporters (Chart 5). Overall, monetary conditions remain unfavorable for risk assets. This is consistent with the poor performance of Chinese stocks Chart 4Falling Credit And Money Growth More Than Offset A Minor Improvement In The MCI Falling Credit And Money Growth More Than Offset A Minor Improvement In The MCI Falling Credit And Money Growth More Than Offset A Minor Improvement In The MCI Chart 5Strengthening RMB Will Not Help The Profit Outlook For Chinese Exporters Strengthening RMB Will Not Help The Profit Outlook For Chinese Exporters Strengthening RMB Will Not Help The Profit Outlook For Chinese Exporters   A sharp jump in state-owned enterprise (SOE) defaults since late last year is due to deteriorating corporate balance sheets. The defaults have exposed the weakened fiscal positions of local governments (Chart 6 & 7). SOE bond defaults have surpassed the number of private bond defaults this year. The more restrictive policy on local government financing, together with an acceleration in SOE defaults, will weigh on spending by local governments, local government financing vehicles (LGFVs) and SOEs.  Chart 6Returns On SOE Assets Remain In Deep Contraction Returns On SOE Assets Remain In Deep Contraction Returns On SOE Assets Remain In Deep Contraction Chart 7SOE Bond Defaults Have Surpassed Private Bond Defaults China Macro And Market Review China Macro And Market Review The Politburo meeting on April 30 established new guidelines to reduce local government leverage, both on- and off-balance sheet debt. According to the new rules, local governments are strictly prohibited from obtaining “hidden debts” for new investment projects directly or through their affiliated SOEs, which include LGFVs. The directives also state that the assets of LGFVs with defaulted loans should be restructured or liquidated if companies are unable to repay their debts. In addition, financial institutions should not accept government guarantees when making decisions on lending to LGFVs or government related entities.  Moreover, stricter measures in the property market have further dampened local governments’ fiscal situations since land sales account for 53% of local government fiscal revenues. Growth in government expenditures decelerated in recent months along with slowing land auctions (Chart 8). Scaled down fiscal supports will lead to subdued infrastructure investment growth this year (Chart 9). Chart 8Fiscal Stance Has Tightened Fiscal Stance Has Tightened Fiscal Stance Has Tightened Chart 9Subdued Growth In Infrastructure Investments Subdued Growth In Infrastructure Investments Subdued Growth In Infrastructure Investments   In addition to policy tightening in the domestic economy, Chinese offshore stocks continue to face regulatory headwinds to root out monopolies in technology, media, and telecom (TMT) companies. The antitrust investigations and fines extending from Alibaba and Tencent to Meituan highlight China’s aim to curb platform oligopolies and monopolies. Meanwhile, Chinese tech firms listed on US exchanges are facing another regulatory threat on their accounting reporting standards, which could potentially result in their delisting from the US bourses.  Moreover, elevated valuations and a weakening in the earnings outlook will generate more downside risks for TMT stocks (Chart 10). Given that TMT stocks account for around 50% of the MSCI China Index’s market capitalization, Chinese investable stocks are disproportionally vulnerable to a selloff in TMT stocks (Chart 11). Chart 10ATMT Stocks: From Tailwind To Headwind TMT Stocks: From Tailwind To Headwind TMT Stocks: From Tailwind To Headwind Chart 10BTMT Stocks: From Tailwind To Headwind TMT Stocks: From Tailwind To Headwind TMT Stocks: From Tailwind To Headwind Chart 11MSCI China Is Highly Concentrated In TMT Stocks MSCI China Is Highly Concentrated In TMT Stocks MSCI China Is Highly Concentrated In TMT Stocks   China’s official PMI and the Caixin China PMI moved in opposite directions in April due to the nature of the two surveys. The Caixin PMI covers smaller, more export-oriented businesses while the NBS Manufacturing PMI includes larger, more domestically exposed companies. The divergence highlights that the domestic economy is losing speed while external demand remains robust (Chart 12). Given the dominance of domestic demand in China’s economy (investment expenditures, household spending and government spending), strong external demand will not fully offset the deceleration in domestic growth.  New orders and production subcomponents in the official PMI moderated in April from March, which indicates a slowing momentum in economic activity (Chart 13). Moreover, construction PMI fell to 57.4 from 62.3 in March, corresponding with weaker infrastructure spending and more policy tightening in the real estate sector (Chart 13, bottom panel). Chart 12Conflicting Messages From The NBS And Caixin PMIs Conflicting Messages From The NBS And Caixin PMIs Conflicting Messages From The NBS And Caixin PMIs Chart 13Slowing Momentum In China's Economic Activity Slowing Momentum In China's Economic Activity Slowing Momentum In China's Economic Activity   The moderating momentum in China’s economy is also reflected in April’s trade data, which showed a strengthening external sector and a slowing domestic demand. A few observations support our view: First, strong imports since early this year were partly due to robust re-exports. Solid external demand boosted processing imports, which in turn contributed to China’s overall import growth (Chart 14). Secondly, Chinese imports of commodities in volume, such as copper and steel products, have plunged recently. Chinese domestic demand for commodities will likely peak in the coming months, therefore, inventory destocking pressures and weakness in underlying consumption will threaten commodities prices (Chart 15). Finally, the strengthening of coal imports in volume terms may be related to China’s increasingly stringent environmental policies. A temporary cutback in domestic coal supply boosted the demand for imports. However, in the long run, China’s push for green energy will be bearish for Chinese coal imports (Chart 16). Chart 14Solid External Demand Boosted Processing Imports Solid External Demand Boosted Processing Imports Solid External Demand Boosted Processing Imports Chart 15Demand Of Commodities May Be Approaching A Cyclical Peak Demand Of Commodities May Be Approaching A Cyclical Peak Demand Of Commodities May Be Approaching A Cyclical Peak Chart 16China's Coal Imports Likely To Decline In The Long Run China's Coal Imports Likely To Decline In The Long Run China's Coal Imports Likely To Decline In The Long Run   Housing prices in tier-one cities continue to post major gains despite a slew of tightening regulations in the property sector introduced since the second half of last year (Chart 17). The Politburo meeting last month reiterated authorities’ concerns over a bubble in housing. We expect authorities to impose additional regulations to constrain both financing supply and demand in the property sector. In the meantime, the existing policies have successfully started to cool the real estate market.  Chart 17Skyrocketing Housing Prices In First-Tier Cities Skyrocketing Housing Prices In First-Tier Cities Skyrocketing Housing Prices In First-Tier Cities Chart 18Real Estate And Mortgage Loans Tumbled Under More Restrictive Borrowing Regulations Real Estate And Mortgage Loans Tumbled Under More Restrictive Borrowing Regulations Real Estate And Mortgage Loans Tumbled Under More Restrictive Borrowing Regulations Both mortgage loans and loans to real estate developers tumbled under more restrictive borrowing policies (Chart 18). Growth in home sales has also started to roll over (Chart 19). Housing completed has dropped significantly, which confirms that construction activity is decelerating. Looking forward, the reduced expansion rate of new projects due to shrinking land transfers and stricter borrowing regulations will further dampen construction activities in the second half of this year (Chart 20).   Chart 19Home Sales Growth Started To Ease Home Sales Growth Started To Ease Home Sales Growth Started To Ease Chart 20Real Estate Investments Are Set To Slow Further Real Estate Investments Are Set To Slow Further Real Estate Investments Are Set To Slow Further Table 1China Macro Data Summary China Macro And Market Review China Macro And Market Review Table 2China Financial Market Performance Summary China Macro And Market Review China Macro And Market Review ​​​​​​​   Footnotes Cyclical Investment Stance Equity Sector Recommendations

Highlights The Singapore dollar has come full circle and has cheapened massively in real terms. This has boosted the economy’s competitiveness. The country is attracting record amounts of FDI inflows. This should benefit manufacturing and new economy sectors, boosting productivity and income growth. A very large weight of value stocks in the Singapore bourse and rising global interest rates have set this market on a course to outperform the EM and global markets. Asset allocators should overweight this market in an EM or Asian equity portfolio. Absolute return investors should go long Singaporean stocks outright. Feature Chart 1Singapore Stocks Underperformance Is Over Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Singapore stocks have been underperforming their emerging markets peers since 2015. The pandemic deepened this further - leading this bourse to all-time lows vis-à-vis their EM counterparts (Chart 1). The question is, can Singapore stocks begin outperforming the EM benchmark on a sustainable basis? We believe that the tide has turned; and are upgrading Singapore from neutral to overweight for EM and Asian equity portfolios. In this report we will explain the regime shifts that the country’s macro backdrop underwent over the past several years, and how that could benefit Singaporean stocks going forward. A Form Of Dutch Disease?  