Equities

Weekly Performance Update For the week ending Thu Jul 08, 2021 The Market Monitor displays the trailing 1-quarter performance of strategies based around the BCA Score. For each region, we construct an equal-weighted, monthly rebalanced portfolio consisting of the top 3 stocks per sector and compare it with the regional benchmark. For each portfolio, we show the weekly performance of individual holdings in the Top Contributors/Detractors table. In addition, the Top Prospects table shows the holdings that currently have the highest BCA Score within the portfolio. For more details, click the region headers below to be redirected to the full historical backtest for the strategy. BCA US Portfolio Total Weekly Return BCA US Portfolio S&P500 TRI -1.33% 0.06% Top Contributors   TX:US IT:US PSA:US TGT:US GOOG.L:US Weekly Return 15 bps 7 bps 7 bps 6 bps 6 bps Top Detractors   SIG:US WES:US MTZ:US SEM:US LPX:US Weekly Return -22 bps -16 bps -15 bps -14 bps -13 bps Top Prospects   ESGR:US MPLX:US ANAT:US TX:US BRK.A:US BCA Score 98.48% 97.38% 96.24% 94.71% 94.62% BCA Canada Portfolio Total Weekly Return BCA Canada Portfolio S&P/TSX TRI -0.62% -0.43% Top Contributors   WIR.UN:CA EMP.A:CA SMU.UN:CA NWC:CA H:CA Weekly Return 8 bps 8 bps 8 bps 7 bps 5 bps Top Detractors   WEED:CA CRON:CA IMO:CA LNR:CA BB:CA Weekly Return -26 bps -17 bps -17 bps -13 bps -13 bps Top Prospects   LNF:CA CS:CA IFP:CA RUS:CA NWC:CA BCA Score 99.30% 99.18% 98.93% 98.46% 96.93% BCA UK Portfolio Total Weekly Return BCA UK Portfolio FTSE 100 TRI -0.37% -1.25% Top Contributors   PZC:GB OXIG:GB SRE:GB BYG:GB FDM:GB Weekly Return 22 bps 16 bps 16 bps 14 bps 9 bps Top Detractors   SPI:GB HFD:GB DEC:GB NFC:GB NVTK:GB Weekly Return -28 bps -26 bps -11 bps -10 bps -9 bps Top Prospects   SVST:GB NLMK:GB GROW:GB GLTR:GB MNOD:GB BCA Score 99.78% 99.55% 98.11% 98.07% 95.26% BCA Eurozone Portfolio Total Weekly Return BCA EMU Portfolio MSCI EMU TRI -0.37% -1.66% Top Contributors   ALTA:FR MONT:BE ATS:AT PHA:FR LOUP:FR Weekly Return 27 bps 20 bps 12 bps 5 bps 4 bps Top Detractors   OMV:AT BB:FR US:IT TESB:BE CNV:FR Weekly Return -17 bps -16 bps -15 bps -12 bps -10 bps Top Prospects   STR:AT SOLV:BE FDJ:FR TESB:BE ROTH:FR BCA Score 99.79% 98.01% 97.87% 97.25% 96.82% BCA Japan Portfolio Total Weekly Return BCA Japan Portfolio TOPIX TRI -0.31% -0.97% Top Contributors   6960:JP 8979:JP 9543:JP 4694:JP 3468:JP Weekly Return 17 bps 10 bps 9 bps 8 bps 7 bps Top Detractors   8595:JP 3291:JP 3539:JP 7593:JP 4966:JP Weekly Return -33 bps -15 bps -9 bps -8 bps -8 bps Top Prospects   4966:JP 8133:JP 3291:JP 6960:JP 8117:JP BCA Score 99.91% 99.20% 98.35% 97.57% 97.49% BCA Hong Kong Portfolio Total Weekly Return BCA Hong Kong Portfolio Hang Seng TRI -2.28% -5.43% Top Contributors   990:HK 856:HK 215:HK 43:HK 2380:HK Weekly Return 33 bps 26 bps 18 bps 7 bps 4 bps Top Detractors   3600:HK 6100:HK 329:HK 857:HK 468:HK Weekly Return -29 bps -27 bps -24 bps -22 bps -22 bps Top Prospects   1277:HK 1839:HK 98:HK 2232:HK 857:HK BCA Score 99.98% 99.35% 99.32% 99.19% 98.85% BCA Australia Portfolio Total Weekly Return BCA Australia Portfolio S&P/ASX All Ord. TRI 0.12% 0.98% Top Contributors   GRR:AU ZIM:AU YAL:AU NHC:AU PSQ:AU Weekly Return 72 bps 23 bps 22 bps 11 bps 10 bps Top Detractors   FLN:AU NEC:AU BLX:AU RIC:AU TLX:AU Weekly Return -38 bps -27 bps -23 bps -17 bps -15 bps Top Prospects   BFG:AU AGI:AU BSE:AU ZIM:AU JLG:AU BCA Score 99.07% 99.04% 98.90% 97.03% 97.01%

Underweight (Upgrade Alert) We are currently underweight US banks, but the macro environment is changing and today we put this sub-sector on an upgrade alert looking to push it to a neutral allocation. The news on the buyback and dividend fronts is encouraging as banks will be allowed to resume their shareholder friendly activities that were halted last year due to the Fed’s Stress Test. Already, financials stocks are at the front of the pack with a roughly 3% total yield that is likely to increase further. Tack on the current search for yield environment, and the allure of financials equities becomes even more tempting.  Bottom Line: We are putting banks on our upgrade alert watchlist. Please see an upcoming Strategy Report where we delve deeper into the buyback and dividend topics.

