BCA Indicators/Model

Highlights In this Weekly Report, we present our semi-annual chartbook of the BCA Central Bank Monitors. The message now conveyed by the Monitors is that divergences between the cyclical pressures faced by the individual central banks are growing larger. This is occurring within some countries, where the growth and inflation indicators are trending in opposite directions. This is also visible across countries, with not every Monitor calling for rate hikes - a significant shift from the coordinated backdrop seen in 2017 (Chart of the Week). Chart of the WeekFrom Convergence To Divergence In The BCA Central Bank Monitors From Convergence To Divergence In the BCA Central Bank Monitors From Convergence To Divergence In the BCA Central Bank Monitors The combined message from the Monitors is that the slower pace of global growth seen in 2018 has not been enough put a serious dent in inflation pressures stemming from a dearth of spare capacity in most major countries. Perhaps that changes if a full-blown U.S.-China trade war develops, or if the tensions in emerging markets spill over more broadly into global financial conditions, but that remains to be seen. Add it all up, and a below-benchmark stance on overall global duration exposure remains appropriate. Feature An Overview Of The BCA Central Bank Monitors Chart 2CB Monitor Divergence = Bond Yield Divergence CB Monitor Divergence = Bond Yield Divergence CB Monitor Divergence = Bond Yield Divergence The BCA Central Bank Monitors are composite indicators designed to measure the cyclical growth and inflation pressures that can influence future monetary policy decisions. The economic data series used to construct the Monitors are not the same for every country, but the list of indicators generally measure the same things (i.e. manufacturing cycles, domestic demand strength, commodity prices, labor market conditions, exchange rates, etc). The data series are standardized and combined to form the Monitors. Readings above the zero line for each Monitor indicate pressures for central banks to raise interest rates, and vice versa. Through the nexus between growth, inflation, and market expectations of future interest rate changes, the Monitors do exhibit broad correlations to government bond yields in the Developed Markets (Chart 2). Our current recommended country allocation for global government bonds reflects the trends seen in the Central Bank Monitors - underweighting countries were the Monitors are most elevated (the U.S., Canada) in favor of regions where the Monitors are lower (Australia, Japan, euro area, New Zealand). In each BCA Central Bank Monitor Chartbook, we include a new chart for each country that we have not shown previously. In this edition, we show the Monitors plotted against the relative returns for each country versus the overall Bloomberg Barclays Global Treasury index (shown inversely in the charts so that a rising line means underperformance versus the benchmark index). Fed Monitor: Still On A Gradual Rate Hike Path Our Fed Monitor remains in the "tight money required" zone, signalling that the cyclical backdrop justifies additional Fed rate hikes (Chart 3A). Resilient U.S. growth, a dearth of spare capacity and an acceleration of both wage growth and core inflation are all consistent with a U.S. economy starting to overheat and requiring tighter monetary policy (Chart 3B). Chart 3AU.S.: Fed Monitor U.S.: Fed Monitor U.S.: Fed Monitor Chart 3BU.S. Inflation On The Rise U.S. Inflation On The Rise U.S. Inflation On The Rise The growth and inflation components of the Fed Monitor have both accelerated since our last Central Bank Monitor Chartbook was published back in April. Most notably, the inflation component has blasted through the zero line to the highest level since 2008 (Chart 3C). The financial conditions component has retreated from very elevated (i.e. growth-supportive) levels, mostly due to the stronger U.S. dollar but also because of wider corporate credit spreads seen since the start of 2018. Importantly, the financial conditions component has not tightened enough to offset the impact on the Monitor from faster growth and inflation. Chart 3CAll Fed Monitor Components Now Above Zero All Fed Monitor Components Now Above Zero All Fed Monitor Components Now Above Zero Recent comments from senior Fed officials (Chair Jay Powell and Governor Lael Brainard) have indicated that the Fed is less confident in its own estimates of the full-employment NAIRU or the appropriate neutral level of the funds rate. Our read on this is that the Fed will instead continue to raise the funds rate at a gradual 25bp per quarter pace until there are signs that U.S. monetary policy has become tight (i.e. an inverted yield curve, wider credit spreads, softer U.S. economic data). Until then, the message sent by the Fed Monitor is to remain underweight U.S. Treasuries with below-benchmark duration, as market pricing of expectations for both the funds rate and inflation remain too low (Chart 3D). Chart 3DU.S. Treasury Underperformance Will Continue - Stay Underweight U.S. Treasury Underperformance Will Continue - Stay Underweight U.S. Treasury Underperformance Will Continue - Stay Underweight BoE Monitor: Brexit Uncertainty Trumps Inflation Pressures The BoE Monitor remains in the "tighter money required" zone as it has since late 2015 (Chart 4A). Despite that persistent signal, the BoE has kept monetary policy at highly accommodative levels, only raising the base rate 50bps over the past year. The BoE Monetary Policy Committee remains torn between signs that inflation risks are tilted to the upside and the downside risks to U.K. growth from an uncertain Brexit outcome. The U.K. unemployment rate is well below NAIRU with an output gap that is now estimated to be closed (Chart 4B). Yet realized inflation has peaked, with core inflation drifting back below 2%. Wages are finally starting to grow in real terms, which the BoE cites as an important factor underpinning consumer spending, but the pace remains modest. Chart 4AU.K.: BoE Monitor U.K.: BoE Monitor U.K.: BoE Monitor Chart 4BNo Spare Capacity, Yet Has Inflation Peaked? No Spare Capacity, Yet Has Inflation Peaked? No Spare Capacity, Yet Has Inflation Peaked? Looking at the breakdown of our BoE Monitor, both the growth and inflation sub-components of the indicator have recently reaccelerated (Chart 4C). Yet U.K. leading economic indicators continue to decline and dampened business confidence measures reflect the heightened uncertainty over the future relationship between the U.K. and the European Union. Chart 4CBoth Growth & Inflation Components Are Boosting The BoE Monitor Both Growth & Inflation Components Are Boosting The BoE Monitor Both Growth & Inflation Components Are Boosting The BoE Monitor The performance of U.K. Gilts has diverged from the Monitor since the 2016 Brexit vote (Chart 4D), as the BoE has been more worried about Brexit than inflation and has stayed accommodative. Stay overweight U.K. Gilts within global government bond portfolios, even with the more bearish signal implied by our BoE Monitor, given the weakening trend in leading economic indicators and persistent Brexit uncertainty. Chart 4DBrexit Uncertainty Preventing More BoE Hikes - Stay Overweight Gilts Brexit Uncertainty Preventing More BoE Hikes - Stay Overweight Gilts Brexit Uncertainty Preventing More BoE Hikes - Stay Overweight Gilts ECB Monitor: No Pressure To Hike Rates Quickly Post-QE Our European Central Bank (ECB) Monitor has fallen sharply since we last published this Chartbook back in April, and it now sits below the zero line (Chart 5A). The growth deceleration in the first half of the year from the rapid pace seen in 2017 is the main reason for this move, as inflation pressures have not subsided (Chart 5B). Chart 5AEuro Area: ECB Monitor Euro Area: ECB Monitor Euro Area: ECB Monitor Chart 5BEuro Area At Full Capacity Euro Area At Full Capacity Euro Area At Full Capacity ECB President Mario Draghi noted last week that the plan remains in place to end the net new buying phase of the ECB's Asset Purchase Program at the end of 2018. Policymakers' have grown more confident that their inflation forecasts will be met as most measures of euro area wage growth (and headline inflation) have accelerated to 2% over the past year. It remains to be seen if those expectations are too optimistic, as the growth component of our ECB Monitor remains well below the zero line, while the inflation component is no longer rising (Chart 5C). Chart 5CGrowth Component Dragging Down The ECB Monitor Growth Component Dragging Down The ECB Monitor Growth Component Dragging Down The ECB Monitor For now, we recommend a neutral stance on core euro area government bonds with an underweight posture on Peripheral sovereign debt as a way to manage these conflicting trends. The overall performance of euro area bonds versus global benchmarks has followed the pace of the ECB's bond-buying since 2015, and not the pressures suggested by our ECB Monitor (Chart 5D), suggesting a bearish stance as the bond buying ends. Yet from a more bullish perspective, the mixed message on growth and lack of immediate pressures on core inflation (still at 1%) imply that the ECB will not deviate from its current dovish forward guidance of no interest rate hikes until at least September 2019. Chart 5DECB Will Not Hike Rates Quickly After QE Ends - Stay Neutral Core European Bonds ECB Will Not Hike Rates Quickly After QE Ends - Stay Neutral Core European Bonds ECB Will Not Hike Rates Quickly After QE Ends - Stay Neutral Core European Bonds BoJ Monitor: Too Soon To Consider Policy Changes Our Bank of Japan (BoJ) Monitor has stayed just barely in the "tighter money required" zone since last October, due mostly to growing inflation pressures (Chart 6A). Yet with the Japanese labor market now as tight as it has been in decades, headline and core CPI inflation are only at 0.9% and 0.3% respectively, well below the BoJ's 2% target (Chart 6B). Chart 6AJapan: BoJ Monitor Japan: BoJ Monitor Japan: BoJ Monitor Chart 6BInflation Pressures Slowly Building In Japan Inflation Pressures Slowly Building In Japan Inflation Pressures Slowly Building In Japan Japanese firms appear to finally be reacting to the tightness of the labor market, however, as wage growth has accelerated in recent months. The pick-up in wages has helped boost inflation expectations, both of which are part of the inflation component of the BoJ Monitor that is now at the highest level since 2008 (Chart 6C). However, the growth component just rolled over and now sits at the zero line, as the Japanese economy has lost some momentum. Chart 6CInflation Boosting BoJ Monitor Inflation Boosting BoJ Monitor Inflation Boosting BoJ Monitor We continue to recommend an overweight stance on JGBs, based on our view that the BoJ will maintain hyper-easy monetary policy settings - especially compared to the rest of the developed markets - until there is much higher realized inflation in Japan. JGBs have indeed been outperforming over the past year, even with the less dovish signal sent by the BoJ Monitor (Chart 6D). Yet the absolute level of the Monitor remains around zero, suggesting that no policy changes should be expected. That means no upward adjustment of the BoJ's 0% yield target on 10-year JGBs or major further reductions in the annual pace of BoJ JGB buying (even though the central bank is hitting capacity constraints as it now owns close to ½ of all outstanding JGBs). Chart 6DBoJ In No Hurry To Turn Hawkish - Stay Overweight JGBs BoJ In No Hurry To Turn Hawkish - Stay Overweight JGBs BoJ In No Hurry To Turn Hawkish - Stay Overweight JGBs BoC Monitor: Rate Hikes - More To Come The Bank of Canada (BoC) Monitor has stayed in "tighter money required" since the beginning of 2017 and is now well above the zero line (Chart 7A). The BoC has been following our BoC Monitor, hiking rates by a cumulative 100bps since July 2017. Chart 7ACanada: BoC Monitor Canada: BoC Monitor Canada: BoC Monitor Chart 7BAn Overheating Canadian Economy? An Overheating Canadian Economy? An Overheating Canadian Economy? The BoC has been responding to the growing inflation pressure in Canada. There is no evidence that spare economic capacity exists, while realized inflation is near the upper bound of BoC's target range of 1-3% (Chart 7B). There is a growing divergence between the growth and inflation subcomponents of the BoC Monitor, with the latter decelerating over the past several months. That was due to a combination of slowing Chinese import demand and the imposition of trade tariffs on Canada by the Trump administration (Chart 7C). Yet the domestic economy remains in good shape, with the overall indicator from the BoC's Business Outlook Survey at the highest level since 2010. Chart 7CInflation Component Boosting BoC Monitor Inflation Component Boosting BoC Monitor Inflation Component Boosting BoC Monitor We continue to recommend an underweight stance on Canadian government bonds, as the relative performance has broadly followed the path of the BoC Monitor over the past three years (Chart 7D). The BoC tends to follow the policy actions of the Fed with a short lag, thus our bearishness on Canadian government bonds is related to our more hawkish views on the Fed. Yet the surge in Canadian inflation, at a time when the economy has no spare capacity, suggests that there are good domestic reasons to expect more rate hikes from the BoC over the next year than what is currently discounted by markets. Chart 7DBoC Not Done Yet - Stay Underweight Canadian Bonds BoC Not Done Yet - Stay Underweight Canadian Bonds BoC Not Done Yet - Stay Underweight Canadian Bonds RBA Monitor: Easier Policy Needed The Reserve Bank of Australia (RBA) monitor has rapidly fallen below the zero line for the first time since 2016, and now indicates that easier monetary policy is required (Chart 8A). This stands out from the more stable trajectory of the rest of the BCA Central Bank Monitors. Unlike most other developed countries, there is still excess capacity in the Australian economy. Australia's output gap has not closed while the current unemployment rate is just at the OECD's NAIRU estimate of 5.3%. Headline and core inflation are at the low end of the RBA's 2-3% target and struggling to gain much upward momentum (Chart 8B). Chart 8AAustralia: RBA Monitor Australia: RBA Monitor Australia: RBA Monitor Chart 8BMinimal Inflation Pressure In Australia Minimal Inflation Pressure In Australia Minimal Inflation Pressure In Australia While both the growth and inflation components of the RBA Monitor have fallen, the biggest decline has come from the inflation side (Chart 8C). The sluggishness of Australia's economy is due to the slow growth of consumer spending and a big deceleration in exports related to softer Chinese demand. On inflation, excess labor market slack, with an underemployment rate close to 8.5%, is the main factor explaining soft wage growth and overall sluggish inflation. Chart 8CInflation Component Weighing On RBA Monitor Inflation Component Weighing On RBA Monitor Inflation Component Weighing On RBA Monitor Our highest conviction country allocation call this year has been to overweight Australian Government bonds, and we see no need to change that given the bullish signal from our RBA Monitor (Chart 8D). It would likely take a rise in unemployment, a renewed decline in realized inflation or a big external shock for the RBA to actually cut rates as our Monitor suggests, but the signal is still bullish for Australian debt on a relative basis. Chart 8DRBA A Long Way From A Hike - Stay Overweight Australian Government Bonds RBA A Long Way From A Hike - Stay Overweight Australian Government Bonds RBA A Long Way From A Hike - Stay Overweight Australian Government Bonds RBNZ Monitor: Policy On Hold For A While Longer The Reserve Bank of New Zealand (RBNZ) Monitor is currently just above the zero line, indicating that tighter monetary policy is required (although just barely) (Chart 9A). This is consistent with the mixed messages in the New Zealand economic data. For example, there is no spare capacity in the economy according to estimates of the output and employment gaps, yet both headline and core inflation have decelerated to the lower end of the RBNZ's 1-3% target band (Chart 9B). Chart 9ANew Zealand: RBNZ Monitor New Zealand: RBNZ Monitor New Zealand: RBNZ Monitor Chart 9BNo Spare Capacity In NZ, But No Inflation Either No Spare Capacity In NZ, But No Inflation Either No Spare Capacity In NZ, But No Inflation Either Looking at the components of the RBNZ Monitor, the growth factors have continued to plunge whereas the inflation factors have been increasing (from below zero) since the start of 2018 (Chart 9C). New Zealand's economic growth has slowed because of softer consumer spending and weaker housing activity, the latter of which is related to lower net immigration. Yet business confidence is falling, both the manufacturing and services PMIs have also declined, and export growth has cooled thanks to weaker growth from China and Australia. Meanwhile, the uptick in the inflation components has not yet translated into any broader improvement in realized inflation that would cause the RBNZ to take a more hawkish turn. Chart 9CConflicting Trends Within The RBNZ Monitor Conflicting Trends Within The RBNZ Monitor Conflicting Trends Within The RBNZ Monitor We continue to recommend an overweight stance on New Zealand Government Bonds, in line with the bullish signal sent by our RBNZ Monitor (Chart 9D). The RBNZ has already provided forward guidance indicating that the Overnight Cash Rate (OCR) will stay unchanged until 2020, and it will take some time before there is evidence that the recent hook down in inflation is nothing more than a temporary blip. Chart 9DRBNZ To Remain On Hold - Stay Long New Zealand Bonds RBNZ To Remain On Hold - Stay Long New Zealand Bonds RBNZ To Remain On Hold - Stay Long New Zealand Bonds Robert Robis, CFA, Senior Vice President Global Fixed Income Strategy rrobis@bcaresearch.com Ray Park, CFA, Research Analyst ray@bcaresearch.com Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index BCA Central Bank Monitor Chartbook: Divergences Opening Up BCA Central Bank Monitor Chartbook: Divergences Opening Up Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Following up from our inaugural U.S. Equity Market Indicators Report in early-August 2017, this week we introduce the second part in our Indicators series. In this Special Report we have drilled down to the ten GICS1 S&P 500 sectors (excluding the real estate sector) and have compiled the most important Indicators in four broad categories: earnings, financial statement reported, valuations and technicals. Once again this is by no means exhaustive, but contains a plethora of Indicators - roughly thirty Indicators per sector condensed in seven charts per sector - we deem significant in aiding us in our decision making process of setting/changing a view on a certain sector. The way we have structured this Special Report is by sector and we start with the early cyclicals continue with the deep cyclicals and finish with the defensives. Within each sector we then show the four broad categories. In more detail, the first three charts depict earnings Indicators including our EPS growth model, EPS breadth, profit margins, relative forward EPS and EBITDA growth forecasts and ROE and its deconstruction into its components. The following two charts relate to financial statement Indicators including indebtedness, cash flow growth and capital expenditures. And conclude with one valuation and one technical chart. As a reminder, the charts in this Special Report are also made available through BCA's Analytics platform for seamless continual updates. Due to length constraints, Part III of our Indicators series, expected in mid-October, will introduce a style and size flavor along with cyclicals versus defensives and end with the S&P 500, again highlighting Indicators in these four broad categories. Finally, likely before the end of 2018, we aim to conclude our Indicators series with Part IV that would feature our most sought after Macro Indicators per the ten GICS1 S&P 500 sectors, along with value/growth, small/large and cyclicals/defensives. We trust you will find this comprehensive Indicator chartbook useful and insightful. Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com Dulce Cruz, Senior Analyst dulce@bcaresearch.com Consumer Discretionary Chart 1Consumer Discretionary: Earnings Indicators Consumer Discretionary: Earnings Indicators Consumer Discretionary: Earnings Indicators Chart 2Consumer Discretionary: Earnings Indicators Consumer Discretionary: Earnings Indicators Consumer Discretionary: Earnings Indicators Chart 3Consumer Discretionary: ROE And Its Components Consumer Discretionary: ROE And Its Components Consumer Discretionary: ROE And Its Components Chart 4Consumer Discretionary: Financial Statement Indicators Consumer Discretionary: Financial Statement Indicators Consumer Discretionary: Financial Statement Indicators Chart 5Consumer Discretionary: Financial Statement Indicators Consumer Discretionary: Financial Statement Indicators Consumer Discretionary: Financial Statement Indicators Chart 6Consumer Discretionary: Valuation Indicators Consumer Discretionary: Valuation Indicators Consumer Discretionary: Valuation Indicators Chart 7Consumer Discretionary: Technical Indicators Consumer Discretionary: Technical Indicators Consumer Discretionary: Technical Indicators Financials Chart 8Financials: Earnings Indicators Financials: Earnings Indicators Financials: Earnings Indicators Chart 9Financials: Earnings Indicators Financials: Earnings Indicators Financials: Earnings Indicators Chart 10Financials: ROE And Its Components Financials: ROE And Its Components Financials: ROE And Its Components Chart 11Financials: Financial Statement Indicators Financials: Financial Statement Indicators Financials: Financial Statement Indicators Chart 12Financials: Financial Statement Indicators Financials: Financial Statement Indicators Financials: Financial Statement Indicators Chart 13Financials: Valuation Indicators Financials: Valuation Indicators Financials: Valuation Indicators Chart 14Financials: Technical Indicators Financials: Technical Indicators Financials: Technical Indicators Energy Chart 15Energy: Earnings Indicators Energy: Earnings Indicators Energy: Earnings Indicators Chart 16Energy: Earnings Indicators Energy: Earnings Indicators Energy: Earnings Indicators Chart 17Energy: ROE And Its Components Energy: ROE And Its Components Energy: ROE And Its Components Chart 18Energy: Financial Statement Indicators Energy: Financial Statement Indicators Energy: Financial Statement Indicators Chart 19Energy: Financial Statement Indicators Energy: Financial Statement Indicators Energy: Financial Statement Indicators Chart 20Energy: Valuation Indicators Energy: Valuation Indicators Energy: Valuation Indicators Chart 21Energy: Technical Indicators Energy: Technical Indicators Energy: Technical Indicators Industrials Chart 22Industrials: Earnings Indicators Industrials: Earnings Indicators Industrials: Earnings Indicators Chart 23Industrials: Earnings Indicators Industrials: Earnings Indicators Industrials: Earnings Indicators Chart 24Industrials: ROE And Its Components Industrials: ROE And Its Components Industrials: ROE And Its Components Chart 25Industrials: Financial Statement Indicators Industrials: Financial Statement Indicators Industrials: Financial Statement Indicators Chart 26Industrials: Financial Statement Indicators Industrials: Financial Statement Indicators Industrials: Financial Statement Indicators Chart 27S&P Industrials: Valuation Indicators S&P Industrials: Valuation Indicators S&P Industrials: Valuation Indicators Chart 28S&P Industrials: Technical Indicators S&P Industrials: Technical Indicators S&P Industrials: Technical Indicators Materials Chart 29Materials: Earnings Indicators Materials: Earnings Indicators Materials: Earnings Indicators Chart 30Materials: Earnings Indicators Materials: Earnings Indicators Materials: Earnings Indicators Chart 31Materials: ROE And Its Components Materials: ROE And Its Components Materials: ROE And Its Components Chart 32Materials: Financial Statement Indicators Materials: Financial Statement Indicators Materials: Financial Statement Indicators Chart 33Materials: Financial Statement Indicators Materials: Financial Statement Indicators Materials: Financial Statement Indicators Chart 34Materials: Valuation Indicators Materials: Valuation Indicators Materials: Valuation Indicators Chart 35Materials: Technical Indicators Materials: Technical Indicators Materials: Technical Indicators Tech Chart 36Technology: Earnings Indicators Technology: Earnings Indicators Technology: Earnings Indicators Chart 37Technology: Earnings Indicators Technology: Earnings Indicators Technology: Earnings Indicators Chart 38ROE And Its Components ROE And Its Components ROE And Its Components Chart 39Technology: Financial Statement Indicators Technology: Financial Statement Indicators Technology: Financial Statement Indicators Chart 40Technology: Financial Statement Indicators Technology: Financial Statement Indicators Technology: Financial Statement Indicators Chart 41Technology: Valuation Indicators Technology: Valuation Indicators Technology: Valuation Indicators Chart 42Technology: Technical Indicators Technology: Technical Indicators Technology: Technical Indicators Health Care Chart 43Health Care: Earnings Indicators Health Care: Earnings Indicators Health Care: Earnings Indicators Chart 44Health Care: Earnings Indicators Health Care: Earnings Indicators Health Care: Earnings Indicators Chart 45Health Care: ROE And Its Components Health Care: ROE And Its Components Health Care: ROE And Its Components Chart 46Health Care: Financial Statement Indicators Health Care: Financial Statement Indicators Health Care: Financial Statement Indicators Chart 47Health Care: Financial Statement Indicators Health Care: Financial Statement Indicators Health Care: Financial Statement Indicators Chart 48Health Care: Valuation Indicators Health Care: Valuation Indicators Health Care: Valuation Indicators Chart 49Health Care: Technical Indicators Health Care: Technical Indicators Health Care: Technical Indicators Consumer Staples Chart 50Consumer Staples: Earnings Indicators Consumer Staples: Earnings Indicators Consumer Staples: Earnings Indicators Chart 51Consumer Staples: Earnings Indicators Consumer Staples: Earnings Indicators Consumer Staples: Earnings Indicators Chart 52Consumer Staples: ROE And Its Components Consumer Staples: ROE And Its Components Consumer Staples: ROE And Its Components Chart 53Consumer Staples: Financial Statement Indicators Consumer Staples: Financial Statement Indicators Consumer Staples: Financial Statement Indicators Chart 54Consumer Staples: Financial Statement Indicators Consumer Staples: Financial Statement Indicators Consumer Staples: Financial Statement Indicators Chart 55Consumer Staples: Valuation Indicators Consumer Staples: Valuation Indicators Consumer Staples: Valuation Indicators Chart 56Consumer Staples: Technical Indicators Consumer Staples: Technical Indicators Consumer Staples: Technical Indicators Telecom Services Chart 57Telecom Services: Earnings Indicators Telecom Services: Earnings Indicators Telecom Services: Earnings Indicators Chart 58Telecom Services: Earnings Indicators Telecom Services: Earnings Indicators Telecom Services: Earnings Indicators Chart 59Telecom Services: ROE And Its Components Telecom Services: ROE And Its Components Telecom Services: ROE And Its Components Chart 60Telecom Services: Financial Statement Indicators Telecom Services: Financial Statement Indicators Telecom Services: Financial Statement Indicators Chart 61Telecom Services: Financial Statement Indicators Telecom Services: Financial Statement Indicators Telecom Services: Financial Statement Indicators Chart 62Telecom Services: Valuation Indicators Telecom Services: Valuation Indicators Telecom Services: Valuation Indicators Chart 63Telecom Services: Technical Indicators Telecom Services: Technical Indicators Telecom Services: Technical Indicators Utilities Chart 64Utilities: Earnings Indicators Utilities: Earnings Indicators Utilities: Earnings Indicators Chart 65Utilities: Earnings Indicators Utilities: Earnings Indicators Utilities: Earnings Indicators Chart 66Utilities: ROE And Its Components Utilities: ROE And Its Components Utilities: ROE And Its Components Chart 67Utilities: Financial Statement Indicators Utilities: Financial Statement Indicators Utilities: Financial Statement Indicators Chart 68Utilities: Financial Statement Indicators Utilities: Financial Statement Indicators Utilities: Financial Statement Indicators Chart 69Utilities: Valuation Indicator Utilities: Valuation Indicator Utilities: Valuation Indicator Chart 70Utilities: Technical Indicator Utilities: Technical Indicator Utilities: Technical Indicator

