Economy

Analysis on Chile is available below. Highlights Major equity leadership rotations normally occur around bear markets or corrections. Hence, a major broad selloff will likely be a precondition for EM, commodities, global cyclicals and value stocks to commence outperforming. The odds that EM equities will underperform the S&P 500 or DM share prices in an equity drawdown are 65-70%. A weaker dollar is essential to EM outperformance. We remain bullish on the dollar and are underweight/short EM. Feature The current decade has been characterized by the substantial outperformance of growth versus value stocks, the S&P 500 versus emerging and other international markets. BCA held its annual conference in New York last week. One of the key topics that investors wanted to get a handle on was the potential for a leadership rotation in global equity markets. The current decade has been characterized by the substantial outperformance of growth versus value stocks, the S&P 500 versus emerging and other international markets, FAANG share prices versus commodities and “old economy” stocks. Is this trend about to reverse? Opinions among our conference speakers certainly differed. Some still showed a penchant for growth stocks and U.S. equities, while others recommended global value and EM stocks. Our Themes For The Decade Our key long-term themes – laid out in our June 8, 2010 Special Report titled How To Play Emerging Market Growth In The Coming Decade1 – have shaped our investment strategy over the past decade have been: Commodities and materials and energy equity sectors as well as machinery stocks will be in a bear market because Chinese capital spending has peaked. Hence, investors should avoid EMs that are very sensitive to resource prices. Favoring EM/Chinese consumer plays, namely technology as well as healthcare stocks in general and healthcare equipment stocks in particular, is the way to play China/EM growth this decade. Given tech and healthcare account for a smaller weighting in EM stock indexes than in DM ones, we have been recommending that investors underweight EM against DM stocks. Needless to say, these themes have panned out extremely well, with EM, resources, commodities-related and machinery equity sectors underperforming massively (Chart I-1), and tech, consumer and healthcare stocks outperforming (Chart I-2). These themes have guided our strategy over the past nine years, leading us to be underweight EM equities in favor of the S&P 500, which is heavily dominated by tech, consumer and healthcare companies. Chart I-1China Capex Plays Have Underperformed This Decade Chart I-2Our Favorites For This Decade Have Outperformed Any investment trend has a beginning and an end. It is essential not to overstay in winning strategies. Critically, Chart I-3 shows that the magnitude of the rise in FAANG stocks over the past 10 years is comparable to bubbles of previous decades. This chart compares asset prices in real (inflation-adjusted) U.S. dollar terms. Chart I-3FAANG And Previous Bubbles In Perspective Only history will tell whether FAANGs are currently in a bubble or not. Presently, we do not have a high conviction view on this matter. However, even if they are not in a bubble, they are extremely overbought and expensive. Their failure to break above their 2018 highs is a negative technical signal. Altogether, this warrants a cautious stance on the absolute performance of FAANGs. Bottom Line: Regardless of the direction of FAANG stocks, odds are that EM share prices will relapse in absolute terms before a sustainable bottom emerges. For a detailed discussion on this, please refer to pages 6-9. In such a scenario, it is hard to envision FAANG stocks rallying. They may continue outperforming on a relative basis, but they will still deflate in absolute terms. Equity Rotations Occur Around Bear Markets The relative performance of global growth versus value stocks often experiences trend reversals during or after selloffs. With respect to equity leadership rotation, it is crucial to note that equity leadership rotations typically occur during or after bear markets and/or corrections in global share prices. Chart I-4 illustrates EM relative stock prices versus DM along with the global equity index. Over the past 25 years, there have been several major leadership changes between EM and DM – and all of them coincided with, or were preceded by, either a bear market or a correction in global share prices. Similarly, the relative performance of global growth versus value stocks often experiences trend reversals during or after selloffs (Chart I-5). Chart I-4EM Versus DM: Equity Rotations Chart I-5Global Growth