Singapore has undergone some profound macro shifts over the past 15 years in its currency competitiveness. Beginning in 2005, the Singapore dollar went on to become a very expensive currency in the decade that followed. That changed the structure of its economy. Since 2015, the currency has embarked on a secular downtrend in real effective exchange rate terms – practically giving up all the gains of the previous decade (Chart 2). And this has begun to change the economy again – in a different direction. Chart 2The Singapore Dollar Has Come Full Circle Since 2005 Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight To recognize the likely implications of it all, we need to understand what led to such regime shifts in the first place. The answer lies partly in the manner in which monetary policy is conducted in Singapore. The Monetary Authority of Singapore (MAS) uses the Singapore dollar,1 rather than interest rates to achieve its monetary policy objective: to maintain price stability. By doing this, it lets the domestic interest rates find their own equilibrium. To give an example of MAS’s framework, when inflation rises, it guides the trade-weighted Singapore dollar to appreciate. They do the opposite when inflation falls. While this method (a rising inflation to be tackled by a stronger currency) can work to rein in inflation, the combination of higher inflation and an appreciating currency can make the latter expensive in real terms vis-à-vis other currencies. In fact, this is what happened to the Singapore dollar between 2005 and 2015 – a period when inflationary pressures were higher. Attempts to counter rising inflation by pushing up the Singapore dollar led to a very overvalued currency, especially in real terms. In other words, the inflation-adjusted “real effective exchange rate” rose significantly (Chart 2). A strong currency in nominal terms can help rein in inflation, but a strong currency in real terms hurts a country’s competitiveness. There was another issue. While MAS’s framework was able to somewhat contain the general inflationary pressures in the economy (i.e. goods and services inflation), it could not contain the rising labor costs (wages). Compounding the problem, Singapore’s productivity growth rate dropped a notch in the mid-2000s as the country veered towards the services sector at the expense of industries (Chart 3). The reason for the drop is that productivity gains are much harder to achieve in services sectors than in industrial sectors. Indeed, Singapore’s productivity levels began to fall relative to its ASEAN neighbors around 2005 (Chart 4). Chart 3When Singapore Veered Towards The Service Sector In The Mid-2000s... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 4...Its' Productivity Growth Rate Dropped A Notch... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight   Rising wages in conjunction with lower productivity gains led to a steep increase in the unit labor cost (ULC) of the firms. Since employee compensation is a major component of any company’s overall cost structure, the ULC matter for a company much more directly than consumer prices. Hence, real exchange rates measured using the ULC are more representative of currency competitiveness than consumer prices. Measured as such, the Singapore dollar had become extremely pricey in real terms by 2015 (Chart 5). An expensive currency can chip away at the external competitiveness of firms. Singaporean exports made a secular peak (as a % of GDP) in 2005 – coinciding with the bottom in the real exchange rates (Chart 6). Chart 5...Leading To Higher Unit Labor Costs, And A Very Expensive Currency... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 6...That Weighed On The Country's Exports Competitiveness... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 7...As Well As On Its Manufacturing Sectors Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Closer to home, the expensive currency weighed much more on the country’s goods-producing industries than it did on services-producing ones. Not surprisingly, the manufacturing sector also reached a secular high at 28% of GDP in 2005 – when the real exchange rate had begun to climb (Chart 7). Over the following decade, goods-producing firms experienced eroding profitability. As a result, the manufacturing and exports sectors lost prominence in Singapore stock indexes. From a high of 28% of market cap in 2011, the industrial sector is down to 8% today on the MSCI Singapore index. The share of consumer durables and staples is down from 20% back then to 6% now.  The Tides Have Turned Singapore’s real exchange rate eventually peaked in 2015 as global macro backdrop changed. Growth in China and the rest of the ASEAN slowed. Global trade and commodity prices fell. The growth slump in Asia and global trade reduced inflationary pressures in this very open economy (Chart 8). Core CPI, that is monitored by MAS, has averaged 1% since 2014 – compared to 2% between 2005 and 2014 – and is well below MAS’s implicit target of 2%. So are the wages: unit labor costs in level terms have been flat to down during the same period. With inflation now firmly under control, MAS has had no reason to push up its currency anymore. Tame inflation and a nominal currency depreciation led to a steep decline in Singapore’s real exchange rate since 2015. Indeed, in level terms, the real exchange rate has now cheapened to 20-year lows (Chart 5, above).  This is a bullish development for the country’s external competitiveness: As the currency became more competitive, it encouraged more FDI inflows. At 16% of GDP, net FDI is now at an all-time high. Recent political turmoil in Hong Kong has also diverted some FDI to Singapore. These tailwinds are likely to persist.  A cheaper currency can rejuvenate Singapore’s manufacturing sector. Large FDI inflows will boost productivity and, hence, long-term income growth. The income growth that it will generate will in turn benefit services sectors like banking and real estate (Chart 9).    Chart 8Muted Goods And Wage Inflation Have Again Made The Currency Very Competitive... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 9...Attracting Record Amounts Of FDI Inflows Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight   What Drives Singapore Stocks? Chart 10Bank And Real Estate Share Prices Are Linked To The Domestic Economy In General... Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight The MSCI Singapore index is now dominated by banks and real estate companies – who together make up 75% of the market cap. The city state is also a global financial and trading hub. Yet its stock market is driven by the growth in domestic non-financial sectors – just like most other economies: Domestic borrowers make up a major chunk of the loan books of listed Singaporean banks, even after their geographic diversification over the years. The ebbs and flows of the domestic economy therefore dictate the profits and share prices of the banks. The top panel of Chart 10 shows that manufacturing growth, or the absence thereof, has a strong bearing on bank stocks’ absolute performance. The other major stock market sector, real estate, is also leveraged to domestic economy. This is evident in stock performance vis-à-vis several non-financial activities such as industrial production and domestic2 exports. When the latter do well, so do real estate firms’ share prices (Chart 10, bottom panel) Notably, even though manufacturing has fallen over the past 15 years, at 22%, it is still the Singapore economy’s largest sector. By comparison, finance and insurance make up 14%, and real estate 3% of the output. As such, what happens in the manufacturing sector has a meaningful impact on the tertiary sectors like banking and real estate. Singapore is also a very open economy where exports of goods make up 110% of GDP, while exports of services make up 55% of GDP. Therefore, manufacturing and export growth drive income for the overall economy and, in turn, stock market cycles. Chart 11provides evidence of how rising new orders boosts the overall stock market, while the lack thereof hurts it. One reason Singapore markets sharply underperformed since late 2019 was due to the dominance of banking and other “old economy” stocks in the index and a lack of new economy ones (such as Alibaba, Tencent, Samsung, TSMC etc.). A substantial drop in global interest rates had benefitted the latter immensely, until very recently. Going forward, as global value stocks begin to outperform global growth ones, Singaporean stocks are well placed to outperform the EM and global equity indexes. While the pandemic has hit Singapore’s banking sector hard, the negative fallouts are mostly priced in. Banks have already set aside a large amount for loan loss provisions – which caused a 30% year-over-year contraction in their earnings. In the months ahead, as the local and global economies gradually re-open, credit demand will resume – benefiting bank stocks. The Singapore banking sector is facing another tailwind. A rising share of the gross value added in the country’s finance and insurance sectors has been accruing to the capital owners (as opposed to providers of labor, i.e. employees) (Chart 12). This is beneficial for this sector’s stock prices. The ongoing automation and digitalization of finance will continue benefiting shareholders more than employees. Hence, the share of bank income going to shareholders will continue rising versus labor compensation.  Chart 11...And The Manufacturing Sector In Particular Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 12A Rising Share Of Output Going To Owners Is Bullish For Bank Stocks Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight   Finally, stronger economic activity will also boost the real estate stocks. A lot of bad news is already priced in this sector – in which saw a massive 80% contraction in earnings. Investment Conclusion Interest rates are already rising around the world. Chart 13 shows that rising interest rates from low levels benefit Singapore stocks. The reason for that is it indicates growth is firming up. In that sense, Singaporean banks are more akin to Developed Market (DM) banks – which benefit from rising interest rates, rather than EM banks – which usually do not. This is because of the inflationary backdrop, and therefore interest rate levels in Singapore resemble more a DM economy rather than a typical EM economy. Singaporean banks are considered among the most efficient and with the cleanest balance sheets among banking sectors across the EM. This is also borne out by their steady outperformance relative to EM banks over the past 15 years (Chart 14). Chart 13Rising Interest Rates From Low Levels Foreshadow Higher Stock Prices Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Chart 14Bank And Real Estate Firms Have Long Outperformed Their EM Counterparts Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight   Singapore real estate stocks have also displayed steady outperformance versus their EM counterparts (Chart 14: bottom panel). All of this is unlikely to change anytime soon. A competitive currency should help manufacturing and attract more FDI, including in new economy sectors. This will support productivity and income growth – benefitting the overall economy and the stock market. The fact that Singapore index is heavily weighted in banks and old economy stocks that are slated to outperform; and that its banks have been among the best performers in EM – makes this bourse a strong candidate for overweighting. Chart 15Rising US Treasury Yields Are A Good Omen For Singapore Stocks' Relative Performance Singapore Stocks: Upgrade To Overweight Singapore Stocks: Upgrade To Overweight Investors therefore should upgrade this market to overweight in an Asian or EM equity portfolio. Absolute return investors should go long Singapore stocks outright. Singapore will also likely outperform other Developed Markets such as the US. Chart 15 shows that periods of rising US interest rates usually coincide with Singapore stocks outperforming their global counterparts. Moreover, the dominance of value stocks in the Singapore index and the extremely expensive new economy stocks in US indexes means Singapore’s long period of underperformance is coming to an end. The Singapore dollar cross versus the US dollar is likely to stay flattish. The absence of local inflation precludes any attempt from MAS to guide it upwards. At the same time, a strong balance of payment will put a floor under the currency. Rajeeb Pramanik Senior EM Strategist rajeeb.pramanik@bcaresearch.com   Footnotes 1 Against a trade-weighted basket of currencies. 2 Domestic exports are the ones that originate in Singapore, as opposed to re-exports which originate from a foreign country for onward exporting to another country.