Highlights Inflation is set to decelerate, job creation has a speed limit, and super-spreaders of new-variant Covid-19 infections will create speed bumps in the economy.  This means that in the second half of the year: Bonds will rally. The US dollar will rally. Growth stocks will outperform value stocks. US stocks will outperform non-US stocks. Fractal trade shortlist: Brazilian real, Saudi Tadawul All Share, and Marine Transportation.  Feature Chart of the WeekThe 60 Percent Correction In Lumber Shows What Happens When Supply Bottlenecks Ease. Are Used Cars Next? As Supply Bottlenecks Ease, Inflation Will Cool Since mid-March, US inflation has surged to 5 percent. Yet bond yields have drifted lower, by almost 50 bps in the case of the 30-year T-bond yield, equating to a handsome return of 12 percent. The seeming contradiction between rising inflation and declining bond yields has puzzled some people, but it shouldn’t. In 2009, the same pattern occurred in reverse. Inflation collapsed, culminating in a modern era low of -2 percent in July 2009. Yet while inflation was collapsing, bond yields rose sharply (Chart I-2 and Chart I-3). Chart I-2In 2009, Bond Yields Rose When Year-On-Year Inflation Fell Chart I-3In 2021, Bond Yields Fell When Year-On-Year Inflation Rose We can explain this seeming contradiction with an analogy from driving. The inflation rate is like your average speed over the past mile. But the bond market cares much more about your average speed over the next mile, or even over the next 5-10 miles. If you are driving at a constant speed, then your speed over the past mile is a good guide to your future speed. But if you have been driving unusually fast or unusually slowly, there is a more important predictor of your future speed. That important predictor is your acceleration – meaning, what is happening to your speed over successive hundred yards stretches. In the same way, during episodes of unusually low or unusually high inflation, the bond market focusses on the monthly rate of inflation, and specifically the moment that it stops decreasing, as in early-2009, or stops increasing, as in mid-2021. In 2008, after a long sequence of declining monthly rates of inflation that went deep into negative territory, the December 2008 print marked the first substantial increase. Hence, the bond yield also bottomed in December 2008 (Chart I-4), even though annual inflation did not bottom until July 2009. Chart I-4In 2009, Bond Yields Bottomed When Month-On-Month Inflation Bottomed Similarly, in 2020-21, after a six month sequence of increasing monthly rates of inflation, the May 2021 print marked the end of the rising trend. To the extent that this was anticipated, most of the decline in the bond yield has happened since mid-May (Chart I-5). Chart I-5In 2021, Bond Yields Topped When Month-On-Month Inflation Topped Since mid-May, the 60 percent crash in the lumber price shows what happens when supply bottlenecks ease. Other prices that are being supported by temporary supply constraints – such as used car prices – are likely to suffer the same fate (Chart of the Week). Hence, so long as the coming monthly prints confirm an ongoing deceleration in inflation, the current rally in bonds will stay intact. Jobs: The Hard Work Starts Now Staying on the theme of speed, there is a well-defined speed limit to every post-recession jobs recovery. In A Fed Rate Hike By Early 2023 Is Pie In the Sky, we pointed out the remarkable consistency in the pace of post-recession US jobs recoveries. The last five recessions had different causes, severities, durations and peak unemployment rates. Yet in the recoveries that followed each recession, the unemployment rate declined at a remarkably