Versus Value: Leadership Rotations Finally, structural trend changes in the relative performance of the global tech sector, energy stocks and materials have also occurred during or after drawdowns in global share prices (Chart I-6). Chart I-6Global Technology, Energy And Materials: Leadership Rotations Bottom Line: Major equity leadership rotations normally occur around bear markets or corrections. Hence, a major selloff is likely before EM, commodities, global cyclicals and value stocks begin to outperform. We will contemplate changing our relative equity strategy if a major broad selloff transpires. In such an equity drawdown, there is a 30-35% chance that EM may outperform the S&P 500, as it did during the carnage in global stocks in the fourth quarter of last year. In short, the probability that EM share prices underperform the S&P 500 and DM is 65-70%. A weaker dollar is essential for EM outperformance. BCA’s Emerging Markets Strategy service remains bullish on the dollar and is underweight/short EM. A Breakdown In EM And Global Cyclicals? With China’s manufacturing PMI once again on the rise, it is critical to challenge our view on the Chinese business cycle as well as global manufacturing and trade. In our opinion, the latest rise in the mainland manufacturing PMI is an aberration rather than a new trend: Chinese share prices over the years have been coincident with or leading mainland manufacturing PMI. Stocks are currently pointing to a relapse in the latter (Chart I-7). The message from Chinese share prices is that the latest improvement in the nation’s manufacturing PMI should be faded. Chart I-7Chinese Share Prices And Manufacturing PMI The global manufacturing recession is still spreading. The global manufacturing recession is still spreading. This has yet to be discounted in global cyclical equity sectors. The latter have been moving sideways over the past year and a half, despite the contraction in global manufacturing activity (Chart I-8). Equity investors’ patience may be wearing thin as the expected global manufacturing recovery has so far failed to materialize. Chart I-8Global Cyclical Stocks And Manufacturing PMI Chart I-9EM EPS And Korean Exports: Moving In Tandem Korean exports in September contracted at a rate close to 10% year-on-year (Chart I-9, top panel). Interestingly, the level of EM corporate earnings per share (EPS) in U.S. dollar terms exhibits a similar pattern with Korean exports (Chart I-9, bottom panel). Both are at the same level they were in 2010. Hence, over this decade EM EPS and Korean exports in U.S. dollar terms have not expanded at all. U.S. high-beta stocks in aggregate as well as share prices of high-beta industrials and technology stocks are close to breaking below their technical support lines (Chart I-10). They could be canaries in a coal mine for the S&P 500. Chart I-10U.S. High-Beta Stocks Are Breaking Down Chart I-11A Bearish Signal For EM And Commodities Despite a very weak U.S. manufacturing PMI, the dollar remains well bid. This signifies that the global manufacturing recession emanates from the rest of the world – not the U.S. In fact, the U.S. manufacturing sector has been the last domino to fall. Persistent strength in the greenback is a symptom of weakening global growth. Our Risk-On / Safe-Haven Currency ratio2 – which is agnostic to dollar trends – is plunging, corroborating the downbeat outlook for global growth in general and commodities prices in particular (Chart I-11). Finally, overall EM and Asian high-yield corporate credit spreads are widening versus investment grade ones. This is a sign of rising risk aversion.  EM credit markets and local currency bonds have so far been reasonably resilient, despite the selloff in EM share prices and currencies (Chart I-12). The basis for such decoupling has been the indiscriminate search for yield rather than improving EM growth dynamics. Chart I-12EM Credit Markets Will Recouple To Downside With Stocks And Currencies Deteriorating growth will eventually cause a widening of EM credit spreads. Besides, persistent EM currency depreciation will likely lead to outflows from EM high-yield local bond markets. Bottom Line: EM equities, credit markets and high-yielding local currency bonds are at risk of a major selloff. Our list of country allocations across various EM asset classes as well as our trades can always be found at the end of our reports, please refer to pages 14-15. We continue to recommend shorting the following basket of EM currencies versus the dollar: ZAR, CLP, COP, IDR, MYR, PHP and KRW.