Highlights Cable is cheap on a PPP basis. However, the discount does not reflect a geopolitical risk premium; it reflects the dollar's general expensiveness. In fact, when the British productivity picture is taken into account, the trade-weighted pound's discount appears rather modest. Our model specifically designed to capture the geopolitical risk premia in GBP/USD and EUR/GBP shows that investors are currently pricing in a very rosy political outlook in the U.K., and near certainty that a soft Brexit will materialize. We are not willing to bet that the path toward a soft Brexit will be easy. As a result, we would expect that if the GBP experiences any rebounds, they will prove short-lived, especially as the outlook for global growth outside the U.S. remains murky. Feature This fall will be a tumultuous time for the pound, as the Brexit process goes into full swing ahead of March 2019. While there remain many possible paths that the U.K.'s relationship with the rest of the EU could ultimately take, ranging from a complete reset of the relationship (i.e. a hard Brexit) to no Brexit at all, another unknown needs to be tackled: Is the GBP priced to adequately compensate investors for such heightened uncertainty? In this week's piece, we develop a simple model to try to ascertain whether geopolitical risk premium is currently present in the pound. We conclude that even though the pound seems cheap enough to compensate investors for the high degree of uncertainty surrounding the U.K.'s long-term economic outlook, this picture is deceiving. As a result, BCA remains concerned about the pound's cyclical outlook, especially against the euro. Is The Pound That Cheap? At first glance, it seems obvious that the pound is very cheap. Cable currently trades at a prodigious 20% discount to it purchasing power parity (PPP) estimate (Chart I-1). Such bargain-basement levels must be a reflection of the economic risks surrounding Brexit. Well, perhaps not. First, the pound may be trading at a large discount against the dollar, but the euro also trades well below its PPP fair value. In fact, when using PPP models, it is hard to dissociate the cheapness of the pound from the expensiveness of the U.S. dollar against its trading partners (Chart I-2). Thus, PPP models are not enough to gauge whether or not the pound is adequately compensating investors for inherent geopolitical risk. Chart I-1Is The Pound Cheap... Is The Pound Cheap... Is The Pound Cheap... Chart I-2U.S. Dollar And PPP ...Or Is The Dollar Expensive? U.S. Dollar And PPP ...Or Is The Dollar Expensive? U.S. Dollar And PPP ...Or Is The Dollar Expensive? Second, when one uses a slightly more sophisticated valuation approach, the discount of the pound seems much more muted than when one looks at PPP alone. Based on our proprietary long-term fair value model, the trade-weighted pound exhibits a much more muted discount of only 3% - well within the historical norm (Chart I-3). Chart I-3Pound: A Much Smaller Discount On A Trade-Weighted Basis Pound: A Much Smaller Discount On A Trade-Weighted Basis Pound: A Much Smaller Discount On A Trade-Weighted Basis What explains this disconnect is the U.K.'s poor productivity performance. In the world of exchange rate determination, there is a phenomenon called the Penn effect. It is an empirical observation - one not fully understood under a theoretical lens1 - which shows that countries with higher levels of productivity growth than their trading partners tend to experience an appreciation in their real exchange rates. As Chart I-4 illustrates, the U.K. is on the wrong side of this phenomenon, as its relative productivity has been falling in comparison to its trading partners. This factor has played an important role in dragging down the pound's fair value. This poor productivity performance has also had another pernicious effect: unit labor costs in the U.K. have risen much more sharply than in the majority of its important trading partners (Chart I-5). This hurts the pound's competitiveness and suggests that a simple PPP model based purely on producer prices might be missing the mark for the true fair value of the British currency - further supporting the message of our proprietary long-term valuation model. Chart I-4Negative Penn Effect For The Pound Negative Penn Effect For The Pound Negative Penn Effect For The Pound Chart I-5The U.K. Is Uncompetitive The U.K. Is Uncompetitive The U.K. Is Uncompetitive Even when these adjustments are taken into account, our model might still be missing the mark due to a very significant problem: All fair value models for the pound are now based on a potentially unrepresentative sample, one where the U.K. was part of the EU. Thus, another exercise is needed to evaluate the pound's geopolitical risk premium. Bottom Line: Based on simple PPP models, cable looks cheap and therefore may already embed a large geopolitical risk premium. However, this conclusion is misleading. A large share of the pound's undervaluation is not GBP-specific and instead simply mirrors the USD's premium to its fair value. Additionally, the U.K.'s poor productivity performance relative to its trading partners already provides an economic justification for a cheap pound. Thus, we need a different exercise to zero in on the degree of geopolitical discount present in the pound. Zeroing In On The Geopolitical Risk In order to assess the degree of political risk priced into the pound, one needs to isolate this risk. The problem is that the traditional variables used to explain exchange rate movements were also greatly affected by the shock following the Brexit vote in June 2016. For example, looking at the behavior of British gilts, the Footsie, consumer confidence or business confidence, one can see very abnormal moves occurring in conjunction with large fluctuations in the pound during the summer of 2016 (Chart I-6). Thus, if one were to regress the pound on these variables, one would not have observed a risk premium, even though the market was clearly very concerned with the geopolitical outlook for the U.K. Chart I-6ATraditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (I) Traditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (I) Traditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (I) Chart I-6BTraditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (II) Traditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (II) Traditional Variables Are Of Little Use To Isolate A Geopolitical Risk Premium (II) We therefore decided to try to explain the pound's normal behavior using variables that did not experience large abnormal moves in the direct aftermath of the British referendum. Moreover, we wanted to keep the model simple, as simplicity permits us to better understand the pound's deviation from its predicted value. Practically, we settled on the following specification: for GBP/USD, we regressed the pair versus the dollar index and the British leading economic indicator. For EUR/GBP, we regressed the cross against the trade-weighted euro and the U.K. LEI. The reason for using the trade-weighted dollar and euro as explanatory variables is simple: it helps us isolate the pound's movements from the impact of fluctuations in the other leg of the pair. Using the U.K. LEI helps incorporate the immediate outlooks for U.K. growth and U.K. monetary policy into the pound's movement. The remaining error term was mostly a reflection of geopolitical risks. To make sure the exercise was robust, we then tested the out-of-sample performance of the model. Reassuringly, the GBP/USD and EUR/GBP models showed great predictive power out-of-sample (see Appendix), while remaining significant and explaining 80% and 65% of the pairs' variations, respectively. The results of the models are shown in Chart I-7, and they are startling. While the pound did show a geopolitical discount in the second half of 2016 (as evidenced by the abnormally large discount from our fundamental-based model), today the pound's pricing shows an absence of geopolitical risk premium, both against the dollar and against the euro. This corroborates the message from the uncertainty index computed by Baker Bloom and Davis, which shows a very low level of economic policy uncertainty based on language in the press (Chart I-8). Chart I-7ALittle Risk Premium In The Pound (I) Little Risk Premium In The Pound (I) Little Risk Premium In The Pound (I) Chart I-7BLittle Risk Premium In The Pound (II) Little Risk Premium In The Pound (II) Little Risk Premium In The Pound (II) This is particularly salient when compared to the euro, where the geopolitical risk premium is currently exaggerated. As Chart I-9 illustrates, the probability of a euro area breakup in the next five years priced into the bond market is at its highest level since the heyday of the euro area crisis in 2011 and 2012. However, this risk is currently overstated as investors have been frightened by the recent Italian elections. Yet, after a tumultuous beginning, the populist Five Star Movement / Lega Nord coalition is backing away from a budget confrontation with Brussels. Giovanni Tria, Italy's minister of finance, wants a 2% budget deficit while Deputy Prime Minister Matteo Salvini is arguing for a 2.9% budget hole - well south of the 6% levels touted during the campaign. Italians realize that life outside the euro area will not be a land of milk and honey. Chart I-8British Political Uncertainty Has Collapsed British Political Uncertainty Has Collapsed British Political Uncertainty Has Collapsed Chart I-9Investors Are Worries About The Euro Area Investors Are Worries About The Euro Area Investors Are Worries About The Euro Area Instead, the pound's cheapness reflects the weakness in the British LEI. This is a consequence of the deterioration in global economic activity. As Chart I-10 shows, the trade-weighted pound has been more sensitive to EM gyrations than the euro or the dollar. This is because total trade represents a stunning 40% of U.K. GDP, versus 37% for the euro area or 28% for the U.S. The U.K. is therefore highly sensitive to global economic conditions. Moreover, the tightening in global liquidity conditions that has contributed to the deterioration of the global growth outlook is itself particularly negative for the pound. The U.K. runs a current account deficit of 4% of GDP, and as FDI inflows into Great Britain have collapsed, the U.K. now runs a basic balance-of-payments deficit (Chart I-11). As such, it is highly dependent on global liquidity flows to finance its current account deficit. As a result, the recent weakness in the pound is more a function of global economic conditions than Brexit itself. Chart I-10The Pound Has Fallen Because of EM Risks... The Pound Has Fallen Because of EM Risks... The Pound Has Fallen Because of EM Risks... Chart I-11...And As Global Liquidity Has Tightened ...And As Global Liquidity Has Tightened ...And As Global Liquidity Has Tightened Bottom Line: After developing a more precise method for evaluating the size of the geopolitical risk premium embedded in the pound, we arrived at an interesting conclusion: There is currently no evidence of a risk premium at all. Instead, the pound's weakness reflects the expensiveness of the dollar, weakening global growth and deteriorating global liquidity conditions. In fact, it is the euro that currently suffers from an exaggerated geopolitical risk premium, as euro area bonds currently incorporate too-large of a break-up risk premium. Investment Implications Taking into account the thin risk premium embedded in the pound against both the dollar and the euro, the GBP does not have much maneuvering room through the fall season. The problem for the pound is that the 5% net disapproval of Brexit among the British public remains smaller than the cohort of British voters who remain undecided (Chart I-12). This means that domestic politics in the U.K. could remain a source of surprise, especially as Prime Minister Theresa May's polling remains tenuous (Chart I-13). This raises the risk that Hard Brexiters end up controlling 10 Downing Street - despite their status as a minority within Conservative MPs. This also raises the risk that Jeremy Corbyn, whose popularity is rising, could end up as British Prime Minister (Chart I-14). Both of these outcomes are worrisome. The pound is currently pricing in neither the risk of a hard Brexit, nor the risk of the U.K. being controlled by the most leftist government of any G10 nation since the election of Francois Mitterrand in France in 1981. Chart I-12More Undecided Voters Than ##br##Net Brexit Detractors More Undecided Voters Than Net Brexit Detractors More Undecided Voters Than Net Brexit Detractors Chart I-13A Risk To ##br##U.K. Stability... A Risk To U.K. Stabiity... A Risk To U.K. Stabiity... Chart I-14...Especially With Mitterand 2.0 ##br##Lurking In The Shadows ...Especially With Mitterand 2.0 Lurking In The Shadows ...Especially With Mitterand 2.0 Lurking In The Shadows Moreover, while Germany and EU chief negotiator Michel Barnier seem amenable to keeping the window of negotiations open for the ultimate form of Brexit during the transition period, it remains to be seen what kind of concessions London is willing to make on the free movement of people required to be granted access to the common market in goods. Additionally, the Northern Ireland border remains an unresolved issue. These factors increase the chances that negotiations with the EU will remain difficult. Hence, the implementation of the Chequers White Paper is far from certain, yet the pound currently seems to be priced for an absolute soft Brexit. With the global economic outlook already justifying a lower pound, especially versus the dollar, it therefore seems that the pound today is too risky an investment. It is true that positioning and sentiment in cable are currently very depressed, raising the risk of a short-term rebound (Chart I-15), especially if the EU meeting in Salzburg in two weeks shows an acquiescent EU. However, this will not remove Britain's domestic political problems. Hence, we would be inclined to fade any such rebound. Finally, it is unlikely that the Bank of England will be of much help to the pound either. The British LEI continues to slow, which not only drags the fair value of the pound lower, but also limits how fast the BoE can raise interest rates. Moreover, while British inflation surged as imported goods prices skyrocketed after the GBP plummeted in 2016, domestic prices have remained well behaved (Chart I-16). Thus, as the pass-through to inflation of the previous pound weakness dissipates, British inflation will decelerate further, limiting the upside for interest rates in the process. This combination is only made more binding for the BoE as the government is expected to exert some drag on growth as the British fiscal thrust will subtract 0.4%, 0.2%, and 0.2% to growth in 2018, 2019, and 2020, respectively (Chart I-17). Chart I-15There Is Room For A ##br##Countertrend GBP Rally U.K. XR There Is Room For The A Countertred GBP Rally U.K. XR There Is Room For The A Countertred GBP Rally Chart I-16Little Domestic ##br##Price Pressures Little Domestic Price Pressures Little Domestic Price Pressures Chart I-17Fiscal Drag ##br##Not Over Fiscal Drag Not Over Fiscal Drag Not Over On a six- to nine-month basis, it makes most sense to short the pound against the dollar and the yen, as slowing global growth hurts the pound but also hurts the euro while benefiting the greenback and the yen. However, on a longer-term basis, we would expect the break-up risk premium in the euro area to dissipate, which will boost the cheap euro in the process. This means that on investment horizons beyond one year, being long EUR/GBP still makes sense. Bottom Line: Since this year's pound weakness did not represent a swelling of the GBP's geopolitical risk premium but instead has been a reflection of poor global growth and liquidity, any hiccups in British politics could inflict considerable pain on cable. While the EU negotiations may progress positively, domestic British politics remain a big source of risk that investors are not being compensated to take on. As such, we are inclined to fade any rally in the pound. While the pound could weaken most against the dollar and the yen through the fall months, the longer-term outlook looks riskier against the euro. To be clear, the confidence interval around these views remains wide, as the British political situation remains very fluid. Mathieu Savary, Vice President Foreign Exchange Strategy mathieu@bcaresearch.com Juan Manuel Correa, Senior Analyst juanc@bcaresearch.com Ekaterina Shtrevensky, Research Associate ekaterinas@bcaresearch.com 1 The Balassa-Samuelson effect has been cited as a potential explanation for this observation, but it still does not fully satisfy many theorists. Appendix Chart II-1Out-Of-Sample Testing Of Model (I) Assessing The Geopolitical Risk Premium In The Pound Assessing The Geopolitical Risk Premium In The Pound Chart II-2Out-Of-Sample Testing Of Model (II) Out-Of-Sample Testing Of Model (II) Out-Of-Sample Testing Of Model (II) Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Closed Trades