consistent pace of 0.4-0.5 percent per year (Table I-1). Table I-1After Every Recession, The Pace Of Recovery In The Jobs Market Is Near-Identical Reassuringly at the last FOMC press conference, Jay Powell supported this thesis: Most of the act of sort of going back to one's old job – that's kind of already happened. So, this is a question of people finding a new job. And that's just a process that takes longer. There may be something of a speed limit on it. You've got to find a job where your skills match, you know, what the employer wants. It's got to be in the right area. There's just a lot that goes into the function of finding a job. Powell’s comments lead to two further points: The act of going back to one’s old job for those on ‘temporary layoff’ is relatively straightforward. For job creation, this is the low hanging fruit, most of which has already been picked. Now comes the much harder part – finding jobs for those ‘not on temporary layoff’ whose numbers have barely declined from the peak (Chart I-6). Chart I-6For Job Creation, The Low Hanging Fruit Has Already Been Picked One way of encapsulating this is to observe that the unemployment rate – including those on temporary layoff – has already made 80 percent of the journey from its recession peak to the February 2020 trough, which makes it seem that the jobs recovery is largely done. However, the unemployment rate for those not on temporary layoff has made only 25 percent of the journey (Chart I-7). Moreover, this process is not a straight line, it is a curve. The first quarter of the journey is the easiest, then it gets harder. Chart I-7The Hard Part Is Finding Jobs For Those Unemployed 'Not On Temporary Layoff' As we, and Jay Powell, have pointed out, the process to reduce this unemployment rate has a remarkably consistent speed limit of 0.4-0.5 percent per year. Starting at the current rate of 2.5 percent and a target of 1.5 percent, this means full employment will not be reached before the second half of 2023. And even this assumes clear blue skies for the world economy through the next two years, which is a tall order. We conclude that the market pricing of a Fed funds rate lift-off in December 2022 is much too optimistic, making the December 2022 Eurodollar contract a good buy. The End Of Pandemic Restrictions Will Unleash Super-Spreaders On July 19, the UK will remove all its domestic pandemic restrictions – meaning no more facemasks, social distancing, and limits on the size of gatherings. This doesn’t mean that the pandemic is over in the UK. Far from it. The delta variant of the virus is rampant. Rather, with a large portion of the population vaccinated, the government is replacing state-imposed laws and regulations with a libertarian onus on personal responsibility. Given that Covid-19 is not going away, the UK strategy raises a fundamental question. Other than implementing a vaccination program, what role should a government take in containing the virus? In Who’s Right On The Pandemic – Sweden Or Denmark? we revealed two important findings: First, it is a misunderstanding that state-imposed restrictions cause the collapse in social consumption. This is a classic confusion between correlation and causation. The true cause of the recession is that a virulent disease focuses millions of people on self-preservation, shunning crowds and public places. But to the extent that the pandemic also leads to state-imposed restrictions, many people blame the slowdown on these correlated restrictions rather than on the underlying cause – the voluntary change in behaviour. Second, without state-imposed restrictions, the majority will voluntarily change their behaviour to avoid catching and spreading the virus, but a minority will not. When a virus is spreading, this is critical because a tiny minority of so-called ‘super-spreaders’ is responsible for most infections. Put simply, economic growth depends on the behaviour of the majority and in a pandemic the majority