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Chile: Still Favor Bonds Over Stocks; Bet On Lower Inflation We have been betting on sluggish growth, lower interest rates and a weakening currency in Chile. These positions have panned out well as the economy has slowed considerably, local bond yields have plunged and the currency depreciated significantly (Chart II-1, top and middle panels). However, our overweight position in Chilean equities within a dedicated EM stock portfolio has performed poorly (Chart II-1, bottom panel). Is it time to reconsider our position? Chart II-1Our Strategy For Chile Having re-examined the cyclical dynamics of this economy and putting it in the context of the global backdrop, we reiterate our investment recommendations. We also see a new investment opportunity within the Chilean fixed-income markets – investors should consider betting on lower inflation expectations, i.e., going long domestic bonds and shorting inflation-linked bonds. We believe the bond market’s medium-to long-term inflation expectations are overstated and will drop in the coming months. The Chilean economy will likely weaken further and inflation is set to drop considerably beyond the near term. Even though the central bank has already cut rates by 100 basis points, it will take both more easing and time before the credit impulse turns positive and lifts domestic demand. The credit impulse for businesses points to a relapse in capital spending (Chart II-2). The adopted fiscal stimulus has been negligible at 0.21% of GDP for 2019 and 2020. While government spending growth is bottoming, overall fiscal expenditures account for 20% of GDP. In brief, they are too small to make a major difference for the economy. Chart II-2Chile: Falling Credit Impulse = Weak Capex With non-mining exports contracting and commodities prices plunging, the export sectors will continue to depress growth. Corporate profits are shrinking and this will dent capital spending and hiring. Critically, rising unit labor costs are depressing corporate profit margins (Chart II-3). The latter have spiked because the output slowdown has not yet been matched by layoffs or lower wage growth. In turn, forthcoming layoffs amid the already rising unemployment rate will certainly lead to considerable wage disinflation (Chart II-4). Chile has seen massive inflows of immigrants from Venezuela in recent years, which will prove to be a major disinflationary force for this economy in the medium-term. Finally, goods price inflation – which has stemmed from currency depreciation – could prevent consumer inflation from falling in the near term. Yet, this phenomena will not be sustainable beyond the near term. Chart II-3Shrinking Profits Will Lead Businesses To Reduce Unit Labor Costs Chart II-4Wage Growth Is Unsustainably High On the whole, the fixed-income market will look through currency depreciation-induced goods inflation and begin pricing in much lower inflation expectations. We recommend betting that 3-year inflation expectations will decline from 2.5% to 1.5% in the next 12 months (Chart II-5). We have been receiving 3-year swap rates since May 31st, 2018 and this position remains intact. The peso will continue to depreciate as copper prices fall further. Notably, the real effective exchange rate based on unit labor costs – computed by the OECD – suggests that the peso is still expensive (Chart II-6). The last datapoint is as of September 2019. This is probably due to depreciation in other Latin American currencies. Chart II-5Chile: Inflation Expectations To Plunge Chart II-6The CLP Is Not Cheap Finally, we are reluctant to downgrade the Chilean bourse within an EM equity portfolio. Policy easing and large underperformance as well as the positive structural outlook should produce a period of outperformance by this stock market amid the selloff in the overall EM equity universe. Local asset allocators should continue favoring bonds versus stocks. Bottom Line: As a new trade for fixed-income investors: We recommend going long 3-year domestic bonds and shorting 3-year inflation-linked bonds.   Juan Egaña, Research Associate juane@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com   Footnotes 1      Please see Emerging Markets Strategy Special Report, “How To Play Emerging Market Growth In The Coming Decade”, dated June 8, 2010, available at ems.bcaresearch.com 2      Average of CAD, AUD, NZD, BRL, CLP & ZAR total return indices relative to average of JPY & CHF total returns (including carry). Equities Recommendations Currencies, Credit And Fixed-Income Recommendations