Highlights 2018 YTD Summary: Investment grade corporate debt in the developed economies has performed poorly so far in 2018, led by lagging returns in Financials and some steepening of credit curves. U.S. credit has outperformed European equivalents. These trends are likely to continue over at least the next six months. Our Sector Portfolios: Our investment grade sector model portfolios have underperformed modestly so far in 2018 (-3bps each in the U.S., euro area & U.K.) - primarily due to our overweight stance on Financials which have performed poorly. Looking Ahead: We are maintaining a neutral level of target spread risk (i.e. duration-times-spread equal that of the benchmark index) in our sector model portfolios for the U.S., euro area and U.K. We will look to reduce that spread risk on signs of a deeper global growth slowdown, which we expect will unfold in 2019. Feature Chart of the WeekReversal Of Fortune Reversal Of Fortune Reversal Of Fortune The performance of investment grade (IG) corporate bonds in the developed markets, as an asset class, has been underwhelming so far in 2018. Using the total return indices from Bloomberg Barclays, IG corporates in the U.S., euro area and U.K. - the regions with the three largest corporate bond markets among the developed economies - have lost -2.0%, -0.3% and -1.1%, respectively. The numbers do not look much better when shown on an excess return basis versus duration-matched government bonds: U.S. IG -0.8%, euro area -1.2% and the U.K. -1.3%. The sluggish performance for IG corporates is a mirror image of the strong showing in 2017 when looking at credit spreads, which reached very tight levels at the end of last year (Chart of the Week). The 2017 rally left global corporates exposed to any negative shocks, of which there have been many so far in 2018 (the February VIX spike, the Q1 global growth slowdown, intensifying U.S.-China trade tensions, ongoing Fed tightening, a strengthening U.S. dollar, less dovish non-U.S. central banks, Italian politics, emerging market turmoil). Given the more challenging environment for overall corporate bond performance, the role of sector selection as a way to generate alpha, by mitigating losses from beta, is critical. In this Weekly Report, we take a brief look at IG sector performance so far this year and update our sector allocations based on our relative value models for IG corporates in the U.S., euro area and U.K. 2018 YTD Global Corporates Performance: A Down Year The major IG sector groupings for the U.S., euro area and U.K. are presented in Table 1, ranked by the 2018 year-to-date excess returns (all are shown in local currency terms). The overall index return for each region is also shown (highlighted in gray) in the table, to highlight how individual sectors have performed relative to the overall IG index. Table 12018 Year-To-Date Investment Grade Sector Returns For The U.S., Euro Area & U.K. A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors As is always the case with IG corporates, the performance of the broad Financials grouping (which includes banks, insurance companies, REITs, etc.) heavily influences the returns of the overall IG index given the large weighting of Financials within the Corporates index across all three regions. In both the euro area and U.K., the sharp underperformance of Financials seen year-to-date (-1.3% and -1.4%, respectively) has created a somewhat odd situation where the majority of sectors have outperformed the overall index. That could only happen given the large weight of Financials in the euro area index (40%) and U.K. index (43%). Financials are also a big part of the U.S. index (32%), but there is more balance in the U.S. IG index which has helped boost the "beta" return from U.S. corporates. Specifically, the weightings of the top three largest U.S. broad sector groupings - Energy (9%), Technology (8%) and Communications (9%) - are a combined 26% of the overall U.S. IG index. Those three sectors are also among upper tier of the 2018 performance table in the euro area and U.K., but only represent a combined 15% and 8%, respectively, of each region's IG index. The conclusion is that index composition has flattered the performance of U.S. IG corporates versus European equivalents, given the latter's heavier weighting in Financials. The poor performance of Financials can be attributed to flattening global government bond yield curves (which is a negative for banks) and poor returns from global credit, especially in emerging markets (which is a negative for insurers that invest in spread product). We do not anticipate either of those trends reversing anytime soon - particularly the ongoing selloff in emerging market assets - thus Financials are likely to remain a drag on corporate bond performance for at least the next 3-6 months. One other factor that has weighed on overall IG corporate performance has been the steepening of credit spread curves. The gaps between credit spreads for Baa- and A-rated corporates have widened since the end of January, most notably in the euro area and the U.K. where growth has been slower than in the fiscal-policy fueled U.S. economy (Chart 2). With Baa-rated debt now representing one-half of the IG index for the U.S., euro area and U.K. (Chart 3) - a function of rising corporate leverage - continued underperformance of lower quality sectors will negatively impact the future overall returns from IG corporates. Chart 2Spread Curves Are##BR##Steepening In Europe Spread Curves Are Steepening In Europe Spread Curves Are Steepening In Europe Chart 31/2 Of Investment Grade Corporate Indices##BR##Are Now Baa-Rated 1/2 Of Investment Grade Corporate Indices Are Now Baa-Rated 1/2 Of Investment Grade Corporate Indices Are Now Baa-Rated Looking ahead, credit investors should be wary of the potential for downgrade risk in their portfolios given the high proportion of Baa-rated debt in the IG benchmark indices. This risk will become more acute when the global business cycle runs out of steam (a 2019 story, at the earliest, in our view). Bottom Line: Investment grade corporate debt in the developed economies has performed poorly so far in 2018, led by lagging returns in Financials and some steepening of credit curves. U.S. credit has outperformed European equivalents. These trends are likely to continue over at least the next six months. Our Corporate Sector Valuation Models: Winners & Losers Our recommended IG sector allocations come from our relative value model, which measures the valuation of each individual sector compared to the overall Bloomberg Barclays corporate bond index for each region. The methodology takes each sector's individual option-adjusted spread (OAS) and regresses it in a panel regression with all other sectors in each region. The dependent variables in the model are each sector's duration, convexity (duration squared) and credit rating - the primary risk factors for any corporate bond. Using the common coefficients from that panel regression, a risk-adjusted "fair value" spread is calculated. The difference between the actual OAS and fair value OAS is our valuation metric used to inform our sector allocation ranking. The latest output from the models can be found in the tables and charts in the Appendix starting on Page 13. We also show the duration-times-spread (DTS) for each sector in those tables, which we use as the primary way to measure the riskiness (volatility) of each sector. The scatterplot charts in the Appendix show the tradeoff between the valuation residual from our model and each sector's DTS. We then apply individual sector weights based on the model output and our desired level of overall spread risk in our recommended credit portfolio. The weights are determined at our discretion and are not the output from any quantitative portfolio optimization process. The only constraints are that all sector weights must add to 100% (i.e. the portfolio is fully invested with no use of leverage) and the overall level of spread risk (DTS) must equal our desired target. That target portfolio DTS is the first decision in our discretionary allocation process, which is informed by our strategic views on corporate credit in each region. For example, if we were recommending an overweight allocation to U.S. IG corporates, then we would target a portfolio DTS that was greater than the index DTS. If we then became a bit more cautious on U.S. corporates, we could reduce the target DTS (spread risk) of our model sector portfolio while maintaining an overall overweight allocation to U.S. corporates versus U.S. Treasuries. That is exactly what we did one year ago, when we began to target a weighted DTS of all our individual sector tilts that was roughly equal to the overall IG corporate index DTS for each region (U.S. euro area, U.K.) while maintaining an overall overweight stance on global corporate credit versus government debt. More recently, we have downgraded our stance on global spread product to neutral, while continuing to favor the U.S. over Europe, in response to growing tensions from emerging markets and the brewing U.S.-China trade war.1 Chart 4Performance Of Our IG Sector Allocations A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors We last presented a performance update for our global IG corporate sector allocations back on April 12th of this year. Since then, our recommended tilts have modestly underperformed the benchmark index in excess return terms by a combined -3bps (Chart 4). This came entirely from the euro area, with both the U.S. and U.K. sector allocations simply matching the benchmark index. Year-to-date, our IG sector allocations have underperformed the benchmark by a combined -9bps in excess return terms, split equally among the U.S., euro area and U.K. This is a result entirely consistent with our long-standing stance to overweight Financials in all three regions, which continue to appear cheap in our valuation framework. Also, an increasing number of sectors had become expensive within that framework, in all three regions, so some portion of that overweight to global Financials was "by default" given that our model portfolios must be fully invested (finding value has been a persistent problem for credit investors over the past year). The return numbers for our U.S. sector allocations can be found in Table 2. Since our last update in April, the best performing sectors (in excess return terms) within our recommended tilts have all been underweights: Pharmaceuticals (+1.2bps), Electric Utilities (+1.1bps), Retailers (+0.6bps), Health Care (+0.6bps), Diversified Manufacturing (+0.5bps) and Chemicals (+0.4bps). These were fully offset, however, by underperformance from our large overweights to Energy (-4.1bps) and Financials (-2.7bps). Table 2U.S. Investment Grade Performance A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors The return numbers for our euro area sector allocations - shown here hedged into U.S. dollars as is the case when we present all our model portfolio returns - can be found in Table 3. Since our last update in April, the best performing sectors (in excess return terms) within our recommended tilts have been underweights to Transportation (+2.0bps) and Electric Utilities (+0.6bps), with underperformance coming from our underweight to Food/Beverage (-2.4bps) and overweight to Life Insurers (-3.1bps). Table 3Euro Area Investment Grade Performance A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors The return numbers for our U.K. sector allocations (again, hedged into U.S. dollars) can be found in Table 4. Since our last update in April, the best performing sectors (in excess return terms) within our recommended tilts have been our underweight to Utilities (+2.0bps) and Consumer Non-Cyclicals (+0.9bps), but this was nearly fully offset by our large overweight to Financials (-2.6bps). Table 4U.K. Investment Grade Performance A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Despite the underperformance of our sector portfolios year-to-date, the cumulative alpha from the portfolios since we began tracking the performance of the recommendations remains positive (+2bps in the U.S., +9bps in the euro area, +42bps in the U.K.). Bottom Line: Our investment grade sector model portfolios have underperformed modestly so far in 2018 (-3bps each in the U.S., euro area & U.K.) - primarily due to our overweight stance on Financials which have performed poorly. Changes To Our Sector Model Portfolios As mentioned