Policy

Executive Summary The recent 26 percent overspend on durable goods constitutes one of the greatest imbalances in economic history. An overspend on goods is corrected by a subsequent underspend; but an underspend on services is not corrected by a subsequent overspend. This unfortunate asymmetry means that the recent overspend on goods at the expense of services makes the economy vulnerable to a downturn. And the risk is exacerbated by central banks’ intentions to hike rates in response to inflation. As the spending on durable goods wanes, so too will monthly core inflation and the 30-year T-bond yield. As the 30-year T-bond rallies, so too will other long-duration bonds, long-duration stocks, long-duration sectors, and long-duration stock markets such as the S&P 500 versus short-duration stock markets such as the FTSE 100. Fractal trading watchlist: We focus on emerging markets, add financials versus industrials, and review tobacco versus cannabis, CAD/SEK, and biotech. If A 26 Percent Overspend On Goods Is Not A Massive Economic Imbalance, Then What Is? If A 26 Percent Overspend On Goods Is Not A Massive Economic Imbalance, Then What Is? If A 26 Percent Overspend On Goods Is Not A Massive Economic Imbalance, Then What Is? Bottom Line: As the spending on durable goods wanes, so too will monthly core inflation and the 30-year T-bond yield. Go overweight long-duration bonds, long-duration stocks, and long-duration stock markets such as the US versus non-US. Feature My colleague Peter Berezin recently wrote that recessions tend to happen when: “1) the build-up of imbalances makes the economy vulnerable to downturn; 2) a catalyst exposes these imbalances; and 3) amplifiers exacerbate the slump.” Peter is spot on. Using this checklist, I would argue that right now: There is a massive imbalance that makes the economy vulnerable to a downturn. Specifically, a 26 percent overspend on durable goods constitutes one of the greatest imbalances in economic history – the 26 percent overspend on durables refers to the US, but other advanced economies have experienced similar binges on goods. The catalyst that exposes this massive imbalance is the realisation that durables are, well, durable. They last a long time. So, if you front-end loaded many of this year’s purchases into last year, then you will not buy them this year. If you overspent by 26 percent in 2021, then the risk is that you symmetrically underspend by 26 percent in 2022. If central banks hike rates into this demand downturn, they will amplify and exacerbate the slump. A Massive Imbalance In Spending Makes The Economy Vulnerable To A Downturn Much of the recent overspend on goods was spending displaced from the underspend on services which became unavailable in the pandemic – such as eating out, going to the movies, and going to in-person doctor’s appointments. Raising the obvious question, can a future underspend on goods be countered by a future overspend on services? The answer is no. The consumption of services is constrained by time, opportunity, and biology. For example, there is a limit on how often you can eat out, go to the movies, or go to the doctor. If you are used to eating out and going to the movies once a week, and the pandemic prevented you from doing so for a year, that does not mean you will eat out and go to the movies an extra 52 times for the 52 times you missed! Rather, you will quickly revert to your previous pattern of going out once a week. This constraint on services spending means that the underspend will not become a symmetric overspend. In fact, the underspend on certain services will persist. This is because we have made some permanent changes to our lifestyles – for example, hybrid office/home working and more online shopping and online medical care. Additionally, a small but significant minority of people have changed their behaviour, shunning services that require close contact with strangers. To repeat the crucial asymmetry, an overspend on goods is corrected by a subsequent underspend; but an underspend on services is not corrected by a subsequent overspend (Chart I-1 and Chart I-2). Therefore, the recent massive overspend on goods at the expense of services makes the economy vulnerable to a downturn, and the risk is exacerbated by central banks’ intentions to hike rates in response to inflation. These hikes will prove to be overkill, because inflation is set to cool of its own accord. Chart I-1An Overspend On Goods Can Be Corrected By A Subsequent Underspend... An Overspend On Goods Can Be Corrected By A Subsequent Underspend... An Overspend On Goods Can Be Corrected By A Subsequent Underspend...   Chart I-2...But An Underspend On Services Cannot Be Corrected By A Subsequent Overspend ...But An Underspend On Services Cannot Be Corrected By A Subsequent Overspend ...But An Underspend On Services Cannot Be Corrected By A Subsequent Overspend   Durables Are Driving Inflation, And Inflation Is Driving The 30-Year T-Bond The recent binge on goods really comprises three mini-binges, which peaked in May 2020, January-March 2021, and October 2021. With a couple of months lag, these three mini-binges have caused three mini-waves in core inflation. To see the cause and effect, it is best to examine the evolution of inflation granularly – on a month-on-month basis – which removes the distorting ‘base effects.’ The mini-binges in goods lifted the core monthly inflation rate to an (annualised) 7 percent in July 2020, 10 percent in April-June 2021, and 7 percent in January 2022 (Chart I-3). Chart I-3Spending On Durables Is Driving Inflation Spending On Durables Is Driving Inflation Spending On Durables Is Driving Inflation Worryingly, the sensitivity of inflation has increased in each new mini-binge in goods spending, possibly reflecting more pressure on already-creaking supply chains as well as more secondary effects. Nevertheless, the key driver of the mini-waves in core inflation is the demand for durables, and as that demand wanes, so will core inflation. As monthly core inflation eases back, so too will the 30-year T-bond yield. What about the 30-year T-bond yield? Although it is a long-duration asset, its yield has recently been tracking the short-term contours of core inflation. So, when monthly inflation reached an (annualised) 10 percent last year, the 30-year T-bond yield reached 2.5 percent. At the more recent 7 percent inflation rate, the yield has reached 2.35 percent. It follows that as monthly core inflation eases back, so too will the 30-year T-bond yield (Chart I-4). Chart I-4Inflation Is Driving The 30-Year T-Bond Inflation Is Driving The 30-Year T-Bond Inflation Is Driving The 30-Year T-Bond Get The 30-Year T-Bond Right, And You’ll Get Most Things Right For the past year, the story of stocks has been the story of bonds. Or to be more precise, the story of long-duration stocks has been the story of the 30-year T-bond. Through this period, the worry du jour has changed – from the Omicron mutation of SARS-CoV-2 to an Evergrande default to Facebook subscriber losses and now to Russia/Ukraine tensions. Yet the overarching story through all of this is that the long-duration Nasdaq index has tracked the 30-year T-bond price one-for-one (Chart I-5). And the connection between S&P 500 and the 30-year T-bond price is almost as good (Chart I-6). Chart I-5Get The 30-Year T-Bond Right, And You'll Get The Nasdaq Right Get The 30-Year T-Bond Right, And You'll Get The Nasdaq Right Get The 30-Year T-Bond Right, And You'll Get The Nasdaq Right Chart I-6Get The 30-Year T-Bond Right, And You'll Get The S&P 500 Right Get The 30-Year T-Bond Right, And You'll Get The S&P 500 Right Get The 30-Year T-Bond Right, And You'll Get The S&P 500 Right The tight short-term connection between long-duration stocks and the 30-year T-bond makes perfect sense. The cashflows of any investment can be simplified into a ‘lump-sum’ payment in the future, and the ‘present value’ of this payment will move in line with the present value of an equal-duration bond. So, all else being equal, a long-duration stock will move one-for-one in line with a long-duration bond. The story of long-duration stocks has been the story of the 30-year T-bond. ‘Value’ stocks and non-US stock markets which are over-weighted to value have a shorter-duration. Therefore, they have a much weaker connection with the 30-year T-bond. It follows that if you get the 30-year T-bond right, you’ll get most things right: The performance of other long-duration bonds (Chart I-7). The performance of long-duration growth stocks (Chart I-8). The performance of ‘growth’ versus ‘value’ (Chart I-9). The performance of growth-heavy stock markets like the S&P 500 versus value-heavy stock markets like the FTSE100 (Chart I-10). Of course, the corollary is that if you get the 30-year T-bond wrong, you’ll get most things wrong. Observe that the 1-year charts of long-duration bonds, growth stocks, growth versus value, and S&P 500 versus FTSE100 are indistinguishable. Proving once again that investment is complex, but it is not complicated! Chart I-7Get The 30-Year T-Bond Right, And You'll Get The 30-Year German Bund Right Get The 30-Year T-Bond Right, And You'll Get The 30-Year German Bund Right Get The 30-Year T-Bond Right, And You'll Get The 30-Year German Bund Right Chart I-8Get The 30-Year T-Bond Right, And You'll Get Growth Stocks Right Get The 30-Year T-Bond Right, And You'll Get Growth Stocks Right Get The 30-Year T-Bond Right, And You'll Get Growth Stocks Right   Chart I-9Get The 30-Year T-Bond Right, And You'll Get Growth Versus Value Right Get The 30-Year T-Bond Right, And You'll Get Growth Versus Value Right Get The 30-Year T-Bond Right, And You'll Get Growth Versus Value Right Chart I-10Get The 30-Year T-Bond Right, And You'll Get S&P 500 Versus FTSE100 Right Get The 30-Year T-Bond Right, And You'll Get S&P 500 Versus FTSE100 Right Get The 30-Year T-Bond Right, And You'll Get S&P 500 Versus FTSE100 Right Our expectation is that as the spending on durable goods wanes, so too will monthly core inflation and the 30-year T-bond yield. Go overweight long-duration bonds, long-duration stocks, long-duration sectors, and long-duration stock markets such as the US versus non-US. Fractal Trading Watchlist This week we focus on emerging markets, add financials versus industrials, and review tobacco versus cannabis, CAD/SEK, and biotech. Emerging markets (EM) have been a big underperformer through the past year, but it may be time to dip in again, at least relative to value-heavy developed market (DM) indexes. Specifically, MSCI Emerging Markets versus MSCI UK has reached the point of fractal fragility that signalled previous major turning-points in 2014, 2018, and 2020 (Chart I-11). Accordingly, this week’s recommended trade is to go long MSCI EM versus UK (dollar indexes), setting the profit-target and symmetrical stop-loss at 10 percent.  Chart I-11Time To Dip Into EM Again, Selectively Time To Dip Into EM Again, Selectively Time To Dip Into EM Again, Selectively Financials Versus Industrials Is Approaching A Turning-Point Financials Versus Industrials Is Approaching A Turning-Point Financials Versus Industrials Is Approaching A Turning-Point Image CAD/SEK At A Top CAD/SEK At A Top CAD/SEK At A Top Awaiting A Major Entry-Point Into Biotech Awaiting A Major Entry-Point Into Biotech Awaiting A Major Entry-Point Into Biotech Dhaval Joshi Chief Strategist dhaval@bcaresearch.com Fractal Trading System A Massive Economic Imbalance, Staring Us In The Face A Massive Economic Imbalance, Staring Us In The Face A Massive Economic Imbalance, Staring Us In The Face A Massive Economic Imbalance, Staring Us In The Face 6-Month Recommendations Structural Recommendations Closed Fractal Trades Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area Indicators To Watch - Bond Yields - Europe Ex Euro Area   Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Asia Indicators To Watch - Bond Yields - Other Developed Indicators To Watch - Bond Yields - Other Developed Indicators To Watch - Bond Yields - Other Developed   Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations I Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Image   Indicators To Watch - Interest Rate Expectations III A Massive Economic Imbalance, Staring Us In The Face A Massive Economic Imbalance, Staring Us In The Face Image    

Executive Summary Foreign And Domestic Politics Won't Stop The Fed Foreign And Domestic Politics Won't Stop The Fed Foreign And Domestic Politics Won't Stop The Fed Investors woke up to the Ukraine risk this week. It is not yet resolved. Stay defensive. Market reactions to Ukraine suggest investors will favor defensive sectors and growth stocks in the short term, with the notable exception of the energy sector. External risks will not dissuade the Fed from hiking rates in the face of 6% core inflation. Later the Fed might adjust to foreign crises but the stock market faces more downside in the interim. Polarization is reviving ahead of the midterm elections, which will usher in gridlock. Gridlock is disinflationary, reinforcing a tactically defensive market positioning despite our cyclical House View. Bottom Line: Biden’s external risks are not yet subsiding. The Fed will hike rates even in the face of external supply shocks. Stay tactically defensive. Feature Our three key views for the year are: gridlock, executive power, and foreign policy. First, Congress will become gridlocked even prior to the midterm elections. Second, President Biden will have to shift to executive power to achieve policy objectives. Third, Biden’s focus will be forced to engage in foreign policy more than he would prefer due to rising external risks. The Ukraine crisis – covered extensively in our Geopolitical Strategy – is the most pressing external risk but it is not the only one that we think will trouble markets this year. We expect politically induced volatility to persist all year. The cyclical investment view should be driven by the underlying macroeconomic reality. But that macro reality will change if external risks materialize and cause greater supply disruptions or if they alter the US midterm election outlook. We maintain our tactically defensive positioning for now. Mr. Market Wakes Up To Ukraine Risk The reason for the crisis is the historic Russian military buildup on all sides of Ukraine, in the face of US defense cooperation with Ukraine, not the “hysterical” American propaganda over the risk of war. When and if Russian forces withdraw, the crisis will melt away. But for now, Russia’s reported withdrawal of some troops is contradicted by movements of other troops as well as the fact that the Russian navy has effectively blocked off the Black Sea. Investors must judge by capabilities, not intentions, and Russia still has the capability to stage a limited attack at present so investors should maintain a defensive or cautious approach. In this context investors are rightly bidding up the US dollar and bidding down US equities in absolute terms (albeit not relative to European equities). Bond yields have not responded much to the external risk due to the high rate of inflation, which is pushing yields up (Chart 1). If Russia re-invades, stocks and bond yields will fall at least temporarily and the dollar will rise higher. When Russia initially invaded Ukraine eight years ago, in February 2014, the US stock-to-bond ratio moved sideways for several months but cyclicals outperformed defensives. Energy stocks rallied, until the oil crash in summer 2014. Small caps underperformed large caps, yet value outperformed growth stocks (Chart 2). Small caps likely suffered from risk-off sentiment and expectations of a drag on global growth, while value benefited from gently rising interest rates at that time. Chart 1Ukraine Crisis Escalates Ukraine Crisis Escalates Ukraine Crisis Escalates Chart 2Market Response To Crimea Invasion, 2014 Market Response To Crimea Invasion, 2014 Market Response To Crimea Invasion, 2014 Comparing the situation today, the difference is that cyclicals are trailing defensives and small caps are trailing large caps even more than they were in 2014. Yet value stocks have performed far better against growth now than then, in accordance with higher inflation and bond yields (Chart 3). Further escalation of the Ukraine crisis should drive investors to favor defensives, large caps, and growth stocks on a tactical time frame, even though this decision runs against our BCA House View on a cyclical time frame. The past week’s market moves reinforce the 2014 experience in general, with the stock-to-bond ratio faltering and cyclicals falling back (Chart 4). Small caps and value have benefited but these charts suggest that a negative hit to global growth will hurt small caps, while value is overextended relative to growth in the short term. The market only really began to discount the risk of a new war in Europe this past week, specifically on Friday, February 11 and Monday, February 14. Chart 3Market Response 2022 Versus 2014 Market Response 2022 Versus 2014 Market Response 2022 Versus 2014 Chart 4US Equities Just Woke Up To Ukraine US Equities Just Woke Up To Ukraine US Equities Just Woke Up To Ukraine There is not yet a solid diplomatic solution as we go to press on Tuesday, February 15, but some positive signs are fueling a rebound in risk assets. Fade these improvements in risk appetite until Russia makes its decision on whether to use military force and, if so, until Europe makes its decision on whether to impose crippling sanctions.  