Developed Countries

Special Report

Highlights Gen Z Is Coming Of Age And Has Money To Spend Generation Z in the US includes 62 million people born between the 1997 and 2012. With $143B in buying power in the US alone, making up nearly 40% of all consumer sales, Gen Z wields increasing influence over consumer trends. This is the first generation of digital natives—they simply can’t remember the world without the internet. They are the early adopters of the new digital ways to bank, get medical treatments, and learn. Gen Z is joining the workforce and replacing retiring baby boomers. Gen Z Investment Themes Fintech: Gen Z loves seamless connectivity, online banking, and digital wallets. They are also the early adopters of semi-autonomous digital and non-traditional banking and insurance: PayPal (PYPL), Square (SQ), Lemonade (LMND), and Social Finance (Sofi). Investing And Crypto: Gen Z are avid investors: They opened 20% of all new investment accounts in 2020. Crypto is also very popular among the digital natives: Coinbase (COIN), Paypal (PYPL), and Square/Cash App (SQ). Alternative Reality And Online Gaming: Members of Gen Z will become the key gaming demographic in the decade ahead. E-sports betting is also gaining prominence. Two online gaming ETFs capture the theme: GAMR and ESPO. Quality-Over-Price Shoppers: Gen Z was found to be less price-sensitive when buying products, choosing quality over price. Lululemon (LULU) is among the Gen Z’s favorites. Finally, Gen Zers won’t have any qualms about buying a car online: Vroom (VRM). Online Dating: Gen Zers have whole-heartedly accepted online dating: Match (MTCH) and Bumble (BMBL). Pet Ownership: The Gen Z cohort often feels lonely and loves their furry friends: They are more than happy to spend time and money on them: Chewy (CHWY), Trupanion (TRUP), and IDEXX Labs (IDXX). PAWZ is the ETF. Healthy Lifestyle: Gen Z is a “green” generation that deeply cares about the planet, loves outdoors and traveling, with many identifying as vegans. This is also a generation that prizes a healthy lifestyle and working out: Beyond Meat (BYND), Planet Fitness (PLNT), and Yeti (YETI). Generation Sober Chooses Cannabis: Gen Zers perceive hard liquor and tobacco as bad for their health. Curiously, marijuana is perceived as “healthy.” CNBS, YOLO, and THCX are the biggest ETFs in this space. How To Invest In Gen Z Gen Z is a nascent investment theme, so there are no ETFs available in the market yet. We propose investors follow our Gen Z investment themes or replicate fully or partially our Gen Z basket (Table 1). Table 1Gen Z Basket Constituents Feature ​​​​​​​Gen Z Is Coming Of Age And Has Money To Spend Generation Z in the US includes 62 million people born between the years of 1997 and 2012 – a cohort starting to come of age now, with the oldest members hitting 25 this year (Chart 1). Gen Z-ers now outrank Millennials as the majority generation on the planet. With $143B in buying power in the US alone, making up nearly 40% of all consumer sales, Gen Z commands an increasing influence over consumer trends. Chart 1Gen Zers Are Taking Over Furthermore, while most Gen Zers are still in high school and college, their parents, who have padded their savings accounts after a series of stimulus checks, are ready to step in and foot the bill, fortifying the financial impact of this new generation. In this report, we have outlined the Gen Z investment themes and most representative stocks. The Gen Z basket is a compilation of these themes and stocks. However, we are not stock-pickers - our selections are for illustration only. Digital Natives This is the first cohort that has grown up with a phone in one hand and a computer mouse in the other. Dubbed “digital natives,” they simply can’t remember a world without the internet. Gen Z, often referred to as “Zoomers” or “Centennials,” are connected nearly every waking hour of the day and are deeply social, even if considerable interaction may take place in cyberspace. The average Gen Z got their first smartphone just before their twelfth birthday, communicates primarily through social media and texts, and spends as much time on their cell phones as their parents on television. Because tech made Gen Z’s personal lives easier, faster, and more efficient, they emphasize customization and optimization as users and consumers. One of the most educated generations, they are more likely to pursue college than earlier generations. Among 18- to 21-year-olds no longer in high school in 2018, 57% were enrolled in two- or four-year college (that number was 52% for Millennials). The last year has also blurred the lines between work and home: Many college graduates have never met their new colleagues in person. Generation Z students had unprecedented exposure and experience using technology to continue their education outside the traditional brick-and-mortar school setting. They are also most likely to adopt new ways to bank, get medical treatments, and learn. Zoomers are future