Highlights US natural gas prices will remain well supported over the April-October injection season, as the global economic expansion gains traction, particularly in Europe, which also is refilling depleted storage levels. China's natgas demand is expected to rise more than 8% yoy, and EM Asia consumption also will be robust, which will revive US liquified natural gas (LNG) exports. Exports of US light-sweet crude into the North Sea Brent pricing pool – currently accounting for close to half the physical supply underpinning the global oil-price benchmark – also will increase over the course of the year, particularly in the summer, when maintenance will markedly reduce the physical supply of crudes making up the Brent index. At the margin, coal demand will increase in the US, as industrial natgas demand and LNG exports incentivize electric generators to favor coal. Higher-than-expected summer temperatures in the US also would boost coal demand.  This will be tempered somewhat in Europe, where carbon-emissions rights traded through €50/MT for the first time this week on the EU's Emission Trading System (ETA). We expect US LNG and oil exports to revive this year (Chart of the Week) and remain long natgas in 1Q22. Feature The importance of US LNG and crude oil exports out of the US Gulf to the global economy is only now becoming apparent. As demand for these fossil fuels grows and the supply side continues to confront a highly uncertain risk-reward tradeoff, their importance will only grow. In natgas markets, US LNG cargoes out of the US Gulf balanced demand coming from Asia and Europe this past winter, which was sharply colder than expected and stretched supply chains globally. As a widening economic recovery from the COVID-19 pandemic spurs industrial, residential and commercial demand, and inventories in Europe and Asia are re-built in preparation for next winter, US LNG exports will be called upon to meet increasing demand, particularly since they are priced attractively vs regional importing benchmarks, with differentials vs the US presently $4+/MMBtu vs Europe and $5+/MMBtu vs Asia (Chart 2).1 Chart of the WeekUS LNG, Oil Export Growth Will Rebound US LNG, Oil Export Growth Will Rebound US LNG, Oil Export Growth Will Rebound Chart 2Lower US Natgas Prices Encourage LNG Exports Importance Of US Gas, Oil Exports Increases Daily Importance Of US Gas, Oil Exports Increases Daily In oil markets, an ongoing kerfuffle in the pricing of Brent Blend brought about by falling North Sea crude oil production makes American light-sweet crude oil exports from the Gulf (i.e., WTI produced mostly in the Permian Basin) account for almost half of the physical supplies in this critical benchmark-pricing market.2 US LNG Exports Will Increase US natural gas prices will remain well supported as the global economic expansion gains traction, and the US and Europe open the April-October injection season well bid (Chart 3). US inventories are expected to end the Apr-Oct injection season at just over 3.7 TCF according to the EIA, very close to where they ended the 2020 injection season. Chart 3US, Europe Rebuild Storage Importance Of US Gas, Oil Exports Increases Daily Importance Of US Gas, Oil Exports Increases Daily Higher US LNG exports, industrial, commercial and residential demand will be offset by lower consumption from electric generators this year, netting to a slight decline in overall demand. The EIA expects generators to take advantage of lower generating costs to be had burning coal to produce electricity, a view we share given the current differentials in the forward curves for each fuel (Chart 4).3 On the supply side, the EIA's expecting output to remain unchanged from last year at just under 91.5 BCF/d in 2021. Higher LNG exports, even as generator demand is falling, pushes prices higher this year – averaging $3.04/MMBtu this year – which leads to a slight increase in output in 2022. For our part, we continue to expect higher prices during the November-March heating season than currently are clearing the market and remain long 1Q22 $3.50/MMBtu calls vs. short $3.75/MMbtu calls. As of Tuesday night, when we mark to market, this position was up 20.8% since inception on 8 April 2021. Chart 4Lower Prices Will Favour Increased Coal Demand Lower Prices Will Favour Increased Coal Demand Lower Prices Will Favour Increased Coal Demand Natgas demand could surprise on the upside during the injection season if air-conditioning demand comes in stronger than expected and production remains essentially unchanged this year. This could reduce LNG exports and slow the rate of inventory refill in the US, which could further advantage coal as a burner fuel for generators in the US. The US National Weather Service's Climate Prediction Center expects above-average temperatures for most of the US population centers this summer (Chart 5). This could become a semi-permanent feature of the market if current temperature trends persist (Chart 6). Based on analyses’ run by the NOAA's National Centers for Environmental Information, 2021 "is very likely to rank among the ten warmest years on record," with lower (6%) odds of ranking in the top five hottest years on record.4 Chart 5Odds Of Hotter Summer Rising Importance Of US Gas, Oil Exports Increases Daily Importance Of US Gas, Oil Exports Increases Daily Chart 6Higher Global Temperatures Could Become A Recurring Phenomenon Importance Of US Gas, Oil Exports Increases Daily Importance Of US Gas, Oil Exports Increases Daily The Crude Kerfuffle As the Chart of the Week shows, US exports of light-sweet crude oil peaked at ~ 3.7mm b/d in February 2020, just before the COVID-19 pandemic hit the world full force. Exports out of the US Gulf – i.e., WTI priced against the Midland, TX, gathering hub – accounted for ~ 95% of these volumes. With exports currently running ~ 2.5mm b/d, more than 1mm b/d of readily available export capacity remains in place. Additional volumes will be developed as dredging of the Corpus Christi, TX, progresses. While the surge in US crude oil production has subsided in the wake of the pandemic, it most likely will revive as the markets return to normal operating procedure, additional dredging operations are completed, and storage facilities are built out.5 Existing and additional export capacity of the US's light-sweet crude could not arrive at a more opportune time for the Brent market, which remains in a state of uncertainty as to whether markets will have to adjust to CIF contracts or a work-around to the existing FOB pricing regime, which can be augmented to accommodate increasing WTI volumes.6 This will have to be sorted, as this is the future of the market's most important pricing index (Chart 7). The buildout in crude-oil exporting capacity – and natgas LNG exporting capacity, for that matter – ideally accommodates shale-oil- and -gas assets, which can be ramped up quickly to meet demand, and ramped down quickly as demand falters. The quick payback – 2 to 3 years – on these investments allow the producers to expand and contract output without the massive risks longer-lived conventional assets impose. As OPEC 2.0's spare capacity is returned to the market, this will be a welcome feature of a market that most likely will require oil and gas supplies for decades, despite the uncertainty attending oil-and-gas capex during the transition to a low-carbon energy future. Chart 7Permian Replaces North Sea Losses Permian Replaces North Sea Losses Permian Replaces North Sea Losses Bottom Line: As the future of hydrocarbons evolves, the LNG and crude oil exported from the US Gulf will occupy an increasingly important role in these markets. Oil and gas producers are making capex decisions under increasingly uncertain conditions, which favor exactly the type of resources that have propelled the US to the position of the world's largest producer of these fuels – i.e., shale-oil and -gas. Production from these resources can be ramped up and down quickly as prices dictate, and have quick paybacks (2-3 years), which means capital is not tied up for decades as a return is earned.7   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish OPEC 2.0 begins returning 2mm b/d to the market this month, expecting to be done by July. Half of these volumes are accounted for by Saudi Arabia, which voluntarily cut output by 1mm b/d earlier in the year to help balance the market. In line with our maintained hypothesis that OPEC 2.0 prefers prices inside the $60-$70/bbl price band, we expect the return of curtailed production to be front-loaded so as to bring prices down from current levels approaching $70/bbl for Brent (Chart 8). If, as we expect, demand recovers sooner than expected as Europe leans into its vaccination program, additional barrels will be returned to the market to get prices closer to a $60-$65/bbl range. Base Metals: Bullish The International Copper Study Group (ICSG) forecast copper mine production will increase by ~ 3.5% in 2021 and 3.7% in 2022, after adjusting for historical disruption factors. This forecasted increase – after three years of flat mined production growth – is due to a ramp-up of recently commissioned and new copper mines becoming operational in 2021. An improvement in the pandemic situation by 2022 will also boost mined copper production, according to the ICSG. 2020 production remained flat as recoveries in production in some countries due to constrained output in 2019 balanced the negative impacts of the pandemic in others. In Chile, the largest copper producer, state-owned Codelco and Collahuasi reported strong results in March. However, this was countered by a continued downturn at BHP’s Escondida. The world’s largest copper mine saw a drop in production for the eighth consecutive month. This mixed output resulted in a decline in total production of 1.2% year-on-year in March. Precious Metals: Bullish COMEX palladium touched a record high during intraday trading on Tuesday, reaching $3,019/oz due to continued tight market conditions (Chart 9). On the supply side, Nornickel is recovering from flooded mines, which occurred in February. By mid-April, one of the two affected mines was operating at 60% capacity; however, the company's other mine is only expected to come back online by early June. On the demand side, strength in US vehicle sales and a global economic recovery from the pandemic buoyed the metal used in catalytic converters. Palladium prices closed at $2,981.60/oz on Tuesday. Ags/Softs: Neutral Corn again traded above $7/bu earlier in the week on the back of drought-like dry weather conditions in Brazil's principal growing regions and surging US exports, according to Farm Futures. Chart 8 Brent Prices Going Up Brent Prices Going Up Chart 9 Palladium Prices Going Up Palladium Prices Going Up   Footnotes 1     Stronger demand from China – where consumption is expected to rise more than 8% yoy – and EM Asia will continue to support LNG demand through the year.  