Bottom Line: Tactically stay long growth stocks versus value, but prepare to switch back to overweighting value if the Ukraine crisis abates. The Energy Sector Response To Ukraine So Far Commodity prices and the energy sector are naturally benefitting from rising supply risks. But there is a risk that they will suffer later if a war breaks out and generates a supply shock and energy price shock that weigh on European and global growth. Russia will likely maintain energy production to help pay for its military adventures. The Saudis could increase production to prevent demand destruction. It is also possible that a US-Iran nuclear deal could release Iranian oil to the market. The global economy can handle gradually rising energy prices but maybe not a sharp supply shock. Oil prices are rising on signs of escalating tensions and energy sector equities are generally outperforming the broad market and other cyclical sectors. Domestically oriented small cap energy stocks are rising relative to large caps, suggesting that the market does not believe that global growth will suffer greatly from any conflict. Apparently investors do believe that US energy companies will benefit from shipping more fossil fuels abroad (Chart 5). Bottom Line: Cyclically stay long small cap energy stocks versus their large cap brethren. Chart 5US Energy Sector Just Woke Up To Ukraine US Energy Sector Just Woke Up To Ukraine US Energy Sector Just Woke Up To Ukraine Peak-To-Trough Drawdowns Amid Geopolitical Crises The peak-to-trough equity drawdown amid major geopolitical crises ranges from 11%-15%, depending on the magnitude and nature of the crisis (Chart 6). In this case, the US will not be directly involved in any war in Ukraine, but US NATO allies will be right next door and providing aid to Ukraine. For “limited incursion” scenarios we looked at over a dozen crises, from the Berlin Blockade of 1949 to the Russian invasion of Crimea in 2014. The peak-to-trough drawdown averages 10%. For an unlimited or “full-scale” invasion, we looked at the S&P500 reaction to major invasions at the dawn of World War II as well as significant wars in the twentieth century, down to the US invasion of Iraq and NATO’s intervention in Libya in 2011. The peak-to-trough equity drawdown averaged 13%. Chart 6Range Of US Equity Peak-To-Trough Drawdowns Amid Geopolitical Crisis Biden, The Fed, And External Risks Biden, The Fed, And External Risks Given that the S&P500 has fallen by 8% since its peak on January 3, 2022, investors should be prepared for more downside. Health care stocks and consumer staples are outperforming the broad market this year so far, though they are underperforming energy where the supply squeeze is happening (Chart 7). The magnitude of war and sanctions will determine whether energy ultimately falls in expectation of demand destruction. Bottom Line: It is too soon to buy the dip in the S&P 500. Stay long health stocks relative to the broad market. Chart 7Health Care And Consumer Staples Health Care And Consumer Staples Health Care And Consumer Staples Will The Fed Respond To External Risks? No. Over the past year, we have argued with investors who tried to differentiate the current bout of inflation from the inflation of the 1970s by arguing that there is no energy supply shock. We argued that an energy shock could transpire by pointing to external risks such as Russia and Iran. While the Biden administration will likely prove risk-averse, for fear that higher prices at the pump will weigh on the Democratic Party in the midterm elections, what about the Federal Reserve? During the Arab oil embargo of late 1973, and the Iranian revolution of 1979, the Federal Reserve continued to hike interest rates, responding to domestic inflation and rising bond yields. Foreign supply shocks threatened to push up inflation, so the Fed was not deterred from hiking rates (Chart 8). When the US itself engages in war, the Fed might react differently (Chart 9). Chart 8The Fed Responds to Oil Shocks by Hiking Rates But... The Fed Responds to Oil Shocks by Hiking Rates But... The Fed Responds to Oil Shocks by Hiking Rates But... Chart 9... US At War Could Trigger Looser Monetary Policy ... US At War Could Trigger Looser Monetary Policy ... US At War Could Trigger Looser Monetary Policy In 1990, the Fed cut the policy rate once after the US entered the Iraq war, then kept rates flat for a few months before cutting more at the end of the year. Bond yields were falling due to recession. In 2001, the Fed was already cutting rates due to the business cycle and the September 11 terrorist attacks reinforced that process. In 2003, the Fed cut rates after the beginning of the Iraq war and did not start hiking rates until mid-2004 when the initial phase of the war ended. The implication is that Fed Chair Alan Greenspan accommodated both the war and the 2004 presidential election. Most external risks will not prevent the Fed from hiking rates, especially during an inflation bout when the nature of the external risk may be an energy supply disruption that pushes up prices. However, while we do not doubt that the Fed could hike by 50bps in March, we doubt that the consensus of 175bps in hikes in 2022 will pan out. The combination of initial hikes, fiscal drag, and foreign growth shocks would temper the Fed’s enthusiasm. Bottom Line: Stocks face more downside risk in this environment.   Bipartisanship And The Return Of Gridlock Polarization and partisanship are recovering. The Philadelphia Fed “Partisan Conflict Index” is now only 0.6% below its 2020 peaks as the midterm election approaches (Chart 10). Interestingly, one of our key views from last year – bipartisan reform – is still taking place beneath the surface. Our 2022 view of gridlock has not yet fully set in. Congress is stealthily cooperating on fiscal spending, the US Postal Service, women’s issues, public servants’ stock trading, and an attempt to revise the Electoral Count Act. Congress is also passing a bipartisan bill to make the US more economically competitive with China and impose sanctions against Russia. Chart 10Foreign And Domestic Politics Won't Stop The Fed Foreign And Domestic Politics Won't Stop The Fed Foreign And Domestic Politics Won't Stop The Fed The only area where bipartisanship is not happening is Biden’s “Build Back Better” reconciliation bill, which even lacks sufficient support from moderate Democratic senators due to high inflation. Passage is still possible in a partisan, watered-down, and deficit-neutral form. These developments show that Republican lawmakers are demonstrating some pragmatic governing ability and will use their voting records to make a case in the midterms, while pinning the blame for inflation, crime, immigration, and any foreign crises on Democrats. As such they reinforce the market consensus that Republicans are likely to take back Congress this fall. Thus while last year’s bipartisanship is spilling into the current legislative session, gridlock is rapidly approaching. When investors look to the second half of the year and beyond, they should expect to see legislative cooperation dry up, especially if Republicans only take the House and not the Senate. Bottom Line: Gridlock will freeze fiscal policy, which is non-inflationary or disinflationary for 2022-24. As such the midterm election is not fully priced. Midterm dynamics will support an overweight or at least neutral stance toward defensives and growth stocks. Investment Takeaways Tactically stay long defensives, notably health care, and growth stocks. Cyclically remain invested in the bull market – and stay long energy small caps. The chief risks to these views would be a speedy diplomatic resolution to the Ukraine and Iran conflicts or a dramatic revival of the Democratic Party’s popular support ahead of the midterm election. Diplomacy would remove risks to global growth, whereas a Democratic comeback would boost inflation expectations.   Matt Gertken Senior Vice President Chief US Political Strategist mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.kuri@bcaresearch.com Strategic View Open Tactical Positions (0-6 Months) Open Cyclical Recommendations (6-18 Months) Table A2Political Risk Matrix Biden, The Fed, And External Risks Biden, The Fed, And External Risks Table A3US Political Capital Index Biden, The Fed, And External Risks Biden, The Fed, And External Risks Chart A1Presidential Election Model Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Chart A2Senate Election Model Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table A4APolitical Capital: White House And Congress Biden, The Fed, And External Risks Biden, The Fed, And External Risks Table A4BPolitical Capital: Household And Business Sentiment Biden, The Fed, And External Risks Biden, The Fed, And External Risks Table A4CPolitical Capital: The Economy And Markets Biden, The Fed, And External Risks Biden, The Fed, And External Risks Footnotes  

Executive Summary China Needs To Create RMB35 Trillion In Credit In 2022 China Needs To Create RMB35 Trillion In Credit In 2022 China Needs To Create RMB35 Trillion In Credit In 2022 The pace of credit creation in January increased sharply over December. However, the jump was less than meets the eye compared with previous easing cycles and adjusted for seasonality. Our calculation suggests that a minimum of approximately RMB35 trillion of new credit, or a credit impulse that accounts for 29% of this year's nominal GDP, will be needed to stabilize the economy. January’s credit expansion falls short of the RMB35 trillion mark on a six-month annualized rate of change basis. Our model will provide a framework for investors to gauge whether the month-over-month credit expansion data is on track to meet our estimate of the required stimulus. Despite an improvement in January's credit growth from December, it is premature to update Chinese stocks (on- and off-shore) to overweight relative to global equities. Bottom Line: Approximately RMB35 trillion in newly increased credit this year will probably be needed to revive China’s domestic demand.  Any stimulus short of this goal would mean that investors should not increase their cyclical asset allocation of Chinese stocks in a global portfolio. Feature January’s credit data for China exceeded the market consensus. The aggregate total social financing (TSF) more than doubled in the first month of 2022 from December last year. However, on a year-over-year basis, the increase in January’s TSF was smaller than in previous easing cycles, such as in 2013, 2016 and 2019. Furthermore, underlying data in the TSF reflects a prolonged weak demand for bank loans from both the corporate and household sectors. While January’s uptick in credit expansion makes us slightly more optimistic about China’s policy support, economic recovery and equity performance in the next 6 to 12 months, we are not yet ready to upgrade our view. An estimated RMB35 trillion in newly increased credit this year will likely be necessary to revive flagging domestic demand. In the absence of seasonally adjusted TSF data in China, our framework will help investors determine whether incoming stimulus is on course to meet this objective. Interpreting January’s Credit Numbers Chart 1A Sharp Increase In Credit Creation In January A Sharp Increase In Credit Creation In January A Sharp Increase In Credit Creation In January January’s credit creation beat the market consensus to reach RMB6.17 trillion, pushed up by a seasonal boost and a frontloading of government bond issuance (Chart 1). However, the composition of the TSF data reflects an extended weakness in business and consumer credit demand. On the plus side, net government bond financing, including local government special purpose bonds, rose to RMB603 billion last month, more than twice the amount from January 2021 (Chart 1, bottom panel). Corporate bond issuance also picked up, reflecting cheaper market rates and more accommodative liquidity conditions (Chart 2). Furthermore, shadow credit (including trust loans, entrust loans and bank acceptance bills) also ticked up in January compared with a year ago. The increase in informal lending sends a tentative signal that policymakers may be willing to ease the regulatory pressure on shadow bank activities (Chart 3). Chart 2Corporate Financing Through Bond Issuance Also Increased Corporate Financing Through Bond Issuance Also Increased Corporate Financing Through Bond Issuance Also Increased Chart 3Shadow Banking Activity Ticked Up For The First Time In A Year Shadow Banking Activity Ticked Up For The First Time In A Year Shadow Banking Activity Ticked Up For The First Time In A Year Meanwhile, several factors suggest that the surge in January’s credit expansion may be less than what it appears to be at first glance. First, credit growth is always abnormally strong in January. Banks typically increase lending at the beginning of a year, seeking to expand their assets rapidly before administrative credit quotas kick in. In recent years loans made during the first month of a year accounted for about 17% - 20% of total bank credit generated for an entire year. Secondly, the credit flow in January, although higher than in January 2021, was weaker than in the first month of previous easing cycles. Credit impulse – measured by the 12-month change in TSF as a percentage of nominal GDP – only inched up by 0.6 percentage points of GDP in January this year from December, much weaker than that during the first month in previous easing cycles (Chart 4). TSF increased by RMB980 billion from January 2021, lower than the RMB1.5 trillion year-on-year jump in 2019 and the RMB1.4 trillion boost in 2016 (Chart 4, bottom panel). Chart 4The Magnitude Of Increase In January’s Credit Impulse Less Than Meets The Eye Takeaways From January’s Credit Data Takeaways From January’s Credit Data Chart 5Corporate Demand For Bank Credit Remains Soft Corporate Demand For Bank Credit Remains Soft Corporate Demand For Bank Credit Remains Soft Furthermore, China’s households and private businesses have significantly lagged in their responses to recent policy easing measures and their demand for credit remained soft in January (Chart 5). Bank credit in both short and longer terms to households were lower than a year earlier due to downbeat consumer sentiment (Chart 6A and 6B). Chart 6AConsumption Was Unseasonably Weak During Chinese New Year Consumption Was Unseasonably Weak During Chinese New Year Consumption Was Unseasonably Weak During Chinese New Year Chart 6BHouseholds' Propensity To Consume Continues Trending Down Households' Propensity To Consume Continues Trending Down Households' Propensity To Consume Continues Trending Down How Much Stimulus Is Necessary? Our calculation suggests that China will probably need to create approximately RMB35 trillion in new credit, or 29% of GDP in credit impulse, over the course of this year to avoid a contraction in corporate earnings. In our previous reports, we argued that the state of the economy today is in a slightly better shape than the deep deflationary period in 2014/15, but the magnitude of the property market contraction is comparable to that seven years ago. Chart 7 illustrates our approach, which uses a model of Chinese investable earnings growth. The model is designed to predict the likelihood of a serious contraction in investable earnings in the coming 12 months. It includes variables on credit, manufacturing new orders and forward earnings momentum. The chart shows that the flow of TSF as a share of GDP needs to reach a minimum of 28.5% in order that the probability of a major earnings contraction falls below 50%. The size of the credit impulse necessary is 2 percentage points higher than that achieved last year, but still lower than the scope of the stimulus rolled out in 2016. Assuming an 8% growth rate in nominal GDP in 2022, the credit flow that should to be originated this year would be about RMB35 trillion, as illustrated in Chart 8. The chart also shows that this amount would exceed a previous high in credit flow reached in late-2020. Chart 7China Needs At Least A 29% Credit Impulse In 2022 To Avoid An Earnings Recession China Needs At Least A 29% Credit Impulse In 2022 To Avoid An Earnings Recession China Needs At Least A 29% Credit Impulse In 2022 To Avoid An Earnings Recession Chart 8China Needs To Create RMB35 Trillion In Credit In 2022 China Needs To Create RMB35 Trillion In Credit In 2022 China Needs To Create RMB35 Trillion In Credit In 2022 Based on a 3-month annualized rate of change, January’s credit growth appears that it will achieve the RMB35 trillion mark. However, the jump in TSF largely reflects a one-month leap in frontloaded local government bond issuance and it is not certain if private credit will accelerate in the months ahead. For now, we contend the stimulus have been insufficiently provided during the past six months (Chart 8, bottom panel). Chance Of A Stimulus Overshoot? We will closely monitor whether the month-to-month pace of credit growth is consistent with the scope of the reflationary policy response required to revive China’s domestic demand. Despite a sharp improvement in January’s headline credit number, we view the policy signal from January’s credit data as neutral. China’s unique cyclical patterns and the lack of official seasonally adjusted data make monthly credit figures difficult to interpret. Charts 9 and 10 represent an approach that we previously introduced to help gauge whether the pace of credit creation is on track to meet the stimulus called for to stabilize the economy. Chart 9Jan Credit Growth Looked To Be Stronger Than A “Half-Strength” Credit Cycle… Takeaways From January’s Credit Data Takeaways From January’s Credit Data Chart 10…But It Is Too Early To Conclude It Is In Line With What Is Needed Takeaways From January’s Credit Data Takeaways From January’s Credit Data The charts show an average cumulative amount of TSF as the year advances, along with a ±0.5 standard deviation, based on data from 2010 to 2021. The thick black line in both charts shows the progress in new credit creation this year, assuming an 8% annual nominal GDP growth rate. Chart 9 shows the cumulative progress in credit, assuming a 27% new credit-to-GDP ratio for the year, whereas Chart 10 assumes 30%. The 27% ratio scenario shown in Chart 9, which is slightly higher than the magnitude of stimulus in 2019, would correspond to a very measured credit expansion. If the thick black line continues to trend within this range, it would suggest that policymakers are reluctant to allow credit growth to surge. Consequently, global investors should continue an underweight stance on Chinese stocks. In contrast, Chart 10 represents a 30% rate of TSF as a share of this year’s GDP; this would be the adequate stimulus needed for a recovery in domestic demand. A cumulative amount of TSF that trends within or above this range would provide more confidence that a credit overshoot similar to 2015/16 and 2020 would occur.   Investment Conclusions It is premature to upgrade Chinese stocks to an overweight cyclical stance (i.e. over 6-12 months) within a global portfolio. For now, we recommend investors stay only tactically overweight in Chinese investable equities versus the global benchmark, given their cheap relative valuations. Meanwhile, the increase in January’s TSF, while registering an improvement relative to previous months, does not signal that the pace of credit growth will be strong enough to overcome the negative ramifications of the ongoing deceleration in housing market activity. Therefore, in view of policymakers’ steadfast desire to avoid another major credit overshoot, our cyclical recommendation to underweight Chinese stocks remains unchanged.   Jing Sima China Strategist jings@bcaresearch.com Strategic Themes Cyclical Recommendations Tactical Recommendations