entrepreneurs (72% of high schoolers want to start their own business)1 and evangelists of the gig economy. Demographics & Macro Trends Chart 2 displays US demographic trends. Until 2018, baby boomers dominated the labor force; but, over the past three years, they have passed the baton to Gen Z. Moreover, during the pandemic, the retirements of baby boomers have accelerated. With more Zoomers graduating from high school and college, their proportion in the labor force is rising and their spending patterns are becoming increasingly more prominent in the economy. Gen Z wage data also reveals an interesting trend. Since 2014, median weekly earnings for the coming generation noticeably outpaced one of the departing generations—by 14.5%, to be exact (Chart 3). Chart 2Generational Shifts In The Labor Force Chart 3They Also Have Money To Spend Investment Themes A host of investment themes reflects the retail preferences of Gen Z, collectively called the Gen Z basket. While some of the themes are ubiquitous (most of the US middle class aspire to maintain a healthy lifestyle), it is the quirks specific to Gen Z that we focus on. The oldest Zoomers turned 18 in 2015. Since then, the Gen Z basket has outperformed the S&P 500 Growth index by 46% (Chart 4). A word of caution: As any emerging investment theme, the basket remains volatile. Chart 4Solid Performance Since 2015 Fintech Gen Z is financially minded and risk averse. Many watched parents struggle during the Great Recession. They’re often leery of debt and credit, and thus stick to debit cards. Digital natives expect seamless connectivity, and their finances are no exception. They can't live without their digital wallets and online banking. Generation Z members are early adopters of semi-autonomous digital banking, which deploys digital cognitive agents or AI systems to help with financial decisions. It provides Zoomers with the right degree of personalization and autonomy to make smarter, faster, and better money moves. And, when it comes to money movements, 75% of Zoomers are using peer-to-peer (P2P)2 banking methods, with easy-to-use apps like Zelle and Venmo taking the lead in downloads. Similar fintech trends apply to other financial transactions, like loans and insurance. This theme may be expressed through Paypal (PYPL), Square (SQ), Lemonade (LMND) online insurance, and Social Finance (Sofi)—an online platform for student loan refinancing, private student loans, and a host of other financial products. Interest In Investing And Cryptocurrencies Zoomers are avid investors. They opened 20% of all the new investment accounts in 2020 — impressive, considering that half of the cohort are underage (Chart 5). Crypto is also very popular among digital natives. Last year, Business Insider (BI) released a survey asking if Zoomers are “likely to purchase cryptos in the next six months”. What is telling is that approximately 1/4 of responders indicated that they are likely to purchase crypto, which correlates to the percentage of Zoomers who are currently age 18 or older (Chart 6). We can play the crypto theme in the equity space by investing in Coinbase (COIN), Paypal (PYPL)—which recently started accepting crypto as a payment—and Square/Cash App (SQ). Chart 5Gen Zers Are Avid Investors... Chart 6...Including In The Crypto Space Alternative Reality And Online Gaming Members of Gen Z will become a key gaming demographic in the decade ahead. 91% of Gen Z males regularly play video games, compared to 84% of Millennials. In a recent study, “From Nerdy to Norm: Gen Z Connects Via Gaming” conducted by Whistle, 68% of Gen Z males agreed that gaming is an important part of their identity. The industry has responded to the mores of this incoming generation by shifting its focus towards highly stylized immersive mobile games, live dealers, and interactive experiences rather than the traditional click-to-spin style slot games. E-sports betting is also getting prominence. We have very little doubt that the proliferation of e-sports will accelerate, especially as Gen Z comes of age. The upcoming 2021 e-sports “world cup” event for just one game already has more than $40,000,000 in prize pool money secured. To express the online gaming theme, we included six stocks in our basket: Online game developers, such as Take Two Interactive (TTWO), Electronic Arts (EA), and Activision Blizzard (ATVI); Zinga (ZNGA), which develops apps for phone games; DraftKings (DKNG), a leader in online sports betting; and finally, Nvidia (NVDA), a graphic chip manufacturer that thrives as a market leader in gaming computing. There are also a couple of online gaming ETFs: GAMR and ESPO. Quality-Over-Price Shoppers As consumers, tech-savvy Zoomers are pragmatic shoppers who rely on social networks to make informed purchasing decisions. They were also found to be less price-sensitive when buying products, choosing quality over price as their top purchasing factor, while sustainability was also highlighted as an important issue. As a