Highlights European and global growth will rebound in the fourth quarter but the rebound will lack longevity. Bonds: Expect bond yields to edge modestly higher, especially for those yields that are deeply in negative territory. Underweight German bunds in a European or global bond portfolio. Currencies: Zero/negative yielding currencies have the most to gain, and our preference remains the yen. Equities: a tug of war between growth and valuation will leave the broad equity market index in a sideways channel. But with the higher yield, prefer equities over bonds. Equity sectors: Non-China cyclical plays will outperform China plays. Continue to overweight banks versus resources and/or industrials. Equity regions: Continue to overweight the Eurostoxx 50 versus the Shanghai Composite and/or the Nikkei 225. Feature Comfort and discomfort are not absolute, they are relative. Put your hand in cold water, and whether it feels comfortable or uncomfortable depends on where your hand has come from. If your hand has come from room temperature, the cold water will feel uncomfortable. But if your hand has come from an ice bucket, the cold water will feel like bliss! The same principle applies to how we, and the financial markets, perceive short-term economic growth. After a strong expansion, a pedestrian growth rate of 1 percent feels uncomfortable. But after an economic contraction, 1 percent growth feels very pleasant. This leads to two important points: In the short term, the market is less concerned about the rate of growth per se, it is more concerned about whether the rate of growth is accelerating or decelerating. When it comes to the short term drivers of growth – bond yields, credit, and the oil price – we must focus not on their changes, we must focus on their impulses, meaning the changes in their changes. This is because it is the impulses of bond yields, credit, and the oil price that drive the accelerations and decelerations of economic growth, often with a useful lead time of a few months. The Chart of the Week combined with Chart I-1-Chart I-4 should leave you in no doubt. In the euro area, United States, and China, the domestic bond yield 6-month impulses have led their domestic 6-month credit impulses with near-perfect precision. Chart of the WeekCredit Growth To Rebound In The Fourth Quarter, Then Fade Chart I-2The Euro Area Bond Yield Impulse Leads Its Credit Impulse Chart I-3The U.S. Bond Yield Impulse Leads Its Credit Impulse Chart I-4The China Bond Yield Impulse Leads Its Credit Impulse Based on this near-perfect precision, the credit impulses in the euro area and the U.S. should briefly rebound in the fourth quarter. But expect much less of a rebound, if any, in China. While bond yields have collapsed in the euro area and the U.S., resulting in tailwind credit impulses, they have moved much less in China. Indeed, China’s bond yield 6-month impulse has been moving deeper into headwind territory in the past few months (Chart I-5). Chart I-5Bond Yield Impulses Were Tailwinds In The Euro Area And U.S., But Not In China It follows that a credit growth rebound in the fourth quarter will be sourced in Europe and the U.S. rather than in China. From a tactical perspective, this will favour non-China cyclical plays over China plays. But moving into the early part of 2020, expect the credit impulses to fade across all the major economies – unless bond yields now fall very sharply everywhere. Investing On Impulse Many people still find it confusing that it is the impulses – and not the changes – of bond yields, credit, and the oil price that drive the accelerations and decelerations of economic growth. To resolve this confusion, let’s clarify the point. The credit impulses in the euro area and the U.S. should briefly rebound in the fourth quarter.  A bond yield decline will trigger new borrowing. For example, a given decline in the U.S. bond yield, say 0.5 percent, will trigger a given increase in the number of mortgage applications (Chart I-6). New borrowing will add to demand, meaning it will generate growth. But in the following period, a further bond yield decline of 0.5 percent will generate the same further new borrowing and growth rate. The crucial point is that, if the decline in the bond yield is the same, growth will not accelerate. Chart I-6A Given Decline In The Bond Yield Triggers A Given Increase In New Borrowing Growth will accelerate only if the first 0.5 percent bond yield decline is followed by a bigger, say 0.6 percent, decline – meaning a tailwind impulse. Conversely and counterintuitively, growth will decelerate if the first 0.5 percent decline is followed by a smaller, say 0.4 percent, decline – meaning a headwind impulse. Don’t Blame Autos For A German Recession Chart I-7German Car Production Rebounded In The Third Quarter If the German economy contracts in the