Dear Client, This week, the US Bond Strategy service is hosting its Quarterly Webcast (February 15 at 10:00 AM EST, 15:00 PM GMT, 16:00 PM CET). In addition, we are sending this Quarterly Chartpack that provides a recap of our key recommendations and some charts related to those recommendations and other areas of interest for US bond investors. Please tune in to the Webcast and browse the Chartpack at your leisure, and do let us know if you have any questions or other feedback. To view the Quarterly Chartpack PDF please click here. Best regards, Ryan Swift, US Bond Strategist

Feature This week, we present the third edition of the BCA Research Global Fixed Income Strategy (GFIS) Global Credit Conditions Chartbook – a review of central bank surveys of bank lending standards and loan demand. The data from lending surveys during the last quarter of 2021 were mixed, with business credit standards easing in the US, Japan, Canada, and New Zealand while remaining mostly unchanged in the euro area and UK (Chart 1). Supply chain disruptions have had a two-pronged effect on borrowing. While they have hurt business confidence and prospects, they have also created loan demand as firms look to replenish depleted inventory stocks. The overall picture is one of solid economic fundamentals that are nonetheless perturbed by inflation concerns and lingering uncertainty regarding Covid-19 infections. Chart 1Credit Standards Eased In Most Developed Markets In Q4/2021 Credit Standards Eased In Most Developed Markets In Q4/2021 Credit Standards Eased In Most Developed Markets In Q4/2021 An Overview Of Global Credit Conditions Surveys Chart 2Credit Standards And Spreads Are Correlated Credit Standards And Spreads Are Correlated Credit Standards And Spreads Are Correlated After every quarter, major central banks compile surveys to assess prevailing credit conditions. The purpose is to obtain from banks an assessment of how their lending standards and demand for loans, for both firms and consumers, changed over the previous quarter. Most surveys also ask questions about the key factors driving these changes and expectations for the next quarter.1 For fixed income investors, these surveys are valuable for a few reasons. Firstly, data on consumer lending is a window into consumer health while business loan demand sheds light on the investment picture. These help derive a view on the path of future economic growth and interest rates and thus, the appropriate duration stance of a bond portfolio. Also, credit standards can tell us about the pass-through from fiscal and monetary policy measures to realized financial conditions (i.e. corporate borrowing rates). Most importantly, credit standards exhibit a direct correlation with corporate bond spreads (Chart 2). As they have access to detailed, non-public information on a large number of borrowers, loan officers are uniquely positioned to evaluate corporate health. When banks are tightening standards, they see an issue with the credit quality of either current or future loans, which impacts borrowing costs in the corporate bond market. Tightening standards indicate a worsening borrowing backdrop and weaker growth, which then pushes up corporate spreads. Vice-versa, easing standards imply a favorable backdrop and plentiful liquidity—both bullish signs for spread product. US In the US, a net percentage of domestic respondents to the Fed’s Senior Loan Officer Survey, reported easing standards for commercial and industrial (C&I) loans to firms of all sizes over Q4/2021 (Chart 3). This marks the fourth consecutive quarter of easing standards. However, banks did report a slower pace of easing, which correlates with tighter financial conditions on the margin (top panel). While we are still in a period of easy financial conditions in absolute terms, this could soon start to change as hot inflation prints and booming economic data cause the Fed to turn increasingly hawkish. Despite this, banks expect to ease standards further over 2022, indicating confidence that underlying economic fundamentals and corporate health will be able to weather monetary tightening. US banks also reported stronger C&I loan demand from all firms in Q4, marking three consecutive quarters of improvement (middle panel). The picture was optimistic, with banks attributing increased loan demand to inventory financing, mergers & acquisitions, and fixed investment. Meanwhile, only 4.2% and 12.5% of banks saw a decrease in internal funds and increasing precautionary demand, respectively, as somewhat important. Inventories accounted for all but 2% of the 6.9% annualized GDP growth in Q4. With inventory stocks still depressed in absolute terms, we expect inventory restocking will continue to buoy demand over 2022. Chart 3US Credit Conditions US Credit Conditions US Credit Conditions ​​​​​ Chart 4US Loan Demand Outlook For 2022 Q1/2022 Credit Conditions Chartbook: Tightening Cometh? Q1/2022 Credit Conditions Chartbook: Tightening Cometh? On the consumer side, banks reported easier standards across the board, with standards easing for credit card, auto, and other consumer loans (bottom panel). However, the pace of easing, which has historically been good at calling turning points in consumer confidence (on a rate-of-change basis), appears to have peaked. Consumer sentiment has already been battered by rampant inflation and falling real wage expectations; tighter credit standards down the road could prove to be a further headwind. As part of the one-off special questions in this edition of the survey, respondents were asked about the reasoning behind their outlook for loan demand over 2022 (Chart 4). Of those that expected higher demand, 70% cited higher spending and investment demand from borrowers as their income prospects improved. Meanwhile, only 33% thought that precautionary demand for liquidity would be a factor. Lenders thought that both, a worsening or an improvement in supply chain disruptions, could contribute to increased demand. 53% expected that continued disruption would create greater inventory financing needs. Meanwhile, 55% expected that easing supply chain troubles would boost demand as product availability concerns faded. Of those that expected weaker loan demand, interest rates were by-and-large the biggest factor, with an overwhelming 96% believing that rising rates would quell loan demand. This was followed by concerns that supply chain disruptions would keep prices high and product availability scarce (70%). On the whole, the responses capture a US economy that is at a tipping point, with market participants watching to see how it weathers an aggressive rate hiking cycle from the Fed. While underlying economic variables such as growth and employment remain strong, it still remains to be seen how much of a tightening in financial conditions the markets can bear. Euro Area In the euro area, banks on net reported a very slight tightening of standards to enterprises for the second consecutive quarter in Q4/2021 (Chart 5). Effectively, standards were unchanged as 96 of the 100 respondents to the survey reported no change from Q3. Slightly lower risk tolerance from banks contributed to tightening while lower risk perceptions related to the general economic outlook and the value of collateral had an easing effect. As in the US, standards in the euro area do show a correlation to overall financial conditions. Those have already tightened noticeably since the February 3rd meeting of the European Central Bank (ECB) Governing Council where President Lagarde set a more hawkish tone. While banks do expect a slight easing of standards over Q1/2022, that is unlikely given high inflation and geopolitical uncertainties which will negatively impact risk perceptions. Chart 5Euro Area Credit Conditions Euro Area Credit Conditions Euro Area Credit Conditions ​​​​​​ Chart 6Credit Demand In Major Euro Area Economies Credit Demand In Major Euro Area Economies Credit Demand In Major Euro Area Economies ​​​​​​ Loan demand growth from enterprises was remarkably strong in Q4, with 18% of firms reporting increased demand for loans (middle panel). The main driver was increased demand for inventories, followed closely by fixed investment and merger & acquisition needs. Loan demand leads realized growth in inventories, which has been already been picking up. In Q1, banks expect continued growth in loan demand, albeit at a slower pace. On the consumer side, however, loan demand only increased slightly, with the pace of growth slowing from the previous quarter (bottom panel). This was in line with consumer confidence taking a hit from rising inflation and the Omicron variant in the fourth quarter. The generally low level of interest rates had a small positive impact, while durable goods spending had a slight negative impact on consumer credit demand. Lenders expect moderate growth in consumer credit demand in Q1. Moving to the four major euro area economies, demand for loans to enterprises picked up in Germany, France, and Italy, while remaining unchanged in Spain (Chart 6). Fixed investment needs made a positive contribution across the board. This is corroborated by data on total lending, which is still growing on a year-on-year basis, even though the pace of growth is slowing in all the major euro area economies except Spain. UK In the UK, overall corporate credit standards eased slightly in Q4/2021, marking the fourth straight quarter of easing (Chart 7). However, there was dispersion along firm size. Large private non-financials accounted for all the easing and standards for small and medium firms actually tightened slightly. Going forward, lenders expect a further easing in standards in Q1, about on par with the easing seen in Q4. Chart 7UK Credit Conditions UK Credit Conditions UK Credit Conditions ​​​​​ Chart 8UK Lenders Expect A Robust Growth To Ease Credit Availability Q1/2022 Credit Conditions Chartbook: Tightening Cometh? Q1/2022 Credit Conditions Chartbook: Tightening Cometh? ​​​​​​ On the demand side, lenders reported slightly weaker corporate demand for lending in Q4. Again, the results were uneven across firm size – loan demand from large firms strengthened moderately, while demand from small and medium firms weakened. On average, lenders expect a slight pickup in corporate demand over Q1. Moving to the UK consumer, demand for unsecured lending continued to rise at a brisk pace, hovering around the highest levels since Q4/2014 (bottom panel). Going forward, lenders expect a continued increase in demand, but at a much slower pace. The strong developments in loan growth are seemingly at odds with the GfK consumer confidence index which has declined a total of 12 points since its July peak. Although the Bank of England does not survey respondents on the factors driving household unsecured lending demand, the divergence between confidence and loan demand suggests that precautionary demand for liquidity is playing a role. This lines up with the GfK survey, where expectations for the general economic situation over the next year are in freefall with consumers bracing for high inflation and further Bank Rate increases. Pivoting back to the drivers of corporate lending, the leading factor behind increased credit availability was an improvement in the overall economic outlook, followed by market share objectives (Chart 8). In contrast to the UK consumer, lenders are bullish on the economic outlook and believe it will continue to drive further easing over Q1/2022. On the demand side, investment in commercial real estate, which has seen steady improvement since Q3/2020, was the leading factor. This was followed by merger & acquisition and inventory financing needs. Capital investment needs, meanwhile, were a drag on demand. Moving forward, real estate investment and inventory restocking needs are expected to drive demand. Japan In Japan, credit standards to firms and households continued to ease in Q4/2021 (Chart 9). However, more than 90% of respondents in each case reported that standards were basically unchanged, and there were no reported instances of tightening among the sample of 50 lenders. Those that did report easier standards cited aggressive competition from other banks and strengthened efforts to grow the business. The vast majority of lenders expect standards to remain unchanged over Q1, but there is a slight easing expected on a net percentage basis. Chart 9Japan Credit Conditions Japan Credit Conditions Japan Credit Conditions Business loan demand on the whole was unchanged in Q4 although small and medium firms did increase demand slightly (middle panel). In contrast to other regions, business loan demand tends to behave counter-cyclically in Japan, with businesses borrowing more on a precautionary basis when they are pessimistic and vice-versa. Those dynamics were at play in Q4, with lenders attributing increased demand to a fall in firms’ internally generated funds. Banks expect a slight net pickup in demand next quarter, in line with business confidence which has fallen from its September peak on the back of concerns about Covid-19 infections, supply chain disruptions, and rising input prices. On the consumer side, loan demand was basically unchanged, with a very small net percentage of banks reporting weaker demand (bottom panel). The key reason for decreased demand was a decrease in household consumption, which is in line with retail sales, where the pace of growth has been falling. Even though core inflation in Japan is low, consumers are still exposed to rising energy prices, which might cause them to tighten other parts of their budgets. Canada Chart 10Canada Credit Conditions Canada Credit Conditions Canada Credit Conditions In Canada, business lending standards continued to ease at a slightly slower pace in Q4/2021 (Chart 10). This marks the fourth consecutive quarter of easing conditions, coming amid booming economic activity, high capacity utilization, and buoyant sentiment. Both, price and non-price lending conditions eased at roughly the same pace. On the consumer side, non-mortgage lending conditions continued to ease, but at a slower pace (middle panel). 1-year ahead consumer spending growth expectations, sourced from the Bank of Canada’s (BoC) Survey Of Consumer Expectations, and non-mortgage lending conditions typically display an inverse correlation, with expected spending growth increasing when standards are getting easier on the margin and vice-versa. The divergence in Q4 is explained in part by excess savings accumulated during the pandemic that have yet to be spent down, and in part by expected price increases over the coming year. In either case, it demonstrates that nominal spending has room to grow even in an environment where consumer credit availability is worsening. We also saw mortgage standards ease at a slightly slower pace in Q4, with both price and non-price lending conditions easing (bottom panel). While the BoC has made a hawkish pivot, underlying conditions are still easy – the conventional 5-year mortgage rate is still flat at 4.79%, the same level as Q3/2020. However, house price growth has peaked, and rate hikes this year will help prices moderate further. New Zealand Chart 11New Zealand Credit Conditions New Zealand Credit Conditions New Zealand Credit Conditions In New Zealand, business credit standards eased in the six month period ended September 2021 (Chart 11). However, the real impact of the Reserve Bank of New Zealand’s (RBNZ) tightening is being felt in the housing market, where actual standards entered tightening territory. More importantly, a net 23.1% of respondents expect mortgage credit availability to erode by the end of March; if realized, this figure would be a series high. Banks reporting less credit availability cited regulatory changes and risk perceptions. On the mortgage loan demand side, banks continued to see increased demand even after the record spike in March 2021 (middle panel). Going forward, demand is expected to moderate and fall from current levels. These dynamics have already made their mark on house prices which have already peaked, indicating that the RBNZ’s push is working as intended. Business loan demand does not appear to have been much affected by higher rates, with demand picking up slightly and expected to increase going forward (bottom panel). However, confidence has been falling since September 2021, with businesses feeling the twin bite of supply chain disruptions and labor shortages.   Shakti Sharma Senior Analyst ShaktiS@bcaresearch.com Appendix: Where To Find The Bank Lending Surveys A number of central banks publish regular surveys of bank lending conditions in their domestic economies. The surveys, and the details on how they are conducted, can be found on the websites of the central banks: US Federal Reserve: https://www.federalreserve.gov/data/sloos.htm European Central Bank: https://www.ecb.europa.eu/stats/ecb_surveys/bank_lending_survey/ Bank of England: https://www.bankofengland.co.uk/credit-conditions-survey/2021/2021-q4 Bank of Japan: https://www.boj.or.jp/en/statistics/dl/loan/loos/index.htm/ Bank of Canada: https://www.bankofcanada.ca/publications/slos/ Reserve Bank of New Zealand: https://www.rbnz.govt.nz/statistics/c60-credit-conditions-survey   Footnotes 1      The weblinks to each individual survey for the US, euro area, UK, Japan, Canada and New Zealand can be found in the Appendix on page 12. GFIS Model Bond Portfolio Recommended Positioning     Active Duration Contribution: GFIS Recommended Portfolio Vs. Custom Performance Benchmark Q1/2022 Credit Conditions Chartbook: Tightening Cometh? Q1/2022 Credit Conditions Chartbook: Tightening Cometh? The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Q1/2022 Credit Conditions Chartbook: Tightening Cometh? Q1/2022 Credit Conditions Chartbook: Tightening Cometh? Global Fixed Income - Strategic Recommendations* Duration Regional Allocation Spread Product Tactical Overlay Trades