result, brick-and-mortar shops with a strong online presence, such as Urban Outfitters (URBN) and Lululemon(LULU) are Gen Z favorites. Vintage clothing has also recently been in vogue among these teens. Companies like Poshmark (POSH) capture this trend. High-end outdoor clothes brands also have a Zoomer following. Canadian Goose (GOOS) is one of them: For many, a “goose” jacket is a winter campus uniform. Lastly, Zoomers won’t have any qualms about buying a car online: Vroom (VRM). Online Dating Gen Z is different from any other generation in their whole-hearted acceptance of online dating. For example, Zoomers represent 40% of all Tinder users. The online dating landscape3 in the US is dominated by just two companies, Match/Tinder (MTCH) and Bumble (BMBL), an app whereby only a female can make initial contact. Pet Ownership Zoomers are lonely – 3 million adolescents had a major depressive episode,4 and there is an increase in anxiety and depression among high schoolers. Many feel isolated as a result of too much screen time. Zoomers are also known to avoid long-term relationships. It is not surprising that this cohort loves their furry friends and is more than happy to spend time and money on them. Since the worst of the pandemic, PAWZ pet care ETF has outperformed the S&P 500 growth index by 24%, while the US pet & vet services CPI series rose by 5.6%, compared to 4.6% for core CPI (Chart 7). While the love of pets is certainly not a unique characteristic of this cohort, it is a significant part of their spending basket. The following stocks capture this trend: PAWZ ETF; Chewy (CHWY), online pet supplies; Trupanion (TRUP), pet insurance; and IDEXX Labs (IDXX), the vet pharma company. Chart 7Pet Ownership Is On The Rise Healthy Lifestyle Aside from gaming, pet ownership, and online dating, there are some other Gen Z behavioral shifts. This is a “green” generation that deeply cares about the planet, loves outdoors and traveling, and has a soft spot for animals, with many Zoomers identifying as vegans. This generation also prizes a healthy lifestyle and working out. Stocks like Beyond Meat (BYND), makers of meat substitute products; Planet Fitness (PLNT), a gym favored by the Zoomers; and Yeti (YETI), high-end hiking equipment (indeed, this generation chooses quality over price) are the stocks that provide exposure to these new tastes and preferences. Generation Sober Chooses Cannabis Gen Z certainly cares about their health, and most Zoomers perceive hard liquor and tobacco as harmful. Gen Z drinks 20%5 less alcohol than Millennials did at their age. Curiously, marijuana is perceived as “healthy.” BusinessWeek commissioned a survey through the polling firm Morning Consult, which found Zoomers were more than twice as likely to be regular or occasional cannabis users than the national average (Chart 8). They concluded, “It’s always hard to generalize about an entire age group, but early signs suggest it will be a generation of marijuana consumers.” CNBS, YOLO, and THCX are the biggest ETFs in this space. Other Themes Finally, our discussion about Gen Z wouldn’t be complete without mentioning economic digitalization (Amazon, Teladoc, Zoom), proliferation of social media (SNAP, PINS, FB), and the sharing economy (UBER, ABNB, FVRR). Please refer to Table 1 at the beginning of the report for a complete list of Gen Z basket constituents. Chart 8Cannabis Is Not Considered A Drug For Gen Z Chart 9Expensive... Fundamentals And Valuations The Gen Z basket is certainly not cheap, trading at 28x forward earnings and 5.5x sales. This is rich but on par with the S&P 500 Growth index, which trades at 28x and 5.7x respectively (Charts 9 & 10). This basket has strong sales growth and has had a healthy post-COVID recovery bounce (Chart 11 ). Chart 10...But On Par... Chart 11...With The S&P 500 Growth Index How To Invest In Gen Z Gen Z presents an untapped investment opportunity. We have created our own Gen Z basket, as there is no direct way to play the Gen Z theme: There are no ETFs nor dedicated active funds in this space. While we used our entire basket in our analysis, it should not be viewed as an optimal investment vehicle. Instead, we advise using the basket as a helpful starting point and then filtering through its constituents to choose stocks that better meet one’s investment mandate. We emphasize that we are not stock pickers and that our company selections are mere illustrations of the investment thesis. We recommend investors to initiate a position in Gen Z themes, as they have a tremendous runway and are yet to go through their peak growth phase. Gen Z is a cyclical and structural investment idea and offers prospects for growth. Bottom Line Gen Z is coming of age and, being one of the largest cohorts in the US with $143B in buying power, wields increasing influence over consumer trends. The Gen Z investment thesis captures a host of nascent themes that reflect new generational preferences and spending patterns, such as fintech and online gaming, and a keen interest in investing and crypto, among others. Our Gen Z basket of stocks captures these investment themes, which are yet to go through their peak growth phase and provides investors with an opportunity to profit from them over short- and long-term investment horizons.     