S&P Global Platts Analytics expects Chinese natural gas demand to reach 12,713 Bcf in 2021, up 8.4% from the previous year.  Chinese national oil company Sinopec is slightly more conservative in its outlook, expecting gas demand of ~ 12,006-12,184 Bcf in 2021, up 6-8% from 2020.  China’s average annual increase in natural gas demand is expected to exceed 716 Bcf in the 14th FYP and reach 15,185 Bcf in 2025. 2     Please see CIF Brent Benchmark? published 3 March 2021 by the Oxford Institute for Energy Studies for a discussion. 3    In Chart 3, we plot a rough measure of coal- vs natgas-fired generation economics for these fuels based on their average operating heat rates published by the EIA. We would note that a carbon tax would erase much of the benefit accruing to coal at this point in time. 4    Please see NOAA's Global Climate Report - March 2021. 5    Please see Low Rider - Corpus Christi's Ship Channel Dredging Will Streamline Crude Oil Exports published by RBN Energy 3 May 2021. 6    The OIES analysis cited above concludes, "… the volumes of the FOB deliverable crudes are diminishing and some change, bolstering the contract is certainly needed. The most likely compromise is to retain the existing FOB Brent with an inclusion of CIF WTI Midland assessment, netted back to an FOB equivalent North Sea value."  We agree with this assessment.  Please see CIF Brent Benchmark? published 3 March 2021 by the Oxford Institute for Energy Studies, p. 8. 7     Please see Is shale activity actually profitable? Size matters, says Rystad published 7 February 2019.   Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Highlights A slower money and credit growth in China will eventually generate disinflationary pressures by weighing on demand for commodities. The PBoC has shifted its inflation anchor and policy framework to target core CPI and the PPI rather than headline CPI. Beijing is scaling back its fiscal supports and cooling the property sector to tackle local government and housing sector debt issues. In the next six to nine months we favor companies and sectors that will benefit from global economic recovery rather than China’s domestic demand. We are long CSI500 relative to China’s A shares. The CSI500 has a larger exposure to the global economy and lower valuation relative to China’s broad onshore market.  Feature As a follow up to last week’s report, we look at another topic raised in recent client meetings: whether rapidly rising producer prices in China will morph into a broad-based inflationary risk and how macroeconomic policies will evolve to counter such a risk. Clients who believe that the ongoing producer price inflation is transitory cited China’s low consumer price inflation, and slowing money and credit growth, as leading indicators of budding disinflationary pressures. Advocates of sustained inflation pointed to robust recoveries and demand among advanced economies, extremely accommodative monetary conditions worldwide, massive fiscal stimulus in the US, a weak US dollar, and supply constraints. It remains to be seen what the worldwide pandemic’s impact will be on the balance between global production capacity and aggregate demand. In this report we analyze the PBoC’s inflation target and policy framework, and conclude that while China’s monetary policy has not become more hawkish, policy tightening seems to be taking place on the fiscal front. Is Inflation In China A Risk? It is debatable whether the strong rebound in GDP growth in Q4 last year and in Q1 this year has closed China’s output gap and will lead to widespread inflation. Given data distortions due to low-base effects from the previous year and uncertainty about China’s productivity and labor force growth, any calculation of the output gap will be unreliable. In addition, China’s employment statistics lack cyclicality and cannot be used to gauge inflationary pressure stemming from wage growth and unit labor costs.     Chart 1A Rollover In Credit Growth Will Weigh On Chinese Demand For Commodities A Rollover In Credit Growth Will Weigh On Chinese Demand For Commodities A Rollover In Credit Growth Will Weigh On Chinese Demand For Commodities Our cyclical view of inflation is therefore based on the framework that the ongoing moderation in China's money and credit growth will eventually generate disinflationary pressures by weighing on the country’s demand for and price of commodities (Chart 1).  Furthermore, behind a resilient PPI, there are suggestions that the strength in China’s economy is still bifurcated. A narrow-based uptrend in the PPI lacks the ground for sustained inflation, and is unlikely to trigger a general tightening in monetary policy.  While mounting global prices for raw materials propelled strong upstream PPI, producer prices for consumer goods and core consumer price inflation remain very subdued (Chart 2).  The inconsistency in producer prices among various industries highlight the unevenness of the economic recovery and, importantly, persistently muted household consumption (Chart 3). Chart 2A Bifurcated Economic Recovery A Bifurcated Economic Recovery A Bifurcated Economic Recovery Chart 3A Muted Recovery In Household Consumption A Muted Recovery In Household Consumption A Muted Recovery In Household Consumption Chart 4Weak Price Transmission From Upstream To Downstream Industries Weak Price Transmission From Upstream To Downstream Industries Weak Price Transmission From Upstream To Downstream Industries The transmission from upstream industrial PPI to the middle and downstream sectors has also been weak (Chart 4). It is evidenced in the faster growth of manufacturing output volume compared with price increases (Chart 5). This contrasts with the previous inflationary cycles, as well as mining and ferrous metals where surging prices for raw materials have way surpassed recovery in output volume (Chart 6). Given that price changes are more important to corporate profits than volume changes, Chinese middle-to-downstream industries face downward pressure on their profit margins and will likely deliver disappointing profits, despite a strong rebound in production. Chart 5China's Manufacturing Recovery: Stronger Volume Than Prices China's Manufacturing Recovery: Stronger Volume Than Prices China's Manufacturing Recovery: Stronger Volume Than Prices Chart 6China's Upstream Industries: Prices Surged Faster Than Production China's Upstream Industries: Prices Surged Faster Than Production China's Upstream Industries: Prices Surged Faster Than Production Furthermore, PMI input prices, which lead core CPI by about nine months, rolled over in April (Chart 7). While it is too soon to conclude that input prices have peaked, it is implied that upward pressure on core CPI from input prices may start to ease in 2H21. Bottom Line: So far there is no sign that elevated upstream producer prices will create sustainable inflationary pressure on consumer prices. Hence our view is that the PBoC will not respond to a rising PPI by further tightening monetary policy. Chart 7PMI Input Prices Have Rolled Over PMI Input Prices Have Rolled Over PMI Input Prices Have Rolled Over Chart 8Core CPI And PPI Have Been The PBoC's Inflation Targets Since 2015 Core CPI And PPI Have Been The PBoC's Inflation Targets Since 2015 Core CPI And PPI Have Been The PBoC's Inflation Targets Since 2015 The PBoC’s Inflation Target Since 2015, China’s monetary tightening cycles have closely correlated with a combination of the core CPI and PPI instead of headline CPI (Chart 8). The shift to targeting core CPI and PPI occurred despite the central bank’s frequent mention of headline CPI as its inflation target. The reasons for the shift are twofold. First, swings in food and fuel prices have become much larger since 2014, often dominating fluctuations in headline CPI (Chart 9).  Secondly, the price swings were often driven by supply-side factors and did not reflect changes in demand. Therefore, monetary policies could do little to mitigate inflationary or deflationary pressures. Furthermore, the PPI seems to play a greater role in the PBoC’s monetary policymaking than the headline and core CPI (Chart 10).  The tighter relationship between the de facto policy rate and the PPI is not surprising, given that China’s ex-factory price inflation reflects changes in corporate pricing, profit, and inventory cycles – all are driven by the country’s money supply and credit cycles.  Chart 9Large Swings In Food And Energy Prices Distorted Headline CPI In Recent Years Large Swings In Food And Energy Prices Distorted Headline CPI In Recent Years Large Swings In Food And Energy Prices Distorted Headline CPI In Recent Years Chart 10PPI Plays A Greater Role In The PBoC's Monetary Policymaking PPI Plays A Greater Role In The PBoC's Monetary Policymaking PPI Plays A Greater Role In The PBoC's Monetary Policymaking The relationship between the 7-day repo rate - the de jure policy rate - and the PPI has broken down since 2015 (Chart 11). Meanwhile, the 3-month repo rate has maintained a close relationship with the PPI (Chart 10, bottom panel). The change in the relationship is because the PBoC shifted its policy to target interest rates instead of the quantity of money supply since 2015 (Chart 12). Moreover, since 2016 the PBoC has generated monetary policy tightening measures through changes in its Macro Prudential Assessment Framework (MPA) rather than directly through interest rate hikes.  Chart 11Relationship Between The 7-Day Repo Rate And The PPI Has Broken Down Since 2015... Relationship Between The 7-Day Repo Rate And The PPI Has Broken Down Since 2015... Relationship Between The 7-Day Repo Rate And The PPI Has Broken Down Since 2015... Chart 12...Due To Monetary Policy Regime Shifted ...Due To Monetary Policy Regime Shifted ...Due To Monetary Policy Regime Shifted Bottom Line:  The PBoC has shifted its inflation anchor and policy framework since 2015. Core CPI and the PPI are now the main inflation targets. A Quiet Fiscal Tightening? Despite a jump in the PPI, the 3-month repo rate fell sharply in the past two months (Chart 10 on page 6, bottom panel).  It is possible that the PBoC considers escalating producer prices as transitory and, therefore, intends to keep its overall policy stance unchanged. However, the PBoC’s relaxed policy response towards inflation risk may be explained by Beijing’s quiet tightening on the fiscal front. Chart 13The Central Bank Has Made Little Interbank Liquidity Injections Lately The Central Bank Has Made Little Interbank Liquidity Injections Lately The Central Bank Has Made Little Interbank Liquidity Injections Lately The PBoC can hold its policy rates steady by supplying adequate liquidity to the interbank system through open market operations or by reducing the demand for liquidity. On a net basis, the PBoC has recently injected very little liquidity into the interbank system, implying that banks’ liquidity demand has likely softened (Chart 13).  