Highlights A feedback loop has emerged in European markets. Tightening financial conditions will preempt the European Central Bank from hiking rates as much as the money market is pricing in. The widening in peripheral and credit spreads is overdone. Investors already long should maintain their positions. Investors without exposure will soon find an attractive entry point. Despite these near-term gyrations, the ECB is still on track to hike interest rates once in Q4 2022 and lift them aggressively in 2023. Feature Last week’s hawkish pivot by the European Central Bank (ECB) continues to affect markets. We take the words of the ECB at their face value; we anticipate the Governing Council (GC) to begin lifting interest rates at the end of 2022 and to continue to do so steadily over 2023 and 2024. However, as the shock filters through financial asset prices, we become more confident that the ECB will not lift rates five times in 2022 as the Euro Short Term Rate (ESTR) curve currently anticipates. Chart 1Growing Tensions In The Periphery... Growing Tensions In The Periphery... Growing Tensions In The Periphery... First, the behavior of Italian and Greek bond markets constitutes a major support to our view. Italian and Greek 10-year spreads have widened by respectively 46 and 65 basis points over the past six trading days (Chart 1). This tension highlights that investors still view these economies as continental trouble spots. Meanwhile, the ECB’s communication continues to highlight the need for flexibility to maintain order in the sovereign debt market. The GC does not want inadvertently to engineer a severe tightening in financial conditions in the already fragile periphery. In this context, it is highly unlikely that the ECB will rush to terminate the Asset Purchase Program (APP), an end on which rate hikes depend. Second, the corporate bond market is also going through a significant period of ruction. Both investment grade and high-yield bond yields have risen rapidly in recent days, and they are now retesting their late-2018 levels (Chart 2, top two panels). Spreads too are widening meaningfully, even though they remain further away from their 2018 highs (Chart 2, bottom two panels) The ECB is unwilling to let a liquidity shock morph into a solvency problem for European firms. For now, the behavior of the European credit market remains consistent with a liquidity shock. Funding markets are experiencing a violent adjustment, which is bleeding into the overall level of spreads. However, investors are not differentiating based on credit risk. Chart 3 shows that CCC credit (the lowest rated HY bonds) is not selling off relative to the overall high-yield index, which we would anticipate if investors were worried about underlying default risk. Chart 3No Distinction On Credit Risk No Distinction On Credit Risk No Distinction On Credit Risk Chart 2...And In European Corporates ...And In European Corporates ...And In European Corporates If the liquidity shock were to deepen further and last long enough, the resilience of the corporate sector would fritter away. However, the GC has tried to resist a deflationary shock for more than ten years now, and a solvency problem would undo all the progress made toward escaping the European liquidity trap, especially because wages have yet to recover. Third, members of the ECB’s GC are already trying to talk down the market. President Christine Lagarde displayed a more dovish tone when she spoke in front of the EU Parliament on February 7, 2022. ECB Chief Economist Philippe Lane remains steadfast that wages are not yet a problem. The Governor of the Bank of France, François Villeroy de Galhau still sees an imminent peak in CPI, and Olli Rehn, Governor of the Bank of Finland, recently lectured about the need for a gradual normalization of policy. Even hawks like the Bundesbank’s Joachim Nagel or the DNB’s Klaas Knot have gestured toward higher rates, but only toward the end of the year. In this context, we expect credit spreads to begin to narrow again; however, it will likely first require an easing in funding pressures. This is unlikely to happen until US yields form an interim peak. However, as Chart 4 highlights, the Treasury market is becoming extremely oversold. Moreover, a JP Morgan survey shows that its clients are massively short duration. The risk of a pullback in Treasury yields is growing, even if rising inflation and fears of a tighter Fed prevail for now. If US yields were to decline Bunds would likely follow the Treasury market because the ECB is becoming louder that it does not want to tighten financial conditions abruptly. Hence, a pullback in global risk-free yields will be the key to a period of calm in credit spreads, since valuations have improved materially, with the breakeven spreads on investment grade and high-yield bonds moving back to their 43rd and 44th percentiles, respectively (Chart 5). A stabilization in global yields and European spreads should also percolate to the peripheral sovereign bond market and limit the upside to Italian and Greek spreads. Chart 4Oversold Treasurys Oversold Treasurys Oversold Treasurys Chart 5Restoring Value In Corporates Restoring Value In Corporates Restoring Value In Corporates Bottom Line: The tightening in financial conditions taking place in Europe indicates that money market curves are pricing in the path for European policy rates too aggressively. The ECB has changed since 2011. It will not let peripheral borrowing costs threaten the recovery in Southern European economies, nor will it allow a liquidity shock in the corporate bond market to become a solvency issue that will damage growth prospects. European peripheral and corporate spreads will narrow once global risk-free rates peak.   Mathieu Savary, Chief European Strategist Mathieu@bcaresearch.com

Executive Summary The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend Rising interest rates and a cooling in pandemic-related tech spending will cap the upside for technology shares over the remainder of 2022. Looking further out, US big tech companies are likely to suffer from heightened competition in increasingly saturated markets. Concerns about big tech’s excessive market power, cavalier attitudes towards personal data, proclivity for censoring non-establishment opinions, and the deleterious impact of social media on teenage mental health are all fueling a public backlash. Investors should expect increased regulation and antitrust enforcement of big tech companies in the years ahead. Bottom Line: The hegemony of today’s US-based big tech companies is coming to an end. While we do not expect tech stocks to decline in absolute terms in 2022, they will lag the S&P 500. Given tech’s heavy representation in the US, investors should underweight the US in a global equity portfolio. Sinking Ark Tech stocks have had a tough ride since the start of the year. So far in 2022, the NASDAQ Composite has fallen 9.3% compared to 5.5% for the S&P 500. The ARK Innovation ETF, Cathie Wood’s collection of “disruptor” companies, has dropped -22%, and is now down -53% from its peak last year (Chart 1). We expect tech shares to lag the market during the remainder of 2022. The pandemic was a boon for many tech companies. Generous stimulus payments and stay-at-home policies led to a surge in e-commerce spending (Chart 2). As economies continue to reopen, many tech companies could face an air pocket in demand for their goods and services.  Chart 1Tech Stocks: Rough Start to 2022 Tech Stocks: Rough Start to 2022 Tech Stocks: Rough Start to 2022 Chart 2The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend The Pandemic-Led Surge In E-Commerce Spending Is Reverting Back To Trend   Despite some softening of late, retail sales remain well above their pre-pandemic trendline (Chart 3). If Amazon’s still-rosy projections are any guide, a further slowdown in goods spending is something that the analyst community is not fully discounting (Chart 4). Chart 3US Retail Spending Is Above Trend US Retail Spending Is Above Trend US Retail Spending Is Above Trend Chart 4Amazon Sales Estimates May Be Too Optimistic Amazon Sales Estimates May Be Too Optimistic Amazon Sales Estimates May Be Too Optimistic Rate Hikes Will Disproportionately Hit Tech Chart 5Long Rates Anticipate The Movements In Short Rates Long Rates Anticipate The Movements In Short Rates Long Rates Anticipate The Movements In Short Rates US rate expectations continued to move up this week, egged on by St. Louis Fed President James Bullard’s statement earlier today declaring that he favors raising interest rates by a full percentage point by the start of July. The market is now pricing in six rate hikes by the end of the year.  Historically, bond yields have increased starting about four months before the first rate hike and over the period in which the Fed is raising rates (Chart 5). While we do not think the Fed will need to deliver more tightening this year than what is already discounted, we do think that investors will eventually be forced to revise up their expectations of the neutral rate to between 3%-and-4%. As Chart 6 shows, the market expects the Fed to stop raising rates when they reach 2%, which we regard as unrealistic. Chart 6The Market Thinks The Fed Will Not Be Able To Lift Rates Above 2% The Disruptor Delusion The Disruptor Delusion An increase in the market’s estimate of the neutral rate will push up bond yields. Unlike banks, tech tends to underperform in a rising yield environment (Chart 7). Priced For Perfection? Higher bond yields and a reversion-to-trend in tech spending would be less of a problem for technology shares if valuations were cheap. They are not, however. The Nasdaq Composite still trades at 29-times forward earnings compared to 20-times forward earnings for the broader S&P 500 (Chart 8). Chart 8Tech Shares Are No Bargain Tech Shares Are No Bargain Tech Shares Are No Bargain Chart 7Rising Bond Yields Will Help Bank Stocks But Hurt Tech Shares Rising Bond Yields Will Help Bank Stocks But Hurt Tech Shares Rising Bond Yields Will Help Bank Stocks But Hurt Tech Shares Tech investors would argue that such a hefty valuation premium is warranted given the tech sector’s superior growth prospects. Underlying this argument is the assumption that just because tech spending will grow more quickly than the rest of the economy, this will necessarily translate into above-average earnings growth and outsized returns for publicly-listed tech companies. But is that really the case? Over short horizons of a few years, there is a decent correlation between relative industry growth and relative equity returns (Chart 9). However, that relationship evaporates over very long-term horizons (Chart 10). In fact, since 1970, the best-performing equity sector has been tobacco, hardly a paragon of technological innovation (Chart 11). Chart 9Stocks In Industries That Experience A Burst Of Output Growth Do Tend To Outperform Other Stocks … The Disruptor Delusion The Disruptor Delusion Chart 10… But Over The Long Haul, Companies In Fast- Growing Industries Do Not Outperform Their Peers The Disruptor Delusion The Disruptor Delusion Chart 11Tobacco Industry Returns Have Smoked All Others The Disruptor Delusion The Disruptor Delusion What Goes Around Comes Around Table 1History Shows Leaders Can Become Laggards The Disruptor Delusion The Disruptor Delusion Tech stock enthusiasts tend to forget that the disruptors themselves can be disrupted. History is littered with tech companies that failed to keep up with a changing world: RCA, Kodak, Polaroid, Atari, Commodore, Novell, Digital, Sinclair, Wang, Iomega, Corel, Netscape, AltaVista, AOL, Myspace, Compaq, Sun, Lucent, 3Com, Nokia, Palm, and RIM were all major players in their respective industries, only to fade into oblivion. Table 1 shows that all but one of the ten biggest tech names in the S&P 500 IT index in 2000 underperformed the broader market by a substantial degree over the subsequent ten years. Today, the incentive for startups to emerge has never been stronger. Venture capital funds are flush with cash. Tech profit margins are near record highs, making challenging the incumbents an increasingly enticing goal. About one-third of the outperformance of US tech stocks since 1996 can be explained by rising relative profit margins, with faster sales growth and relative P/E multiple expansion explaining 45% and 23% of the remainder, respectively (Chart 12). Chart 12Decomposing Tech Outperformance The Disruptor Delusion The Disruptor Delusion Meta’s Malaise Chart 13Unlike Economists, Facebook Just Ain't Cool No More The Disruptor Delusion The Disruptor Delusion Which of today’s tech titans could join the “has been club”?  As we flagged in August, Meta is certainly a possibility. In its disastrous quarterly earnings report, the company revealed that globally, the number of Facebook users is shrinking for the first time ever. While this came as a surprise to many investors, the writing has been on the wall for a long time. According to Piper Sandler’s survey of teen preferences conducted late last year, only 27% of teenagers used Facebook, down from 94% in 2012 (Chart 13). Meta has been fortunate in that many Facebook users have migrated to Instagram, a social media platform it acquired in 2012. Unfortunately, the latest data suggests that even Instagram usage is starting to slow as more young people flock to TikTok. Google Also Vulnerable Unlike Meta, Alphabet crushed earnings estimates. However, the similarities between the two companies may be greater than most investors are willing to admit. Like Facebook, Google’s profits almost entirely come from ad spending. According to eMarketer, Google garnered 44% of digital ad spending in 2021 while Facebook took in 23%. Digital advertising accounted for 63% of all ad spending in 2021, up from 58% in 2020 and 51% in 2019. While there may be scope for digital ads to take further market share,  eventually, growth in digital ad spending will converge with overall consumption growth, which in the US is likely to average no more than 2% in real terms over time. Monopoly Power Another important similarity between Meta and Alphabet is that both companies are increasingly coming under scrutiny from politicians and regulators. The antitrust case brought against Alphabet by 14 US states contains a litany of allegations of unfair practices. After an initial failed attempt, the Federal Trade Commission’s antitrust suit against Meta is also moving forward. Privacy Matters In addition, the way big tech companies handle private data is raising some hackles. In its annual report filed earlier this month, Meta warned that it would need to shut down Facebook and Instagram in Europe unless regulators drew up new privacy regulations. This came on top of Meta’s disclosure that it will lose $10 billion this year after Apple introduced pop-ups on the iPhone’s operating system asking users if they wanted to be tracked by apps.  Turn Off That Phone! Another looming worry revolves around the corrosive impact of excessive social media usage on mental health. Academic studies have shown that adolescents who use Facebook and Instagram frequently feel greater anxiety and unease than those who do not. The share of students reporting high levels of loneliness more than doubled in both the US and abroad over the past decade, a trend that predates the pandemic (Chart 14). In 2020, the last year for which comprehensive data is available, one-quarter of US girls between the ages of 12 and 17 reported experiencing a major depressive episode, up from 12% in 2011 (Chart 15). Chart 15The Rise In Depression Rates Coincided With Increased Social Media Usage The Disruptor Delusion The Disruptor Delusion Chart 14Alone In The Crowd The Disruptor Delusion The Disruptor Delusion     Backlash Public contempt for tech companies is fueling a political backlash. According to a Gallup poll conducted last year, only 34% of Americans held a favorable view of tech companies such as Amazon, Facebook, and Google, down from 46% in 2019; 45% had an unfavorable opinion, up from 33% in 2019 (Chart 16). Chart 16Americans Do Not Hold Tech Companies In High Regard The Disruptor Delusion The Disruptor Delusion The shift in public sentiment over the past two years has been entirely driven by Independent and Republican voters, many of whom feel that tech companies are unfairly censoring their opinions (Table 2). The same poll revealed that the majority of Americans – including the majority of Republicans – now favor increased regulation of tech companies.  Table 2American Views On Big Tech The Disruptor Delusion The Disruptor Delusion Investment Conclusions Chart 17Value Stocks Are Cheap Value Stocks Are Cheap Value Stocks Are Cheap Considering that global growth is likely to remain above-trend this year, we do not expect tech stocks to decline in absolute terms. A flattish, though volatile, trajectory is the most plausible outcome. In relative terms, however, tech stocks will underperform. Despite having outperformed tech-heavy growth stocks by 14% since last November, value stocks remain exceptionally cheap by historic standards (Chart 17). Tech stocks are overrepresented in the US. Thus, if tech continues to underperform, it stands to reason that non-US equities will outperform their US peers over the coming years.    Peter Berezin Chief Global Strategist peterb@bcaresearch.com Global Investment Strategy View Matrix The Disruptor Delusion The Disruptor Delusion Special Trade Recommendations Current MacroQuant Model Scores The Disruptor Delusion The Disruptor Delusion

