Equities

Biden’s first 100 days can be summed up as the return of Big Government, i.e. “the Leviathan.” But markets are not afraid of one-off corporate tax hikes that only partially reverse the previous administration’s tax cuts amid a brand new stimulus-charged economic cycle. Biden’s approval rating after his first 100 days is comparable to that of Presidents Bill Clinton and George W. Bush, suggesting that he can accomplish a major legislative achievement. The $2.3 trillion American Jobs Plan will be watered down in Congress but not to a great extent. Green energy investments and funding for research and development will survive. Thus Biden’s plan will sow the seeds of a productivity mini-boom, if not a structural boom, in the 2020s. Republicans are favored to win the midterm elections in 2022 but investors should not make any decisions based on that expectation. The risk of Democrats keeping the House of Representatives – and therefore having a new chance to surprise with taxes in the second half of Biden’s term – is much greater than the historical pattern suggests. Stick with our long materials versus tech trade. Stick with short health care trades. Go long renewable energy stocks. Feature President Biden passed the 100 day mark at the end of April. The most striking characteristic of his administration is the giant deficit spending. Biden marks the symbolic return of the “leviathan,” i.e. the state, to American political economy. Normally the budget deficit tracks closely with the unemployment rate because rising unemployment causes tax revenue to fall and government spending to rise. The divergence between the deficit and unemployment became pronounced in 2016 and revealed the structural forces – e.g. slow growth, disinflation, high debt, inequality, populism – driving US policymakers to abandon fiscal discipline. But the 2016-20 political cycle combined with the pandemic broke the dam and the divergence is now gigantic (Chart 1). Chart 1Biden's First 100 Days: An Historic Divergence All else equal, the implication is inflationary, though inflation will respond to a range of factors on different time frames. Signs of inflation today may well be under control, as Federal Reserve Chairman Jay Powell and Secretary of Treasury Janet Yellen believe, but over the long run we take the inflation risk seriously as the policy elite has fundamentally shifted to be vigilant about deflation, not inflation. Biden’s Approval Is “Just Enough”  Biden’s popularity is “fair to middling” as his honeymoon comes to an end. His approval rating clocks in right between that of Presidents Barack Obama and Donald Trump (Chart 2A). He is not as popular and charismatic as Obama and not as unpopular and controversial as Trump. His approval among Democratic voters is higher than that of Obama, similar to Trump among Republicans, due to the fact that the US has hit historic levels of political polarization (Chart 2A, second panel). His embrace of left-wing policy is keeping him in good standing among Democratic voters but may become a liability during the 2022 midterm election (more on that below). Chart 2ABiden’s Approval Rating: Fair-To-Middling Chart 2BBiden Close To Clinton, Bush At 100 Days American presidential approval ratings have fallen continuously for decades and they typically fall after inauguration. This is true of Biden but he looks more like Presidents Bill Clinton or George W. Bush than Trump. His approval is likely to stay over 50% for the foreseeable future due to a supercharged economic recovery (Chart 2B). Trump stands out conspicuously in this chart for his negative net approval, which implies that on a relative basis Biden will be more capable in conducting policy. And yet Trump got his signature piece of legislation – the Tax Cut and Jobs Act – through Congress, which has some bearing on Biden’s proposals.  Our political capital index (Appendix) shows that Biden will benefit from consumer confidence and wage growth shooting up, business sentiment strengthening, and polarization slightly abating due to a slight rise in Republican approval. While Biden’s Democratic Party has only the narrowest of majorities in the Senate, Biden’s signature legislative proposal – the American Jobs Plan – still has an 80% chance of passing in some form. Senate minority leader Mitch McConnell of Kentucky declared this week that Biden will not get any Republican votes for this package of infrastructure and corporate tax hikes but budget reconciliation is a ready way for the bill to pass on a partisan basis. Biden’s fiscal blowout should be seen as the culmination of a popular shift against fiscal discipline (or “austerity”) that took root in the middle of the last decade and was also expressed by Republican support for the big-spending President Trump. But it is more extravagant than what the Republicans proposed or would have been able to get had Trump been elected. Chart 3 highlights the difference between the Democratic and Republican spending proposals for the early 2021 COVID-19 relief bill and infrastructure plan. Chart 4 highlights the corporate tax increases Biden has proposed in excess of the Trump rate. Chart 3Biden’s Spending In Excess Of Republican Plans Chart 4Biden’s Taxes In Excess Of Republican Plans From an investment point of view, now is the perfect time to raise corporate taxes as the early cyclical surge in economic activity will prevent the one-off hit to earnings, which should be around 5%-8% according to our Global Investment Strategy, from hindering the stock market for long. The output gap, apparent from still relatively low industrial capacity utilization, will rapidly be plugged regardless of the tax hikes, as is evident from the surge in retail sales and core capital goods new orders and the decline in fuel inventories (Chart 5). The hyper-stimulated economy has been a key reason for our argument that Biden will mostly get what he wants, in terms of corporate taxes, since growth will be fine. The public is positively crying out for taxing corporations, as we showed in our April 7 missive and other reports. Chart 5The Output Gap Will Close Quickly Given that Biden’s political capital is only “just enough,” and that it is falling over time, many investors believe that Biden’s major legislative proposals will be watered down beyond recognition. They will be watered down but the reconciliation process ensures that Democrats will pass at least one bill and that it will largely gratify the party’s preferences. And any watering down will affect tax hikes more so than spending, since tax hikes are the most controversial parts of the bill for moderate Senate Democrats. As Table 1 reveals, an infrastructure package with half the revenue increase is a $1.3 trillion addition to the budget deficit over the eight-to-15 year life-cycle of the bill, as opposed to a fictitious $341 billion in the event that all tax hikes pass Congress. Hence the paring back of Biden’s ambitions does not imply fiscal restraint and is not bullish for US Treasuries.  Table 1Watering Down Biden’s Proposals Not Good For Deficit A Productivity Boomlet How can we benchmark the magnitude of the structural transformation taking place in the US as a result of Biden’s Leviathanic spending proposals? From the perspective of government spending as a contributor to economic output, the Leviathan shrank in the decades after President Lyndon B. Johnson’s “Great Society” and Vietnam debacle. But from the perspective of government accounts, Big Government never actually went away (Chart 6), as Reagan used spending to win the Cold War and Clinton only enjoyed the briefest hiatus from deficits in the 1990s. From these charts we can conclude that Biden’s administration will create unprecedented spending and deficits that, taken with an extremely accommodative Fed, will increase the risk of substantially higher inflation over the 2020s.  Chart 6Johnson’s ‘Great Society’ Versus Biden’s ‘Green Society’ Chart 7US Adds To Expansive Social Safety Net Biden is not fighting an economic depression and world war, like Franklin D. Roosevelt, although the US has experienced a Great Recession and is entering a new cold war with China. So the shift should be seen as a generational change in the role of government and not as an ephemeral, four-year trend. This is true notwithstanding the fact that the US already spends a lot on health and education (Chart 7) and not as an ephemeral, four-year trend. The element of international competition is critical to the unique components of Biden’s spending package. Biden jettisoned the health care debates of the Obama era – to our surprise – and instead inaugurated the American foray into the global green energy race. Looking at the OECD’s measure of the “greenness” of global fiscal stimulus – and supplementing it with Biden’s proposed jobs plan – the US compares favorably with the EU and China (Chart 8). Chart 8US Enters The Green Energy Race True, climate policy is more controversial in the US, which means it may well be frozen after Biden’s major bill. The EU and China will spend more on renewable energy and environmental protection because they are net energy importers and manufacturing powers. But the US is highly unlikely to exit the green race in the future, as younger generations care about it more than their elders and it is connected to the US strategic imperative of technological leadership. Biden will have opened up a new field of national policy, regardless of where on the field the players will fight over the ball at any given time. Biden is also pumping federal money into research and development, another area of geopolitical competition (Chart 9).  