will voluntarily reduce their social consumption. This explains why libertarian Sweden and lockdown Denmark suffered similar contractions in their economies (Chart I-8). Chart I-8Libertarian Sweden Has Not Significantly Outperformed Lockdown Denmark... In contrast, containing the virus depends on restricting the minority of super-spreaders. Which explains why libertarian Sweden suffered a much worse outbreak of the disease than lockdown Denmark (Chart I-9). Chart I-9...But Libertarian Sweden Has Suffered Many More Covid-19 Casualties The worry now is that the end of state-imposed restrictions will unleash super-spreaders and super-spreading events. This will allow the virus to replicate, mutate, and create new variants which are potentially more transmissible and resistant to existing vaccines. Pulling together our three themes for the second half of the year, inflation is set to decelerate, job creation has a natural speed-limit, and super-spreaders of new-variant Covid-19 infections will create speed bumps in the economy. This means that:  Bonds will rally. The US dollar will rally. Growth stocks will outperform value stocks. US stocks will outperform non-US stocks Candidates For Countertrend Reversal This week, we present three candidates for countertrend reversal. First, the Brazilian real’s recent surge has hit expected resistance at 65-day fractal fragility. A good way to play a continued reversal is to short BRL/COP (Chart I-10). Chart I-10The Brazilian Real Is Correcting Second, within emerging markets, the strong rally in the Saudi equity market is vulnerable to a setback, especially versus other markets. A good way to play this is to short the Saudi Tadawul All Share index versus the FTSE Bursa Malaysia KLCI, given that the 260-day fractal structure is at the point of fragility that marked the major top in 2014 (Chart I-11). Chart I-11The Saudi Stock Market Is Vulnerable To A Setback Finally, coming full circle to short-term supply bottlenecks, one major beneficiary has been the Marine Transportation sector which, since February, has outperformed the world market by 70 percent. As the supply bottlenecks ease, this is vulnerable to correction, especially as the 260-day fractal structure is at the point of fragility that marked the major top in 2007 (Chart I-12). Chart I-12Underweight Marine Transportation Hence, this week’s recommended trade is to underweight Marine Transportation versus the market, setting the profit target and symmetrical stop-loss at 16.5 percent.   Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Fractal Trading System Fractal Trades 6-Month Recommendations Structural Recommendations Closed Fractal Trades Closed Trades Asset Performance Equity Market Performance   Indicators To Watch - Bond Yields Chart II-1Indicators To Watch - Bond Yields - Euro Area Chart II-2Indicators To Watch - Bond Yields - Europe Ex Euro Area   Chart II-3Indicators To Watch - Bond Yields - Asia Chart II-4Indicators To Watch - Bond Yields - Other Developed   Indicators To Watch - Interest Rate Expectations Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations   Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

The bond market continues to dictate the pace for the SPX and relative sector performance. The 30-year US Treasury yield retraced nearly half a percent from the mid-March peak triggering a US equity market rotation from cyclical and value sectors like materials, into growth sectors such as technology. AMZN alone moved more than 3% yesterday breaking out to fresh all-time highs signaling continued outperformance of growth stocks, while more value sectors lag behind (see chart). With growth rolling over and the Fed staying pat despite a slightly more hawkish stance, we expect the rates market to remain range bound for a while longer, further supporting a strong run of growth stocks in general, and tech in particular. Bottom Line: The rotation trade into growth at the expense of value has more room to run.  