This might be a sign of weakening credit origination. In a previous report we discussed how fiscal stimulus has become a more relevant driver of China’s credit origination since the onset of the 2014/15 economic downcycle. A rising 3-month SHIBOR can be the result of rapid fiscal and quasi-fiscal expansions, which occurred in Q3 last year. A flood of local government bond issuance drained liquidity from commercial banks, which boosted the banks’ needs to borrow money from the interbank system and pushed up interbank rates. Despite higher interest rates, credit growth soared in Q3 as fiscal multiplier provided an imminent and powerful reflationary force to the economy. In contrast, local government bond issuance was down sharply in the first four months of this year, compared with 2019 and 2020. Local governments sold 222.7 billion yuan of special-purpose bonds (SPBs) from January to April, a plunge from 730 billion yuan of debt sold in the same period in 2019 and 1.15 trillion yuan in 2020. The total local government bond issuance in Q1 this year has also been 36% and 44% lower than in Q1 2019 and 2020, respectively. A lack of local governments’ appetite to borrow coupled with a shortage in profitable infrastructure projects might have contributed to the sharp drop in bond issuance this year. Local government financing and spending have been under increased scrutiny this year. Following the State Council Executive Meeting in late March, in which Premier Li Keqiang pledged to reduce government leverage ratio and raise regulatory standards on infrastructure investment, Beijing suspended two high-speed rail projects that were initiated by provincial governments. Messages from Politburo’s meeting last week reinforced our view that policymakers may be scaling back fiscal support while further tightening regulations in the property sector. Both aspects have the potential to cool China’s demand for industrial metals and global industrial material prices (Chart 14 and Chart 15). Chart 14A Slowdown In Chinese Manufacturing Demand Will Have A Greater Impact On Global Industrial Material Prices A Slowdown In Chinese Manufacturing Demand Will Have A Greater Impact On Global Industrial Material Prices A Slowdown In Chinese Manufacturing Demand Will Have A Greater Impact On Global Industrial Material Prices Chart 15Lower Housing Demand In China Will Help To Cool Industrial Metal Prices Lower Housing Demand In China Will Help To Cool Industrial Metal Prices Lower Housing Demand In China Will Help To Cool Industrial Metal Prices We expect the intensity of policy tightening to reach its peak between mid-year to third-quarter 2021. It is unclear at this point whether policymakers are willing to allow local governments to significantly undershoot their SPB quota for this year. Local governments reportedly experienced a shortage in profitable investment projects towards the end of last year, and thus, parked more than 10% of proceeds from 2020 SPB issuance at the central bank. The central government may be taking a wait-and-see attitude this year, and saving more fiscal dry powder for later this year when the economic slowdown becomes more meaningful. Bottom Line: Beijing is pulling back its fiscal supports and cooling the property sector to tackle local government and housing sector debt issues. The deleveraging efforts will curb China’s demand for commodities, and may work to ease inflationary pressure on prices for raw materials. Investment Conclusions The outlook for China’s risk asset prices remains bearish, at least in the next six months. If the credit and fiscal impulse slow enough to depress corporate pricing power, inflation will not be a problem because disinflationary pressures will resurface. However, the growth of corporate profits will disappoint (Chart 16). Beijing may be saving more fiscal dry powder for later this year. Still, SPBs are only a small part of local governments’ financing source for infrastructure projects. Given the central government’s renewed focus on reducing public debt, policymakers are unlikely to unleash fiscal power to significantly boost infrastructure spending or economic growth. In the next six to nine months, we favor companies and sectors that will benefit from global economic recovery rather than China’s domestic demand. With this week's report, we initiate a long position on the CSI500 index, which has a larger exposure to the global market and lower valuation relative to China’s broad onshore market (Chart 17).  Chart 16Aggregate Corporate Profit Growth Will Slow Even Though Inflation Is No Longer An Issue Aggregate Corporate Profit Growth Will Slow Even Though Inflation Is No Longer An Issue Aggregate Corporate Profit Growth Will Slow Even Though Inflation Is No Longer An Issue Chart 17Long CSI500/Broad Market Long CSI500/Broad Market Long CSI500/Broad Market   Jing Sima China Strategist jings@bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations

Highlights Biden’s first 100 days are characterized by a liberal spend-and-tax agenda unseen since the 1960s. It is not a “bait and switch,” however. Voters do not care about deficits and debt. At least not for now. The apparent outcome of the populist surge in the US and UK in 2016 is blowout fiscal spending. Yet the US and UK also invented and distributed vaccines faster than others. US growth and equities have outperformed while the US dollar experienced a countertrend bounce. While growth will rotate to other regions, China’s stimulus is on the wane. Of Biden’s three initial geopolitical risks, two are showing signs of subsiding: Russia and Iran. US-China tensions persist, however, and Biden has been hawkish so far. Our new Australia Geopolitical Risk Indicator confirms our other indicators in signaling that China risk, writ large, remains elevated. Cyclically we are optimistic about the Aussie and Australian stocks. Mexico’s midterm elections are likely to curb the ruling party’s majority but only marginally. The macro and geopolitical backdrop is favorable for Mexico. Feature US President Joe Biden gave his first address to the US Congress on April 28. Biden’s first hundred days are significant for his extravagant spending proposals, which will rank alongside those of Lyndon B. Johnson’s Great Society, if not Franklin Delano Roosevelt’s New Deal, in their impact on US history, for better and worse. Chart 1Biden's First 100 Days - The Market's Appraisal Biden's First 100 Days - The Market's Appraisal Biden's First 100 Days - The Market's Appraisal The global financial market appraisal is that Biden’s proposals will turn out for the better. The market has responded to the US’s stimulus overshoot, successful vaccine rollout, and growth outperformance – notably in the pandemic-struck service sector – by bidding up US equities and the dollar (Chart 1). From a macro perspective we share the BCA House View in leaning against both of these trends, preferring international equities and commodity currencies. However, our geopolitical method has made it difficult for us to bet directly against the dollar and US equities. Geopolitics is about not only wars and trade but also the interaction of different countries’ domestic politics. America’s populist spending blowout is occurring alongside a sharp drop in China’s combined credit-and-fiscal impulse, which will eventually weigh on the global economy. This is true even though the rest of the world is beginning to catch up in vaccinations and economic normalization. As for traditional geopolitical risk – wars and alliances – Biden has not yet leaped over the three initial foreign policy hurdles that we have highlighted: China, Russia, and Iran. In this report we will update the view on all three, as there is tentative improvement on the Russian and Iranian fronts. In addition, we will introduce our newest geopolitical risk indicator – for Australia – and update our view on Mexico ahead of its June 6 midterm elections. Biden’s Fiscal Blowout From a macro point of view, Biden’s $1.9 trillion American Rescue Plan Act (ARPA) was much larger than what Republicans would have passed if President Trump had won a second term. His proposed $2.3 trillion American Jobs Plan (AJP) is also larger, though both candidates were likely to pass an infrastructure package. The difference lies in the parts of these packages that relate to social spending and other programs, beyond COVID relief and roads and bridges. The Republican proposal for COVID relief was $618 billion while the Republicans’ current proposal on infrastructure is $568 billion – marking a $3 trillion difference from Biden. In reality Republicans would have proposed larger spending if Trump had remained president – but not enough to close this gap. And Biden is also proposing a $1.8 trillion American Families Plan (AFP). Biden’s praise for handling the vaccinations must be qualified by the Trump administration’s successful preparations, which have been unfairly denigrated. Similarly, Biden’s blame for the migrant surge at the southern border must be qualified by the fact that the surge began last year.1 A comparison with the UK will put Biden’s administration into perspective. The only country comparable to the US in terms of the size of fiscal stimulus over 2019-21 so far – excluding Biden’s AJP and AFP, which are not yet law – is the United Kingdom. Thus the consequence of the flare-up of populism in the Anglo-Saxon world since 2016 is a budget deficit blowout as these countries strive to suppress domestic socio-political conflict by means of government largesse, particularly in industrial and social programs. However, populist dysfunction was also overrated. Both the US and UK retain their advantages in terms of innovation and dynamism, as revealed by the vaccine and its rollout (Chart 2). Chart 2Dysfunctional Anglo-Saxon Populism? Dysfunctional Anglo-Saxon Populism? Dysfunctional Anglo-Saxon Populism? No sharp leftward turn occurred in the UK, where Prime Minister Boris Johnson and his Conservatives had the benefit of a pre-COVID election in December 2019, which they won. By contrast, in the US, President Trump and the Republicans contended an election after the pandemic and recession had virtually doomed them to failure. There a sharp leftward turn is taking place. Going forward the US will reclaim the top rank in terms of fiscal stimulus, as Biden is likely to get his infrastructure plan (AJP) passed. Our updated US budget deficit projections appear in Chart 3. Our sister US Political Strategy gives the AJP an 80% chance of passing in some form and the AFP only a 50% chance of passing, depending on how quickly the AJP is passed. This means the blue dashed line is more likely to occur than the red dashed line. The difference is slight despite the mind-boggling headline numbers of the plans because the spending is spread out over eight-to-ten years and tax hikes over 15 years will partially offset the expenditures. Much will depend on whether Congress is willing to pay for the new spending. In Chart 3 we assume that Biden will get half of the proposed corporate tax hikes in the AJP scenario (and half of the individual tax hikes in the AFP scenario). If spending is watered down, and/or tax hikes surprise to the upside, both of which are possible, then the deficit scenarios will obviously tighten, assuming the economic recovery continues robustly as expected. But in the current political environment it is safest to plan for the most expansive budget deficit scenarios, as populism is the overriding force. Chart 3Biden’s Blowout