The takeaway is that Biden’s first year in office – which may be his most consequential year in terms of legislation, particularly if he is a one-term president – is sowing the seeds for a productivity boom, or at least a mini-boom, in the coming years (Chart 10). The pace of productivity growth in the coming years is a matter of speculation and the long term trend is down. But the expected cyclical increase should be supplemented with the knowledge that the US is now aggressively monetizing debt, aggressively pursuing industrial policy and technological advancement, and aggressively competing with geopolitical rivals like China (and even allies like the EU). The likelihood of productivity breakthroughs may go up in such an extraordinary context. We cannot know but we cannot discount the possibility. Chart 9US Doubles Down On Tech Race Chart 10Productivity Will Rise Cyclically But What About Structurally? Vaccines And Immigration Elsewhere Biden’s first 100 days are less specific to his administration. The US is performing very well on the pandemic, both in innovating vaccines and distributing them, but an objective analysis will force Biden to share the credit with the Trump administration (Chart 11). On immigration, by comprehensively weakening enforcement and raising refugee allowances, all in the midst of a surging American economy, Biden will be vulnerable to Republican accusations of encouraging a humanitarian crisis on the border, vitiating rule of law, and making a cynical ploy to expand the Democratic voter base. The number of southwest border encounters by the Customs and Border Protection agency began to skyrocket over the past year – and as such it reflects structural factors that would have troubled a second Trump administration as well. But the election seems to have had an impact based on the inflection point in the data at the end of 2020 (Chart 12). Chart 11COVID-19 Vaccination Campaign On Track Chart 12Immigration: Biden's Fatal Flaw? Regardless, Biden has made the decision to cater to the pro-immigration side of his party and will now own this trend. It will be a unifying force for Republicans, although they remain deeply split over a range of issues and are not any closer to healing their wounds. The market impact is limited in the short run. In the medium run, if unchecked immigration feeds the nativist and populist elements of the Republican Party, then Biden’s decision could have a substantial impact on future US policy by generating a backlash. Our best guess at the moment is that Biden’s actions will reinforce the Republican Party’s embrace of Trump’s policy platform. Since Biden is not making major bipartisan legislative efforts to reform immigration comprehensively, the great immigration debate will return in 2024 or thereafter. Public opinion suggests Republican nativism is out of fashion but a large influx of immigrants could opinion over time as today’s issues fade. Thus Biden’s successes on economic recovery today are sowing the seeds of his party’s biggest vulnerability in domestic policy in future. But admittedly it is too soon to say whether this weakness will be effectively exploited by the opposition. In the meantime investors and corporations will cheer the prospect of cheap and abundant labor. An Overlooked Market Risk From The Midterm Elections This overview of Biden’s honeymoon period naturally refers to the 2022 midterm elections in several places. The Republicans will not be able to repeal Biden’s laws if they take the House of Representatives – or less likely the Senate – in the 2022 vote. But they will be able to grind proposals to a halt. The fate of Biden’s third major legislative proposal, the $1.8 trillion American Families Plan, will hang in the balance, as will green energy subsidies, the child tax credit, and various social initiatives. Much has been made about the 2020 US census and the reapportionment of seats in the House of Representatives according to the population. States that have a single party in control of the governor’s mansion and the legislature can gerrymander or redraw congressional districts as they please to favor their party. Table 2 shows that this partisan process could easily yield two Republican seats on a net basis. This is less than expected but Republicans only need a net of five seats to reclaim the House.  Table 2US Census And Reapportionment Favors Republicans Slightly Redistricting is an important theme because it perpetuates political polarization. But it is not important in determining who will win the House in 2022. The House has changed hands numerous times despite gerrymandered districts. Midterms almost always work against the president’s party. Only in 1934, during the Great Depression, and 2002, immediately after the Twin Towers were attacked, did voters strengthen a first-term president’s hold on Congress. Judging by Biden’s approval rating, Democrats would be lined up for a loss of far more than five seats on a net basis in 2022. They could lose 20 or more (Chart 13). As noted in the previous section, Republicans may find a rallying point on immigration. Chart 13Midterm Elections Dominated By Opposition Party – And Need For Checks And Balances Having said that, investors should not make any decisions based on the midterm election. While Republicans have a 95% chance of winning the House according to the modern historical pattern, they have a lower 73% chance according to the online political betting hub Predictit.org, and we would side with the latter or even lower, at this early stage in the political cycle.  The pandemic and social unrest of 2020, combined with the slow-growth 2010s and trade war, create a context of upheaval that is not entirely dissimilar to the exceptional midterm elections of 1932 and 2002. Biden’s rescue packages and the economic recovery will be a huge boon for the Democratic Party in 2024 and it is possible that they will reap some benefits even in 2022. This is especially the case because Trump and his allies will challenge establishment and elitist Republicans in the primary elections, which could result in Republicans losing five-to-nine seats. If they put up Trumpists in competitive, purple, or suburban districts, voters will swing toward moderate Democrats over populist Republicans in order to preserve the “bread and butter” gains of Biden’s agenda. The bottom line is that Republicans are favored to take the House in 2022 but the 75% odds are much more realistic than the 95% historical probability and possibly even too high. Gridlock would freeze Biden’s spend-and-tax agenda in place but the absence of gridlock would come as a surprise to investors who counted on a Republican victory. Tax hikes on wealthy individuals and capital gains – as projected in the American Families Plan – could still be on the table after the midterm. These tax hikes would still be unlikely to overturn the equity bull market but they could cause investors to reassess the overall policy setting for the worse. The implication would be that the 2020 political change marked a more lasting leftward shift in US policy. For example, taxes could go up beyond what Biden currently projects. Midterm risks should not trouble investors in the near term but they should be on the radar, particularly as the Republican primaries get underway next year and as investors get a better read on inflation in the wake of Biden’s mammoth spending. Investment Takeaways We would draw a few main investment takeaways from Biden’s first 100 days. In the short run, we would call attention to the “buy the rumor, sell the news” behavior exhibited by financial markets during President Trump’s first year in office with full party control of Congress. US equities stood to benefit from tax cuts, especially relative to the rest of the world, which would not receive tax cuts but could face trade tariffs. This expectation played out after Trump’s election but the market sold upon the news of his inauguration. It played out again after Republicans failed to repeal Obamacare, suggesting they might fail to cut taxes. The market correctly bid up US equities on the rumor that the GOP would then turn its full attention to cutting taxes. US equities outperformed until the end of the year when the tax cuts became a fait accompli, at which point the news was sold (Chart 14, top panel). The implication today is that US stocks, especially cyclical stocks and infrastructure-related plays, will continue generally to rally ahead of Biden signing the American Jobs Plan into law, likely around November. Obviously a correction could occur at any time but upon the signing of the law one should not be surprised to see some serious profit-taking. An analogy can also be drawn to renewable energy plays after the Democrats’ “Blue Sweep” in 2020. Markets have largely discounted the surge in renewable energy plays that occurred upon the recession in 2020 and the rising likelihood that Trump would lose reelection (Chart 14, bottom panel). This creates a buying opportunity for a long-term theme. Republicans will not be able to repeal Biden’s green projects and there is some risk that Democrats retain legislative control. And younger generations, even Republicans, are favorable toward the greening of society. Therefore we recommend going long US renewable energy stocks. It also follows that cyclical and value stocks have not yet exhausted their run against defensives and growth stocks. We will therefore hang onto our long materials / short Big Tech trade until we see more substantial signs that near-term disinflationary risks will derail this trade (Chart 15). We will also stick with our short managed health care trade – and our preference for health care equipment and facilities within the health care sector – despite the Democrats’ tentative decision to sideline the health care policies that would have hit the health insurers and Big Pharma. Chart 14Investment Takeaways: Buy The Green Hype (For Now) Chart 15Housekeeping: Stick With Materials Over Tech In the long run, we would point out that the shift away from Reaganism toward Johnsonianism – the return of Leviathan – is a lasting trend that will bring significant change to the US policy setting. These are mostly but not all inflationary. Larger immigration and a productivity boost are not inflationary. But large deficits, tax hikes, and wage pressures are inflationary. Therefore the risk of inflation has gone up in a historic way even though the magnitude of the risk can be overstated in the short term – when there is still slack in the economy – and there are still disinflationary factors that could work against the risk as events unfold. We remain cyclically bullish.