third quarter and thereby enters a technical recession, the knee-jerk response will be to blame the troubles in the auto industry. But the evidence does not support this story. German new car production rebounded in the third quarter (Chart I-7). Begging the question: if not autos, what is the true culprit for the deceleration? The likely answer is that Germany recently suffered a severe headwind from the oil price impulse. Germany has one of the world’s highest volumes of road traffic per unit of GDP, second only to the U.S. (Table I-1). A possible explanation for Germany’s high traffic intensity is that, just like the U.S., Germany is a decentralised economy with multiple ‘hubs and spokes’ requiring a lot of criss-crossing of traffic. But unlike the U.S., German transport is highly dependent on oil imports, which tend to be non-substitutable and highly inelastic to price. As the value of German oil imports rise in lockstep with the oil price, Germany’s net exports decline, weighing on growth. Table I-1Germany Has A Very High Road Traffic Intensity   The upshot is that the oil price impulse has a major bearing on Germany’s short term growth accelerations and decelerations. The six month period ending around June 2019 constituted a severe headwind impulse. This is because a 30 percent increase in the oil price in that period followed a 40 percent decline in the previous six month period, equating to a headwind impulse of 70 percent.1  Germany has one of the world’s highest volumes of road traffic per unit of GDP. Allowing for typical lags of a few months, this severe headwind impulse was a major contributor to Germany’s recent deceleration. Oscillations in the oil price’s 6-month impulse have explained the oscillations in Germany’s 6-month economic growth with a spooky accuracy (Chart I-8). The good news is that the oil price’s severe headwind impulse has eased – allowing a rebound in German economic growth during the fourth quarter. Chart I-8The Oil Price Impulse Explains Oscillations In German Growth Nevertheless, a putative rebound could be nullified by a wildcard: the ‘geopolitical risk impulse’. To be clear this is not an impulse in the technical sense, but it is a similar concept: are the number of potential tail-events increasing or decreasing? For the fourth quarter, our subjective answer is they are decreasing. In Europe, the formation of a new coalition government in Italy has removed Italian politics as a possible tail-event for the time being. Meanwhile, we assume that the Benn-Burt law in the U.K. has been drafted well enough to eliminate a potential no-deal Brexit on October 31. Elsewhere, the U.S/China trade war and Middle East tensions are most likely to be in stasis through the fourth quarter.  How To Position For The Fourth Quarter After a disappointing third quarter for global and European growth, we expect a rebound in the fourth quarter. But at the moment, we do not have any conviction that the rebound’s momentum will take it deeply into 2020. Position for the fourth quarter as follows:  Expect a rebound in the fourth quarter. Bonds: Expect bond yields to edge modestly higher, especially for those yields that are deeply in negative territory. Underweight German bunds in a European or global bond portfolio. Currencies: Zero/negative yielding currencies have the most to gain, and our preference remains the yen. With a Brexit denouement, the pound could be the biggest mover and our inkling is to the upside. But we await more clarity before pulling the trigger. Equities: a tug of war between growth and valuation will leave the broad equity market index in the sideways range in which it has existed over the past two years (Chart I-9). But with a higher yield than bonds, equities are the preferred asset-class in the ugly contest. Equity sectors: Non-China cyclical plays will outperform China plays. Continue to overweight banks versus resources and/or industrials. Equity regions: Continue to overweight the Eurostoxx 50 versus the Shanghai Composite and/or the Nikkei 225 (Chart I-10). Chart I-9Global Equities Have Gone Nowhere For Two Years Chart I-10Stay Overweight Europe ##br##Versus China   Fractal Trading System* The recent surge in the nickel price is due to scares about supply disruption, specifically an Indonesian export ban. However, the extent of the rally appears technically stretched. We would express this as a pair-trade versus gold: long gold / short nickel. Chart I-11Nickel VS. Gold Set a profit target of 11 percent with a symmetrical stop-loss. 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. 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. * 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. Dhaval Joshi, Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 The 6-month steps in the WTI crude oil price were $74.15, $45.21, and $58.24. The first change equated to a 40 percent decrease and the second change equated to a 30 percent increase. So the 6-month impulse was 70 percent. Fractal Trading Model Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields   Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations  