Executive Summary Brazil: Are Political & Macro Risks Priced-In? Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Presidential elections are due in Brazil on October 2, 2022. While the left-of-center former President Lula da Silva will likely win, the road to his victory will not be as smooth as markets expect. Incumbent President Jair Bolsonaro will make every effort to cling to power, including fiscal populism and attacks on Brazil’s institutions. These moves may roil Brazil’s equity markets as they may provide a fillip to Bolsonaro’s popularity. Bolsonaro’s institutional attacks have triggered down moves in the market before and any fiscal expansion may worry investors as it could prove to be sticky. We urge investors to take-on only selective tactical exposure in Brazil. Equities appear cheap but political and macro risks abound. To play the rally yet stave-off political risk in Brazil, we suggest a tactical pair trade: Long Brazil Financials / Short India. Tactical Recommendation Inception Date Long Brazil Financials / Short India 2022-02-10   Bottom Line: On a tactical timeframe we suggest only selective exposure to Brazil given the latent political and macro risks. On a strategic timeframe, we are neutral on Brazil given that its growth potential coexists with high debt and low proclivity to structural reform. Feature Chart 1Brazil Underperformed Through 2020-21, Is Cheap Today Brazil Underperformed Through 2020-21, Is Cheap Today Brazil Underperformed Through 2020-21, Is Cheap Today Brazil’s equity markets underperformed relative to emerging markets (EMs) for a second consecutive year in 2021 (Chart 1). But thanks to this correction, Brazilian equities now appear cheap (Chart 1). With Brazil looking cheap, China easing policy, and Lula’s return likely, is now a good time to buy into Brazil? We recommend taking on only selective exposure to Brazil on a tactical horizon for now. Brazil in our view may present a near-term value trap as markets are under-pricing political and economic risks. Lula Set For Phoenix-Like Return Luiz Inácio Lula da Silva (or popularly Lula) of the Worker’s Party (PT) appears all set to reclaim the country’s presidency in the fall of 2022. The main risk that Lula’s presidency may bring is a degree of fiscal expansion. Despite this markets may ultimately welcome his victory at the presidential elections as Lula is in alignment with the median voter, is expected to be better for Brazil’s institutions, will institute a superior pandemic-control strategy, and may also undertake badly needed structural reforms in the early part of his tenure. Despite these points we urge investors to limit exposure to Brazil for now and turn bullish only once the market corrects further. Whilst far-right President Jair Bolsonaro managed to join a political party (i.e., the center-right Liberal Party) late last year, he is yet to secure something more central to winning elections i.e., a high degree of popularity. To boost his low popularity ratings (Chart 2), we expect Bolsonaro to leverage two planks: populism and authoritarianism. These measures will bump up Bolsonaro’s popularity enough to shake up Brazil’s markets with renewed uncertainty, but not enough to win him the presidency. Chart 2Lula Is Ahead But His Lead Has Narrowed Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Lula is a clear favorite to win. After spending more than a year in jail on corruption charges, Lula is back in the fray and has maintained a lead on Bolsonaro for the first round of polling (Chart 2). Even if a second-round run-off election were to take place, Lula would prevail over Bolsonaro or other key candidates (Chart 3). By contrast, Bolsonaro’s lower popularity means that in a run-off situation he stands a chance only if pitted against center-right candidates like Sergio Moro (his former justice minister) or João Doria (i.e., the center-right Governor of São Paulo) (Chart 4). Chart 3Lula Leads Run-Off Vote Against All Potential Candidates Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 4In A Run-Off, Bolso Stands Best Chance Of Winning If Pitted Against Moro Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ What has driven the swing to the left in Brazil? After the pandemic and some stagflation, Brazil’s median voter’s priorities have changed. In specific: Brazil’s median voter’s top concerns in 2018 were centered around improving law and order (Chart 5). A right-of-center candidate with concrete law-and-order credentials like Bolsonaro was well placed to tap into this public demand. Chart 5In 2018-19, Law And Order Issues Dominated Voters’ Concerns Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Now, however, Brazil’s voters’ top concerns are focused around improving the economy and controlling the pandemic, where Bolsonaro’s record is dismal (Chart 6). Given this change of priorities, a left-of-center candidate with a solid economic record like Lula is best placed to address voters’ concerns. Lula had the fortune to preside over a global commodity bull market and Brazilian economic boom in the early 2000s (Chart 7). Regarding pandemic control, almost any challenger would be better positioned than Bolsonaro, who initially dismissed Covid-19 as “a little flu” and lacked the will or ability to set up a stable public health policy. Chart 6In 2022, Median Voter Cares Most About Economic Issues, Pandemic-Control Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 7Lula’s Presidency Overlapped With An Economic Boom Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ A left-of-center candidate like Lula, or even Ciro Gomes (Chart 8), is more in step with the median voter today for two key reasons: Inflation Surge, Few Jobs: Inflation has surged, and the increase is higher than that seen under the previous President Michael Temer (Chart 7). Transportation, food, and housing costs have all taken a toll on voter’s pocketbooks (Chart 9). The cost of electricity has also shot up. For 46% of Brazilian families, expenditure on power and natural gas is eating into more than half of their monthly income, according to Ipec. Chart 8Left-Of-Center Candidates Stand A Better Chance In Brazil In 2022 Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 9Under Bolso Inflation Has Surged Across Key Categories Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​ Distinct from inflation, unemployment too has been high under Bolsonaro (Chart 10). Chart 10Unemployment Too Has Surged Under Bolsonaro Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 11Brazil’s Per Capita Income Growth Has Lagged That Of Peers Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 12Since 2018, Brazil's Economic Miseries Have Grown More Than Those Of Peers Since 2018, Brazil's Economic Miseries Have Grown More Than Those Of Peers Since 2018, Brazil's Economic Miseries Have Grown More Than Those Of Peers Stagnant Incomes: Despite a strong post-pandemic fiscal stimulus, GDP growth in Brazil has been low (Chart 7). In a country that is structurally plagued with high inequalities, the slow growth in Brazil’s per capita income (Chart 11) under a right-wing administration is bound to trigger a leftward shift. It is against this backdrop of rising economic miseries (Chart 12) that Latin America’s largest economy is seeing its ideological pendulum swing leftwards. This phenomenon has played out before too - most notably when Lula first assumed power as the president of Brazil in 2002. Brazil’s GDP growth was low, inflation was high and per capita incomes had almost halved under the presidency of Fernando Henrique Cardoso (or popularly FHC) over 1995-2002. This economic backdrop played a key role in Lula’s landslide win in 2002. Brazil’s political differences are rooted in regional as well as socioeconomic disparities. In the 2018 presidential elections, left-of-center candidates like Fernando Haddad generated greatest traction in the economically backward northeastern region of Brazil. On the other hand, Bolsonaro enjoyed higher traction in the relatively well-off regions in southern and northern Brazil (Maps 1 & 2). Now Bolsonaro has faltered under the pandemic and Lula can reunite the dissatisfied parts of the electorate with his northeastern base. Map 1Brazil’s South, Mid-West And North Supported Bolso In 2018 Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Map 2Left-Of-Center 2018 Presidential Candidate Haddad Had Greatest Traction In Regions With Low Incomes Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Bottom Line: The stage appears set for Lula’s return to Brazil’s presidency. But will the road be smooth? We think not. Investors should gird for downside risks that Brazilian markets must contend with as President Bolsonaro fights back. Brace For Bolso’s Fightback The road to Bolsonaro’s likely loss will be paved with market volatility and potentially a correction. Interest rates have surged in Brazil as its central bank combats inflation (Chart 13). Even as BCB’s actions will lend some stability to the Brazilian Real (Chart 13), political events over the course of 2022 will spook foreign investors. Bolsonaro will leverage two planks in a desperate attempt to retain control: Plank #1: Populism Brazil’s financial markets experienced a major correction in the second half of 2021. This was partially driven by the fact that Brazilian legislators approved a rule that allows the government to breach its federal spending cap. Given Bolsonaro’s low popularity ratings today and given that his fiscal stance has been restrained off late, Bolsonaro could well drive another bout of fiscal expansion in the run up to October 2022. Such a move will bump up his popularity but at the same time worry markets given Brazil’s elevated debt levels (Chart 14). Bolsonaro can technically pass these changes in the Brazilian national assembly given that in both houses the government along with the confidence and supply parties has more than 50% of seats. Chart 13Brazil’s Central Bank Has Hiked Rates Aggressively Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Chart 14Brazil Is One Of The Most Indebted Emerging Markets Today Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​​ Plank #2: Institutional Attacks To rally his supporters, the former army captain could also sow seeds of doubt in Brazil’s judiciary and electoral process. Given the strong support that Bolsonaro enjoys amongst conservatives, he may even mobilize supporters to stage acts of political violence in the run up to the elections. Bolsonaro could make more dramatic attempts to stay in power than former US President Trump, whose rebellion on Capitol Hill did not go as far as it could have gone to attempt to seize power for the outgoing president. Last but not the least, there is a possibility that the Brazilian judiciary presents an unexpected roadblock to Lula’s candidacy. Given the unpredictable path of Brazil’s judicial decisions, investors should be prepared for at least some kind of official impediments to Lula’s rise. Even if Lula is ultimately allowed to run, any ruling that casts doubt on his candidacy or corruption-related track record will upset financial markets. Global financial markets rallied through the Trump rebellion on January 6 last year. But US institutions, however flawed, are more stable than Brazil’s. Brazil only emerged from military dictatorship in 1985. Bolsonaro has fired up elements of the populace that are nostalgic for that period, as we discuss below. Bottom Line: Brazil’s equities look cheap today, but political risks have not fully run their course. President Bolsonaro may launch his fightback soon, which could drive another down-leg in Brazil’s markets. His institutional attacks have triggered down moves before and any potential fiscal expansion that Bolsonaro pursues may worry investors, as this expansion could stick under the subsequent administration. In addition, there is a chance that civil-military relations undergo high strain in the run-up to or immediately after Brazil’s elections. Is A Self-Coup By Bolso Possible? “One uncomfortable fact of the dictatorship is that its most brutal period of repression overlapped with what Milton Friedman called an economic miracle.… Brazil’s economy, nineteenth largest in the world before the coup, grew into the eighth largest. Jobs abounded and the regime then was actually popular.” – Alex Cuadros, Brazillionaires: Wealth, Power, Decadence, and Hope in an American Country (Spiegel & Grau, 2016) It is extremely difficult for President Bolsonaro to win the support of a majority of the electorate. But given his open admiration for Brazil’s dictatorship, is a self-coup possible in 2022? The next nine months will be tumultuous. A coup attempt could occur. However, we allocate a low probability to a successful self-coup because: Bolsonaro’s Popularity Is Too Low: Even dictators need to have some popular appeal. Bolsonaro has lost too much support (Chart 15), he never had full control of any major institutions (including the military), and few institutional players will risk their credibility for his sake. If he somehow clung to power, his subsequent administration would face overwhelming popular resistance. Chart 15Bolsonaro’s Low Approval Ratings - A Liability Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Bolsonaro’s Economy Is Too Weak: The dictatorship in Brazil managed to hold power for more than two decades partially because this period of authoritarianism was accompanied by a degree of economic well-being. Currently the public is shifting to the left because low growth and high inflation have dented the median voter’s purchasing power. The weak economy would make an authoritarian government unsustainable from the start. Lack Of American Support: Some military personnel may be supportive of a coup and several retired military officers are occupying civilian positions in the Brazilian federal government, thanks to Bolsonaro. So why can’t Brazil slip right back into a military dictatorship led by Bolsonaro, say if the election results are narrow and hotly contested? The coup d'état in Brazil in 1964 was a success to a large extent because this regime-change was supported by America. Back then communism was a threat to the US and Washington was keen to displace left-leaning heads of states in Latin America, such as Brazilian President João Goulart. But America’s strategic concerns have now changed. America today is attempting to coalesce an axis of democracies and the Biden administration has no incentive whatsoever to muddy its credentials by supporting dictatorship in Latin America’s largest country. Even aside from ideology, any such action would encourage fearful governments in the region to seek support from America’s foreign rivals, thus inviting the kind of foreign intervention that the US most wants to prevent in Latin America. The Brazilian Military Has Not Been Suppressed Or Sidelined: History suggests that coups are often triggered by a drop in the military’s importance in a country. However, the military’s power in Brazil has remained meaningful through the twenty-first century. Brazil has maintained steady military spends at around 1.5% of GDP over the last two decades. Thus, top leaders of Brazil’s military have no reason to feel aggrieved or disempowered. Having said that, it is not impossible that an extreme faction of junior officers might try to pull off a fantastical plot, even if they have little hope of succeeding, which is why we highlight that markets can be rudely awakened by the road to Brazil’s election this year. In Turkey in July 2016, an unsuccessful coup attempt caused Turkish equities to decline by 9% over a four-day period. Bottom Line: Investors must gird for the very real possibility of civil-military relations undergoing high degrees of strain in Brazil, particularly if a contested election occurs. While Bolsonaro’s supporters and disaffected elements of the Brazilian military could resist a smooth transition of power away from Bolsonaro, the transition will eventually take place because two powerful constituencies – Brazil’s median voter and America – will not support a coup in Brazil. Will Lula Be Good For Brazil’s Markets? Looking over Bolsonaro’s presidency, from a market-perspective, some policy measures were good, some were bad, and some were downright ugly. In specific: The Good: Pension Reforms And Independent Monetary Policy In Bolsonaro’s first year in power, he delivered pension sector reforms. The law increased the minimum retirement age and also increased workers’ pension contributions thereby resulting in meaningful fiscal savings. Bolsonaro passed a law to formalise the BCB’s autonomy and the BCB has been able to pursue a relatively independent monetary policy. BCB has now lifted the benchmark Selic rate by 725bps over 2021 thereby making it one of the most hawkish central banks amongst EMs (Chart 13). This is in sharp contrast to the situation in EMs like Turkey where the central bank cut