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com   Appendix Table A1USPS Trade Table Table A2Political Risk Matrix Table A3Political Capital Index Table A4APolitical Capital: White House And Congress Chart A4BPolitical Capital: Household And Business Sentiment Table A4CPolitical Capital: The Economy And Markets

Last September, we showed five reasons, from our pool of short-term indicators we track, not to chase equities higher and warned investors that a pullback was in the cards. Subsequently, the SPX fell 10% from peak-to-trough and suffered its first correction since the March 23, 2020 bottom. Fast-forward to today, and a number of our short-term indicators are flashing red again. While overbought conditions are a notch below the extremes printed last September, we still take this opportunity to revisit and update five of our near-term technical indicators in no particular order. Reason #1: The 200-day Moving Average Moving averages are a reliable tool to put the speed of any rally in perspective and to gauge investor sentiment. Chart 1 shows the SPX and NASDAQ 100 (NDX) price ratios with respect to their 200-day moving averages as Z-scores. Whenever both the SPX and NDX crossed above the one standard deviation (STDEV) line, a sizable pullback was quick to follow. While the NDX retraced below the one STDEV line recently, this week’s price action pushed the ratio back above the one STDEV line sounding the alarm. The implication is that the probability of a pullback is rising rapidly. Chart 1 Reason #2: Bollinger Bands For the second reason, we look at price deviations from the moving average through a different lens – Bollinger bands (BBs). A traditional (20,2) BB includes a 20-period moving price average, as well as 20-period two STDEV lines. Chart 2 shows the S&P 500 together with its (20,2) BBs, on a monthly time frame. Whenever the market spikes above the two STDEV line, a sizable correction ensues. Currently, the market is squarely above the two STDEV line, which has historically been a precursor to a 5-10% drawdown. Chart 2 Reason #3: Market Breadth In addition to looking at popular market breadth indicators such as a percent of stocks above a moving average and new highs/new lows series, we also take a look at the Hindenburg Omen indicator that is a breadth indicator partially based on the new highs/new lows calculation. A more in-depth explanation can be found here. Similarly to the aforementioned Reason #1, the best signal is given when the indicator flashes red for both NYSE and NASDAQ exchanges. Chart 3 shows that when implementing this approach, there has only been one false/positive – the Trump’s tax cut rally. Currently, the indicator represents another warning sign: it produced a sell signal in March. While this can prove another false/positive, given the plethora of other warnings, we doubt this will be the case. Chart 3 Reason #4: Options/Volatility Markets Next, options related volatility reveals more broad equity market vulnerabilities. Specifically, the VIX and the VXN which by construction are inversely correlated with the S&P 500 and NASDAQ 100, respectively, serve as an excellent timing tool. We look at the 20-day moving correlation of those respective variables, and a reliable sell signal is given once both (VIX, SPX) and (VXN, NDX) 20-day moving correlations shoot into positive territory (Chart 4). True, this signal has not been triggered just yet with the (VXN, NDX) pair lagging behind. But the positive print that happened this Monday in the (VIX, SPX) pair was enough to rattle the market yesterday, which could be a precursor to a larger correction. Chart 4 Reason #5: Lack Of Leadership The last reason for near-term cautiousness is the lack of leadership from a key cyclical sub-sector. Weakness in anticipatory semiconductors is far too pronounced to be written off as an industry-only event. Chart 5 depicts how the current divergence between relative semi prices and the SPX is eeriely similar to the one in late-2018. Finally, Chart A1 in the Appendix on the next page examines the relationship between semis and the SPX on a longer timeframe. Bottom Line: There are rising odds of a sizable SPX pullback. Investors who cannot stomach a likely volatility bout can buy some protection in the form of VIX futures (we are long the June expiry contract) in order to withstand a possible 10% SPX correction. Short-term caution on the prospects of the broad equity market that remains fully valued is still warranted. Chart 5 Appendix Chart A1

Highlights Portfolio Strategy Firming operating metrics, a capex upcycle, rock bottom valuations and deeply oversold conditions all suggest that it no longer pays to be bearish Big Pharma. Upgrade to neutral, today. A looming M&A boom, excess liquidity leaking into biotech stocks, extremely pessimistic Wall Street analysts’ forecasts and severe undervaluation, all suggest that now is the time to go against the grain and overweight biotech equities. Recent Changes Lift the S&P pharmaceuticals index to neutral and remove it from the high-conviction underweight list cementing gains of 12.6% and 10.3% respectively. Boost the S&P biotech index to overweight today. Both of these moves also lift the S&P health care sector to an above benchmark allocation. Table 1 Feature The bulls have taken full control of the equity market and propelled almost every index to fresh all-time highs despite a muted earnings season. Not only are the SPX, the DOW industrials and transports, the NASDAQ composite and the NASDAQ 100 all flirting with uncharted territory, but also more obscure indexes like the Value Line Arithmetic (gauging the average US stock) and Geometric (gauging the median US stock) indexes have also cleared the all-time high bar (Chart 1). On a stock level, bellwether AAPL – the largest stock in the world – has yet to make the leap to new highs despite a blowout profit report and gargantuan buyback announcement, which is cause for near-term concern. Given that the Fed orchestrated this once in a lifetime bonanza, it is also the Fed that can spoil this party, at least temporarily, by removing the proverbial punchbowl. Peering toward the back half of the year, our view remains that the Fed will have to relent and taper asset purchases as inflation will be rearing its ugly head not in a transitory, but more on a semi-permanent fashion. Importantly, the USD can further fan this inflationary impulse. Chart 2 shows that US real GDP expectations are trouncing the rest of the world (ROW) as we first showed in early March. Similarly the ISM manufacturing dichotomy compared with the ROW PMIs is as good as it gets. While this would typically call for a surge in the greenback, counterintuitively we think the path of least resistance is lower for the US dollar as the US economy reaches an inflection point versus the ROW mid-year. Crudely put, if the USD merely ticked up on such a wide economic differential, once Europe and Japan play catch up as the vaccine rollouts and economic reopening smoothen up, then investors will likely flee the US dollar. Chart 1All Time Highs Everywhere Chart 2Relative Growth Expectations At A Zenith With regard to stock market dynamics, this is welcome news for revenue growth, especially for internationally sourced SPX sales that garner a 40% share of total revenues. Since the US dollar floated in the early 1970s, the inverse correlation has increased between top line S&P 500 growth and the greenback (Chart 3). The implication is that a US dollar debasing from current levels will further boost the allure of companies that can raise selling prices. On that front our Corporate Pricing Power Indicator (CPPI) that we recently updated has been on a tear, underscoring that sales growth will soon follow suit (Chart 4). Chart 3Depreciating USD A Boon For SPX Sales Chart 4Rising Inflation Will Boost Revenues Tack on optimistic Chief Executives, and the picture brightens further for SPX revenue prospects. Inflation breakevens also corroborate the messages from our soaring CPPI and surging business confidence (Chart 4). One level down to the SPX GICS1 sector level, Charts 5, 6 & 7 highlight sales growth expectations, with deep cyclicals reigning supreme –especially the energy complex– and defensives the clear laggards (all sectors are compared with the broad market). On the early cyclical front, consumer discretionary equities are forecast to