Foreword Today we are publishing a charts-only report focused on the S&P 500, Cyclicals/Defensives, Growth/Value, and Small/Large. Many of the charts are self-explanatory; to some we have added a short commentary. The charts cover macro, valuations, fundamentals, technicals, and the uses of cash. Our goal is to equip you with all the data you need to make investment decisions along these style dimensions. We also include performance, valuations and earnings growth expectations tables for all styles, sectors, industry groups, and industries (GICS 1, 2 and 3). We hope you will find this publication, which we plan to update on a monthly basis, useful. Overarching Investment Themes Macro Economic growth remains robust, albeit slowing from a high peak. The business cycle has moved to an unusual slowdown stage, characterized by high growth. Investors’ inflation fears are dissipating, and the reflation trade is on the way out. However, concerns remain: According to the Consumer Confidence Survey, higher inflation is getting embedded into consumer expectations, potentially propagating a vicious cycle of stronger demand and higher prices (Chart 1). Fed rhetoric is becoming more hawkish. Yet, investors are shrugging it off, concluding a more active Fed is worth it to tame inflation. Companies are struggling to fill job openings and are hit with rising materials prices. However, corporate America's pricing power remains at an all-time high, helping offset the margin squeeze (Chart 2). Chart 1Consumer Confidence Survey: Inflation Expectations Chart 2Corporate Pricing Power Post-pandemic economic recovery was plagued by shortages and supply-chain disruptions. While it will take a long time for the supply issues to be resolved, bottlenecks are showing early signs of easing as delivery times are starting to fall (Chart 3). Last, but not least, consumers have money to spend, but prefer to splurge on services and experiences rather than goods. Chart 3Philadelphia Fed Business Survey: Delivery Times Valuations And Profitability The US stock market remains expensive, trading more than two standard deviations above the long-term average (Chart 4). Cyclicals look even worse, trading three standard deviations above Defensives. The six-month forward earnings outlook for the S&P 500 remains healthy with the BCA earnings model pointing towards higher growth. Hopefully, the index will grow into its elevated valuation. Small, Value, and Cyclicals also have impressive earnings growth expectations relative to their safer counterparts, but growth has peaked across the board, which does not bode well for performance. Chart 4Valuations Indicator (S&P 500) Uses Of Cash Share buybacks and other shareholder-friendly activities are on the rise again and are expected to gain steam this year and next. A falling denominator in the EPS ratio is another factor that will propel the S&P 500 higher (Chart 5). Capex is still lagging. A pickup in Capex will signal that the post-pandemic recovery is firmly on track, and life is fully back to normal as companies are comfortable investing in future growth. This will give the US equity rally, especially Cyclicals, a new lease of life (Chart 6). Chart 5Buybacks Chart 6Capex/Sales Investment Implications Normalization has been sending ripples through the US equity markets, as investors rotate back into Growth, and away from the reflation trade, and give a cold shoulder to small caps. We recommend a rotation from Value into Growth. While we are agnostic between Small and Large, we prefer both small- and large-cap Growth to large caps in general. While we think that the value trade has (mostly) run its course, we still like the Cyclicals most exposed to Consumer and Business Services, Infrastructure, and Oil.     Irene Tunkel Chief Strategist, US Equity Strategy irene.tunkel@bcaresearch.com   S&P 500 Chart 7Macroeconomic Backdrop Chart 8Profitability Chart 9Valuations And Technicals Chart 10Uses Of Cash Cyclicals Vs Defensives Chart 11Macroeconomic Backdrop Chart 12Profitability Chart 13Valuation And Technicals Chart 14Uses Of Cash Growth Vs Value Chart 15Macroeconomic Backdrop Chart 16Valuations, Profitability And Technicals Small Vs Large Chart 17Macroeconomic Backdrop Chart 18Profitability Chart 19Valuations And Technicals Chart 20Uses Of Cash  Table 1Performance Table 2Valuations And Forward Earnings Growth Recommended Allocation Footnotes  .