Highlights Global LEI Upturn: Our Global leading economic indicator (LEI) has started to climb higher, signaling a potential end to the current global growth slowdown. LEI Components: This improvement is broad-based across countries and regions, focused mostly within EM countries (with the U.S. and Germany lagging the global move). The uptick in the global LEI is well-supported when looking at the individual components that go into the overall indicator. Implications for Bond Yields: Given the historically strong correlation between our global LEI and global bond yields, we view the improving LEI as a core element behind our current below-benchmark stance on global duration exposure. Feature Chart of the WeekGlobal LEI Rising - Are Bond Yields Next? We have received many client questions recently regarding the latest uptick in our BCA Global Leading Economic indicator (LEI), which bottomed back in July of this year and has since steadily climbed. This pickup in the global LEI has been broad-based across countries, as evidenced by the run up in our global LEI diffusion index, which measures the percentage of countries with a rising LEI versus a falling LEI. That diffusion index is itself a reliable leading indicator of the global LEI, and of both the level and rate-of-change of global bond yields (Chart of the Week), and is flagging an end to the massive government bond rally of 2019. For our global LEI, we prefer to use a smaller set of countries but with a bigger weighting on EM economies (Table 1), given the larger share of global economic growth generated in the EM world (including, most notably, China).  At a time when U.S.-China trade uncertainty has yet to subside significantly, and with reliable coincident cyclical indicators like manufacturing PMIs still showing that global growth momentum is decelerating, this naturally invites questions on what is in our global LEI and what could possibly be driving it higher. In this Weekly Report, we try to answer those questions visually by breaking down the details of our global LEI by region, country and individual component data series. What Is In The BCA Global LEI? The BCA global LEI is a composite index that combines the LEIs of 23 individual countries using GDP-weights. The underlying list of countries differs from that of the widely-followed OECD LEI, which is comprised of data from 33 countries but with a heavy weighting on developed market (DM) economies. The overall OECD LEI excludes important EM exporting countries such as Taiwan and Singapore, which are highly sensitive to changes in global growth. For our global LEI, we prefer to use a smaller set of countries but with a bigger weighting on EM economies (Table 1), given the larger share of global economic growth generated in the EM world (including, most notably, China). Table 1Country Weightings Of The BCA & OECD Global LEIs According to our calculations using global growth data from the IMF, 58% of global growth has come from EM or developing economies (including China) since the 2009 global recession, with that number projected to rise to 64% by 2024. That compares to a nearly 50/50 split, on average, between 2001 and 2010. Thus, the 33% weight of EM countries in our global LEI (which is based on GDP level weights and not GDP growth weights) provides a much better measure of future global prospects than the OECD LEI which has only a 13% weight in EM. That can be seen in the much higher correlation (Chart 2) between the BCA global LEI (advanced by one year) and global real GDP growth relative to a similar correlation using the OECD LEI (also advanced one year so it leads growth). Chart 2The BCA Global LEI Is A Better Predictor Of Future Growth For most of the nations in our global LEI, we do use the country-level LEIs produced by the OECD.1 That also includes several large and important non-OECD EM countries that the OECD calculates LEIs for - a list that includes China, Brazil, India, Russia, Indonesia and South Africa. For a few selected countries, however, we use the following data: U.S., Korea, Taiwan and Singapore: LEIs produced by national government data sources or, in the case of the U.S., the Conference Board Argentina, Malaysia