rates owing to the influence of a populist head of state. The Bad: Poor Free Market Credentials And Fiscal Expansion In early 2021, President Bolsonaro fired the head of Petrobras (the state-owned energy champion) reportedly for raising fuel prices. Bolsonaro then picked a former army general (with no relevant work experience) to head the company. Although Bolsonaro positioned himself as a supporter of privatization in the run up to his presidency, he failed to follow through. Another area where the far-right leader has disappointed markets is with respect to Brazil’s debt levels. Under his presidency, a constitutional amendment to raise a key government spending cap was passed. Shortly afterwards came the creation of the massive welfare program Auxílio Brasil. Bolsonaro embraced fiscal populism to try to save his presidency after the pandemic. Consequently Brazil’s public debt to GDP ratio ballooned from 86% in 2018 to a peak of 99% in 2020. The Ugly: Poor Pandemic Response And Institutional Attacks The darkest hour of Bolsonaro’s presidency came on September 7, 2021, i.e., Brazil’s Independence Day. During rallies with his supporters, Bolsonaro levelled attacks on the Brazilian judiciary and sowed seeds of doubt in Brazil’s electoral process. More concretely, the greatest failing of the Bolsonaro administration has been its lax response to the pandemic. Bolsonaro delayed preventive measures, and this has meant that Brazil was one of the worst hit major economies of the world. The pandemic has claimed more than 630,000 lives in Brazil i.e., the second highest in the world. In relative terms too, Brazil has experienced a high death rate of about 2,960 per million which is even higher than the US rate of 2,720 per million. President Bolsonaro’s poor handling of the pandemic will cost the President in terms of votes in 2022 as the highest Covid-19-related death rates were seen in Southern Brazil (Map 3) i.e., a region that had voted in large numbers for Bolsonaro in 2018 (see Map 1 above). Map 3The Pandemic Has Had A Devastating Impact In Brazil’s South, Mid-West And North Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Given this backdrop, a Lula presidency will be welcomed by global financial markets, potentially for three reasons: Superior Pandemic-Control: An administration headed by Lula will bring in a more scientific and cohesive pandemic-control strategy thereby saving lives and benefiting the economy. Alignment With Institutions: Lula will act in alignment with Brazil’s institutions. He stands to benefit from the existing electoral system, the civil bureaucracy, academia, and the media. He may have rougher relations with the judiciary and parts of the military, but he is a known quantity and not likely to attempt to be a Hugo Chavez. Possibility Of Some Structural Reform: Given Brazil’s unstable debt dynamics, and the “lost decade” of economic malaise in the 2010s, there is a chance that Lula could pursue some structural reforms. Lula is more popular than his Worker’s Party, which is still tainted by corruption, so his strength in Congress will not be known until after the election. But Brazilian parties tend to coalesce around the president and Lula has experience in managing the legislative process. The probability of Lula pushing through some bit of structural reform will be the greatest in 2021. Back in 2019, it is worth recounting that only 4% of the Brazilian public supported pension reforms. Despite this Bolsonaro managed the passage of painful pension reforms in 2019 because market pressure forced the parties to cooperate. Faced with inflation and low growth, Lula may be forced to push through some piecemeal structural financial sector and economic reforms. However, if commodity prices and financial markets are cheering his election, he may spend his initial political capital on policies closer to his base of support, which means that a market riot may be necessary to force action on structural reforms. This dynamic will have to be monitored in the aftermath of the election. Assuming Lula does pursue some structural reforms while he has the political capital, and therefore that his first year is positive for financial markets, there is a reason to be positive on Brazil selectively on a tactical basis. However, electoral compulsions could cause Lula to pursue left-wing populism, fiscal expansion, and to resist privatization over the remaining three years of his presidency. Given Brazil’s already elevated debt levels (Chart 14), such a policy tilt would be market negative. It is against this backdrop that we expect a pro-Lula market rally to falter after the initial excitement. Bottom Line: Once the power transition is complete, a relief rally may follow as markets factor in the prospects of institutional stability and possibly a dash of structural reform in the first year of Lula’s presidency. But given Brazil’s elevated inequalities, even a pro-Lula rally will eventually fade as the administration will be constrained to switch back to the old ways and pursue an expansionary fiscal policy when elections loom. Investment Conclusions Brazil Presents A Value Trap, Fraught with Politico-Economic Risks From a strategic perspective, we are neutral on Brazil. A decade of bad news has been priced in but there is not yet a clear and sustainable trajectory to improve the country’s productivity. History suggests that both left-wing and right-wing presidents are often forced to backtrack on structural reforms and resort to cash-handouts in the run up to elections. This tends to add to Brazil’s high debt levels, prevents the domestic growth engine from revving up, and adds to inflation. Low growth and high inflation then set the wheels rolling for another bout of fiscal expansion (Chart 16). Chart 16The Vicious Politico-Economic Cycle That Brazil Is Trapped In Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Exceptions to this politico-economic cycle occur when a commodity boom is underway or if China, which is Brazil’s key client state, is booming. China today buys a third of Brazil’s exports (Chart 17) and is Brazil’s largest export market. The other reason we remain circumspect about Brazil’s strategic prospects is because of the secular slowdown underway in China. China is not in a position today to recreate the commodity and trade boom that buoyed Lula during his first presidency. China’s policy easing is a tactical boon at best, which can coincide with a Lula relief rally, but afterwards investors will be left with Chinese deleveraging and Brazilian populism. Political Risks Are High, Selective Tactical Exposure Brazil Will Be Optimal We urge investors to buy into Brazilian assets only selectively, even as Brazilian equities appear cheap (Chart 18). Political risks and economic risks such as low growth in GDP and earnings (Chart 19) could contribute to another correction and/or volatility in Brazilian equities. Chart 17China Buys A Third Of Brazil’s Exports Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions ​​​​​ ​​​​​Chart 18Brazil: Are Political & Macro Risks Priced-In? Brazil: The Road To Elections Won't Be Paved With Good Intentions Brazil: The Road To Elections Won't Be Paved With Good Intentions Chart 19Brazil's EPS Growth Tracks China's Total Social Financing Growth With A Lag Brazil's EPS Growth Tracks China's Total Social Financing Growth With A Lag Brazil's EPS Growth Tracks China's Total Social Financing Growth With A Lag China’s policy easing is an important macro factor playing to Brazil’s benefit. As we highlighted in our “China Geopolitical Outlook 2022,” Beijing is focused on ensuring stability over the next 12 months. But history suggests that Brazil’s corporate earnings respond to a pick-up in China’s total social financing with a lag of more than six months (Chart 19). Thus, even from a purely macro perspective it may make sense to turn bullish on Brazil after the election turmoil concludes. Given that politically sensitive sectors account for an unusually high proportion of Brazil’s market capitalization (Chart 18), and given the political risks in the offing for Brazil, we suggest taking-on selective exposure in Brazil. To play the rally yet mitigate political risks (that can be higher for capital-heavy sectors), we suggest a pair trade: Long Brazil Financials / Short India. We remain positive on India on a strategic horizon. However, in view of India approaching the business-end of its five-year election cycle, when policy risks tend to become elevated, we reiterate our tactical sell on India. India currently trades at a 81% premium to MSCI EM on a forward P-E ratio basis versus its two year average of 56%. A Quick Note On The Nascent EM Rally Investors should gradually look more favorably on emerging markets, but tactical caution is warranted. MSCI EM and MSCI World are down YTD 1.1% and 4.6% respectively. Despite the dip, we are not yet turning bullish on EM as a whole, owing to both geopolitical and macroeconomic factors. Global geopolitical risks in the new year are high. We recently upgraded the odds of Russia re-invading Ukraine from 50% to 75%. Besides EM Europe, we also see high and underrated geopolitical risks in the Middle East in the short run. Both the Russia and Iran conflicts raise a non-negligible risk of energy shocks that undermine global growth. Once these hurdles are cleared, we will turn more positive toward risky assets. Macroeconomically, the current EM rally can be sustained only if China delivers a substantial stimulus, and the US dollar continues to weaken. The former is likely, as we have argued, but the dollar looks to be resilient and it will take several months before China’s credit impulse rebounds. Hence conditions for a sustainable EM rally do not yet exist. Ritika Mankar, CFA Editor/Strategist ritika.mankar@bcaresearch.com   Strategic Themes Open Tactical Positions (0-6 Months) Open Cyclical Recommendations (6-18 Months)

Executive Summary A Floor In Biden’s Approval? Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Biden’s approval rating is forming a bottom. Democrats will pivot away from Covid-19 to boost the economy and consumer sentiment. While Democrats face a dismal midterm election, Republican infighting could conceivably cost the GOP control of the Senate. Policy uncertainty will rise as the election approaches. Republican infighting is unlikely to affect the outcome in the House of Representatives, although Republicans could lose three-to-nine seats that they might otherwise hold if the party establishment fails to coordinate effectively with former President Trump as we expect. Our tactical trades hinge on Biden’s near-term external risks: the risk of an energy shock that weighs on Treasury yields and pushes up the dollar. Defensives like health care should benefit. Our cyclical recommendations continue to favor cyclical equities such as small cap energy stocks.     Bottom Line: Investors should be tactically prepared for geopolitical risks to push up the dollar and push down Treasury yields in the short run, contrary to the cyclical BCA House View. Feature Has Biden’s Approval Hit The Floor? Probably. President Biden’s net approval rating is still under water at -9%, only slightly better than President Trump’s at this stage in the approach to the 2018 midterm elections. Biden’s handling of the economy receives a lower approval rating, which is dangerous for his party because the economy is likely to be the most important issue in the midterm election, given that the Covid-19 pandemic is waning. If Biden follows the path of his predecessors then his approval rating will trend upward as the midterm approaches. That will not prevent a Republican victory in the House but it could affect the Senate and the size of the Republican majority (Chart of the Week). The latest jobs report saw 467, 000 new jobs created. The labor participation rate grew from 81.9% to 82%, while women’s participation rose from 56.5% to 56.8%. The unemployment rate ticked up from 3.9% to 4%, with the broader U6 measure rising from 7.2% to 7.9%, but the reason was that more workers joined the workforce, which is a good thing for the economy (Chart 1). The Omicron variant of the Covid-19 virus is having little impact so the labor market is continuing to heal, a positive for the Biden administration, which is otherwise struggling. Chart 1A Solid Jobs Report A Solid Jobs Report A Solid Jobs Report American sentiment about the economy will hinge on inflation. If inflation abates along with the virus then the Democratic Party will be able to pare some losses in the midterms. At the moment the polarization of economic sentiment – divergence based on partisan affiliation – is declining, but for reasons that will give the administration a headache. Democratic sentiment is falling while Republican sentiment is improving (Chart 2). If inflation stays high, Republican sentiment will tick back down and  the public will be increasingly united in a negative view of the president’s economic management. If inflation peaks and rolls over, Democratic sentiment will recover as the election approaches and Republican sentiment will at least not get much worse. Chart 2Economic Sentiment Polarization In Decline Economic Sentiment Polarization In Decline Economic Sentiment Polarization In Decline For this reason Biden and the Democrats are rapidly pivoting away from Covid-19 and social restrictions and trying to create the “return to normalcy” that failed last year. While they were in the opposition they had an interest in hyping the virus but now they are the incumbents and it is important to show that the pandemic is in the rear-view mirror. With 64% of Americans now vaccinated, and 40% having received booster shots, government social restrictions are likely to become less stringent (Chart 3). The latest data from the service sector will motivate this policy pivot away from the virus. The manufacturing sector improved again last month but the non-manufacturing sector was less upbeat in January. Services activity declined by a whopping 12% in January. It is still above its November 2020 level, when Biden got elected, but only by around 2.2%. The non-manufacturing employment index declined by 4.3% and only stands 0.8% above its November 2020 level. The ratio of new orders to inventories declined by 0.6% in January (Chart 4). Chart 3Democrats To Pivot Away From Covid-19 Democrats To Pivot Away From Covid-19 Democrats To Pivot Away From Covid-19 These statistics suggest that the non-manufacturing sector slowed down sharply in January, probably due to omicron and post-Christmas belt tightening. But employers did not let go of a lot of workers, as seen by the discrepancies between business activity and employment. The mostly positive jobs report reinforces this point. The weakness is seen as temporary and employers expect higher demand in coming months. Now that consumer durable spending is running out of steam (at least, excluding cars), consumers are likely to switch to consuming services, as long as services are open for them to consume. There is little reason to think restrictions will stay tight, given the political points cited above. Even in Europe the Covid “hawks” are loosening controls. Chart 4Democrats Want To Boost Service Sector Democrats Want To Boost Service Sector Democrats Want To Boost Service Sector All that being said, the Biden administration has limited ability to control inflation that emanates from foreign supply shocks (e.g. Asia, Russia, Iran). Also voter perceptions of inflation will lag, even if inflation starts to abate. Crime and immigration will also weigh on the administration this fall. And the political clockwork favoring the opposition in midterm elections is remorseless. Bottom Line: Biden and the Democrats are likely to shift policy focus away from emphasis on the pandemic, which weighs on the service sector and employment, and instead pursue other policy options in preparation for the midterm election. The outlook is not positive but if Biden’s approval rating bottoms then Democrats’ chances of performing better in the midterm elections will rise and policy uncertainty will also rise. Will GOP Infighting Affect The Midterms? Maybe In The Senate Former President Trump clashed with former Vice President Mike Pence and others in the Republican Party over whether Pence had the right “to change the Presidential Election results” in 2020 by refusing to validate electoral college votes from states in which electoral fraud was alleged. Pence called the idea “un-American” and reiterated his position that the vice president has no “unilateral authority” to discard a state’s electoral votes while certifying the electoral count.1 Trump lashed out because moderate Republicans are flirting with Democrats over how to pass a bipartisan revision to the Electoral Count Act of 1887, which left a number of ambiguities in the US electoral process, including about the vice president’s role in election certification. It is conceivable that the law will be revised in time for the 2024 election but odds are against a quick solution: the original law took 10 years to pass. Throughout the 2022-24 election cycle, Trump will continue to clash with his party, which raises the single greatest risk to Republicans: that they will be too divided to capitalize fully on the Democrats’ weaknesses. We do not expect Trump to coordinate effectively with Republicans. His interest in revolutionizing the political establishment and winning a second term in 2024 diverges from the interest of the traditional Republicans, who want to preserve the political establishment with themselves on top, and want a fresh face to contend for eight years in the White House in 2024. However, Trump controls a plurality of the party’s grassroots voters (about 54%2 according to opinion polls) so that the Republican Party cannot afford to spurn him. If Trump were willing to cooperate with party leaders, then he would have cooperated when it mattered most: ahead of the Georgia special elections on January 5, 2020. If he had recognized the constitutional supremacy of the electoral college vote, he might have saved Republican control of the Senate. He did not, so the burden of proof falls on those who say that Trump can coordinate effectively with the Republican Party at critical junctures. Most likely the party will continue to play both sides, keeping Trump in the party but seeking a post-Trump future. Trump will continue to pursue the Republican nomination in 2024 and the party will have to acquiesce to him as long as he retains the support of a majority of the party’s grassroots. Trump’s conflict with the party will flare up in the primary elections this spring because Trump will endorse his own favorite candidates regardless of whether the Republican establishment agrees and views them as the most likely to win. Any success of Trump-backed populists in the primaries may become a liability for Republicans in the general election if the seat is competitive and the Democrats put up a moderate candidate. This point is primarily relevant in the Senate: Five Senate Republicans are stepping down, leaving an open competition in Alabama, Missouri, North Carolina, Ohio, and Pennsylvania (Table 1). The last three of these (NC, OH, PA) are competitive seats, especially if the Republican candidate is weak and Biden’s approval revives by the time of the vote. Trump has only made an endorsement in North Carolina, where his candidate is far from assured to win. Given that control of the Senate could hang on a single seat, it is at least possible that Trump’s split with the GOP could affect the Senate balance of power in 2023-24. Table 1Senate Incumbents Not Seeking Re-Election, 2022 Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Trump will also have an impact on the House of Representatives but he is less likely to affect the outcome of the midterm there, given that Republicans are likely to win 40 seats when they only need five to take control. There are a lot more Democrats retiring from the House than Republicans in this cycle, a positive indication for Republicans (Chart 5). In total there are 48 competitive seats (13 Republican-leaning, 22 Democrat-leaning, and 13 toss-up).3 Of these 48 competitive seats, 12 seats are “open” (no incumbent), divided evenly among Republicans and Democrats. In most of these competitive seats, but especially in Democrat-leaning seats and toss-up seats, a Trump-backed Republican will have a harder time winning than a traditional Republican.  