Spending Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s campaign plan was even more visionary, so it is not true that Biden pulled a “bait and switch” on voters. Rather, the median voter is comfortable with greater deficits and a larger government role in American life. Bottom Line: The implication of Biden’s spending blowout is reflationary for the global economy, cyclically negative for the US dollar, and positive for global equities. But on a tactical time frame the rotation to other equities and currencies will also depend on China’s fiscal-and-credit deceleration and whether geopolitical risk continues to fall. Russia: Some Improvement But Coast Not Yet Clear US-Russia tensions appeared to fizzle over the past week but the coast is not yet clear. We remain short Russian currency and risk assets as well as European emerging market equities. Tensions fell after President Putin’s State of the Nation address on April 21 in which he warned the West against crossing Russia’s “red lines.” Biden’s sanctions on Russia were underwhelming – he did not insist on halting the final stages of the Nord Stream II pipeline to Germany. Russia declared it would withdraw its roughly 100,000 troops from the Ukrainian border by May 1. Russian dissident Alexei Navalny ended his hunger strike. Putin attended Biden’s Earth Day summit and the two are working on a bilateral summit in June. Chart 4Russia's Domestic Instability Will Continue Russia's Domestic Instability Will Continue Russia's Domestic Instability Will Continue De-escalation is not certain, however. First, some US officials have cast doubt on Russia’s withdrawal of troops and it is known that arms and equipment were left in place for a rapid mobilization and re-escalation if necessary. Second, Russian-backed Ukrainian separatists will be emboldened, which could increase fighting in Ukraine that could eventually provoke Russian intervention. Third, the US has until August or September to prevent Nord Stream from completion. Diplomacy between Russia and the US (and Russia and several eastern European states) has hit a low point on the withdrawal of ambassadors. Fourth, Russian domestic politics was always the chief reason to prepare for a worse geopolitical confrontation and it remains unsettled. Putin’s approval rating still lingers in the relatively low range of 65% and government approval at 49%. The economic recovery is weak and facing an increasingly negative fiscal thrust, along with Europe and China, Russia’s single-largest export destination (Chart 4). Putin’s handouts to households, in anticipation of the September Duma election, only amount to 0.2% of GDP. More measures will probably be announced but the lead-up to the election could still see an international adventure designed to distract the public from its socioeconomic woes. Russia’s geopolitical risk indicators ticked up as anticipated (Chart 5). They may subside if the military drawdown is confirmed and Biden and Putin lower the temperature. But we would not bet on it. Chart 5Russian Geopolitical Risk: Wait For 'All Clear' Signal Russian Geopolitical Risk: Wait For 'All Clear' Signal Russian Geopolitical Risk: Wait For 'All Clear' Signal Bottom Line: It is possible that Biden has passed his first foreign policy test with Russia but it is too soon to sound the “all clear.” We remain short Russian ruble and short EM Europe until de-escalation is confirmed. The Russian (and German) elections in September will mark a time for reassessing this view. Iran: Diplomacy On Track (Hence Jitters Will Rise) While Russia may or may not truly de-escalate tensions in Ukraine, the spring and summer are sure to see an increase in focus on US-Iran nuclear negotiations. Geopolitical risks will remain high prior to the conclusion of a deal and will materialize in kinetic attacks of various kinds. This thesis is confirmed by the alleged Israeli sabotage of Iran’s Natanz nuclear facility this month. The US Navy also fired warning shots at Iranian vessels staging provocations. Sporadic attacks in other parts of the region also continue to flare, most recently with an Iranian tanker getting hit by a drone at a Syrian oil terminal.2 The US and Iran are making progress in the Vienna talks toward rejoining the 2015 nuclear deal from which the US withdrew in 2018. Iran pledged to enrich uranium up to 60% but also said this move was reversible – like all its tentative violations of the Joint Comprehensive Plan of Action (JCPA) so far (Table 1). Iran also offered a prisoner swap with the US. Saudi Arabia appears resigned to a resumption of the JCPA that it cannot prevent, with crown prince Mohammed bin Salman offering diplomatic overtures to both the US and Iran. Table 1Iran’s Nuclear Program And Compliance With JCPA 2015 Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Still, the closer the US and Iran get to a deal the more its opponents will need to either take action or make preparations for the aftermath. The allegation that former US Secretary of State John Kerry’s shared Israeli military plans with Iranian Foreign Minister Javad Zarif is an example of the kind of political brouhaha that will occur as different elements try to support and oppose the normalization of US-Iran ties. More importantly Israel will underscore its red line against nuclear weaponization. Previously Iran was set to reach “breakout” capability of uranium enrichment – a point at which it has enough fissile material to produce a nuclear device – as early as May. Due to sabotage at the Natanz facility the breakout period may have been pushed back to July.3 This compounds the significance of this summer as a deadline for negotiating a reduction in tensions. While the US may be prepared to fudge on Iran’s breakout capabilities, Israel will not, which means a market-relevant showdown should occur this summer before Israel backs down for fear of alienating the United States. Tit-for-tat attacks in May and June could cause negative surprises for oil supply. Then there will be a mad dash by the negotiators to agree to deal before the de facto August deadline, when Iran inaugurates a new president and it becomes much harder to resolve outstanding issues. Chart 6Iran Deal Priced Into Oil Markets? Iran Deal Priced Into Oil Markets? Iran Deal Priced Into Oil Markets? Hence our argument that geopolitics adds upside risk to oil prices in the first half of the year but downside risk in the second half. The market’s expectations seem already to account for this, based on the forward curve for Brent crude oil. The marginal impact of a reconstituted Iran nuclear deal on oil prices is slightly negative over the long run since a deal is more likely to be concluded than not and will open up Iran’s economy and oil exports to the world. However, our Commodity & Energy Strategy expects the Brent price to exceed expectations in the coming years, judging by supply and demand balances and global macro fundamentals (Chart 6). If an Iran deal becomes a fait accompli in July and August the Saudis could abandon their commitment to OPEC 2.0’s production discipline. The Russians and Saudis are not eager to return to a market share war after what happened in March 2020 but we cannot rule it out in the face of Iranian production. Thus we expect oil to be volatile. Oil producers also face the threat of green energy and US shale production which gives them more than one reason to keep up production and prevent prices from getting too lofty. Throughout the post-2015 geopolitical saga between the US and Iran, major incidents have caused an increase in the oil-to-gold ratio. The risk of oil supply disruption affected the price more than the flight to gold due to geopolitical or war risk. The trend generally corresponds with that of the copper-to-gold ratio, though copper-to-gold rose higher when growth boomed and oil outperformed when US-Iran tensions spiked in 2019. Today the copper-to-gold ratio is vastly outperforming the oil-to-gold on the back of the global recovery (Chart 7). This makes sense from the point of view of the likelihood of a US-Iran deal this year. But tensions prior to a deal will push up oil-to-gold in the near term. Chart 7Biden Passes Iran Test? Likely But Not A Done Deal Biden Passes Iran Test? Likely But Not A Done Deal Biden Passes Iran Test? Likely But Not A Done Deal Bottom Line: The US-Iran diplomacy is on track. This means geopolitical risk will escalate in May and June before a short-term or interim deal is agreed in July or August. Geopolitical risk stemming from US-Iran relations will subside thereafter, unless the deadline is missed. The forward curve has largely priced in the oil price downside except for the risk that OPEC 2.0 becomes dysfunctional again. We expect upside price surprises in the near term. Biden, China, And Our Australia GeoRisk Indicator Ostensibly the US and Russia are avoiding a war over Ukraine and the US and Iran are negotiating a return to the 2015 nuclear deal. Only US-China relations utterly lack clarity, with military maneuvering in the Taiwan Strait and South China Sea and tensions simmering over the gamut of other disputes. Chart 8Biden Still Faces China Test Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) The latest data on global military spending show not only that the US and China continue to build up their militaries but also that all of the regional allies – including Japan! – are bulking up defense spending (Chart 8). This is a substantial confirmation of the secular growth of geopolitical risk, specifically in reaction to China’s rise and US-China competition. The first round of US-China talks under Biden went awry but since then a basis has been laid for cooperation on climate change, with President Xi Jinping attending Biden’s virtual climate change summit (albeit with no bilateral summit between the two). If John Kerry is removed as climate czar over his Iranian controversy it will not have an impact other than to undermine American negotiators’ reliability. The deeper point is that climate is a narrow basis for US-China cooperation and it cannot remotely salvage the relationship if a broader strategic de-escalation is not agreed. Carbon emissions are more likely to become a cudgel with which the US and West pressure China to reform its economy faster. The Department of Defense is not slated to finish its comprehensive review of China policy until June but most US government departments are undertaking their own reviews and some of the conclusions will trickle out in May, whether through Washington’s actions or leaks to the press. Beijing could also take actions that upend the Biden administration’s assessment, such as with the Microsoft hack exposed earlier this year. The Biden administration will soon reveal more about how it intends to handle export controls and sanctions on China. For example, by May 19 the administration is slated to release a licensing process for companies concerned about US export controls on tech trade with China due to the Commerce Department’s interim rule on info tech supply chains. The Biden administration looks to be generally hawkish on China, a view that is now consensus. Any loosening of punitive measures would be a positive surprise for Chinese stocks and financial markets in