and Thailand: LEIs produced in-house at BCA, a necessary step given the lack of domestically-produced LEIs in those countries at the time our global LEI was first constructed. Where Is The Current Uptick In The BCA Global LEI Coming From? Chart 3The Latest Global LEI Uptick Is All About EM When we separate our global LEI into “sub-LEIs” for the DM and EM countries, we see that the current uptick in the global LEI has come entirely from EM (Chart 3). A potential bottoming of the DM LEI, however, is also on the horizon given the sharp run-up in the DM-only global LEI diffusion index. We have also broken down the list of countries in our global LEI into regional sub-indices (Chart 4). On this basis, the LEIs paint an optimistic picture for South America and Eastern Europe, while the Asian and Western Europe LEIs are in the process of bottoming out. The regional LEI for North America, however, remains in a downtrend, although the most recent data point did hook upward. Chart 4The Global LEI Uptick Is Regionally Broad-Based Pages 8-18 of this report contain charts showing the underlying data series that go into the individual country LEIs that comprise our global LEI. The charts are presented with the top panel showing the relationship between the LEI and GDP growth for each country, with the remaining panels of each chart containing the individual components of each country’s LEI. Shown this way, we can show both the reliability of the each LEI in predicting economic growth, as well as what is contributing to the change in the LEI. When we separate our global LEI into “sub-LEIs” for the DM and EM countries, we see that the current uptick in the global LEI has come entirely from EM (Chart 3). A potential bottoming of the DM LEI, however, is also on the horizon given the sharp run-up in the DM-only global LEI diffusion index. It should be noted that we are presenting the underlying LEI data series with very little of the usual de-trending and smoothing that the OECD uses to turn more volatile data into less noisy measures that correlate better with economic growth. We chose to do this in the interest of transparency, as the goal of this report is to “look under the hood” of our global LEI to see the raw, untransformed data that is driving the current upturn. For the most part, the choice of data that goes into the LEIs does show some similarity across countries. The most common LEI components are those related to equity markets, money supply growth, export orders, business/consumer confidence, inventories, short-term interest rates (or by association, the slope of yield curves) and for some EM countries, consumer price inflation. We can make a few summary comments on the latest trends within the country LEIs: Key Asian emerging markets such as Malaysia, Thailand, and Taiwan have been supported by a growing money supply. However, hard data relating to exports and domestic demand remain mixed. The Chinese LEI, on a standardized and de-trended basis, has rebounded back above zero. Despite trade tensions, hard data has helped push up expected Chinese growth. Growth in fertilizer and motor vehicles production has hooked up, while crude steel production continues to grow at a healthy 9% pace. In developed Asian markets, the picture has been more mixed. Japan and Korea have been hurt by a decline in small business and consumer confidence, respectively. Stock prices in Japan have remained flat while they have actually declined in Korea. Data relating to construction is weak in both countries. At the same time, Singapore, an important barometer of global growth, has been hurt by the falling imports and business expectations. In Latin American markets, we have seen improvement in the soft data measured through business tendency surveys focused on manufacturers. An expanding money supply has seen Argentina and Chile begin to dig themselves out of negative territory. Also, a narrowing yield spread between Mexican and U.S. sovereign debt and strong production tendency numbers have helped the Mexican LEI hit a 10-year high, on a standardized and de-trended basis. So, where is the weakness in the global economy? If you were to consider only the LEIs, the U.S. and Germany appear to be the main culprits. The U.S. LEI has steadily drifted into negative territory in 2019, owing to a downtrend in average weekly hours in manufacturing, contracting new orders for consumer goods and materials, and the inverted U.S. Treasury yield curve. Although the latest readings from building permits, equity prices and M2 growth are sending a more hopeful message on future U.S. growth. With all the geopolitical uncertainties stemming from the U.S.