Irene Tunkel Chief Strategist, US Equity Strategy irene.tunkel@bcaresearch.com Arseniy Urazov Senior Analyst ArseniyU@bcaresearch.com   Footnotes 1    Sean McDowell, "6 Trends Among Gen Z in 2016" (Nov 23, 2016) 2    https://www.pymnts.com/news/payments-innovation/2020/why-digital-payments-innovation-sticks-to-gen-z/ 3    https://www.statista.com/statistics/426066/tinder-age-distribution/ 4    Susanna Schrobsdorff, “The Kids Are Not All Right,” Time (Nov 7, 2016): 47. 5    https://www.businessinsider.com/millennials-gen-z-drag-down-beer-sales-2018-2   Recommended Allocation

Highlights We are reviewing our recommendations. We are also introducing recommendation tables to monitor these positions. Overall, our main recommendations have generated alpha and have a positive batting average. Feature The end of the month of August offers an opportunity to review the positions recommended in this publication. We introduce three tables corresponding to three investment horizons—tactical, cyclical, and structural—which summarize our main views. Each table is subdivided by asset class, namely equities, fixed income, and currencies. The tables can be found on page 12 and 13 and will be available at the end of future strategy reports. Tactical Recommendations Short Equity Leaders / Long Laggards This position is down 1.4% since inception. The idea behind this bet was that the easy money in the market had been made, and investors needed to become more discerning, although the big-picture economic backdrop continued to favor a pro-cyclical, pro-risk bias in a portfolio. To achieve this goal, we opted to buy cyclicals sectors that had lagged the broad market and to sell the ones that had already overtaken their pre-COVID highs, in the hope of creating a portfolio hedge. Practically, this meant buying sectors such as Industrials, Banks and Energy, while selling sectors such as Capital goods, Autos and Consumer services (Chart 1). This position has not worked out well as yields fell. Chart 1Leaders vs Laggards UK Mid-Cap And Small-Cap To Outperform This position is up 3.4% since inception. We initially favored the more domestically-oriented mid- and small-cap indices in the UK as a bet on the re-opening trade, following the lead taken by the UK in the global vaccination campaign. A faster re-opening would not only boost the ability of smaller domestic firms to generate cash flows, it would also elevate the pound, which would hurt the profit translation of the multinational dominating the UK large-cap indices. By mid-May, we opted to move small cap back to neutral, as the positive story was well discounted and we expected the GBP to correct, which would help large-cap stocks. Favor European Banks Relative To US Ones This position is up 4.1% since inception. It is mainly a value trade. The European economy has lagged behind that of the US, and European yields remain well below US ones. As a result, European financials have greatly underperformed their US counterparts. However, this performance differential has left European banks trading at an enormous discount relative to their US peers. Hence, as continental European economies were catching up to the US on the vaccination front, we expected European banks to regain some ground. This trade has further to go, as valuation differentials remain excessive, especially since European banks are not as risky as they once were. Underweight / Short Norway As Hedge To Swedish Stocks This position is down 1% since inception. We have a cyclical overweight on the Swedish equity market (see page 9), which is extremely sensitive to the global industrial cycle. Thus, we were concerned by the potential near-term impact of the Chinese credit slowdown on this position. Selling Norway remains an appropriate hedge, because this market massively overweight materials stocks, which are even more exposed to the Chinese credit cycle than industrials are. Positive European Small-Cap Stocks This position is up 0.2% since inception. This was a bet on the economic re-opening taking place in the wake of the accelerating pace of vaccination in Europe. However, the weakness in the Euro since May has caused the large-cap European stocks to perform almost as well as their more-domestically focused counterparts. Neutral Stance On Cyclicals Relative To Defensives Chart 2The Cause Of Our Cautious Tactical Stance This trade is up 2.3% since inception. While we like cyclical plays on an eighteen to twenty-four months basis, we became concerned this spring about a tactical pullback. Globally, cyclical stocks had become extremely expensive and overbought relative to defensive sectors (Chart 2). Moreover, the rapid deceleration of the Chinese credit impulse pointed toward