All ten Republicans who voted to impeach President Trump after the January 6 rebellion are vulnerable to Trump challengers (Table 2). Three are already retiring. Given that Wyoming Representative Liz Cheney won her seat by a 44% margin, and yet is polling poorly relative to her Trump-backed challenger, it is fair to say that all seven of the remaining Republican impeachers are vulnerable to a Trumpist challenge. Of these, the general election could be competitive in five seats, i.e. those held by John Katko (R, NY-24), David Valadao (R, CA-21), Peter Meijer (R, MI-3), Fred Upton (R, MI-6), and Jaime Herrera Beutler (R, WA-3). However, given that the national tide does not favor the Democrats, five seats is the maximum that Democrats could poach from this group of lawmakers due to Republican infighting (three is a more likely number).   Chart 5House Members Not Seeking Re-Election, 2022 Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table 2House Republicans Who Voted To Impeach President Trump Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks More broadly there are 21 moderate Republicans in the House whose seats could be vulnerable to intra-party struggle (Table 3): So far President Trump has only endorsed candidates in seats which Republicans are highly likely to win anyway: namely Beth Van Duyne (R, TX-24), Mario Diaz-Balart (R, FL-25), and Carlos Gimenez (R, FL-26). But as the primary heats up, Trump’s endorsements could cause more tension with the Republican Party machinery.  The following six moderate Republicans’ seats could be at risk: Maria Elvira Salazar (R, FL-27), Rodney Davis (R, IL-13), Jeff Van Drew (R, NJ-2), Andrew Garbarino (R, NY-2), Mike Turner (R, OH-10), and Brian Fitzpatrick (R, PA-1). Of these, Fitzpatrick and Garbarino do not face any challengers yet, and only Davis faces a Trump-backed challenger. So six is the maximum Democrats could steal while one-to-three vulnerable seats is more likely. Table 3Republican Moderates Vulnerable To Populist Challengers Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Summing up, the Republican Party could fail to retain three-to-nine Republican seats that they might otherwise win in this cycle. Previously we put the number at five-to-nine seats.   These numbers do not include any Democratic-leaning seats that Republicans could fail to poach if they choose a populist candidate who is not competitive in a “purple” state or district. In conclusion, Republican infighting will not prevent Republicans from retaking the House of Representatives this fall. Cyclical factors in favor of Republicans will overwhelm their internal differences. But infighting could leave them with a smaller majority than consensus expects. In 2024 Republican internal divisions will become much more important than in 2022. A competitive Republican primary election for president will reduce Republican odds in the general election. If President Trump fails to win the nomination, he could defect and form his party. If he wins the nomination, Liz Cheney or another traditional Republican could defect and run as a third party, acting as a spoiler. Given the tight margins of victory in presidential elections, even a splinter group could steal enough votes to determine the outcome. The midterms will shed light on the depth of GOP divisions but in general these divisions reinforce our view that while Democrats will perform poorly in the midterms, they are still favored to retain the White House in 2024. Bottom Line: While the odds are stacked against Democrats in the midterms, Republican infighting could affect several Senate seats and will subtract anywhere from three-to-nine seats from expected seat gains in the House. While control of the House will not be affected, it is conceivable that control of the Senate could hang in the balance. Policy uncertainty will rise if Republican infighting makes Senate races more competitive later this year. Housekeeping To conclude we offer a few remarks on our outstanding investment recommendations: Cyclically Long Energy Small Caps: US energy production is rising in keeping with global oil and commodity prices. West Texas Intermediate crude sells for $89 per barrel on the spot market, inventories are drawing, OPEC 2.0 is intact, and there are plenty of supply risks on the horizon. American natural gas exports are picking up but not enough to meet demand if conflict in Ukraine causes a European shortage, while US oil exports are falling (Chart 6). Chart 6US Energy Production Picking Up US Energy Production Picking Up US Energy Production Picking Up Evidence from initial unemployment claims in O&G-dependent states like North Dakota and Wyoming suggests that shale producers need more time to ramp up production (Chart 7), as highlighted by our Commodity Strategist Bob Ryan.  Small cap energy stocks have not benefited much from the sharp spike in energy prices this year. We see this as an opportunity, given that US small caps are insulated from geopolitical troubles and will become key players if shortages occur (Chart 8). The risk comes if the supply response overwhelms the supply disruptions, as occurred in 2014 – but oil companies were in a much better position to surge production at that time. The 2015 nuclear deal with Iran also appeared more durable at that time than it will this year if it is rejoined, and there is no guarantee it will be rejoined. Cyclically Long Infrastructure Stocks: Infrastructure stocks peaked along with the equity market and in the wake of the Biden administration’s $550 billion Infrastructure Investment and Jobs Act, which is now being implemented. Indicators of infrastructure construction peaked in late 2020 and early 2021 and are slipping of late. But as long as the economy does not relapse into recession they should stabilize, especially as the virus wanes and global demand recovers (Chart 9). Cyclically Long Cyber-Security Stocks: Global threats, proxied by the Canadian dollar’s exchange rate with the Russian ruble, suggest that cyber security stocks will rebound after getting caught up in the current tech selloff (Chart 10). Tech stocks are also likely to bounce if inflation expectations peak as the Federal Reserve kicks into action.     Chart 7It Takes Time To Boost Shale Output It Takes Time To Boost Shale Output It Takes Time To Boost Shale Output Chart 8US Small Caps Yet To Benefit From Oil Price US Small Caps Yet To Benefit From Oil Price US Small Caps Yet To Benefit From Oil Price Chart 9Buy The Dip In Infrastructure Stocks Buy The Dip In Infrastructure Stocks Buy The Dip In Infrastructure Stocks Chart 10Cyber Stocks A 'Buy' In Tech Selloff Cyber Stocks A 'Buy' In Tech Selloff Cyber Stocks A 'Buy' In Tech Selloff Investment Takeaways Chart 11A Floor In Biden’s Approval? Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks US financial markets do not care about the midterm elections in the near term but that will change as policy uncertainty will rise over the course of the year. A bottom in Biden’s approval rating (Chart 11) and Republican primary election infighting both suggest that the Democratic Party’s odds in the midterms will improve going forward, raising policy uncertainty, especially over the Senate. Midterm uncertainty typically works in favor of the US dollar, Treasuries, defensive equity sectors, and growth stocks. As such it poses a risk to current market trends. The recent selloff in Big Tech confirms what we have argued since we launched the US Political Strategy: the tech sector faces a slow boil from inflation and rising interest, which are more immediate threats than government regulation. Having said that, we favor growth versus value on a tactical basis as we expect the dollar to rise and Treasury yields to fall on the back of geopolitical risks in the near term (Chart 12).  Chart 12A Tactical Bounce For Tech Stocks? A Tactical Bounce For Tech Stocks? A Tactical Bounce For Tech Stocks?   Matt Gertken Senior Vice President Chief US Political Strategist mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.kuri@bcaresearch.com   Footnotes 1     See Vice President Michael R. Pence’s letter, dated January 6, 2021, available at “Read Pence’s full letter saying he can’t claim ‘unilateral authority’ to reject electoral votes,” PBS, pbs.org. See also Mychael Schnell, “Trump says he wanted Pence to overturn election, eyes effort to reform law,” January 31, 2022, and Brett Samuels, “Pence breaks with Trump: ‘I had no right to overturn the election,’” February 4, 2022, thehill.com. 2     Please see “Over half of Americans believe the country's economy is headed in the wrong direction,” Ipsos, December 29, 2021, Ipsos.com 3    See Cook Political Report, “2022 House Race Ratings,” February 8, 2022, cookpolitical.com.   Strategic View Open Tactical Positions (0-6 Months) Open Cyclical Recommendations (6-18 Months)   Table A2Political Risk Matrix Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table A3US Political Capital Index Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Chart A1Presidential Election Model Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Chart A2Senate Election Model Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table A4APolitical Capital: White House And Congress Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table A4BPolitical Capital: Household And Business Sentiment Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks Table A4CPolitical Capital: The Economy And Markets Biden’s Floor, Republican Cracks Biden’s Floor, Republican Cracks

Executive Summary The End Of The Negative Bond Yield Era Europe Joins The Global Bond Bear Market Europe Joins The Global Bond Bear Market Recent price action in developed market government bond markets confirms a backdrop that has been in place for the past several years - movements in US Treasuries define the trend in global yields, but Europe sets the effective floor. Higher core European bond yields are also pushing up non-European yields, in the context of the current global monetary policy tightening cycle. The hawkish market pricing for the ECB this year has gone a bit too far, as the start of European rate hikes this year is more likely in Q4 than in the summer – and only after ECB asset purchases begin to formally wind down. In the UK, the Bank of England appears to be trying to front load policy tightening, both rate hikes and balance sheet runoff, in response to overshooting UK inflation. A shorter, sharper policy tightening cycle means that the UK Gilt curve will continue to bear-flatten.  Bottom Line: Within the “Big 3” developed market central banks, the Fed and Bank of England are more likely to deliver discounted rate hikes than the ECB over the next 6-12 months. Remain underweight US Treasuries and UK Gilts versus German Bunds in global bond portfolios. Feature Chart 1A Global Repricing Of Interest Rate Expectations A Global Repricing Of Interest Rate Expectations A Global Repricing Of Interest Rate Expectations Persistent elevated inflation readings are forcing policymakers to move up the timetable of expected cyclical interest rate increases, but without signaling any change to longer-term interest rate expectations. The result has been an upward move in bond yields led by a repricing of shorter-term yields, leading to bearish yield curve flattening pressure across the developed markets (Chart 1). As the global bond bear market has intensified and broadened across countries and fixed income sectors, the amount of bonds worldwide with negative yields has been slashed by $9 trillion since December (Chart 2). Some notable examples: the 10-year German Bund yield is now up to +0.26%, the 30-year US real TIPS yield is now at +0.04% and even the 5-year Japanese government bond yield climbed to +0.02% for the first time since 2016. Last week, bond markets had to digest both a 25bp Bank of England (BoE) rate hike - that was almost a 50bp move - and a huge upside surprise in the January US employment report. However, it was the more hawkish-than-expected messaging from the European Central Bank (ECB) that really rattled fixed income markets. At the February monetary policy meeting, ECB President Christine Lagarde opened the door to potential ECB rate hikes this year, a notable change from the previous forward guidance that rates would stay unchanged in 2022. This not only triggered a major decline in European government bond prices, but also notable jumps in bond volatility for both longer-term and, especially, shorter-term yields. Implied volatilities for swaptions on 2-year European swap rates now sit at the highest levels since the depths of the European Debt Crisis in 2011 (Chart 3). Chart 2The End Of The Negative Bond Yield Era The End Of The Negative Bond Yield Era The End Of The Negative Bond Yield Era ​​​​​ Chart 3The Front-Ends Of Yield Curves Awaken The Front-Ends Of Yield Curves Awaken The Front-Ends Of Yield Curves Awaken ​​​​​​ Overnight index swap (OIS) curves are now discounting multiple rate hikes from the Fed (+127bps), BoE (+125bps) and ECB (+46bps) this year. Tighter monetary policy is the inevitable consequence of the current combination of steady above-trend growth, tight labor markets and very high inflation in those countries. This mix will continue to put upward pressure on global bond yields through a blend of steady inflation expectations and higher real yields as pandemic era monetary stimulus is removed – a process that is already underway in the US and Europe (Chart 4). Our Central Bank Monitors – designed to measure the cyclical pressure to change monetary policy – are all indicating the need for tightening in the US, UK and euro area. However, the risk is that tightening perceived to be too aggressive or too rapid will be received poorly by financial markets that have grown accustomed to easy money policies during the pandemic. Given the current starting point of high equity valuations and relatively tight corporate credit spreads in the US, financial conditions are no impediment to additional Fed rate hikes in 2022 (Chart 5). The same cannot be said in the UK, where the steady appreciation of the trade-weighted pound is tightening financial conditions, on the margin. In the euro area, financial conditions remain relatively stimulative, as the euro is undervalued on a trade-weighted basis. Chart 4A Recipe For Even Higher Bond Yields A Recipe For Even Higher Bond Yields A Recipe For Even Higher Bond Yields Given high realized inflation, financial stability concerns are playing a secondary role in the policy deliberations of central banks facing an inflation-fighting credibility crisis. In the absence of a big fall in inflation, it will take much larger selloffs in equity and corporate credit markets than what has occurred so far in 2022 before policymakers would step back from interest rate increases over the next year. Chart 5Financial Conditions Are No Impediment To Rate Hikes Financial Conditions Are No Impediment To Rate Hikes Financial Conditions Are No Impediment To Rate Hikes ​​​​​​ The ECB Will Lag The Fed On Rate Hikes Chart 6Faster Growth & Slower Inflation Expected In 2022 Faster Growth & Slower Inflation Expected In 2022 Faster Growth & Slower Inflation Expected In 2022 One of our highest conviction bond market views to begin 2022 called for US Treasuries to underperform German Bunds. Our view was based on the likelihood that the Fed would lift the fed funds rate multiple times this year and