earlier, the first choice we make when determining the recommended sector allocations within our model portfolios is how much spread risk (DTS) to take. For the U.S., euro area and U.K., we have already been maintaining a portfolio DTS that is close to the index DTS since August 2017. After our recent decision to downgrade global spread product allocations to neutral versus government bonds, we do not feel a need to further reduce our spread risk by targeting a below-index DTS. That would likely be our next decision when we wish to get more defensive on credit, which would await evidence that global leading economic indicators are sharply slowing and/or global monetary policy is becoming restrictive. Within that neutral level of spread risk, we are making the following portfolio changes based on the updated output from our valuation models presented in the Appendix Tables on pages 13-18. The goal is to favor sectors that have a DTS close the index DTS but have positive valuation residuals from our model: U.S.: We downgrade Tobacco and Wireless to Neutral; we downgrade Paper to Underweight. Euro Area: We upgrade Transportation, Other Industrials, Natural Gas, Brokerages/Asset Managers and Finance Companies to Overweight; we upgrade Automotive, Retailers and Tobacco to Neutral; we downgrade Wireless to Neutral; we downgrade Diversified Manufacturing & Media Entertainment to Underweight. U.K.: We upgrade Health Care, Transportation and Other Industrials to Overweight; we upgrade Integrated Energy to Neutral; we downgrade Technology & Wireless to Neutral; we downgrade Metals & Mining and Supermarkets to underweight. Robert Robis, Senior Vice President Global Fixed Income Strategy rrobis@bcaresearch.com 1 Please see BCA Global Fixed Income Strategy Weekly Report, "Time To Take Some Chips Off The Table: Downgrade Global Corporate Bond Exposure To Neutral", dated June 26th 2018, available at gfis.bcaresearch.com. Appendix Appendix Table 1U.S. Corporate Sector Valuation And Recommended Allocation* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Appendix Chart 1U.S. Corporate Sector Risk Vs. Reward* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Appendix Table 2Euro Area Corporate Sector Valuation And Recommended Allocation* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Appendix Chart 2Euro Area Corporate Sector Risk Vs. Reward* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Appendix Table 3U.K. Corporate Sector Valuation And Recommended Allocation* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Appendix Chart 3U.K. Corporate Sector Risk Vs. Reward* A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index A Performance Update On Global Corporate Bond Sectors A Performance Update On Global Corporate Bond Sectors Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

Feature GAA DM Equity Country Allocation Model Update The GAA DM Equity Country Allocation model is updated as of August 31, 2018. The quant model has further lifted its U.S. allocation to overweight from neutral, and the U.K. underweight has also been reduced by half. On the other hand, Italy is downgraded and the overweight in Spain, Germany and the Netherlands are all significantly reduced, as shown in Table 1. Table 1Model Allocation Vs. Benchmark Weights GAA Quant Model Updates GAA Quant Model Updates As shown in Table 2 and Charts 1, 2 and 3, the overall model underperformed its benchmark by 32 bps in August, largely driven by Level 2 model which underperformed its benchmark by 75 bps. expected, the model did not catch the "Turkey Effect" which drove deep losses in the Italian and Spanish markets. The Level 1 model slightly unperformed its MSCI World benchmark by 2 bps in August. Since going live, the overall model has outperformed its benchmarks by 87bps, driven by the Level 2 outperformance of 260 bps offset by the 5 bps of Level 1 underperformance. Table 2Performance (Total Returns In USD %) GAA Quant Model Updates GAA Quant Model Updates Chart 1GAA DM Model Vs. MSCI World GAA DM Model Vs. MSCI World GAA DM Model Vs. MSCI World Chart 2GAA U.S. Vs. Non U.S. Model (Level 1) GAA U.S. Vs. Non U.S. Model (Level 1) GAA U.S. Vs. Non U.S. Model (Level 1) Chart 3GAA Non U.S. Model (Level 2) GAA Non U.S. Model (Level 2) GAA Non U.S. Model (Level 2) Please see also the website http://gaa.bcaresearch.com/trades/allocation_performance. For more details on the models, please see Special Report, "Global Equity Allocation: Introducing The Developed Markets Country Allocation Model," dated January 29, 2016, available at https://gaa.bcaresearch.com. Please note that the overall country and sector recommendations published in our Monthly Portfolio Update and Quarterly Portfolio Outlook use the results of these quantitative models as one input, but do not stick slavishly to them. We believe that models are a useful check, but structural changes and unquantifiable factors need to be considered too in making overall recommendations. GAA Equity Sector Selection Model Dear Client, The GAA Equity Sector Selection Model has been live since July 2016, and has outperformed the benchmark over this period in line with our back-testing. However, GICS will make significant changes to sector compositions at the end of September, most notably creating a new "Communication Services" sector, dominated by internet-related companies, to replace "Telecommunication Services". However, MSCI has not yet made available the final details of membership or historical performance of the revised sectors. Accordingly, after this update we are temporarily suspending publication of this model until full data is available and we have been able to rebuild the model using the newly constituted sectors. The GAA Equity Sector Selection Mode (Chart 4) is updated as of August 31, 2018. Table 3Allocations GAA Quant Model Updates GAA Quant Model Updates Table 4Performance Since Going Live GAA Quant Model Updates GAA Quant Model Updates Chart 4Overall Model Performance Overall Model Performance Overall Model Performance The model continues to have a negative outlook on global growth and consequently has a net underweight on cyclical sectors. However, the magnitude of this tilt was reduced from 5.8% to 2.8%. The biggest move was a downgrade of consumer staples from a 2.5% overweight to a 1.4% underweight on the back of unfavorable momentum indicators. The only two sectors with favorable momentum are healthcare and technology. Finally, energy stocks also saw a 0.8% boost in its overweight recommendation on the back of attractive valuations. For more details on the model, please see the Special Report "Introducing The GAA Equity Sector Selection Model," dated July 27, 2016, available at https://gaa.bcaresearch.com. Xiaoli Tang, Associate Vice President xiaoliT@bcaresearch.com Aditya Kurian, Senior Analyst adityak@bcaresearch.com

Feature Desynchronization To Continue This year has been characterized by strong growth and asset performance in the U.S., and weakness everywhere else. While U.S. stocks are up by 10% year-to-date, those in the rest of the world have fallen by 3% in dollar terms (Chart 1). GDP growth in Q2 was 4.2% QoQ annualized in the U.S., compared to 1.6% in the euro area and 1.9% in Japan. Leading economic indicators point to this continuing and, therefore, to the U.S. dollar strengthening further (Chart 2). This has already put significant pressure on emerging markets, where equities have fallen by 7% this year in USD terms. Recommended Allocation Monthly Portfolio Update Monthly Portfolio Update Chart 1U.S. Has Outperformed U.S. Has Outperformed U.S. Has Outperformed Chart 2...And Leading Indicators Suggest This Will Continue ...And Leading Indicators Suggest This Will Continue ...And Leading Indicators Suggest This Will Continue There are many reasons why the desynchronization is likely to continue: U.S. growth continues to be boosted by tax cuts and increased fiscal spending which, according to IMF estimates, will add 0.7% to GDP growth this year and 0.8% next. The peak impact from the stimulus will not come until around Q1 next year. Further protectionist tariff increases. Despite August's tentative agreement between the U.S. and Mexico, the Trump administration still plans to implement 10-25% tariffs on $200 billion of Chinese imports, and also possibly 25% tariffs on auto imports, in September. This will - initially at least - be more negative for global exporters, such as China, the euro area and Japan, than for the U.S. China is unlikely to implement the sort of massive stimulus that it carried out in 2009 and 2015.1 It has recently cut interest rates and brought forward fiscal spending to cushion downside risk. But, given the Xi administration's focus on deleveraging and structural reform, we do not expect to see a substantial increase in credit creation (Chart 3). This indicates that emerging markets, and capital goods and commodities exporters, will continue to struggle. European banks will stay under pressure because of the problems in Italy (which will fight this fall with the European Commission over its fiscal stimulus plans) and Turkey. Euro zone equity relative performance is heavily influenced by the performance of financials, even though the sector is only 18% of market cap (Chart 4). The euro zone and Japan are also far more sensitive to a slowdown in EM growth: exports to EM are 8.4% and 6.4% of GDP in the euro zone and Japan respectively, but only 3.6% in the U.S. Chart 3China Unlikely To Repeat 2009 and 2015 China Unlikely To Repeat 2009 and 2015 China Unlikely To Repeat 2009 and 2015 Chart 4Banks Drive European Equity Performance Banks Drive European Equity Performance Banks Drive European Equity Performance Eventually, however, strong growth in the U.S. will become a headwind for U.S. assets too. Already, there are some signs of wage growth ticking up (Chart 5), suggesting that the labor market is finally becoming tight. Fed chair Jerome Powell, in his speech at Jackson Hole last month, reiterated that a "gradual process of normalization [of monetary policy] remains appropriate", suggesting that the Fed will continue to hike by 25 basis points a quarter. But the futures market is pricing in only 75 basis points in hikes over the next two years (Chart 6). And, if core PCE inflation were to rise above the Fed's forecast of 2.1% (it is currently 2.0%), the Fed would need to accelerate the pace of tightening. This all points to further dollar strength which will hurt emerging markets, given the consistent inverse correlation between U.S. financial conditions and EM asset performance (Chart 7). Chart 5Is Wage Growth Finally Accelerating? Is Wage Growth Finally Accelerating? Is Wage Growth Finally Accelerating? Chart 6Markets Pricing In Only Three More Fed Hikes Markets Pricing In Only Three More Fed Hikes Markets Pricing In Only Three More Fed Hikes Chart 7Tightening Financial Conditions Are Bad For EM Tightening Financial Conditions Are Bad For EM Tightening Financial Conditions Are Bad For EM We continue for now, therefore, to remain overweight U.S. equities in USD terms within a global multi-asset portfolio, despite their strong performance this year. We are neutral on equities overall and expect to move to negative perhaps early next year, when we will see some of the classic warning signs of recession (inverted yield curve, rise in credit spreads, peak in profit margins) starting to flash. Profit expectations are one key to the timing of this. Analysts forecast 22% YoY EPS growth for S&P 500 companies in Q3 and 21% in Q4, slowing to 10% in 2019. Those are strong numbers. But if companies are unable to beat these forecasts, what would be the catalyst for stocks to continue to rise? Moreover, analysts' expectations for long-term earnings growth are more optimistic currently than any time since 2000 (Chart 8). It would not take much of a downside earnings surprise - perhaps caused by the strength of the dollar, or regulatory change for internet companies - to disappoint the market. Equities: Our strongest conviction call remains an underweight on emerging markets. Emerging markets are entering what is likely to be a prolonged period of deleveraging, given their elevated levels of debt relative to GDP and exports (Chart 9). That makes them very vulnerable to the stronger U.S. dollar and higher interest rates that we expect. While EM equities have already fallen significantly, they are not yet cheap and investors have mostly not capitulated: outflows from EM funds have been small relative to inflows in previous years (Chart 10). Among developed markets, we keep our overweight on the U.S.: not only does its lower beta mean it should outperform in the event of a sell-off, but if markets were to see a last-year-of-the-bull-market "melt-up" (similar to 1999), this would likely be led by tech and internet stocks, where the U.S. is overweight. Chart 8Analysts Too Optimistic About Long-Term Earnings Growth Analysts Too Optimistic About Long-Term Earnings Growth Analysts Too Optimistic About Long-Term Earnings Growth Chart 9Long Period Of Deleveraging Ahead For EM Long Period Of Deleveraging Ahead For EM Long Period Of Deleveraging Ahead For EM Chart 10No Signs Of Capitulation In EM Yet No Signs Of Capitulation In EM Yet No Signs Of Capitulation In EM Yet Fixed Income: Higher inflation, and more Fed tightening than the market is pricing in, suggest that long-term rates have further to rise. Fed rate surprises have historically been a good indicator of the return from U.S. Treasury bonds (Chart 11). We expect to see the 10-year yield reach 3.3-3.5% by early next year. We therefore remain underweight duration, and prefer TIPS over nominal bonds. We recently lowered our weighting in corporate credit to neutral (within the underweight fixed-income category). Junk bonds have continued to perform well, thanks to their 250 basis point default-adjusted spread over Treasuries. But spreads typically start to widen one to two quarters before equities peak, so we think caution is already warranted, particularly in the light of the higher leverage, longer duration, and falling average credit rating which currently characterize the U.S. corporate credit market. Currencies: As described above, mainly because of divergent growth and monetary policy, we expect the U.S. dollar to strengthen further, but more against emerging market currencies than against the yen or euro. Short-term, however, the dollar may have overshot and speculative positions are significantly dollar-long (Chart 12), so a temporary pullback would not be surprising. Chart 11More Fed Hikes Means Higher Long-Term Rates More Fed Hikes Means Higher Long-Term Rates More Fed Hikes Means Higher Long-Term Rates Chart 12Are Investors Too Dollar Bullish? Monthly Portfolio Update Monthly Portfolio Update Chart 13Dollar And China Hurting Commodities Dollar And China Hurting Commodities Dollar And China Hurting Commodities Commodities: Industrial metals prices have declined sharply over the past few months, on the back of the stronger dollar and slowdown in China (Chart 13). We expect this to continue. Gold, we have long argued, has a place in a portfolio as an inflation hedge. But it is also negatively impacted by rises in the dollar and real interest rates, and these are likely to continue to be a drag on performance. The oil price is currently being driven by supply dynamics: How much more oil will Saudi Arabia produce? Will the E.U. and Japan follow the U.S. in imposing sanctions on Iran? Will Venezuelan production fall further? These will make the crude oil price more volatile, but our energy strategists see Brent softening a little to average $70 in H2 this year, but with potential upside surprises taking it up to an average of $80 in 2019. Garry Evans, Senior Vice President Global Asset Allocation garry@bcaresearch.com 1 For details on why we think massive stimulus is unlikely, please see BCA Geopolitical Strategy Special Reports, "China: How Stimulating Is The Stimulus?" Parts One and Two, dated 8 August 2018 and 15 August 2018, available at gps.bcaresearch.com GAA Asset Allocation