a period of negative economic surprises and was historically consistent with a period of underperformance of cyclical names. Now that China is stepping off the brake pedal, this trade is becoming long in the tooth. Neutral Stance On Europe Relative To The Rest of The World This trade is down 0.3% since its inception. This position is a corollary to the neutral view on cyclicals, as European equities possess a high beta. This bet did not pan out; European equities did underperform US stocks, but weaknesses in China and EM undid this benefit. Favoring Industrials Over Materials This trade is up 0.6% since inception. Industrial equities are less exposed to the Chinese credit slowdown than materials, but are more direct beneficiaries of the large infrastructure spending packages being rolled out across advanced economies. Industrials are also a direct bet on a capex recovery, which we expect to intensify over the next two years as companies address supply side issues. The tactical element of this trade may soon dissipate as China’s policy tightening ends, which would warrant booking profits. However, the industrials versus materials theme remains attractive as a cyclical bets on capex. Financials Over Other Cyclicals This trade is down 1.6% since inception. This was another trade aiming to keep some cyclical exposure on the book (long financials), while diminishing the exposure to the Chinese credit slowdown. The fall in yields and the weakness in the euro prevented this trade from working out. We now close this position. Long / Short Basket Based On Combined Mechanical Valuation Indicator This trade is flat since inception. This market-neutral trade uses the methodology developed in our May 31st Special Report in which we introduced our Combined Mechanical Valuation Indicator (CMVI). We bought the most undervalued sectors and sold the most overvalued. We will look to rebalance this portfolio in the coming months. Short Euro Area Energy Stocks / Long UK Energy Stocks Chart 3UK Energy Stocks As A Bargain This trade is up 7.5% since inception. This market neutral trade was fully based on the results from our CMVI (Chart 3). We are taking profits today. Short Consumer Discretionary / Long Telecommunication In Europe This trade is up 10.6% since inception. It is our favored way to express our tactical worries toward cyclical equities and the resulting preference for defensive stocks. Moreover, this trade is attractive from a valuation perspective, as the CMVI gap between discretionary and telecommunication equities is at a record high despite the higher RoE offered by telecom equities (Chart 4). Short Tech / Long Healthcare In Europe This trade is up 9.3% since inception. It is a low-octane version of the short discretionary / long telecommunications position. While it is a short cyclicals / long defensive trade, it does not have the long value / short growth overlay as its higher-octane cousin. However, it is also supported by attractive valuation differentials (Chart 5). Chart 4An Extreme Version Of Short Cyclicals / Long Defensives... Chart 5...and A Lower Octane Expression Favor Spain Over France This trade is down 2% since inception. Based on sectoral composition, the Spanish market is more defensive than that of France, which was an appealing characteristic considering our tactical worries for cyclical bets. Moreover, Spanish equities were more attractively priced. However, the Spanish economy has proven less resilient to the Delta variant than that of France. As a result, Spanish financials, which represent a large share of the national benchmark, have suffered. Underweight French Consumer Discretionary Equities Relative To Global Peers This trade is up 0.6% since inception. French discretionary stocks, led by beauty and luxury names, remain attractive structural plays. However, they have become expensive and risk temporarily underperforming their foreign competitors. Buy Swiss Equities / Sell Eurozone Defensive This trade is up 0.5% since inception. Due to their sectoral bias toward consumer staples and healthcare, Swiss equities are extremely defensive. However, they often outperform their Euro Area counterparts when Swiss yields rise relative to those of Germany. We do expect such widening to take place over the coming months. The ECB will continue to expand its balance sheet, which will force the SNB to become increasingly active about putting a floor under EUR/CHF. Historically, these processes boost Swiss stocks relative to Eurozone defensives. Buy European Momentum Stocks / Sell European Growth Stocks Chart 6The Recovery In Momentum Stocks Can Run Further This trade is up 1.7% since inception. In Europe, momentum stocks are exceptionally oversold relative to growth stocks (Chart 6). As yields stabilize, momentum stocks are well placed to outperform growth equities. Moreover, this trade is a careful attempt to begin to move away from our defensive tactical stance as China backs away from policy tightening. More Value Left In