grow sales by 500bps more than the SPX, while financials are slated to trail the overall market by 500bps. Chart 5Consumer Discretionary… Chart 6…And Deep Cyclicals… Chart 7…Have The Upper Hand With regard to the contribution to SPX sales growth for calendar 2021, Table 2 details sector sales growth, sector sales weight, all ranked by sector contribution to SPX sales growth. Chart 8 highlights that consumer discretionary, energy and health care comprise roughly half of the increase in overall revenue growth for 2021. Adding industrials and tech to the mix and these five sectors explain 80% of this year’s projected top line growth contribution to the SPX. Table 2SPX GICS1 Sector Sales Analysis Chart 8Sector Contribution To 2021 SPX Sales Growth Drilling further into industry sub-groups and for inclusion purposes, Table 3 shows our universe of coverage, ranking GICS1 sectors by 12-month forward sales growth and then re-ranking by sub-groups always from highest-to-lowest. Table 3Identifying S&P 500 Sector Sales Growth Leaders And Laggards Circling back to investment implications and gelling everything together, what should investors do given this backdrop? If portfolio managers can stomach volatility and sail through the seasonally weak month of May, then holding the line and sitting tight is the appropriate strategy. However, if investors cannot stomach the bout of volatility that is likely looming, then playing some defense would make sense. We stand closer to the latter camp, and this week we take profits on a defensive group and lift exposure to neutral and boost another beaten down health care sub-group to overweight. These two moves also lift the S&P health care sector to an above benchmark allocation. Exiting The ER The bearish undertones haunting the S&P pharmaceuticals index are well ingrained in investors’ minds and our portfolio has also handsomely benefited from avoiding this key health care industry group. However, it no longer pays to be negative Big Pharma and today we book gains of 12.6% and lift exposure to neutral, and also take this index out of our high-conviction underweight list locking in gains of 10.3% since the early December inception. Chart 9 shows that likely all the adverse news is priced in rock bottom valuations and extremely oversold technical conditions. In fact, the pharma forward P/E ratio is trading at a 40% discount to the SPX and all time low since the GICS reclassification of sectors took place in the early 1990s! While such drubbing is warranted, as this defensive index has to contend an economy exiting recession and also a near unanimous outcry against industry pricing power gains, the easy money has been made on the short/underweight side. This de-rating has coincided with a collapse in relative forward profit growth, on a 12-month and five-year basis, both of which are probing all-time lows (Chart 10). The implication is that the EPS bar is so low it is nearly guaranteed that Big Pharma will surpass it. Such extreme pessimism is contrarily positive and if there is even a whiff of positive profit news, an explosive rally will take root. Chart 9Unloved And Under-owned Chart 10Analysts Have Given Up On Pharma Encouragingly, our macro EPS growth models signal that pharma profits have a strong pulse and will outshine the overall market in the coming year (Chart 11). We recently highlighted the near perfect inverse correlation of the relative share price ratio with the US leading economic indicator and the US ZEW. Similarly, we have shown in the recent past that a number of subcomponents of the ISM manufacturing survey also move inversely with pharma relative profitability. Now that the ISM is at a zenith, staying bearish pharmaceutical stocks will likely prove offside. Meanwhile, Chart 12 shows that the fed funds rate impulse is neither contracting nor weighing on relative share prices. Similarly, the bond market has already priced in two hikes in two years, warning that the relative share price ratio risk/reward tradeoff is slowly shifting to the overweight column. Chart 11Out Of The Ward On the operating front, Big Pharma is investing anew with capex gone parabolic (bottom panel, Chart 13). The last time pharma capital outlays rose over 20%/annum was in the early 1990s! Chart 12There Is A Pulse Chart 13Capex To The Rescue? Industry shipments are climbing roughly at a double digit clip and pharma output is also expanding smartly, underscoring that soon industry productivity will also ascend, which is a boon for profits (Chart 14). Tack on the export relief valve pharma manufacturers are enjoying of late, and factors are falling into place for an earnings led rebound in pharma equities (second panel, Chart 14). Finally, the top panel of Chart 15 highlights that demand for pharmaceuticals in as upbeat as ever and has been significantly diverging from relative share prices. The implication is that this steep gulf will narrow via a catch up phase in the latter. Chart 14Glimmers Of Hope Chart 15Upbeat Demand, But Deflation Is A Tough Pill To Swallow Nevertheless, before getting outright bullish this heavyweight health care sub-group, there are two significant (and related) offsets. Industry pricing power is under attack and will remain in duress until it reaches a new equilibrium (middle panel, Chart 15). As a result, pharmaceutical profit margins have been in an almost uninterrupted multi year squeeze, warranting only a neutral allocation to Big Pharma manufacturers, until these dark profit clouds clear (bottom panel, Chart 15). Netting it all out, firming operating metrics, a capex upcycle, rock bottom valuations and deeply oversold conditions all signal that it no longer pays to be bearish Big Pharma. Upgrade to neutral, today. Bottom Line: Crystalize gains in the S&P pharma index of 12.6% since inception and lift exposure to neutral. We are also removing it from the high-conviction underweight list locking in gains of 10.3% since inception. The ticker symbols for the stocks in this index are: BLBG: S5PHARX– JNJ, PFE, MRK, LLY, BMY, ZTS, CTLT, VTRS, PRGO. Buy Biotech Stocks Against The Grain We recommend investors buy the budding recovery in biotech stocks, and today we are boosting the S&P biotech index to an above benchmark allocation. Rising interest rates have dampened demand for biotech stocks as these high growth stocks should command a lower multiple on the back of a rising discount rate (top panel, Chart 16). Add on waning US dollar liquidity and the relative underperformance phase gets explained away (bottom panel, Chart 16). However, there still remains a sizable gap between relative profits and relative share prices. If our four-pronged bullish thesis that we detail below pans out, then a catch up phase looms in crushed biotech stocks (Chart 17). Chart 16Bearish Story Well Documented Chart 17Peculiarly Wide GapFirst, we posit that this highly fragmented industry is prime for consolidation. Even in the large cap S&P 500 biotech index there is scope for M&A activity. Not only intra-industry mergers, but also cash rich and drug pipeline extension thirsty Big Pharma is lurking in the shadows ready to deploy their cash hoard. Already, there is an ongoing mini M&A boom and given the recent biotech firms’ success stories in the race to discover the COVID-19 vaccine, they command a high profile in investment banking board rooms (Chart 18). Second, as long as the Fed remains committed to ZIRP and margin debt balances continue to balloon, some of this excess liquidity will flow toward biotech stocks that are more speculative than their safe-haven health care brethren. Historically, relative margin debt balances and relative share prices have been joined at the hip, and the message from spiking margin debt uptake is to expect a similar rebound in biotech equities (Chart 19). Chart 18M&A Boom Is Bullish Chart 19Speculative Excesses Go Hand-In-Hand With Biotech Stocks Third, the sell side has thrown in the towel on the prospects of the S&P biotech index. Relative sales growth expectations are negative, relative 12-month and five-year forward growth numbers are sinking like a stone and probing all-time lows (Chart 20). All this analyst pessimism is gaining steam at a time when the S&P biotech dividend yield is 2.5%, roughly 100bps higher than the 10-year US Treasury yield and 125bps higher than the SPX dividend yield (bottom panel, Chart 20). Finally, not only the relatively large dividend yield gap signals that biotech stocks are cheap, but on a forward P/E basis the S&P biotech index trades at a whopping 50% discount to the SPX (fourth panel, Chart 20). Our Valuation Indicator has collapsed to levels that have marked prior bull phases going back 25 years and similarly technicals are as downbeat as ever (Chart 21). Chart 20Low Threshold To Overcome Chart 21Cheap And Oversold In sum, a looming M&A boom, excess liquidity leaking into biotech stocks, extremely pessimistic Wall Street analysts’ forecasts and severe undervaluation, all signal that now is the time to go against the grain and overweight biotech equities. Bottom Line: Lift the S&P biotech index to overweight, today. This upgrade along with the S&P pharma upshift to neutral also lift the S&P health care sector to overweight. The ticker symbols for the stocks in this index are: BLBG: S5BIOTX– AMGN, ABBV, GILD, VRTX, REGN, ALXN, BIIB, INCY.       Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com   Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Size And Style Views February 24, 2021 Stay neutral cyclicals over defensives January 12, 2021  Stay neutral small over large caps June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, ABNB, V). January 22, 2018 ​​​​​​​Favor value over growth