-China tariff battles, Brexit, bubbling Mideast tensions and even the 2020 U.S. Presidential cycle, the value of using forward-looking indicators with a successful track record of forecasting economic growth – rather than watching contemporaneous or even lagging data - has never been greater. In Germany, however, the picture is much worse. The soft data indicates that a deep pessimism has set in among German manufacturers. The IFO business climate index and manufacturing expectations of export order books have both been on a sharp decline year-to-date and showed only the slightest of upticks in the month of September. This pessimism is also reflected on the non-manufacturing side, where expected demand for services and consumer confidence have tumbled. We can draw some hope from the recent uptick in manufacturing new orders, but we will have to see sustained improvement across more LEI components before we can call a turnaround in German growth. Given how widely followed the U.S. and German economic data releases are among investors, it should not be surprising that there is a palpable fear in the markets of potential global recession. Yet the U.S. and German economies typically lag the global business cycle. EM economies, especially in China and non-Japan Asia, are where growth upturns begin and the LEIs there are now bottoming out and, in some cases, outright improving. Investment Implications Our final assessment of our global LEI is that: a. there is nothing in the construction of the index that is distorting the message from the current uptick in the LEI b. the rise in the global LEI is still in its early days c. The improvement in the LEI is coming from a significant share of the global economy, and has roots in hard data and not just liquidity-based measures like rising equity prices or money supply growth. With all the geopolitical uncertainties stemming from the U.S.-China tariff battles, Brexit, bubbling Mideast tensions and even the 2020 U.S. Presidential cycle, the value of using forward-looking indicators with a successful track record of forecasting economic growth – rather than watching contemporaneous or even lagging data - has never been greater. Given the historically strong correlation between our global LEI and the level and change of global bond yields, we view the improving LEI as a core element behind our current below-benchmark stance on global duration exposure. Chart 5Argentina LEI: Bottoming Out Chart 6Brazil LEI: Modestly Improving   Chart 7Canada LEI: Hooking Up Chart 8Chile LEI: Bottoming Out Chart 9China LEI: Strong Improvement Chart 10Czech Republic LEI: Deteriorating     Chart 11France LEI: Hooking Up Chart 12German LEI: Steadily Falling   Chart 13Hungary LEI: Falling Chart 14Italy LEI: Bottoming Out   Chart 15Japan LEI: Still Falling Chart 16Korea LEI: Stabilizing   Chart 17Malaysia LEI: Bottoming Out Chart 18Mexico LEI: Booming Chart 19Poland LEI: Stabilizing Chart 20Russia LEI: Stabilizing Chart 21Singapore LEI: Still Falling Chart 22South Africa LEI: Stabilizing Chart 23Taiwan LEI: Solid Uptrend Chart 24Thailand LEI: Solid Uptrend   Chart 25Turkey LEI: Very Strong Uptrend Chart 26U.K. LEI: Inching Upward   Chart 27U.S. LEI: Weakening Ray Park, CFA, Research Analyst ray@bcaresearch.com Shakti Sharma, Research Associate shaktis@bcaresearch.com Robert Robis, CFA, Chief Fixed Income Strategist rrobis@bcaresearch.com Footnotes 1Details on how the OECD calculates the individual country leading economic indicators can be found here: http://www.oecd.org/sdd/leading-indicators/compositeleadingindicatorsclifrequentlyaskedquestionsfaqs.htm   The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Recommendations Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns

The latest ISM manufacturing report made for grim reading. All of the survey’s subcomponents were either contracting, slowing, too low or decreasing, despite the recent, at the margin, improved news on the U.S./China trade war. Importantly, new export orders fell further to 41 from last month’s 43.3 reading (middle panel), warning that U.S. manufacturing is hurting from the rising U.S. dollar and the ongoing trade war. Thus, CEO’s are clearly in retrenchment mode. As a reminder, this comes on the heels of the Duke CFO survey that was downright pessimistic and last week’s Business Roundtable CEO Survey release that sunk further (bottom panel). The Atlanta Fed’s compiled Survey of Business Uncertainty update corroborated these dire messages, underscoring that animal spirits are in retreat posing a rising threat to economic growth. Bottom Line: Such a backdrop warrants caution on the prospects of the overall equity market.