European IG This trade is up 0.9% so far. European IG bonds have low spreads, but their breakeven spreads may narrow further as policy remains extremely accommodative and European growth continues to recover, even in the face of the Delta variant. In this context, we see the modest yield pick-up offered by these products as attractive, especially compared to the meagre yields generated by European safe-haven securities. Despite the modest success of the overall recommendation, the country implication did not work out as well. Overweight Italian And Spanish Bonds In Balance Portfolios This trade is up 0.2% since inception. Italian and Spanish government bonds are expensive in absolute terms, but compare well relative to French, Dutch, or German bonds. In a backdrop in which the ECB continues to purchase these instruments, where the NGEU funds create an embryo of fiscal risk-sharing within the EU and where growth is recovering, risk premia in the European periphery have room to decline further. Buy European Steepeners And US Flatteners As A Box Trade Chart 7Buy European Steepeners and US Flatteners This trade is up 63 bps since inception. The ECB will lag behind the Fed, but market pricing already reflects this future. Meanwhile, the terminal policy rate proxy embedded in the EONIA and US OIS curves overstates how high the neutral rate is in the US compared to that of Europe (Chart 7). Thus, as the Fed begins to remove accommodation in the US, the US yield curve should flatten compared to that of Europe. Favor The GBP Over The EUR This trade is up 0.6% since inception. The pound is cheaper than the euro, and the domestic UK economy is well supported by the more advanced re-opening process. This combination will continue to hurt EUR/GBP. Sell EUR/NOK This trade is down 2.6% since inception. The NOK is cheaper than the EUR, and the Norges Bank will lead DM central banks in raising interest rates. Moreover, higher oil prices create a positive term of trade shock in favor of Norway. However, this trade has not worked out so far. Among G-10 currencies, the NOK (along with the SEK) is the most sensitive to the USD’s fluctuations. The rebound in the Greenback since March has therefore hurt this position significantly. Cyclical Recommendations Overweight Stocks Vs Bonds This position is up 7% since inception. European equities follow the global business cycle; while we warned a slowdown would take shape, growth is slated to remain above trend for the foreseeable future. Consequently, while we may adjust tactical positioning to take advantage of these gyrations in growth relative to expectations, our core cyclical view remains to overweight stocks within European balanced portfolios. Overweight Bank Equities Chart 8Euro Area Banks Are Not As Risky Anymore This position is up 2.4% since inception. We have espoused the near-term decline in yields, but our big picture cyclical view remains that yields have more upside globally. An environment in which yields increase is one in which bank profit margins expand, which will in turn boost the relative return of cheap financial equities. Even though the long-term growth rate of bank cash flows warrants a discount, these firms’ valuations also reflect the perception that they carry elevated risks. However, if European NPLs have greatly improved, capital buffers have expanded significantly (Chart 8), and the ECB is unwilling to precipitate a crisis as it did ten years ago. In this context, the risk premia embedded in European bank valuations have room to decrease, which will boost the relative performance of these equities. Bullish German Equities (Absolute) This position is up 3.9% since inception. German stocks are a direct bet on the global economy, as a result of their heavy weighting in industrials and consumer discretionary stocks. Moreover, the German economy continues to fare well, boosted by a cheap euro and a low policy rate. Finally, we expect German fiscal policy to remain accommodative after the upcoming federal election weakens the power of the CDU. This combination will allow German stocks to generate further upside over the coming years. Favor Swedish Equites Over Eurozone And US Benchmarks Since inception, this position is up 0.9% on its European leg and is up 0.3% on its US leg. Sweden is a particularly appealing market despite its demanding valuations. The Swedish benchmark overweighs industrials and financials, two of our favorite sectors for the coming eighteen months. Moreover, the Swedish corporate sector’s operating metrics are robust, with wide profit margins, elevated RoEs, and comparatively healthy levels of leverage. Finally, the SEK is one of our favored currencies on a twenty-four-month basis, because it has a strong beta to the USD, which BCA expects to depreciate on a cyclical time frame. Buying Sweden versus the Eurozone has worked out, but selling the US market has not, because yields experienced a countertrend decline. Once global yields begin to rise anew and Chinese credit