Highlights Sweden’s economic recovery is robust and will deepen. Policy is accommodative. Very few advanced economies will benefit as much from the global economic rebound. The labor market will tighten, capacity utilization will increase, and inflation will rise faster than the Riksbank forecasts. On a one- to two-year investment horizon, the SEK is a buy against both the USD and the EUR. Despite their pronounced outperformance, Swedish stocks possess significantly more upside against both Eurozone and US equities over the remainder of the cycle. Swedish industrials will beat their competitors in both these markets. Nonetheless, China’s policy tightening creates a meaningful tactical risk, which selling Norwegian stocks can hedge. Italy’s fiscal plan constitutes a new salvo in Europe’s efforts to avoid last decade’s mistakes. Feature Last week, the Swedish Riksbank did not follow in the footsteps of the Norges Bank. The Swedish central bank acknowledged that the economy is performing better than anticipated and that the housing market is gaining in strength; yet, it refrained from hinting at any forthcoming adjustment to its policy rate or the pace of its asset purchase program. The positive outlook for the Swedish economy will force the Riksbank to tighten policy significantly before the ECB. As a result, we expect the Swedish Krona to outperform the euro and the US dollar. Moreover, investors should continue to overweight Swedish equities due to their large exposure to industrials and financials, even if they have already significantly outperformed the Euro Area. Sweden’s Economic Outlook The Swedish economy will accelerate, which will put pressure on resource utilization and fan inflationary risk in the years ahead. The degree of stimulus supporting Sweden is consequential. Chart 1A Dual Labor Market On the fiscal front, the government support measures that have been announced since the beginning of the COVID-19 crisis currently amount to SEK420bn, or SEK197bn for 2020 (4% of GDP), and SEK223bn for 2021 (4.5% of GDP). Moreover, generous labor market protection and part-time employment schemes meant that the number of employees in permanent employment contracts remained stable during the pandemic (Chart 1). Thus, the bulk of the rise in Swedish unemployment came from workers on fixed-term contracts. Monetary policy remains very accommodative as well. The Riksbank left its repo rate unchanged at 0% through the crisis, but cut its lending rate from 0.75% to 0.1%. More importantly, the Swedish central bank is aggressively injecting liquidity into the economy. It set up a SEK500bn funding-for-lending facility in order to incentivize bank lending to the nonfinancial private sector, and started a SEK700bn QE program, which as of Q1 2021 had purchased SEK380bn securities and which will purchase another SEK120bn in Q2, with covered bonds issued by banks accounting for 70% of it. As a result, the amount of securities held on the Riksbank balance sheet will nearly triple by year end (Chart 2). Chart 2The Riksbank Is Open For Business Beyond the monetary and fiscal stimulus, many factors point to greater economic strength for Sweden. Despite a slow start to the process, as of last week, nearly 30% of the Swedish population had received at least one vaccine dose, which is broadly in line with vaccination rates prevalent in France or Germany. Crucially, the pace of vaccination is accelerating at a rate of 13% per week. Even if this second derivative slows, more than 70% of the population will have received at least one dose by this summer. Thus, greater mobility is in the cards during the second quarter, which will boost household spending. Chart 3The Wealth Effect The housing market also favors a pick-up in consumption. The HOX housing price index is growing at a 15% annual rate, its fastest expansion in over 5 years. As a result of the wealth effect, this rapid appreciation is consistent with a swift improvement in the growth rate of household expenditures (Chart 3). Moreover, spending on durable goods now stands 1.3% above its pre-pandemic levels, while spending on non-durables is back to pre-pandemic levels. This context suggests that increased mobility translates into greater spending. The industrial sector remains a particularly bright spot in the Swedish economy. Sweden is extremely sensitive to the global industrial and trade cycle, because exports represent 45% of GDP. Moreover, the highly cyclical intermediate and capital goods comprise 56% of the country’s foreign shipments, which accentuates the beta of the Swedish economy. BCA Research remains optimistic about the global industrial cycle. Sweden will reap a significant dividend. Already the Swedish PMI points to stronger industrial production, and the index’s exports component is roaring ahead (Chart 4). The potential for a greater uptake in consumption, capex, and durable goods spending in the rest of the EU (Sweden’s largest trading partner) bodes well for the Swedish manufacturing sector. Additionally, if the collapse in the US inventory-to-sales ratio is any indication for the rest of the world, a global restocking cycle is forthcoming, which will further boost Swedish industrial activity (Chart 4, bottom panels). Finally, global public infrastructure plans are on the rise, which will also help Sweden. Chart 4Sweden Is well Placed Chart 5Brightening Labor Market Prospects In this context, the Swedish labor market should tighten significantly in the approaching quarters. Already, job vacancies are rebounding, and redundancy notices have normalized, which matches both the GDP growth surprise in Q1 and the continued rise in the NIER Sweden Economic Tendency Indicator. Furthermore, the employment component of the PMIs stands at 58.9 and is consistent with a sharp improvement in job growth over the coming year (Chart 5). The expected labor market growth will contribute to an increase in capacity utilization, which will place upward pressure on wages and inflation. When the 12-month moving average of US and Eurozone imports rises, so does the Riksbank Resource Utilization Indicator, because global trade has such a pronounced effect on the Swedish economy (Chart 6). Meanwhile, greater resource utilization leads to accelerated inflation, greater labor shortages, and rising unit labor costs (Chart 7).  Chart 6CAPU Will Rise Chart 7The Coming Pressure Buildup Bottom Line: As a result of generous stimulus and the global economic recovery, the Swedish economy is set to continue its rebound. Consequently, employment and capacity utilization will improve meaningfully, which will lead to a resurgence of inflation and wages in the coming 24 months. Investment Implications On a 12 to 24 months horizon, we remain positive on the Swedish krona and Swedish equities. Fixed Income And FX Chart 8Three Hikes By 2025 The backend of the Swedish OIS curve only discounts 75bps of hikes by 2025. This pricing is too modest (Chart 8). The Swedish economy will rebound further as the vaccination campaign advances, and rising house prices and household indebtedness will fan growing long-term risk to financial stability, both of which suggest that the Riksbank will have to change its tack in 2022. The great likelihood that the Fed will start tapering off its asset purchase toward the end this year, that the ECB will follow sometime in 2022, and that the Norges Bank will be increasing interest rates next year will give more leeway to the Swedish central bank. A wider Sweden/Germany 10-year government bond spread is not an appealing vehicle to play a more hawkish Riksbank down the road. This spread hit a 23-year high in March and now rests at 62bps or its 98th percentile since 2000. Moreover, the terminal rate proxy embedded in the German money market curve is currently so low that the spread between Sweden’s and the Eurozone’s terminal rate proxy stands near a record high. Hence, German yields already embed much more pessimism than Swedish ones. Nonetheless, BCA recommends a below benchmark duration exposure within the Swedish fixed-income space, as we do for other government bond markets around the world.1 A bullish bias toward the SEK is a bet on the Riksbank that offers a very appealing risk/reward ratio, according to BCA Research’s Foreign Exchange Strategy strategists.2 The krona is very cheap against both the euro and the US dollar, trading at 9% and 29% discounts to purchasing power parity, respectively. Moreover, the Swedish current account stands at 5.2% of GDP, compared to 2.3% and -3.1% for the Euro Area and the US, creating a natural underpinning under the SEK. Chart 9The SEK Loves Growth Over the coming 12 to 24 months, cyclical forces favor selling EUR/SEK and USD/SEK on any strength. The SEK is one of the most cyclical G-10 currencies and has one of the strongest sensitivities to the US dollar. Hence, our positive global economic outlook and our FX strategists negative view on the greenback are synonymous with a weak USD/SEK. These same factors also mean that the krona will appreciate more than the euro, as the negative correlation between EUR/SEK and our Boom/Bust Indicator and global earnings growth illustrate (Chart 9). Equities We also like Swedish equities, but the state of the Swedish economy and the evolution of the Riksbank policy surprise have a limited impact on Swedish equities. The Swedish bourse is mostly about the evolution of the global business cycle. The Swedish benchmark heightened