general. There are other indications that China’s relationship with the West is not about to improve substantially – namely Australia. Australia has become a bellwether of China’s relations with the world. While the US’s defense commitments might be questionable with regard to some of China’s neighbors – namely Taiwan (Province of China) but also possibly South Korea and the Philippines – there can be little doubt that Australia, like Japan, is the US’s red line in the Pacific. Australian politics have been roiled over the past several years by the revelation of Chinese influence operations, state- or military-linked investments in Australia, and propaganda campaigns. A trade war erupted last year when Australia called for an investigation into the origins of COVID-19 and China’s handling of it. Most recently, Victoria state severed ties with China’s Belt and Road Initiative. Despite the rise in Sino-Australian tensions, the economic relationship remains intact. China’s stimulus overweighed the impact of its punitive trade measures against Australia, both by bidding up commodity prices and keeping the bulk of Australia’s exports flowing (Chart 9). As much as China might wish to decouple from Australia, it cannot do so as long as it needs to maintain minimum growth rates for the sake of social stability and these growth rates require resources that Australia provides. For example, global iron ore production excluding Australia only makes up 80% of China’s total iron ore imports, which necessitates an ongoing dependency here (Chart 10). Brazil cannot make up the difference. Chart 9China-Australia Trade Amid Tensions China-Australia Trade Amid Tensions China-Australia Trade Amid Tensions Chart 10China Cannot Replace Australia China Cannot Replace Australia China Cannot Replace Australia This resource dependency does not necessarily reduce geopolitical tension, however, because it increases China’s supply insecurity and vulnerability to the US alliance. The US under Biden explicitly aims to restore its alliances and confront autocratic regimes. This puts Australia at the front lines of an open-ended global conflict. Chart 11Introducing: Australia GeoRisk Indicator (Smoothed) Introducing: Australia GeoRisk Indicator (Smoothed) Introducing: Australia GeoRisk Indicator (Smoothed) Our newly devised Australia GeoRisk Indicator illustrates the point well, as it has continued surging since the trade war with China first broke out last year (Chart 11). This indicator is based on the Australian dollar and its deviation from underlying macro variables that should determine its course. These variables are described in Appendix 1. If the Aussie weakens relative to these variables, then an Australian-specific risk premium is apparent. We ascribe that premium to politics and geopolitics writ large. A close examination of the risk indicator’s performance shows that it tracks well with Australia’s recent political history (Chart 12). Previous peaks in risk occurred when President Trump rose to power and Australia, like Canada, found itself beset by negative pressures from both the US and China. In particular, Trump threatened tariffs and the Australian government banned China’s Huawei from its 5G network. Today the rise in geopolitical risk stems almost exclusively from China. There is potential for it to roll over if Biden negotiates a reduction in tensions but that is a risk to our view (an upside risk for Australian and global equities). Chart 12Australian GeoRisk Indicator (Unsmoothed) Australian GeoRisk Indicator (Unsmoothed) Australian GeoRisk Indicator (Unsmoothed) What does this indicator portend for tradable Australian assets? As one would expect, Australian geopolitical risk moves inversely to the country’s equities, currency, and relative equity performance (Chart 13). Australian equities have risen on the back of global growth and the commodity boom despite the rise in geopolitical risk. But any further spike in risk could jeopardize this uptrend. Chart 13Australia Geopolitical Risk And Tradable Assets Australia Geopolitical Risk And Tradable Assets Australia Geopolitical Risk And Tradable Assets An even clearer inverse relationship emerges with the AUD-JPY exchange rate, a standard measure of risk-on / risk-off sentiment in itself. If geopolitical risk rises any further it should cause a reversal in the currency pair. Finally, Australian equities have not outperformed other developed markets excluding the US, which may be due to this elevated risk premium. Bottom Line: China is the most important of Biden’s foreign policy hurdles and unlike Russia and Iran there is no sign of a reduction in tension yet. Our Australian GeoRisk Indicator supports the point that risk remains very elevated in the near term. Moreover China’s credit deceleration is also negative for Australia. Cyclically, however, assuming that China does not overtighten policy, we take a constructive view on the Aussie and Australian equities. Biden’s Border Troubles Distract From Bullish Mexico Story The biggest criticism of Biden’s first 100 days has been his reduction in a range of enforcement measures on the southern border which has encouraged an overflow of immigrants. Customs and Border Patrol have seen a spike in “encounters” from a low point of around 17,000 in 2020 to about 170,000 today. The trend started last year but accelerated sharply after the election and had surpassed the 2019 peak of 144,000. Vice President Kamala Harris has been put in charge of managing the border crisis, both with Mexico and Central American states. She does not have much experience with foreign policy so this is her opportunity to learn on the job. She will not be able to accomplish much given that the Biden administration is unwilling to use punitive measures or deterrence and will not have large fiscal resources available for subsidizing the nations to the south. With the US economy hyper-charged, especially relative to its southern neighbors, the pace of immigration is unlikely to slacken. From a macro point of view the relevance is that the US is not substantially curtailing immigration – quite the opposite – which means that labor force growth will not deviate from its trend. What about Mexico itself? It is not likely that Harris will be able to engage on a broader range of issues with Mexico beyond immigration. As usual Mexico is beset with corruption, lawlessness, and instability. To these can be added the difficulties of the pandemic and vaccine rollout. Tourism and remittances are yet to recover. Cooperation with US federal agents against the drug cartels is deteriorating. Cartels control an estimated 40% of Mexican territory.4 Nevertheless, despite Mexico’s perennial problems, we hold a positive view on Mexican currency and risk assets. The argument rests on five points: Strong macro fundamentals: With China’s fiscal-and-credit impulse slowing sharply, and US stimulus accelerating, Mexico stands to benefit. Mexico has also run orthodox monetary and fiscal policies. It has a demographic tailwind, low wages, and low public debt. The stars are beginning to align for the country’s economy, according to our Emerging Markets Strategy. US and Canadian stimulus: The US and Canada have the second- and third-largest fiscal stimulus of all the major countries over the 2019-21 period, at 9% and 8% of GDP respectively. Mexico, with the new USMCA free trade deal in hand, will benefit. US protectionism fizzled: Even Republican senators blocked President Trump’s attempted tariffs on Mexico. Trump’s aggression resulted in the USMCA, a revised NAFTA, which both US political parties endorsed. Mexico is inured to US protectionism, at least for the short and medium term. Diversification from China: Mexico suffered the greatest opportunity cost from China’s rise as an offshore manufacturer and entrance to the World Trade Organization. Now that the US and other western countries are diversifying away from China, amid geopolitical tensions, Mexico stands to benefit. The US cannot eliminate its trade deficit due to its internal savings/investment imbalance but it can redistribute that trade deficit to countries that cannot compete with it for global hegemony. AMLO faces constraints: A risk factor stemmed from politics where a sweeping left-wing victory in 2018 threatened to introduce anti-market policies. President Andrés Manuel López Obrador (known as AMLO) and his MORENA party gained a majority in both houses of the legislature. Their coalition has a two-thirds majority in the lower house (Chart 14). However, we pointed out that AMLO’s policies have not been radical and, more importantly, that the midterm election would likely constrain his power. Chart 14Mexico’s Midterm Election Looms Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) These are all solid points but the last item faces a test in the upcoming midterm election. AMLO’s approval rating is strong, at 63%, putting him above all of his predecessors except one (Chart 15). AMLO’s approval has if anything benefited from the COVID-19 crisis despite Mexico’s inability to handle the medical challenge. He has promised to hold a referendum on his leadership in early 2022, more than halfway through his six-year term, and he is currently in good shape for that referendum. For now his popularity is helpful for his party, although he is not on the ballot in 2021 and MORENA’s support is well beneath his own. Chart 15AMLO’s Approval Fairly Strong Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) MORENA’s support is holding at a 44% rate of popular support and its momentum has slightly improved since the pandemic began. However, MORENA’s lead over other parties is not nearly as strong as it was back in 2018 (Chart 16, top panel). The combined support of the two dominant center-right parties, the Institutional Revolutionary Party and the National Action Party, is almost equal to that of MORENA. And the two center-left parties, the Democratic Revolution Party and Citizen’s Movement, are part of the opposition coalition (Chart 16, bottom panel). The pandemic and economic crisis will motivate the opposition. Chart 16MORENA’s Support Holding Up Despite COVID Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Traditionally the president’s party loses seats in the midterm election (Table 2). Circumstances are different from the US, which also exhibits this trend, because Mexico has more political parties. A loss of seats from MORENA does not necessarily favor the establishment parties. Nevertheless opinion polling shows that about 45% of voters say they would rather see MORENA’s power “checked” compared to 41% who wish to see the party go on unopposed.5 Table 2Mexican President’s Party Tends To Lose Seats In Midterm Election Biden’s First 100 Days In Foreign Policy (GeoRisk Update) Biden’s First 100 Days In Foreign Policy (GeoRisk Update) While the ruling coalition may lose its super-majority, it is not a foregone conclusion that MORENA will lose its majority. Voters have decades of experience of the two dominant parties, both were discredited prior to 2018, and neither has recovered its reputation so quickly. The polling does not suggest that voters regret their decision to give the left wing a try. If anything recent polls slightly push against this idea. If MORENA surprises to the upside then AMLO’s capabilities would increase substantially in the second half of his term – he would have political capital and an improving economy. While the senate is not up for grabs in the midterm, MORENA has a narrow majority and controls a substantial 60% of seats when its allies are taken into account. In this scenario AMLO could pursue his attempts to increase the state’s role in key industries, like energy and power generation, at the expense of private investors. Even then the Supreme Court would continue to act as a check on the government. The 11-seat court is currently made up of five conservatives, two independents, and three liberal or left-leaning judges. A new member, Margarita Ríos Farjat, is close to the government, leaving the conservatives with a one-seat edge over the liberals and putting the two independents in the position of swing voters. Even if AMLO maintains control of the lower house, he will not be able to override the constitutional court, as he has threatened on occasion to do, without a super-majority in the senate. Bottom Line: AMLO will likely lose some ground in the lower house and thus suffer a check on his power. This will only confirm that Mexican political risk is not likely to derail positive underlying macro fundamentals. Continue to overweight Mexican equities relative to Brazilian.