Highlights The global 6-month credit impulse is likely to turn up in the fourth quarter. This warrants profit-taking in some pro-defensive equity sector, regional, and country allocation... ...for example, in the 35 percent outperformance of European healthcare versus banks in just seven months. But do not become aggressively pro-cyclical until the 10-year yield on the Italian BTP (now at 3.2) moves closer to 3... ...and the sum of the 10-year yields on the U.S. T-bond, German bund and JGB (now at 3.4) also moves closer to 3. Chart Of The WeekThe Cycle Is About To Turn The Cycle Is About To Turn The Cycle Is About To Turn Feature One of the most common questions we get is, when will the cycle turn? And our response is always, which cycle? The cycle that most people focus on is the so-called business cycle, which describes multi-year economic expansions punctuated by recessions. However, the business cycle - to the extent that it is a cycle - is very irregular. Its upswings and downswings vary greatly in length (Chart I-2). This irregularity is one reason why economists are useless at calling the turns. Nevertheless, investors still obsess with calling the business cycle because they think this is the only cycle that drives the financial markets. Chart I-2The Business Cycle Is Very Irregular The Business Cycle Is Very Irregular The Business Cycle Is Very Irregular We disagree. Nature bestows us with a multitude of cycles with different periodicities: the daily tides, the monthly phases of the moon, the annual seasons, and the multi-year climate cycles. So it would be unnatural, and somewhat arrogant, to assume the economy and financial markets possess only one cycle. In fact, just as in nature, the economy and financial markets experience a multitude of cycles with different periodicities. There Is Not One Cycle In The Economy, There Are Many If you plotted yearly changes in temperature, you would get a flat line and you would think there were no seasons! The point being that you cannot see a yearly cycle if you look at yearly changes. To see the cyclicality of the seasons, you must plot 6-month changes in temperature. Likewise, you cannot see the shorter-term cycles in the economy and financial markets using analysis, such as yearly changes, designed to see longer-term cycles. Once you grasp this basic maths, the mini-cycles in the economy and financial markets will stare you in the face (Chart I-3), and a whole new world of investment opportunities will open up. Chart I-3The Mini-Cycle Is Very Regular The Mini-Cycle Is Very Regular The Mini-Cycle Is Very Regular As we advised on January 4: "Global growth experiences remarkably consistent - and therefore predictable - 'mini-cycles', with half-cycle lengths averaging eight months. As the current mini-upswing started in May 2017 we can infer that it is likely to end at some point in early 2018. So one surprise could be that global growth will lose steam in the first half of 2018 rather than in the second half, contrary to what the consensus is expecting... Pare back exposure to cyclicals and redeploy to defensives" The advice proved to be very prescient. The global economy did enter a mini-downswing sourced in the emerging markets (Charts I-4 - I-6). Chart I-4The U.S. Mini-Downswing Was Muted... The U.S. Mini-Downswing Was Muted The U.S. Mini-Downswing Was Muted Chart I-5...The Euro Area Mini-Downswing Was Also Muted... ...The Euro Area Mini-Downswing Was Also Muted... ...The Euro Area Mini-Downswing Was Also Muted... Chart I-6...But The China Mini-Downswing Was Severe ...But The China Mini-Downswing Was Severe ...But The China Mini-Downswing Was Severe Nevertheless, the global nature of financial markets meant that the German 10-year bund yield declined by 40 bps, while European healthcare equities outperformed banks by a mouth-watering 35 percent, and materials by 15 percent (Chart I-7 and Chart I-8). Some of these performances are as large as can be gained in a full business cycle begging the question: Why obsess with the impossible-to-predict business cycle when there are equally rich pickings in the easier-to-predict mini-cycle? Chart I-7Banks Vs. Healthcare Tracks The Mini-Cycle Banks Vs. Healthcare Tracks The Mini-Cycle Banks Vs. Healthcare Tracks The Mini-Cycle Chart I-8Materials Vs. Healthcare Tracks The Mini-Cycle Materials Vs. Healthcare Tracks The Mini-Cycle Materials Vs. Healthcare Tracks The Mini-Cycle Furthermore, if you get the equity sector calls right, you will get the equity regional and country calls right too. As cyclicals have underperformed, the less cyclically-exposed S&P500 has been the star performer of the major regional indexes. And cyclical-heavy stock markets like Italy's MIB have strongly underperformed defensive-heavy stock markets like Denmark's OMX (Chart I-9). Chart I-9Italy Vs. Denmark = Banks Vs. Healthcare Italy Vs. Denmark = Banks Vs. Healthcare Italy Vs. Denmark = Banks Vs. Healthcare It follows that the evolution of the global economic mini-cycle is pivotal in every investment decision (Box 1). BOX 1 The Theory Of Economic And Market Mini-Cycles The academic foundation of the global economic mini-cycles is a model called the Cobweb Theorem.1 When bond yields rise, interest rate sensitive sectors in the economy feel a headwind, but with a lag. Similarly, when bond yields decline, interest rate sensitive sectors feel a tailwind, but again with a lag. The lag occurs because credit demand leads credit supply by several months. As credit demand leads credit supply, the turning point in the price of credit (the bond yield) always leads the quantity of credit supplied (the credit impulse). The result is a perpetual mini-cycle oscillation in both economic variables. And because the quantity of credit supplied is a marginal driver of economic activity, this also creates mini-cycles in economic activity. These mini-cycles are remarkably regular with half-cycle lengths averaging around eight months and the regularity creates predictability. Moreover, as most investors are unaware of this predictability, the next turning point is not discounted in financial market prices - providing a compelling investment opportunity for those who do recognise the existence and predictability of these cycles. The Mini-Cycle Will Soon Turn Up The global 6-month credit impulse entered its current mini-downswing in January. Given that mini-downswings tend to last around eight months, we should expect the global economy to exit its mini-downswing in September, the escape valve being the recent decline in bond yields (Chart Of The Week). The caveat is that bond yields were slow to react to the mini-downswing and the decline in 10-year yields, averaging around 40 bps from the peak, has been pretty shallow. It follows that the next mini-upswing could be delayed to October/November, and be somewhat muted. Nevertheless, the surprise could be that global growth will stabilise in the fourth quarter of 2018, contrary to what the consensus is expecting. And this would suggest taking some of the most mouth-watering profits in pro-defensive equity sector, regional, and country allocation - for example, in the 35 percent outperformance of European healthcare versus banks (Chart I-10). Chart I-10Banks Have Severely Underperformed Healthcare Banks Have Severely Underperformed Healthcare Banks Have Severely Underperformed Healthcare Would we go a step further and become pro-cyclical? Not yet. One reason is that there is a limit to how far bond yields can rise before destabilising the very rich valuations of all risk-assets. This is captured in our 'rule of 4' which says that when the sum of the 10-year yields on the U.S. T-bond, German bund, and Japanese government bond (JGB) exceeds 4 - which broadly equates to the global 10-year yield exceeding 2 percent - it is time to go underweight equities. With the sum now equal to 3.4, yields can rise by only 25-30 bps before hurting risk-assets. Another reason for circumspection is that the investment landscape is still scattered with a large number of landmines, one of which has its own rule of 4. The Other 'Rule Of 4': The Italian 10-Year Bond Yield When Italian bond prices decline, it erodes the value of Italian banks' €350 billion portfolio of BTPs and weakens the banks' balance sheets. Investors start to get nervous about a bank's solvency when equity capital no longer covers net non-performing loans (NPLs). On this basis, the largest Italian banks now have €160 billion of equity capital against €130 billion of net NPLs, implying excess capital of €30 billion (Chart I-11). It follows that the markets would start to worry about Italian banks' mark-to-market solvency if their bond valuations sustained a drop of around a tenth from the recent peak. We estimate this equates to the 10-year BTP yield breaching and remaining above 4 percent (Chart I-12).2 Chart I-11Italian Banks' Equity Capital Exceeds Net NPLs By 30 Bn Euro Italian Banks' Equity Capital Exceeds Net NPLs By €30 Bn Italian Banks' Equity Capital Exceeds Net NPLs By €30 Bn Chart I-12Italian Banks' Solvency Would Be In Question If The 10-Year Yield Breached 4% Italian Banks' Solvency Would Be In Question If The 10-Year Yield Breached 4% Italian Banks' Solvency Would Be In Question If The 10-Year Yield Breached 4% Today the 10-year BTP yield stands just shy of 3.2 percent, but it is about to enter a testing period. The Italian government must agree its 2019 budget by September and present a draft to the European Commission by mid-October. The budget must tread a fine line. Cutting the structural deficit to appease the Commission would diminish the credibility of the populist government. It would also be terrible economics, making it harder for Italy to escape its decade-long stagnation.3 On the other hand, locking horns with Brussels and aggressively increasing the structural deficit might panic the bond market. The optimal outcome would be to leave the structural deficit broadly where it is now. To sum up, the global 6-month credit impulse is likely to turn up in the fourth quarter, warranting some profit-taking in pro-defensive positions. But we do not advise aggressive pro-cyclical sector, regional, and country allocation until the 10-year yield on the Italian BTP (now at 3.2) - and the sum of the 10-year yields on the U.S. T-bond, German bund and JGB (now at 3.4) - both move closer to 3. Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com 1 Please see the European Investment Strategy Special Report 'The Cobweb Theory And Market Cycles' published on January 11 2018 and available at eis.bcaresearch.com. 2 Assuming that the average maturity of Italian banks' BTPs is around 5 years. 3 Please see the European Investment Strategy Special Report 'Monetarists Vs Keynesians: The 21st Century Battle' July 12 2018 available at eis.bcaresearch.com. Fractal trading Model* In support of the preceding fundamental analysis, the outperformance of healthcare versus banks is technically extended. Its 130-day fractal dimension is at the lower bound which has reliably signalled previous trend exhaustions. On this basis we would position for a 10% reversal with a symmetrical stop-loss. In other trades, long PLN/USD reached the end of its 65-day holding period comfortably in profit, and is now closed. This leaves six open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment's fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-13 Long Global Basic Resources, Short Global Chemicals Long Global Basic Resources, Short Global Chemicals * For more details please see the European Investment Strategy Special Report "Fractals, Liquidity & A Trading Model," dated December 11, 2014, available at eis.bcaresearch.com Fractal Trading Model The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. Recommendations Equities Bond & Interest Rates Currency & Other Positions Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations Indicators To Watch - Interest Rate Expectations