sensitivity to the global business cycle reflects its massive overweight in deep cyclicals, with industrials, financials, consumer discretionary, and materials accounting for 38.4%, 26.1%, 9.7% and 3.7% of the MSCI index respectively, or 78% altogether (Table 1). As a result, BCA’s preference for global cyclicals at the expense of defensives and this publication’s fondness for the recovery laggards like the industrial and financial sectors automatically translate into a favorable bias toward Sweden’s stocks.3 Table 1Mamma Mia! That’s A Lot Of Cyclicals Valuations offer a more complex picture, but they do not diminish our predilection for Sweden. Swedish equities trade at a discount to US stocks but at a premium to Euro Area ones (Chart 10). However, Swedish stocks offer higher RoEs and profit margins than both the US and the Euro Area, while also sporting lower leverage (Chart 11). Thus, their valuation premium to Euro Area stocks is warranted and their discount to US ones is excessive, especially when rising yields hurt the relative performance of the growth stocks that dominate US indexes. Chart 10Swedish Discounts And Premia Chart 11Profitable Sweden The outlook for Swedish earnings is appealing, both in absolute and relative terms. The Swedish market’s extreme sensitivity to global economic activity means that Sweden’s EPS increase and beat US profits when the Riksbank Resource Utilization Indicator expands (Chart 12). These relationships are artefacts of the Swedish economy’s pro-cyclicality, which causes capacity utilization to interweave tightly with the global business cycle (Chart 6). Chart 12The Winner Takes It All Chart 13Better Capex Play Than You Global capex and infrastructure spending favor Swedish equities compared to Euro Area ones. Over the past thirty years, Sweden’s stocks have outperformed those of the Eurozone when capital goods orders in the advanced economies have expanded (Chart 13). This reflects the Swedish benchmark’s large overweight in industrials, a sector that is the prime beneficiary of global capex. Capital goods orders are recovering well, and their growth rate can climb higher, especially as western multinationals announce capex plans and as governments from the US to Italy intend to ramp up infrastructure spending. Moreover, the large pent-up demand for durable goods in the Eurozone further enhances the potential of industrial firms, and thus, of Swedish equities.4  Chart 14Another Sign Of Pro-Cyclicality BCA Research’s positive cyclical stance on commodities offers another reason to overweight Sweden’s market relative to that of the US and the Euro Area. Our Commodity and Energy Strategy sister service anticipates significant further upside for natural resources, especially base metals, over the remainder of the business cycle.5 Commodity prices still have room to rally, because demand will grow as the global economy continues to recover and because the supply of natural resources has been constrained by a decade of low investment. As a result, rising metal prices will symptomatize strong economic activity around the world and will incentivize capex in commodity extraction, both of which will boost the revenue of industrial firms. Furthermore, commodity price inflation often corresponds with rising yields, which boosts financials as well. These relationships explain the Swedish stocks’ outperformance of US and Eurozone stocks, when natural resource prices rally, despite the former’s low exposure to materials (Chart 14). At the sector level, the appeal of Swedish industrials relative to those of the Eurozone and the US completes the rationale to favor Swedish equities in a global portfolio. Swedish industrials are just as profitable as US ones and are more so than Euro Area ones, while having significantly lower leverage than either of them (Chart 15). Additionally, for the past two years, the EPS growth of Swedish industrials has bested that of US and Eurozone ones. Yet, their forward P/E ratio trades in line with the US and the Euro Area, while the sell-side’s long-term relative earnings growth estimate is too depressed (Chart 16). The same observations are valid when comparing Swedish industrials to French or German ones. Hence, in the context of a global business cycle upswing, buying Swedish industrials while selling their US and Euro Area competitors is an appealing pair trade, especially since it also involves short USD/SEK and short EUR/SEK bets. Chart 15Attractive Swedish Industrials... Chart 16...And Not Expensive Despite our optimism toward Swedish stocks on a 12 to 24 months basis, investors must hedge a near-term risk. Chinese authorities are aiming to contain financial excesses and trying to restrain credit growth. As we showed four weeks ago, China’s excess reserve ratio is contracting, which points toward a slowdown in the Chinese credit impulse.6 Historically, such a development can hurt global cyclicals, and thus, also Swedish equities. However, BCA Research’s China strategists believe that Beijing will not kill off the Chinese business cycle; thus, the recent disappointment in the Chinese PMI is transitory.7   Chart 17Industrials vs Materials: Europe vs China Materials more than industrials will suffer the brunt of a China slowdown, as the re-opening trade and capex cycle among advanced economies will create a buffer for the latter. Indeed, the performance of global industrials relative to materials stocks correlates with the evolution of the spread between the Euro Area and Chinese PMI (Chart 17). Thus, we recommend selling Norwegian equities to hedge the tactical risk inherent in an overweight on Sweden. As Table 1 above shows, Norway overweighs materials and energy (two sectors greatly exposed to China), hence, a temporary pullback in commodity prices should hurt Norwegian stocks more than Swedish ones. Bottom Line: The SEK is an inexpensive and attractive vehicle to bet on both the global business cycle strength and the Swedish economic recovery. Thus, investors should use any rebound in EUR/SEK and USD/SEK to sell these pairs. Moreover, Swedish stocks greatly overweight cyclical sectors, particularly industrials and materials. This sectoral profile renders Swedish equities as attractive bets on the global economy. Additionally, Swedish shares display alluring operating metrics. As a result, we recommend investors go long Swedish industrials relative to those of the US and Euro Area. They should also overweight Swedish equities against the US and the Eurozone. Consequent to some China-related tactical risks, an underweight stance on Norwegian stocks constitutes an attractive hedge to this Swedish exposure. A Few Words On Italy’s National Recovery And Resilience Plan Mario Draghi’s plan to revive the Italian economy, announced last week, is an important marker of Europe’s changing relationship with fiscal policy. Last decade, excessive austerity contributed to subpar growth, ultimately firing up concerns about debt sustainability in many peripheral economies, and fueled risk premia in Italy and Spain. Under the cover of the current crisis, and in the face of the changing political winds in Brussel and Berlin where fiscal rectitude is not the mantra it once was, national European governments are beginning to propose ambitious fiscal stimulus plans. The National Recovery and Resilience program illustrates these dynamics. The EUR248bn plan is a testament to the importance of the NGEU recovery program as well as the REACT EU recovery fund. Through these facilities, the EU will contribute EUR191.5bn to the fiscal plan via grants and loans. Italy will contribute the remainder of the funds. While the total amount disbursed over the next six years corresponds to 14% of Italy’s 2019 GDP, the Draghi government estimates that the program will add 3.2 percentage points to GDP between 2024 and 2026. Importantly, markets are not rebelling. Despite expectations that Italy would continue to run an accommodative fiscal policy, the BTP/Bund spreads remain stable. We can expect this trend of greater stimulus to be mimicked around the EU. Spain is another large recipient of the NGEU program, and it too is likely to increase stimulus beyond what the EU will fund. France will hold an election in May 2022, and President Macron has all the incentives to stimulate the economy between now and then. If, as we wrote last week, Germany shifts to the left in September, then this outcome will be guaranteed. Bottom Line: The Draghi plan is the first salvo of greater fiscal stimulus in the EU. This trend will help Eurozone growth improve relative to the US over the coming few years. Despite a loose fiscal policy, BTPs and other peripheral bonds will continue to outperform on the back of declining risk premia.   Mathieu Savary, Chief European Investment Strategist Mathieu@bcaresearch.com   Footnotes 1Please see Global Fixed Income Strategy “GFIS Model Bond Portfolio Q1/2021 Performance Review & Current Allocations: Grand Reopening,” dated April 6, 2021, available at gfis.bcaresearch.com 2Please see Foreign Exchange Strategy “2021 Key Views: Tradeable Themes,” dated December 4, 2020, available at fes.bcaresearch.com 3Please see European Investment Strategy “Summer Of ‘21,” dated March 22, 2021, available at eis.bcaresearch.com 4Please see European Investment Strategy “Winds Of Change: Germany Goes Green,” dated April 23, 2021, available at eis.bcaresearch.com 5Please see Commodity & Energy Strategy “Industrial Commodities Super-Cycle Or Bull Market?” dated March 4, 2021, available at ces.bcaresearch.com 6Please see European Investment Strategy “The Euro Dance: One Step Back, Two Steps Forward,” dated March 29, 2021, available at eis.bcaresearch.com 7Please see China Investment Strategy “National People’s Congress Sets Tone For 2021 Growth,” dated March 17, 2021, available at cis.bcaresearch.com Cyclical Recommendations Structural Recommendations Currency Performance Fixed Income Performance Government Bonds Corporate Bonds Equity Performance Major Stock Indices Geographic Performance Sector Performance Closed Trades