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Appendix 1 The market is the greatest machine ever created for gauging the wisdom of the crowd and as such our Geopolitical Risk Indicators were not designed to predict political risk but to answer the question of whether and to what extent markets have priced that risk. Our Australian GeoRisk Indicator (see Chart 11-12 above) uses the same simple methodology used in our other indicators, which avoid the pitfall of regression-based models. We begin with a financial asset that has a daily frequency in price, in this case the AUD, and compare its movement against several fundamental factors – in this case global energy and base metal prices, global metals and mining stock prices, and the Chilean peso. Australia is a commodity-exporting country. It is the largest producer of iron ore and is among the largest producers of coal and natural gas. It is also a major trading partner for China. Due to the nature of its economy the Australian dollar moves with global metal and energy prices and the global metals and mining equity prices. Chile, another major commodity producer also moves with global metal prices, hence our inclusion of the peso in this indicator. The AUD has a high correlation with all of these assets, and if the changes in the value of the AUD lag or lead the changes in the value of these assets, the implication is that geopolitical risk unique to Australia is not priced by the market. We included the peso as Chile is not as affected as Australia by any conflict in the South China Sea or Northeast Asia, which means that a deviation of the AUD from CLP represents a unique East Asia Pacific risk. Our indicator captures the involvement of Australia in a few regional and international conflicts. The indicator climbed as Australia got involved in the East Timor emergency and declined as it exited. It continued declining even as Australia joined the US in the Afghanistan and Iraq wars, which showed that investors were unperturbed by faraway wars, while showing measurable concern in the smaller but closer Timorese conflict. Risks went up again as the nation erupted in labor protests as the Howard government made changes to the labor code. We see the market pricing higher risk again during the 2008 financial crisis, although it was modest and Australia escaped the crisis unscathed due to massive Chinese stimulus. Since then, investors have been climbing a wall of worry as they priced in Northeast Asia-related geopolitical risks. These started with the South Korean Cheonan sinking and continued with the Sino-Japanese clash over the Senkaku islands. They culminated with the Chinese ADIZ declaration in late 2013. In 2016, Australia was shocked again when Donald Trump was elected, and investor fears were evident when the details of Trump-Turnbull spat were made public. The risk indicator reached another peak during the trade wars between the US and the rest of the world. Investors were not worried about COVID-19 as Australia largely contained the pandemic, but the recent Australian-Chinese trade war pushed the risk indicator up, giving investors another wall of worry. If the Biden administration forces Australia into a democratic alliance in confrontation with autocratic China then this risk will persist for some time.   Jesse Anak Kuri Associate Editor Jesse.Kuri@bcaresearch.com We Read (And Liked) ... The Narrow Corridor: States, Societies, And The Fate Of Liberty This book is a sweeping review of the conditions of liberty essential to steering the world away from the Hobbesian war of all against all. In this unofficial sequel to the 2012 hit, Why Nations Fail: The Origins Of Power, Prosperity, And Poverty, Daron Acemoglu (Professor of Economics at the Massachusetts Institute of Technology) and James A. Robinson (Professor of Global Conflict Studies at the University of Chicago) further explore their thesis that the existence and effectiveness of democratic institutions account for a nation’s general success or failure. The Narrow Corridor6 examines how liberty works. It is not “natural,” not widespread, “is rare in history and is rare today.” Only in peculiar circumstances have states managed to produce free societies. States have to walk a thin line to achieve liberty, passing through what the authors describe as a “narrow corridor.” To encourage freedom, states must be strong enough to enforce laws and provide public services yet also restrained in their actions and checked by a well-organized civil society. For example, from classical history, the Athenian constitutional reforms of Cleisthenes “were helpful for strengthening the political power of Athenian citizens while also battling the cage of norms.” That cage of norms is the informal body of customs replaced by state institutions. Those norms in turn “constrained what the state could do and how far state building could go,” providing a set of checks. Though somewhat fluid in its definition, liberty, as Acemoglu and Robinson show, is expressed differently under various “leviathans,” or states. For starters, the “Shackled Leviathan” is a government dedicated to upholding the rule of law, protecting the weak against the strong, and creating the conditions for broad-based economic opportunity. Meanwhile, the “Paper Leviathan” is a bureaucratic machine favoring the privileged class, serving as both a political and economic brake on development and yielding “fear, violence, and dominance for most of its citizens.” Other examples include: The “American Leviathan” which fails to deal properly with inequality and racial oppression, two enemies of liberty; and a “Despotic Leviathan,” which commands the economy and coerces political conformity – an example from modern China. Although the book indulges in too much jargon, it is provocative and its argument is convincing. The authors say that in most places and at most times, the strong have dominated the weak and human freedom has been quashed by force or by customs and norms. Either states have been too weak to protect individuals from these threats or states have been too strong for people to protect themselves from despotism. Importantly, many states believe that once liberty is achieved, it will remain the status quo. But the authors argue that to uphold liberty, state institutions have to evolve continuously as the nature of conflicts and needs of society change. Thus society's ability to keep state and rulers accountable must intensify in tandem with the capabilities of the state. This struggle between state and society becomes self-reinforcing, inducing both to develop a richer array of capacities just to keep moving forward along the corridor. Yet this struggle also underscores the fragile nature of liberty. It is built on a precarious balance between state and society; between economic, political, and social elites and common citizens; between institutions and norms. If one side of the balance gets too strong, as has often happened in history, liberty begins to wane. The authors central thesis is that the long-run success of states depends on the balance of power between state and society. If states are too strong, you end up with a “Despotic Leviathan” that is good for short-term economic growth but brittle and unstable over the long term. If society is too strong, the “Leviathan” is absent, and societies suffer under a pre-modern war of all against all. The ideal place to be is in the narrow corridor, under a shackled Leviathan that will grow state capacity and individual liberty simultaneously, thus leading to long-term economic growth. In the asset allocation process, investors should always consider the liberty of a state and its people, if a state’s institutions grossly favor the elite or the outright population, whether these institutions are weak or overbearing on society, and whether they signify a balance between interests across the population. Whether you are investing over a short or long horizon, returns can be significantly impacted in the absence of liberty or the excesses of liberty. There should be a preference among investors toward countries that exhibit a balance of power between state and society, setting up a better long-term investment environment, than if a balance of power did not exist.   Guy Russell Research Analyst GuyR@bcaresearch.com GeoRisk Indicator China China: GeoRisk Indicator China: GeoRisk Indicator Russia Russia: GeoRisk Indicator Russia: GeoRisk Indicator UK UK: GeoRisk Indicator UK: GeoRisk Indicator Germany Germany: GeoRisk Indicator Germany: GeoRisk Indicator France France: GeoRisk Indicator France: GeoRisk Indicator Italy Italy: GeoRisk Indicator Italy: GeoRisk Indicator Canada Canada: GeoRisk Indicator Canada: GeoRisk Indicator Spain Spain: GeoRisk Indicator Spain: GeoRisk Indicator Taiwan – Province Of China Taiwan-Province of China: GeoRisk Indicator Taiwan-Province of China: GeoRisk Indicator Korea Korea: GeoRisk Indicator Korea: GeoRisk Indicator Turkey Turkey: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil Brazil: GeoRisk Indicator Brazil: GeoRisk Indicator Australia Australia: GeoRisk Indicator Australia: GeoRisk Indicator Footnotes 1 "President Biden’s first 100 days as president fact-checked," BBC News, April 29, 2021, bbc.com. 2 "Oil tanker off Syrian coast hit in suspected drone attack," Al Jazeera, April 24, 2021, Aljazeera.com. 3 See Yaakov Lappin, "Natanz blast ‘likely took 5,000 centrifuges offline," Jewish News Syndicate, jns.org. 4 John Daniel Davidson, "Former US Ambassador To Mexico: Cartels Control Up To 40 Percent Of Mexican Territory," The Federalist, April 28, 2021, thefederalist.com. 5 See Alejandro Moreno, "Aprobación de AMLO se encuentra en 61% previo a campañas electorales," El Financiero, April 5, 2021, elfinanciero.com. 6 Penguin Press, New York, NY, 2019, 558 pages. Section III: Geopolitical Calendar