the ECB was likely to hold off on rate hikes until the first half of 2023 at the earliest. Last week’s shift in the ECB’s tone does not change that relative call. The Fed is still under far greater pressure to hike rates than the ECB, even if there is now a greater chance that the ECB could begin to tighten by the end of 2022. From an economic growth perspective, both central banks have good reasons to consider withdrawing monetary accommodation. The economic expectations in both the US and euro area have started to recover, according to the ZEW survey of financial market professionals, with a bigger bounce seen in the latter since the trough of last October (Chart 6). The fading Omicron wave is likely playing a large role in lifting economic expectations, as the variant has proven to be less lethal than previous waves of the virus. The ZEW survey also asks respondents about their views on future inflation and interest rate changes. The ZEW Inflation Expectations index has fallen back to pre-pandemic lows in both the US and euro area, indicating that a majority expect lower inflation in the US and Europe over the next year. Both the Fed and ECB also expect inflation to fall from current elevated levels this year. However, there is still a much stronger case for tightening in the US given the tight labor market that is pushing up wages. Last week’s January US payrolls data was a shocker, with employment rising +476,000 on the month when some forecasters were calling for an outright contraction in jobs due to the impact of the Omicron variant. Wage growth accelerated smartly, with average hourly earnings up 0.7% on the month and 5.7% on a year-over-year basis (Chart 7). This continues the trend of wage acceleration seen in other data series like the Employment Cost Index, confirming that the US labor market is tight enough to elicit a strong policy response from the Fed. In the euro area, the recent economic data has been a bit more mixed. The Markit manufacturing PMI rose to a five-month high of 59.0 in January, beating expectations. However, the services PMI fell to a nine-month low of 51.2 as renewed COVID lockdowns weighed on consumer confidence and spending (Chart 8). With Omicron numbers now slowing, some recovery in consumer spending is likely over the next few months as euro area governments reduce restrictions. However, the manufacturing recovery will struggle to gain significant upside momentum without stronger demand for European exports – an outcome that is not currently heralded by an upturn in reliable indicators like the global leading economic indicator or the China credit impulse (Chart 9). Chart 7Persistent US Labor Market Strength Persistent US Labor Market Strength Persistent US Labor Market Strength ​​​​​​ Chart 8A Mixed Picture On European Growth A Mixed Picture On European Growth A Mixed Picture On European Growth ​​​​​​ Even within the euro area inflation data, there are mixed trends that make it less clear that a major tightening cycle is necessary. Headline euro area HICP inflation hit a 37-year high of 5.1% in January, which was heavily influenced by a 28.6% rise in the energy component of the index (Chart 10). Goods price inflation reached 6.8%, its highest level since 1991, fueled by global supply chain disruptions and greater consumer demand for goods versus services during the pandemic. For the latter, services inflation reached a much more subdued 2.4% in January, in line with core HICP inflation of 2.3%. We expect goods price inflation to slow substantially, on a global basis and not just in Europe, as supply chain disruptions ease over the course of 2022 and consumers shift spending back towards services from durable goods as economies reopen post-Omicron. Chart 9A Gloomy Picture For European Exports A Gloomy Picture For European Exports A Gloomy Picture For European Exports ​​​​​ Chart 10European Inflation Surge Focused On Energy & Goods European Inflation Surge Focused On Energy & Goods European Inflation Surge Focused On Energy & Goods ​​​​​ Surging oil and natural gas prices will keep the energy component elevated over the next few months, particularly if geopolitical tensions over Ukraine result in Russia withholding natural gas supplies to Europe. Yet it is not clear how much of this will pass through to core inflation, which actually decelerated in January from the 2.6% pace seen in December 2021 despite surging energy prices. What does a typical ECB liftoff look like? Should the ECB focus more on the headline or core inflation numbers when deciding if rate hikes are necessary later this year? The answer may lie more in the breadth across countries, rather than depth across sectors, of euro area inflation pressures. In the relatively short history of the ECB, dating back to the inception of the euro in 1998, there have been only three monetary tightening episodes that involved interest rate increases: 1999-00, 2006-08 and 2011. In Chart 11, we show the percentage share of individual euro area countries that have accelerating growth momentum (measured as a leading economic indicator above the level of a year earlier), and with headline/core inflation above the ECB’s 2% target. In all three of those past ECB tightening episodes, essentially all euro area countries had to see strong growth or inflation at or above the ECB target before the ECB would hike rates. Chart 11The Growth & Inflation Conditions For An ECB Rate Hike Are In Place The Growth & Inflation Conditions For An ECB Rate Hike Are In Place The Growth & Inflation Conditions For An ECB Rate Hike Are In Place Chart 12Watch European Wages To Determine The ECB's Next Move(s) Watch European Wages To Determine The ECB's Next Move(s) Watch European Wages To Determine The ECB's Next Move(s) A similar story can be told looking at the state of the euro area labor market. The 1999-00 and 2006-08 tightening cycles occurred when nearly all euro area countries had an unemployment rate below the OECD’s estimate of the full employment NAIRU (Chart 12). Only in 2011, which was widely regarded as a major policy error, did the ECB hike rates without widespread labor market strength across the euro area. Right now, the breadth of the growth and inflation data across the euro area would indicate that the ECB will soon begin to tighten policy, if history is any guide. The one missing piece of the puzzle is faster wage growth. Euro area wage growth is severely lagging compared to other developed economies. For the last known data point in Q3/2021, wages were only growing at a 1.5% year-over-year rate. Wage growth has very likely accelerated since then, with the overall euro area unemployment rate now down to an all-time low of 7.0%, well below the OECD NAIRU estimate of 7.7%. The ECB will need to see confirmation of that faster wage growth in the data, however, before embarking on a path of rate hikes. Since last week’s ECB meeting, numerous ECB officials – including President Lagarde - have stated that asset purchases must stop before rate hikes can begin. While the ECB’s pandemic emergency bond buying program is set to end next month, the existing Asset Purchase Program is set to continue with no expiry date. If the ECB officials are to be taken at their word, it is very difficult to imagine a scenario where asset purchases would be fully wound down (i.e. net purchases of zero, with buying only to replace maturing bonds held by the ECB) before the July liftoff date now priced into the Euro OIS curve. Such a rapid removal of the ECB bid would be very disruptive to the riskier parts of European fixed income markets, like Italian and Greek sovereign debt, that have benefited from heavy ECB buying under the pandemic bond buying program. European bond strategy implications While an ECB rate hike in 2022 is now a more probable scenario, it is not yet a done deal. The European growth picture remains mixed, and inflation readings outside of supply-constrained energy and durable goods – including wages - are far less threatening than headline inflation. At the moment, underlying inflation pressures are far more intense in the US. Durable goods inflation in the US reached 16.8% on a year-over-year basis last month, but climbed to “only” 3.8% in Europe (Chart 13). The Cleveland Fed’s trimmed mean CPI index accelerated to 4.8% in January, compared to 3.0% for the euro area trimmed mean CPI inflation gauge constructed by our colleagues at BCA Research European Investment Strategy. Chart 13Stay Positioned For A Wider UST-Bund Spread Stay Positioned For A Wider UST-Bund Spread Stay Positioned For A Wider UST-Bund Spread The Fed has a lot more work ahead of it in terms of tightening monetary policy to rein in inflation pressures (and inflation expectations) than the ECB. This will lead to a faster pace of rate hikes in the US than in Europe and renewed widening of the US Treasury-German Bund yield spread. Financial conditions in Europe will also play a role in limiting when, and how much, the ECB can eventually tighten monetary policy. Yields and spreads on the riskier parts of the European fixed income markets like Italian government bonds have already widened substantially in response to the more hawkish guidance from the ECB (Chart 14). The euro has also stabilized after the steady depreciation seen since the May 2021 peak. Markets are obviously pricing in an end to ECB asset purchases – the precursor to rate hikes – which would force the private sector to absorb a greater share of Italian bond issuance than has been the case over the past few years. It will likely take higher yields to entice those buyers compared to the price-insensitive ECB that has been buying Italian debt as a monetary policy tool. The speed of the adjustment in Italian bond yields has no doubt alerted the ECB Governing Council to the financial stability risks of moving too fast on tightening monetary conditions. We must acknowledge that most the recent trends in the Treasury-Bund spread (narrower) and Italian bond yields/spreads (higher) go against our current strategic recommendations to overweight European fixed income. Markets have moved to price in a far more aggressive move from the ECB than we had envisioned for 2022. However, as highlighted above, it is not clear that the ECB needs to dial back monetary accommodation as rapidly as markets now expect. Thus, we are sticking with our strategic recommendations to overweight euro area government bonds, both in the core and periphery, in global bond portfolios. At the same time, we continue to recommend a below-benchmark duration stance within dedicated European portfolios, even with the 10-year German Bund yield having already reached our end-2022 yield target of 0.25% (Chart 15). European bond yields will remain under upward pressure until euro area inflation finally peaks and the ECB will be under less pressure to tighten. Chart 14ECB Facing An "Italy-vs-Inflation" Tradeoff ECB Facing An "Italy-vs-Inflation" Tradeoff ECB Facing An "Italy-vs-Inflation" Tradeoff ​​​​​ Chart 15Too Much, Too Soon Priced Into Bund Yields Too Much, Too Soon Priced Into Bund Yields Too Much, Too Soon Priced Into Bund Yields ​​​​​ Bottom Line: Markets are overestimating how quickly the ECB can begin to tighten European monetary policy. An initial rate hike can occur in Q4 of this year, at the earliest, which is later than the current mid-summer liftoff date discounted in interest rate forwards. Ride out the current European rates volatility and stay overweight European government debt versus the US. UK Update: The BoE Wants To Tighten Fast At last week's policy meeting, the BoE Monetary Policy Committee (MPC) voted 5-4 to raise Bank Rate by 25bps to 0.5%. That close vote is less dovish than it appears, though, as the four “dissenting” MPC members wanted to raise rates by 50bps instead! This was a hawkish surprise that resulted in bearish flattening of the UK Gilt yield curve. Chart 16UK Gilts: Volatile, But Underperforming UK Gilts: Volatile, But Underperforming UK Gilts: Volatile, But Underperforming We have maintained a below-benchmark strategic recommendation on Gilts since August of last year. The relative performance of Gilts versus the Bloomberg Global Treasury benchmark index has seen tremendous volatility since then, particular after the BoE delayed the expected initial rate hike last November (Chart 16) Gilts began to underperform again after the BoE hiked in December and have continued to be one of the worst performing G10 bond markets, validating our bearish call. After last week’s BoE hike, we still see value in betting on additional Gilt underperformance, as markets may still be underestimating how high the BoE will have to raise rates in the current tightening cycle. In the new set of economic projections from the BoE’s Monetary Policy Report published last week, the central bank raised its expectation for the April peak in UK inflation to 7.25% (Chart 17). This compares to the latest inflation rate of 5.4%. Higher energy and goods prices account for three-quarters of that expected inflation increase, according to the BoE. UK inflation is projected to fall rapidly from that April peak, in response to an expected deceleration of energy and goods prices and slower UK economic growth. However, the Monetary Policy Report also highlighted that domestic UK cost pressures are intensifying in response to a very tight UK labor market. The BoE’s Agents’ survey of UK businesses reported that UK firms continue to have difficulty filling job openings, while also having success in passing on rising labor costs into selling prices. Thus, the UK labor market is now the critical variable to watch to determine how many more rate hikes the BoE will need to deliver in the current cycle. On that note, the BoE expects UK wage growth to accelerate to just under 5% over the next year, which is well above the central bank’s estimate of “underlying” pre-pandemic wage growth around 3.5%. Inflation expectations in the UK remain elevated. The YouGov/Citigroup survey shows that UK consumers expect inflation to be 4.8% on year from now and 3.8% 5-10 years ahead (Chart 18, top panel). Market-based inflation expectations have been more volatile of late but CPI swaps are pricing in inflation of 5.0% in two years and 4.2% in ten years.1 Thus, by any measure – realized inflation, expected inflation or wage growth – UK inflation is too high, which justifies tighter monetary policy. The UK OIS curve now discounts a peak in Bank Rate of 1.85% in April 2023, but this is immediately followed by rate cuts that take Bank Rate to 1.5% by the end of 2024. That path over the next year is a bit more hawkish than the results from the BoE’s new Market Participants Survey of bond investors, which showed an expected peak in Bank Rate of 1.5% sometime in the latter half of 2023. In both cases, Bank Rate is expected to settle below the BoE’s 2% inflation target, or below current inflation expectations. Suggesting an implied belief that the BoE will not be able to raise real interest rates into positive territory. In terms of forward guidance, several BoE officials have noted that they expect that only a few more hikes will be needed to help bring UK inflation back down to the 2% target. Yet the OIS curve is pricing in a “policy error” scenario where the BoE pushes up rates too rapidly and is then forced to cut rates soon afterward. We see both the BoE guidance and the OIS pricing as far too cautious on the eventual peak in Bank Rate, which leads us to maintain our underweight recommendation on UK Gilt exposure, both in terms of duration and country allocation in global bond portfolios. Chart 17BoE Sees A Short, Sharp Shock From Inflation & Rates BoE Sees A Short, Sharp Shock From Inflation & Rates BoE Sees A Short, Sharp Shock From Inflation & Rates We have also been recommending a Gilt curve steepening trade in our Tactical Overlay portfolio on page 20 since last October. This trade went long a 10-year Gilt bullet versus a barbell combination of a 7-year and 30-year Gilt. Chart 18Stay Underweight UK Gilts Stay Underweight UK Gilts Stay Underweight UK Gilts ​​​​​ Our view at the time of trade inception was that a Gilt steepener would benefit from a scenario where the market would be forced to reassess how high rates would go in the next BoE tightening cycle. However, the BoE now appears to be “front loading” the tightening cycle by moving rates sooner and more aggressively, as evidenced by the near 50bp rate hike last week, while also moving to an accelerated runoff of bonds accumulated during quantitative easing operations. The Gilt yield curve has flattened considerably in response to increasing BoE hawkishness, with the yield spread between the 10-year and 2-yield Gilt now down to a mere +17bps. While we still see the potential for the longer-end of the Gilt curve to rise in response to an eventual repricing of terminal rate expectations that appear too low, the BoE’s acceleration of its hiking timetable will make it difficult for the curve to bearishly steepen in the near term. Thus, we are closing out our tactical Gilt curve steepener at a small gain of +23bps.   Robert Robis, CFA Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1      UK CPI swaps, and inflation breakevens on index-linked Gilts, reference the UK Retail Price Index (RPI) which typically runs higher than the UK Consumer Price Index (CPI). This imparts an upward bias to UK inflation expectations when compared to CPI swaps and breakevens in other countries. Currently, RPI inflation is running at 7.5% compared to CPI inflation of 5.4%. GFIS Model Bond Portfolio Recommended Positioning     Active Duration Contribution: GFIS Recommended Portfolio Vs. Custom Performance Benchmark Europe Joins The Global Bond Bear Market Europe Joins The Global Bond Bear Market The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Cyclical Recommendations (6-18 Months) Europe Joins The Global Bond Bear Market Europe Joins The Global Bond Bear Market Tactical Overlay Trades