Highlights Last week featured a lot of good news for financial markets and the economy … : US GDP grew at 6.4% in the first quarter, powered by 10.7% growth in consumption; the six largest companies in the S&P 500 reported first quarter earnings that exceeded expectations by an average of 41%; and the Fed remained resolutely dovish. … and we continue to believe that they are likely to remain in our “just-right” base-case scenario over the next twelve months … : Our Goldilocks base-case scenario is underpinned by strong growth and accommodative monetary policy. Strong growth is assured as long as the virus doesn’t come roaring back, and the Fed still isn’t even talking about talking about tapering its asset purchases, much less hiking the fed funds rate. … so our risk-friendly asset allocation recommendations remain unchanged: There are no signs yet that equities and credit will not continue to generate significant excess returns over Treasuries and cash over the next twelve months. Feature We will be holding a webcast next Monday, May 10th at 10:00 a.m. Eastern time in lieu of publishing a Weekly Report. Please join us with your questions to make it a fully interactive event. We will resume our regular publication schedule on the 17th. Some say the world will end in fire, Some say in ice. – Robert Frost, “Fire and Ice”   We continue to view financial markets and the economy through the lens of our stylized Goldilocks-and-the-Two-Tails distribution (Figure 1). Though the figure gives short shrift to our subjective probability that the Goldilocks base-case scenario will unfold over the next twelve months (≈ 70-75%), and overstates the likelihood of a too-cold outcome (≈ 5-10%), the size of the too-hot right tail (≈ 20-25%) is roughly in line with our expectations. Last week’s spate of economic data, company earnings releases and Fed guidance supported our view and shored up our conviction in it. The twin pillars of well-above-trend growth and extremely accommodative monetary policy remain firmly in place. Figure 1Goldilocks And The Two Tails Last week’s data were especially strong. Sticking to the highlights, and skipping the uncertain impacts of the measures President Biden floated before a joint session of Congress, the following items suggest that the just-right scenario is considerably more probable than not. The Conference Board’s consumer confidence index surged higher (Chart 1, top panel) and given the way it tends to track the jobs plentiful sub-index (Chart 1, bottom panel), the road ahead looks good, provided that job openings rise as businesses still operating at limited capacity ramp up their operations. We have not found that consumer confidence is a robust predictor of key economic series, but the advance supports the notion that several elements are falling into place. Chart 1Consumer Confidence Is Surging ... Initial jobless claims for the week ended April 23rd made their third straight post-pandemic low and the four-week moving average extended its recent descent (Chart 2). The four-week moving average is poised to take another step lower next week once the 742,000 April 2nd reading falls out of the calculation (the last three weeks have averaged 568,000). Headline first-quarter GDP growth of 6.4% was strong, albeit just shy of consensus expectations, but the underlying details were better. Adjusting for the 2.6-percentage-point drag from inventory destocking, which will turn into a boost when inventories are replenished in the future, and backing out the 0.9-percentage-point trade deficit, real final domestic demand surged at an annualized rate of 9.9%. Chart 2... And Layoffs Are Steadily Falling On the corporate earnings front, the six largest S&P 500 constituents, Apple, Microsoft, Amazon, Google, Facebook and Tesla, all reported earnings that easily surpassed consensus expectations (Table 1). Those six companies account for 23% of aggregate index market cap and their beats drove projected per-share first-quarter earnings more than 7% higher, from $42.69 to $45.83. Even if the reports were not necessarily greeted by share-price gains, they have the index poised to deliver a fourth consecutive earnings beat of outsized proportions (Chart 3). Although the biggest companies’ successes in the calendar first quarter cannot blindly be extrapolated into the future, they suggest that S&P 500 earnings over the next four quarters will be greater than the market expected before last week. The beat goes on. Table 1Lifting All Boats Chart 3Four Straight Quarters Of Eye-Popping Beats The Fed Maintains Its Poker Face While the FOMC acknowledged that the economy has strengthened since its mid-March meeting, it showed no inclination to accelerate its timetable for dialing back accommodation. Though all four of the tweaks to its mid-March statement amounted to a marginal upgrade of its assessment of the economy’s current state and/or prospects, Chair Powell held fast to his messaging and the committee stayed the course on asset purchases. We continue to take the Fed at its word that it will not hike rates until the economy passes its “three tests” and it will not begin to taper asset purchases until it judges that the economy has made "substantial progress" toward meeting them. The picture has surely improved, but the inflation and employment criteria are not yet within reach. To recap, the Fed’s three preconditions for hiking the fed funds rate are as follows: 12-month PCE inflation must be 2% or higher. Labor market conditions must have reached levels consistent with maximum employment. 12-month PCE inflation must be on track to moderately exceed 2% for some time. Whether or not the economy has made substantial progress toward meeting those criteria is a squishier concept and the Fed has already given itself pre-emptive discretion on the first and most objective criterion by saying it will look through any transitory factors that push measured inflation higher. Powell called out base effects from last year’s pandemic wipeout that will disappear by June. He also cited supply-chain bottlenecks, and while he conceded that it is much harder to predict when they will be resolved, the committee is certain that they will prove to be a temporary phenomenon as well. “Full employment” is also a subjective metric, but the quarterly Summary of Economic Projections, released after every other FOMC meeting, provides a ready proxy. Our US Bond Strategy colleagues have calculated the average monthly net payroll gains required to reach the low end, the midpoint and the high end of the range of the participants’ long-run unemployment rate estimates, which currently span 3.5% to 4.5%, under various labor force participation rate assumptions (Tables 2A, 2B and 2C). We are focused on the top row of each iteration of the table because only a return to the pre-pandemic labor force participation rate of 63.3% would seem to satisfy the Fed’s stated commitment to achieving broad-based employment gains. While a return to the 3.5% pre-pandemic unemployment rate would also be consonant with spreading the gains from the expansion most broadly, it is useful to consider the full range of plausible outcomes given the Fed’s desire to retain some decision-making flexibility. Table 2AAverage Monthly Nonfarm Payroll Growth Required For The Unemployment Rate To Reach 4.5% By The Given Date Table 2BAverage Monthly Nonfarm Payroll Growth Required For The Unemployment Rate To Reach 4% By The Given Date Table 2CAverage Monthly Nonfarm Payroll Growth Required For The Unemployment Rate To Reach 3.5% By The Given Date Per our colleagues’ simple assumptions, it would require an average of anywhere from 701,000 to 833,000 monthly net payroll additions to hit full employment by the end of the year, 534,000 to 631,000 by the middle of 2022, and 410,000 to 487,000 by the end of 2022. The year-end 2021 targets are probably too ambitious, but we think the economy can return to full employment at some point next year, given that labor demand will likely rise sharply upon the release of pent-up consumption demand. As a back-of-the-envelope check on the tables’ conclusions, we take a return to pre-pandemic employment as the goal for a return to full employment. Through March, 8.3 million fewer people were employed than at the pre-pandemic peak in December 20191 (Chart 4). It would take fourteen months (May 2022) to regain full employment at an average monthly pace of 600,000 net hires or seventeen months (August 2022) to achieve that goal at a 500,000-per-month clip. Chart 4More Than 8 Million Workers Still Don't Have A Job A 500,000-to-600,000 range seems doable to us if herd immunity can be achieved before the end of the summer and we expect that the economy will return to full employment somewhere around the middle of next year. That will position the Fed to hike rates for the first time in 2022, in line with the market’s December 2022 lift-off projection, and announce the start of tapering at the end of 2021 or the beginning of 2022. Those Fed views support our recommendations to maintain below-benchmark duration within fixed income