growth begins to recover, Swedish equities should also beat their US peers. Long Swedish Industrials / Short Eurozone And US Industrials Chart 9Favor Swedish Industrials This position is up 3% on its European leg and 8.5% on its US one. This market neutral position narrows in on the very reason to favor Swedish equities: industrials. As is the case for the overall market, Swedish industrials offer stronger operating metrics than their counterparts in both the Eurozone and the US (Chart 9). Additionally, the early positioning of Sweden in global supply chains adds some operating leverage to these firms, which gives them an advantage in an environment of continued inventory rebuilding, infrastructure spending, and capex plans around the world. Underweight German Bunds Within European Fixed-Income Portfolios German bund yields have declined 15bps since inception. German Bunds suffer from their extremely demanding valuations versus other European fixed-income securities. As long as global and European growth remains above trend, German yields should underperform other European fixed-income assets, even if the ECB stands pat for the foreseeable future (which would force greater spread compression across European markets). Weakness In EUR/USD Creates Long-Term Buying Opportunities Earlier this spring, we expected the dollar to experience a counter-trend bounce as a result of skewed positioning and the potential for a decline in global growth surprises. However, BCA’s cyclical view calls for a weaker USD because of the US balance of payments deficit, the greater tolerance of the Fed for higher inflation, and the overvaluation of the Greenback. Based on these diverging forces, we continue to recommend investors use the current episode of weakness in EUR/USD as an opportunity to garner more exposure to the euro. Short EUR/SEK This position is down 0.6% since inception. The SEK is even more sensitive to the dollar’s gyration than the euro. Moreover, beyond some near-term disappointment in global economic activity, we expect global growth to remain generally robust over the coming eighteen months. This combination will allow the SEK to appreciate versus the EUR, especially when Sweden’s domestic economic activity and asset markets are stronger than that of the Eurozone. Structural Recommendations A Structural Underweight On European Financial Chart 10Too Much Capital This long-term position is at odds with our near-term optimism about the sector. However, Europe has an excessively large capital stock, which, relative to GDP, dwarves that of the US or China (Chart 10). This phenomenon hurts rate of returns across the region and will remain a long-term structural handicap for the financial industry. Hence, investors with long investment horizons should use the expected rebound in European financials over the next year or two to diminish further their exposure to that sector. Norwegian Equities Remain Challenged As Long-Term Holdings Norwegian stocks overweight the financials, materials, and energy sectors. While materials face a bright future as electricity becomes an even more important component of the global energy mix, financials and energy face deep structural headwinds. Moreover, the krone faces its own structural challenges (see below). This combination augurs poorly for the long-term rates of return of Norwegian stocks. Overweight French Industrials Relative To German Ones This position is a bet on the continuation of the reform efforts of the French economy. BCA expects Emmanuel Macron to win a second mandate next year, which should result in additional reforms to the French economy. As a result, the French unit labor costs should remain contained relative to those of Germany. This process will help the profit margins of French industrial firms relative to that of their competitors across the Rhine. Overweight French Tech Equities Relative To European Ones French tech stocks will benefit from the greater R&D subsidies and budgets promoted by the French government. The Euro Will Underperform Pro-Cyclical European Currencies The Swedish krona and the British pound are particularly attractive versus the euro on a long-term basis. They benefit not only from their cheaper valuations, but also from the fact that the Riksbank and the Bank of England will tighten policy considerably ahead of the ECB. Additionally, the SEK and the GBP are now both more pro-cyclical than the euro. The Norwegian Krone Faces Structural Challenges The NOK is cheap and may even benefit in the coming month from its historical pro-cyclicality. However, Norway suffers from declining productivity relative to that of its trading partners, which creates a strong long-term handicap for its currency. As a result, long-term investors should withdraw from the NOK.   Mathieu Savary, Chief European Strategist Mathieu@bcaresearch.com   Tactical Recommendations Cyclical Recommendations Structural Recommendations ​​​​​​​ Currency Performance Fixed Income Performance Equity Performance