Highlights The indicators that led the EM selloff continue to point to more downside. Meanwhile, broader EM valuation and positioning indicators have not yet bombed out to warrant bottom fishing. In China, policymakers are not yet embracing stimulus of the same magnitude as in 2015-2016. Consequently, the odds for now favor staying put on China-leveraged plays. Feature Calling market bottoms and tops is an art -not a science - as there is no formula that works at all times, in all markets. The fundamental case for EM/China remains negative, as credit excesses of previous years have not been unwound, and commodities prices remain at risk. However, to avoid being part of a herd and to maintain investment discipline, it is vital to re-visit market indicators from time to time. In this week's report, we explore directional market indicators and valuations, and offer some thoughts on investor sentiment and positioning in EM. Putting all of these together with our fundamental analysis, we still see meaningful downside in EM risk assets, and continue recommending a defensive strategy. A Review Of Indicators The indicators that led this EM selloff continue to point to additional downside. Meanwhile, valuation and positioning indicators have not yet bombed out. Chart I-1 illustrates that EM corporate U.S. dollar bond yields continue to rise (shown inverted on the chart), entailing lower EM share prices. The message is the same whether we consider EM high-yield or investment-grade corporate or EM sovereign U.S. dollar bond yields. Chart I-1EM Share Prices Always Decline When EM Corporate Bond Yields Rise EM Share Prices Always Decline When EM Corporate Bond Yields Rise EM Share Prices Always Decline When EM Corporate Bond Yields Rise We have repeatedly highlighted1 that EM share prices correlate with EM borrowing costs rather than risk-free rates. So long as the rise in U.S. bond yields is offset by compressing EM credit spreads, EM corporate bond yields decline and EM share prices rally. But when EM corporate (or sovereign) yields rise, irrespective of whether this is due to rising U.S. Treasury yields or widening EM credit spreads, EM equity prices come under selling pressure. Chart I-2 illustrates that a similar relationship exists between China's onshore AA- corporate bond yields and A share prices. AA- corporate bond yields have not yet dropped, and, thereby, they still point to lower share prices ahead. Even though risk-free and interbank rates have plummeted on the mainland, corporate borrowing costs have not. If the Chinese authorities do indeed eradicate the perception of implicit government guarantees for the majority of corporate borrowers - one of the most important items on the government's structural reforms agenda - the odds are that corporate bond yields will rise further to price in higher risk of defaults. This would be a bad omen for corporate borrowing costs, capital spending and share prices. Our risky to safe-haven currency ratio is making new lows. Given it has historically been highly correlated with EM stocks, odds are that EM share prices will continue to drop (Chart I-3). Chart I-2China: On-Shore Corporate Bond (AA-) ##br##Yields And A-Share Market China: On-Shore Corporate Bond (AA-) Yields and A-Share Market China: On-Shore Corporate Bond (AA-) Yields and A-Share Market Chart I-3Risky To Safe-Haven Currencies ##br##Ratio And EM Stocks Risky To Safe-Haven Currencies Ratio And EM Stocks Risky To Safe-Haven Currencies Ratio And EM Stocks Notably, this ratio is also agnostic to the dollar's direction - it swings between risk-on versus risk-off regimes in financial markets, regardless of the greenback's general trend. Hence, it addresses the question of the direction of EM equity prices, irrespective of the dollar's trajectory. Industrial metals prices correlate with EM corporate earnings growth as demonstrated in Chart I-4. The basis is that both are affected by global growth. Presently, falling metals prices are signaling further deceleration in EM non-financials corporate EBITDA growth. We want to emphasize again that the EM selloff this year has primarily been due to the growth slowdown in EM/China rather than higher U.S. bond yields. If anything, the opposite has been occurring: the EM turmoil and growth slowdown have capped U.S. bond yields since April. Moreover, the currency selloff in EM ex-China has led to rising local currency interest rates in many developing economies. Looking forward, higher local rates entail a capital spending slump, which will weigh on EM and global growth. EM risk assets are highly sensitive to global trade growth. The poor performance of global cyclical equity sectors corroborates weakening world trade. In particular, global mining, steel, chemicals, industrials and semiconductor stocks have all broken below their 200-day moving averages (Chart I-5). Chart I-4More Deceleration In EM Corporate Profits More Deceleration In EM Corporate Profits More Deceleration In EM Corporate Profits Chart I-5Global Equities: Cyclical Sectors Have Broken Down Global Equities: Cyclicals Have Broken Down Global Equities: Cyclicals Have Broken Down EM equity valuations are currently roughly neutral, down from being one standard deviation above fair value in January (Chart I-6). Hence, EM stocks are not expensive, but they are not cheap either. When equity valuations are neutral rather than at extremes, the market can either rally or sell off. In brief, when equity valuations are not at extremes, the direction of share prices is contingent on the profit cycle. The outlook for EM corporate earnings at the moment is downbeat (as shown in Chart I-4 on page 3), presaging a market selloff. With respect to high-yielding EM currencies, Chart I-7 demonstrates that the aggregate real effective exchange rate for EM ex-China, Korea and Taiwan has dropped quite a bit, but still stands above its historical lows. Chart I-6EM Stocks Are Not Cheap EM Stocks Are Not Cheap EM Stocks Are Not Cheap Chart I-7EM Currencies Are Only Moderately Cheap EM Currencies Are Only Moderately Cheap EM Currencies Are Only Moderately Cheap Regarding credit market valuations, EM corporate credit spreads are still below their post-2009 mean (Chart I-8, top panels). EM sovereign spreads are above their post-2009 mean, but this is due to crisis-stricken outliers. Some pockets of EM, such as Argentina or Turkey,2 might be undervalued for a reason. However, sovereign spreads for EM ex-Venezuela, Argentina and Turkey are still at their post-2009 mean (Chart I-8, bottom panel). On the whole, EM market valuations have improved, but EM assets are not yet cheap to warrant bottom-fishing. Finally, investor sentiment towards EM is no longer wildly bullish as it was last year, but our sense is that the average investor believes this EM selloff will not develop into an extended major bear market. Consistent with this, investors may have hedged some of their bets, or are reducing their exposure, but they have not capitulated or gone bearish/underweight on EM assets. For example, Chart I-9 illustrates that leveraged investors - who have little tolerance for volatility - have substantially reduced their net long positions in EM ETF equity futures, yet asset managers are still very long. Chart I-8EM Credit Spreads Do Not Yet Offer Value EM Credit Spreads Do Not Yet Offer Value EM Credit Spreads Do Not Yet Offer Value Chart I-9EM Stock Futures: Leveraged Funds Have Sold, ##br##But Asset Managers Have Not EM Stock Futures: Leveraged Funds Have Sold, But Asset Managers Have Not EM Stock Futures: Leveraged Funds Have Sold, But Asset Managers Have Not Besides, investor sentiment on copper - a proxy for EM - is not yet depressed (Chart I-10). As can be seen on this chart, EM share prices bottom when the net bullish sentiment on copper typically drops close to 25%. That is not the case at the moment. Chart I-10Bullish Sentiment On Copper And EM Share Prices Bullish Sentiment On Copper And EM Share Prices Bullish Sentiment On Copper And EM Share Prices Bottom Line: Investors should stay put on EM and underweight EM assets relative to their DM counterparts in general, and the U.S. in particular. China: Juggling Contradictory Objectives China's central bank has substantially eased liquidity in the banking system, as evidenced by the 200-basis-point plunge in interbank rates. In addition, the authorities have instructed local governments to accelerate issuance of the remaining quota of their bonds. What's more, the banking regulator has urged banks to lend more to infrastructure development and to the export sector. We offer several comments and observations regarding China's current round of policy stimulus: First, there has so far been no additional fiscal stimulus announced. General government spending growth for 2018 is planned at 3%, and managed funds spending at 24.1%. Altogether public (fiscal and quasi-fiscal) spending in 2018 is projected to be 8% compared to 8.6% in 2017 and 8.1% in 2016 (Table I-1). Table I-1China: Fiscal And Quasi-Fiscal Spending (Annual Nominal Growth Rates) EM: Do Not Catch A Falling Knife EM: Do Not Catch A Falling Knife With no new announced public spending, front-loading previously planned spending could alter the near-term growth trajectory, but it will not affect the economy's cyclical outlook. Second, the key risk to our downbeat view is an acceleration in credit origination.3 Our baseline scenario is that regulatory tightening for banks and shadow banking as well as the ongoing anti-corruption campaign in the financial sector - both components of the broader structural reforms agenda - will continue, and will curb credit growth despite more liquidity provision by the People's Bank of China and lower interbank rates. Importantly, so far there has been little deleveraging. If the authorities allow a credit acceleration, it would negate their adherence to structural reforms in general, and deleveraging in particular. In such a case, China's growth will revive and the negative view on China-leveraged markets will prove to be wrong. Furthermore, a revival in credit growth would go against the policy priority of containing financial risks - code for not allowing bubbles to inflate further. In fact, property sales and starts have recently accelerated (Chart I-11). Stimulating money and credit now would mean inflating the real estate bubble further. Third, broad money (official M2 and our measure of M3) impulses have ticked up, but the credit impulse has not (Chart I-12, top panel). Chart I-11China: Housing Is Proving Resilient China: Housing Is Proving Resilient China: Housing Is Proving Resilient Chart I-12China: Money/Credit Impulses China: Money/Credit Impulses China: Money/Credit Impulses Importantly, the broad money impulses rolled over in the second half of 2016, yet EM/China markets and commodities prices remained resilient until early 2018 (Chart I-12, bottom panel). There was roughly an 12-month plus time lag between the rollover in the money/credit impulses and the peak in China-related financial markets. Hence, there will likely be an interval of at least six months before financial markets react to the recent improvement in the money impulses. As such, it is probably too early to bottom-fish EM/China plays. There could be considerable downside in financial markets in the next six months or so, notwithstanding short-term rebounds. Finally, the PBoC's ability to keep money market rates down will be constrained by its appetite for further weakness in the RMB exchange rate. Chart I-13 illustrates that the drop in the interest rate differential between China and the U.S. has coincided with the latest down-leg in the RMB's value. Chart I-13China: Lower Interest Rate Differential = Weaker RMB China: Lower Interest Rate Differential = Weaker RMB China: Lower Interest Rate Differential = Weaker RMB The interest rate differential between China and the U.S. is now only 100 basis points. Given that U.S. short interest rates are bound to rise further, we expect one of the following scenarios to unfold: If the PBoC opts to lower rates further or keep them at current levels, the yuan will continue to depreciate versus the U.S. dollar. This will be negative for China/EM financial markets; If the PBoC prefers to stabilize the RMB exchange rate versus the dollar, it will need to push up money market rates, thereby undoing its liquidity easing of the past several months. If this takes place, the odds of a credit revival will drop considerably and chances of an economic growth recovery will diminish. Given the above and the fact that EM financial markets have reacted poorly to the RMB's recent depreciation, staying negative on EM risk assets appears to be the more prudent course. We are not sure which option the PBoC will choose in the near term, but in the long run China will have to drop interest rates to soften the deleveraging process. Bottom Line: Chinese policymakers are attempting to simultaneously achieve contradictory objectives: On one hand, they want to deleverage the system and contain the property and credit bubbles. On the other hand, they are not ready to tolerate weaker growth, and have lately opted for stimulus as soon as growth has downshifted. It will be very hard to achieve these contradictory objectives at the same time. For now, policymakers are not yet embracing stimulus of the magnitude that was implemented in 2015-2016. Consequently, the odds for now favor staying put on China-leveraged plays. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com 1 Please see Emerging Markets Strategy Weekly Report "On EM Blues, Brazil And Malaysia," dated May 17, 2018, a link available on page 13. 2 Please see Emerging Markets Strategy Special Alert "Turkey: Booking Profits On Shorts," dated August 15, 2018, a link available on page 13. 3 Underestimating the recovery in credit growth was the reason why we misjudged the magnitude and duration of 2016-17 recovery in China. Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Highlights The persistent weakness of the RMB appears to be one important factor weighing on Chinese stocks, particularly the domestic market. CNYUSD may have some upside from current levels if the Trump administration applies only 10% rate to the second round of planned tariffs, but on balance is likely to come under further market pressure. This explains the PBOC's decision to try to support the currency. Interestingly, July brought some hopeful (albeit early) macro signals from China among the data that we track, some of which appear to have been overlooked by investors. Still, a neutral stance towards Chinese investable stocks versus the global benchmark continues to be warranted, at least until some clarity emerges about the magnitude and disposition of the export shock. Feature Economic and financial market conditions in China have not meaningfully improved since the publication of our last weekly report. Chart 1 highlights that China's economic surprise index remains in negative territory, and Chart 2 shows that Chinese investable and domestic stocks remain 22% and 29%, respectively, below their rolling 1-year high in local currency terms. In US$ terms, domestic Chinese stocks are 34% below their January peak, owing to the significant decline in CNYUSD. The BCA China Play Index and the relative performance of domestic infrastructure stocks versus global equities are two additional market indicators that we are watching closely as proxies for reflation, and neither is signaling a significant improvement (Chart 3). Chart 1Persistently Negative Economic Surprises... Persistently Negative Economic Surprises... Persistently Negative Economic Surprises... Chart 2...And Still In A Bear Market ...And Still In A Bear Market ...And Still In A Bear Market Chart 3Reflation Proxies Are Not Signaling A Major Economic Upturn Reflation Proxies Are Not Signaling A Major Economic Upturn Reflation Proxies Are Not Signaling A Major Economic Upturn The RMB Factor The persistent weakness of the RMB appears to be one important factor weighing on Chinese stocks, particularly the domestic market. While a weaker currency will actually help offset some of the export shock, Chart 4 shows that domestic stocks have not responded positively to the decline: the rolling 3-month correlation between the two has soared even further into positive territory over the past month, which may explain recent actions from the PBOC to help stabilize the currency. In short, the RMB appears to be acting as the "panic barometer" for domestic equity investors. Chart 4The RMB Is Acting As A "Panic Barometer" For Domestic Stocks The RMB Is Acting As A "Panic Barometer" For Domestic Stocks The RMB Is Acting As A "Panic Barometer" For Domestic Stocks Chart 5Some Evidence Of PBOC-Driven Depreciation Some Evidence Of PBOC-Driven Depreciation Some Evidence Of PBOC-Driven Depreciation The PBOC continues to maintain that it is not actively manipulating the RMB, arguing that both last year's appreciation and Q2's depreciation have occurred due to market supply and demand. Chart 5 casts some doubt on this claim, suggesting that at least some of the recent decline has been purposeful. The chart shows the standardized 1-month percent change in official reserves, measured in SDRs to help remove the impact of currency fluctuations. It highlights that the change in currency-neutral reserves has been quite elevated over the past three months relative to recent history, which is what would be expected (absent major capital outflow) if the PBOC was buying foreign currency assets to push down the exchange rate. But we agree that the extent of the decline is now probably more than what policymakers are comfortable with, which raises the question of how much more market-based pressure the RMB is likely to come under. In attempting to answer this question, it is interesting to note that the magnitude of the decline in CNYUSD over the past two months seems to have been closely aligned with the share of proposed tariffs as a share of Chinese exports to the U.S., as would be implied in a simple open economy model with flexible exchange rates. Chart 6 illustrates the magnitude of the decline in CNYUSD that would be implied by this framework in a variety of tariff scenarios. The chart shows that the RMB has some upside from current levels if the rate on the second round of tariffs is limited to 10% (instead of the 25% that has been threatened), and no additional tariffs are levied. But it also shows that further market pressure on the exchange rate is likely if the Trump administration simply follows through with their stated plans, and especially if the U.S. moves to tariff all imports from China. Notably, in the scenarios showing a further RMB decline, all of them fall below the psychologically important level of 7 yuan to the dollar. Chart 6More Pressure On RMB To Come If Trump Merely Follows Through With His Threats More Pressure On RMB To Come If Trump Merely Follows Through With His Threats More Pressure On RMB To Come If Trump Merely Follows Through With His Threats Given this, it is easy to see why investors feel that they are in limbo regarding the outlook for Chinese stock prices. They can observe the reflationary outlook of Chinese policymakers, but they are also factoring in: A looming export shock of still uncertain magnitude A strong signal from authorities that the campaign to control leverage and crackdown on shadow banking will not be abandoned Persistent RMB volatility An ongoing "old economy" slowdown that was already underway prior to the imposition of tariffs Domestic Economy Crosscurrents Chart 7Closely Watched Data Releases Negatively Surprised In July Closely Watched Data Releases Negatively Surprised In July Closely Watched Data Releases Negatively Surprised In July Concerning the last of these factors, we have written about a slowdown in China's old economy for the better part of the past year, a view that is now sharply in the market's focus given the negative external outlook. Last week's disappointing release of the July retail sales, industrial production, and fixed asset investment data certainly did not help improve investor sentiment towards China's economy (Chart 7). Interestingly, however, July did bring some hopeful (albeit early) macro signals from China, some of which appear to have been overlooked by investors. Table 1 presents the dashboard of select macro series that we have showed in several reports over the past few months. It highlights the evolution of the key six components of our BCA Li Keqiang index Leading Indicator, four housing market series that we have found to have strongly leading properties, as well as the NBS and Caixin manufacturing PMIs. Credit growth and the PMIs are currently providing the most negative signals, in that they declined in July and are below their 12-month moving average. In the case of credit growth, this is a continuation of an almost 2-year downtrend, but the PMI weakness has been much more recent (in response to the worsening export outlook). But several indicators that we track ticked up in July, including 4 out of 6 components of our leading indicator for the Li Keqiang index (LKI). The fact that monetary conditions indexes have risen should not be surprising given the recent weakness in the currency, but growth in the money supply also ticked up non-trivially last month (possibly due to the PBOC's apparent manipulation of the RMB). In the case of M2, the tick up technically pushed the YoY growth rate (modestly) above its trend for the first time in 2 years. Table 1Some Hopeful Signs, But Credit Remains Weak In Limbo In Limbo There are two other points from Table 1 worth highlighting, the first of which is negative. While the LKI itself has looked reasonably strong over the past few months (in contrast to our slowing domestic demand view), it ticked down in July for the second time. In addition, the LKI has recently been propped up by two, presumably unsustainable, factors: a spurt of rail cargo volume growth that appears to be strongly linked to trade front-running in advance of the U.S. import tariffs, and a surge in electricity consumption from the services industry (which is not investment-intensive). Chart 8 controls for the second factor by presenting an alternative measure of the LKI that replaces overall electricity production with consumption in primary and secondary industries; the difference in the recent trend between the two measures is clear. Chart 8The LKI Is Being Held Up By Trade Front Running And Services The LKI Is Being Held Up By Trade Front Running And Services The LKI Is Being Held Up By Trade Front Running And Services The second important point from Table 1 is positive: both housing starts and sales accelerated very significantly in July, with sales being particularly notable. BCA's China Investment Strategy service has highlighted that the housing sector represented the best candidate for meaningful acceleration in Chinese economic activity, and the July data was particularly impressive. It remains unclear whether the authorities will continue to follow through with a crackdown on the property sector, despite recent statements suggesting they will: household leverage is not enormously elevated relative to GDP, but it has accelerated very significantly over the past couple of years. But if the recent strength in sales volume continues and policymakers do not respond aggressively with macroprudential measures, our conviction in a sustained residential construction boom in China would rise materially. This will be important for investors to monitor, as it could provide a critical source of investment-driven domestic demand over the coming 6-12 months. Investment Conclusions Despite the crosscurrents buffeting China's economic outlook, we can draw three conclusions that lead us to firm near-term investment strategy recommendations: Market proxies are not signaling that Chinese policymakers will end up overstimulating the economy For now, credit growth, and the domestic "old economy" more generally, continues to decelerate Further RMB weakness may be in the cards To us, these conclusions clearly argue for a neutral stance towards Chinese investable stocks versus the global benchmark, at least until some clarity emerges about the magnitude and disposition of the export shock. We also continue to recommend that investors favor low market beta sectors within the investable universe, such as classical defensives as well as industrials.1 In early-July, we opened a "shadow" trade of being long the MSCI China A Onshore index / short MSCI China index, which we said we would consider implementing in response to a 5% rally in relative dollar performance. Chart 9 highlights that this threshold has not yet been reached, and we continue to warn against trying to catch a falling knife. But Chart 10 underscores how stretched (to the downside) domestic stocks have become: versus the global benchmark, relative stock prices in US$ have fallen to an 11-year low. Panel 2 illustrates that this stretched performance is at least in part driven by the performance of U.S. equities, but domestic stocks prices are still at the very low end of their post-GFC range when compared with global ex-U.S. stocks. Chart 9Still Too Early To Buy A-Shares... Still Too Early To Buy A-Shares... Still Too Early To Buy A-Shares... Chart 10...But The Selloff Seems Extremely Late ...But The Selloff Seems Extremely Late ...But The Selloff Seems Extremely Late In short, the potential for a substantial bounce in relative domestic equity performance is considerable were the economic outlook to stabilize, and we will be watching closely for an opportunity to time a reversal. Stay tuned! Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com 1 Investable industrial stocks in China have become relatively low-beta, owing to the fact that they had already materially underperformed the investable benchmark prior to the emergence of trade frictions with the U.S. Cyclical Investment Stance Equity Sector Recommendations

We published a Special Alert report titled Turkey: Book Profits On Shorts yesterday. The link is available on page 18. This report is Part 2 of an overview of the cyclical profiles of emerging market (EM) economies. This all-in-charts presentation illustrates the business cycle conditions of various developing economies. The aim of this report is to provide investors with a quick assessment of where each EM economy stands. In addition, we provide our view on each market. The rest of the countries were covered in Part 1, published last week (the link to it is available on page 18). Chart I-1 bca.ems_wr_2018_08_16_s1_c1 bca.ems_wr_2018_08_16_s1_c1 Malaysia: Keep Underweight For Now As... Malaysia: Keep Underweight For Now As... CHART 2 CHART 2 Malaysia: Keep Underweight For Now As... CHART 3 CHART 3 Malaysia: Keep Underweight For Now As... CHART 4 CHART 4 ...Bank Shares Have Significant Downside ...Bank Shares Have Significant Downside CHART 5 CHART 5 ...Bank Shares Have Significant Downside CHART 6 CHART 6 ...Bank Shares Have Significant Downside CHART 7 CHART 7 Indonesia: Underweight Equities & Bonds Indonesia: Underweight Equities & Bonds CHART 8 CHART 8 Indonesia: Underweight Equities & Bonds CHART 9 CHART 9 Indonesia: Underweight Equities & Bonds CHART 10 CHART 10 Indonesia: Underweight Equities & Bonds CHART 11 CHART 11 Indonesia: The Sell-Off Is Not Over Yet Indonesia: The Sell-Off Is Not Over Yet As Banks' NPL Provisions Rise, Bank Stocks Could Fall CHART 12 As Banks' NPL Provisions Rise, Bank Stocks Could Fall CHART 12 Indonesia: The Sell-Off Is Not Over Yet CHART 14 CHART 14 Indonesia: The Sell-Off Is Not Over Yet CHART 16 CHART 16 Indonesia: The Sell-Off Is Not Over Yet CHART 13 CHART 13 Thailand: Stay Overweight Thailand: Stay Overweight CHART 19 CHART 19 Thailand: Stay Overweight CHART 17 CHART 17 Thailand: Stay Overweight CHART 20 CHART 20 Thailand: Better Positioned To Weather The EM Storm Thailand: Better Positioned ##br##To Weather The EM Storm CHART 15 CHART 15 Thailand: Better Positioned ##br##To Weather The EM Storm CHART 21 CHART 21 Thailand: Better Positioned ##br##To Weather The EM Storm CHART 18 CHART 18 Thailand: Better Positioned ##br##To Weather The EM Storm CHART 22 CHART 22 Philippines: Inflation Breakout Philippines: Inflation Breakout CHART 28 CHART 28 Philippines: Inflation Breakout CHART 27 CHART 27 Philippines: Inflation Breakout CHART 26 CHART 26 Philippines: Neutral On Equities Due To Oversold Conditions Philippines: Neutral On Equities ##br##Due To Oversold Conditions CHART 25 CHART 25 Philippines: Neutral On Equities ##br##Due To Oversold Conditions CHART 24 CHART 24 Philippines: Neutral On Equities ##br##Due To Oversold Conditions CHART 23 CHART 23 Central Europe: Labor Shortages & Wage Inflation Central Europe: Labor Shortages & Wage Inflation CHART 29 CHART 29 Central Europe: Labor Shortages & Wage Inflation CHART 30 CHART 30 Central Europe: Robust Growth - Overweight Central Europe: Robust Growth - Overweight CHART 31 CHART 31 Central Europe: Robust Growth - Overweight CHART 32 CHART 32 Central Europe: Robust Growth - Overweight CHART 33 CHART 33 Chile: Robust Growth - Overweight Equities Chile: Robust Growth - Overweight Equities CHART 34 CHART 34 Chile: Robust Growth - Overweight Equities CHART 35 CHART 35 Chile: No Inflationary Pressures Chile: No Inflationary Pressures CHART 36 CHART 36 Chile: No Inflationary Pressures CHART 37 CHART 37 Chile: No Inflationary Pressures CHART 38 CHART 38 Chile: No Inflationary Pressures CHART 39 CHART 39 Colombia: Currency Will Be A Release Valve Colombia: Currency Will Be A Release Valve CHART 40 CHART 40 Colombia: Currency Will Be A Release Valve CHART 41 CHART 41 Colombia: Currency Will Be A Release Valve CHART 42 CHART 42 Colombia: Currency Will Be A Release Valve CHART 43 CHART 43 Colombia: Credit Growth Remains A Headwind For Economy - Neutral Colombia: Credit Growth Remains ##br##A Headwind For Economy - Neutral CHART 44 CHART 44 Colombia: Credit Growth Remains ##br##A Headwind For Economy - Neutral CHART 45 CHART 45 Colombia: Credit Growth Remains ##br##A Headwind For Economy - Neutral bca.ems_wr_2018_08_16_s1_c46 bca.ems_wr_2018_08_16_s1_c46 Peru: Vulnerable To External Developments Peru: Vulnerable To External Developments CHART 47 CHART 47 Peru: Vulnerable To External Developments CHART 48 CHART 48 Peru: Vulnerable To External Developments CHART 49 CHART 49 Peru: Vulnerable To External Developments CHART 50 CHART 50 Peruvian Equities - Underweight Peruvian Equities - Underweight CHART 51 CHART 51 Peruvian Equities - Underweight CHART 52 CHART 52 Peruvian Equities - Underweight CHART 53 CHART 53