portfolios and underweight Treasuries. Press Conference Highlights Jay Powell stayed on message at the post-meeting press conference, resisting every attempt to goad him into revealing more about the tapering timetable or expressing concern about the pickup in inflation and inflation expectations or the economy’s potential to overheat following unprecedentedly large fiscal stimulus. On Tapering Direct questions about tapering bookended the press conference and Powell batted them away directly and concisely. Opening question: Is it time to start talking about talking about tapering yet? A: No, it is not time yet. We’ll give the public plenty of notice when it is. Final question: What are we getting for $120 billion [of Treasury and agency purchases each month] that we couldn’t get for less? A: There will come a time to talk about talking about tapering. That time is not now. On Inflation (And Armchair Quarterbacks) The combination of strong fiscal support and the reversal of a synchronized (and unprecedented) global economic shutdown has the economy beginning to move ahead with potent momentum. The re-opening is likely to produce increases in inflation but we are fully cognizant that they are likely to be temporary. While we are not going to adjust monetary policy unnecessarily in response to temporary inflation pressures, we do not want inflation expectations “materially above” 2% and we will use our tools to bring them down if they were to reach those levels. Our commitment to our price stability mandate is the key difference between now and the late sixties and seventies and we’re well aware of the history of that period. On Transitory Inflation Factors Base effects are going to add about one percentage point to headline and 70 basis points to core inflation in April and May. They will disappear and “carry no implications for the rate of inflation in later periods.” Bottlenecks are a temporary blockage or restriction in the supply chain that slows down the process of delivering a good or bringing it to market. We think of them as things that will naturally be resolved as businesses and individuals adapt. They therefore do not call for a change in monetary policy even if it’s difficult to predict when they will disappear. For the bottlenecks, it’s “a matter of when they will pass through, not whether they will pass through.” What’s happening to prices now is a function of the re-opening of the economy. Demand, spurred by fiscal transfers and people going back to work, has come back much more quickly while the supply side will take a little bit of time to adapt. On Overheating/Bubbles The overall financial stability picture is mixed, but we view it as manageable on balance. There’s some froth in capital markets and strong home price appreciation is not an “unalloyed good,” but the housing market is much more stable than it was before the crisis. Leverage in the financial system is not a problem, the large banks are very well capitalized and don’t have any funding issues and households are in very good shape. Investment Implications Although our conviction levels are lower against a backdrop of unprecedented fiscal stimulus and the inherent uncertainty surrounding a global pandemic, we continue to hold to our view that overheating is unlikely in the near term. The output gap has still not closed and while households have an enormous amount of dry powder in the form of what we estimate to be $2.1 trillion of excess savings, some of 2020’s foregone services demand has been lost forever. The share of foregone demand that has been deferred rather than destroyed will not be released immediately and may well be spread out over a broad range of price points where there is available capacity (think flying business instead of coach, sitting in the best seats at the stadium or the theater, or ordering more expensive bottles of wine). Most importantly on the inflation front, broad wage pressures have not yet emerged. As Chair Powell noted, if the labor market really were tightening, one would expect wages to be rising. We expect that idled workers will return to the labor force as vaccinations proceed, schools reopen and the pandemic becomes less of an impediment to working. We are skeptical that the $300 weekly federal unemployment insurance benefit supplement is having a material effect on labor force participation, but the program will cease in September in any event. Chart 5Neither TIPS Inflation Break-Evens ... Chart 6... Nor CPI Swap Inflation Break-Evens Are Sounding The Alarm Our biggest inflation concern revolves around long-term inflation expectations. As long as economic actors like workers and businesses do not believe the long-run trajectory of consumer prices has changed, they have no reason to change their behavior to demand wage and price increases to keep pace with an upward inflection in the CPI. The slope of the two-to-five-year and five-to-ten-year segments of the inflation expectations curve remain negative (Charts 5 and 6), suggesting that the inflation mindset necessary to support an upward price spiral has not taken hold. We will not worry about the risk-asset bull market’s fiery demise until the 2-year/5-year and 5-year/10-year break-even slopes start to test the top of their post-GFC range, implying that investors believe a new inflation era has arrived.   Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 Per the household survey. The monthly employment situation report also includes the establishment survey of employers. We use the household survey here because it is used to calculate the unemployment rate though the establishment survey’s 8.4-million employment shortfall is nearly equivalent to the household survey's.

Since 2017, we have been updating our SPX dividend discount model (DDM) every April when the previous year’s annual S&P 500 dividend payment is finalized from the Standard & Poor’s. Table 1 below summarizes the results of our analysis. Our dividend growth estimates in the DDM result in an SPX 4,047 fair value target. As a reminder, we have been and remain very conservative in our other DDM assumptions. In more detail, we assume that no buybacks will occur, a long-held assumption of ours, i.e. we pencil in a steady divisor in the coming five-year time frame. 2026 is our terminal year when dividend growth settles at 6.6%, 60bps below the long-term average (bottom panel). Our 8.2% discount rate also mirrors the corporate junk bond yield historical average (please click here if you would like to receive our DDM and insert your own assumptions, along with our EPS/multiple sensitivity and ERP analyses that can also be found in the following Strategy Report). Bottom Line: Our DDM corroborates the message that the SPX is fully priced and points to 4,047 as the fair value price.

Weekly Performance Update For the week ending Thu Apr 29, 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 1.69% 1.86% Top Contributors   DCP:US WES:US LPX:US MPLX:US SCCO:US Weekly Return 26 bps 24 bps 22 bps 15 bps 13 bps Top Detractors   TGNA:US TRTN:US UTHR:US NRG:US NWSA:US Weekly Return -10 bps -9 bps -9 bps -6 bps -4 bps Top Prospects   TX:US SCCO:US ESGR:US UHAL:US BRK.A:US BCA Score 99.58% 97.15% 97.12% 95.81% 94.73% BCA Canada Portfolio Total Weekly Return BCA Canada Portfolio S&P/TSX TRI 0.83% 1.19% Top Contributors   TOU:CA APHA:CA PXT:CA LIF:CA TOY:CA Weekly Return 38 bps 25 bps 24 bps 16 bps 13 bps Top Detractors   QBR.A:CA AUP:CA H:CA L:CA EMP.A:CA Weekly Return -22 bps -18 bps -12 bps -9 bps -8 bps Top Prospects   CFP:CA IFP:CA LNF:CA NWC:CA RUS:CA BCA Score 99.22% 98.92% 98.69% 92.61% 88.52% BCA UK Portfolio Total Weekly Return BCA UK Portfolio FTSE 100 TRI 0.61% 0.38% Top Contributors   TUNE:GB HSBK:GB DGOC:GB FXPO:GB CNE:GB Weekly Return 36 bps 33 bps 21 bps 15 bps 12 bps Top Detractors   AO.:GB SSE:GB SVST:GB LSRG:GB DRX:GB Weekly Return -14 bps -11 bps -9 bps -8 bps -8 bps Top Prospects   SVST:GB NLMK:GB TUNE:GB BPCR:GB GLTR:GB BCA Score 99.79% 99.27% 98.05% 97.39% 96.74% BCA Eurozone Portfolio Total Weekly Return BCA EMU Portfolio MSCI EMU TRI 0.48% 0.01% Top Contributors   AOF:DE IPS:FR SOLV:BE EVN:AT PHH2:DE Weekly Return 24 bps 16 bps 9 bps 8 bps 7 bps Top Detractors   CNV:FR VIS:ES VIRP:FR MOL:IT TEN:IT Weekly Return -20 bps -12 bps -9 bps -9 bps -7 bps Top Prospects   CNV:FR PHH2:DE SOL:IT SOLV:BE ROTH:FR BCA Score 99.51% 99.12% 98.75% 97.97% 96.58% BCA Japan Portfolio Total Weekly Return BCA Japan Portfolio TOPIX TRI -1.08% -0.70% Top Contributors   8595:JP 4980:JP 8966:JP 6960:JP 9503:JP Weekly Return 17 bps 14 bps 11 bps 10 bps 9 bps Top Detractors   8255:JP 4534:JP 5451:JP 5943:JP 1766:JP Weekly Return -20 bps -17 bps -17 bps -16 bps -13 bps Top Prospects   1766:JP 9436:JP 4008:JP 8595:JP 8133:JP BCA Score 99.43% 99.07% 98.55% 98.00% 97.78% BCA Hong Kong Portfolio Total Weekly Return BCA Hong Kong Portfolio Hang Seng TRI 1.14% 1.91% Top Contributors   1888:HK 148:HK 1898:HK 867:HK 373:HK Weekly Return 33 bps 25 bps 24 bps 15 bps 14 bps Top Detractors   990:HK 1117:HK 315:HK 1883:HK 719:HK Weekly Return -14 bps -11 bps -8 bps -6 bps -5 bps Top Prospects   990:HK 2232:HK 811:HK 3306:HK 86:HK BCA Score 99.91% 98.78% 97.55% 97.11% 96.98% BCA Australia Portfolio Total Weekly Return BCA Australia Portfolio S&P/ASX All Ord. TRI -0.14% 0.47% Top Contributors   STX:AU 360:AU SGF:AU PDN:AU CAJ:AU Weekly Return 40 bps 34 bps 19 bps 16 bps 9 bps Top Detractors   API:AU HVN:AU ADH:AU HT1:AU DDR:AU Weekly Return -34 bps -26 bps -22 bps -16 bps -16 bps Top Prospects   BSE:AU GRR:AU PSQ:AU BLX:AU BFG:AU BCA Score 99.83% 99.32% 98.75% 97.77% 96.89%