Emerging Markets

Executive Summary China's Unemployment Questions From The Road Questions From The Road Over the past week we have been visiting clients along the US west coast. In this report we hit some of the highlights from the most important and frequently asked questions. Xi Jinping is seizing absolute power just as the country’s decades-long property boom turns to bust. He will stimulate the economy but Chinese stimulus is less effective than it used to be. The US and Israel are underscoring their red line against Iranian nuclear weaponization. If Iran does not freeze its nuclear program, the Middle East will begin to unravel again. The UK’s domestic instability is returning, with Scotland threatening to leave the union. Brexit, the pandemic, and inflation make a Scottish referendum a more serious risk than in the past. Shinzo Abe’s assassination makes him a martyr for a vision of Japan as a “normal country” – i.e. one that is not pacifist but capable of defending itself. Japan’s rearmament, like Germany’s, points to the decline of the WWII peace settlement and the return of great power competition. Bottom Line: Investors need a new global balance to be achieved through US diplomacy with Russia, China, and Iran. That is not forthcoming, as the chief nations face instability at home and a stagflationary global economy. Feature The world is becoming less stable as stagflation combines with great power competition. Global uncertainty is through the roof. From a macroeconomic perspective, investors need to know whether central banks can whip inflation without triggering a recession. From a geopolitical perspective, investors need to know whether Russia’s conflict with the West will expand, whether US-China and US-Iran tensions will escalate in a damaging way, and whether domestic political rotations in the US and China this fall will lead to more stable and productive economies. China: What Will Happen At The Communist Party Reshuffle? General Secretary Xi Jinping will cement another five-to-10 years in power while promoting members of his faction into key positions on the Politburo and Politburo Standing Committee. By December Xi will roll out a pro-growth strategy for 2023 and the government will signal that it will start relaxing Covid-19 restrictions. But China’s structural problems ensure that this good news for global growth will only have a fleeting effect. China’s governance is shifting from single-party rule to single-person rule. It is also shifting from commercially focused decentralization to national security focused centralization. Xi has concentrated power in himself, in the party, and in Beijing at the expense of political opponents, the private economy, and outlying regions like Hong Kong, the South China Sea, and Xinjiang. The subordination of Taiwan is the next major project, ensuring that China will ally with Russia and that the US and China cannot repair or deepen their economic partnership. Related Report  Geopolitical StrategyWill China Let 100 Flowers Bloom? Only Briefly. Xi and the Communist Party began centralizing political power and economic control shortly after the Great Recession. At that time it became clear that a painful transition away from export manufacturing and close relations with the United States was necessary. The transition would jeopardize China’s long-term economic, social, political, and geopolitical stability. The Communist Party believed it needed to revive strongman leadership (autocracy) rather than pursuing greater liberalization that would ultimately increase the odds of political revolution (democratization). The Xi administration has struggled to manage the country’s vast debt bubble, given that total debt standing has surged to 287% of GDP. The global pandemic forced the government to launch another large stimulus package, which it then attempted to contain. Corporate and household deleveraging ensued. The property and infrastructure boom of the past three decades has stalled, as the regime has imposed liquidity and capital requirements on banks and property developers to try to avoid a financial crisis. Regulatory tightening occurred in other sectors to try to steer investment into government-approved sectors and reduce the odds of technological advancement fanning social dissent. China’s draconian “zero Covid” policy sought to limit the disease’s toll, improve China’s economic self-reliance, and eliminate the threat of social protest during the year of the twentieth party congress. But it also slammed the brakes on growth. China is highly vulnerable to social instability for both structural and cyclical reasons. Chinese social unrest was our number one “Black Swan” for this year and it is now starting to take shape in the form of angry mortgage owners across the country refusing to make mortgage payments on houses that were pre-purchased but not yet built and delivered (Chart 1). Chart 1China: Mortgage Payment Boycott Questions From The Road Questions From The Road The mortgage payment boycott is important because it is stemming from the outstanding economic and financial imbalance – the property sector – and because it is a form of cross-regional social organization, which the Communist Party will disapprove. There are other social protests emerging, including low-level bank runs, which must be monitored very closely. Local authorities will act quickly to stop the spread of the mortgage boycott. But unhappy homeowners will be a persistent problem due to the decline of the property sector and industry. China’s property sector looks uncomfortably like the American property sector ahead of the 2006-08 bust. Prices for existing homes are falling while new house prices are on the verge of falling (Chart 2). While mortgages only make up 15% of bank assets, and household debt is only 62% of GDP, households are no longer taking on new debt (Chart 3). Chart 2China's Falling Property Prices China's Falling Property Prices China's Falling Property Prices ​​​​​​ Chart 3China's Property Crisis China's Property Crisis China's Property Crisis ​​​​​​ Chart 4China's Unemployment China's Unemployment China's Unemployment Most likely China’s property sector is entering the bust phase that we have long expected – if not, then the reason will be a rapid and aggressive move by authorities to expand monetary and fiscal stimulus and loosen economic restrictions. That process of broad-based easing – “letting 100 flowers bloom” – will not fully get under way until after the party congress, say in December. Unemployment is rising across China as the economy slows, another point of comparison with the United States ahead of the 2008 property collapse (Chart 4). Unemployment is a manipulated statistic so real conditions are likely worse. There is no more important indicator. China’s government will be forced to ease policy, creating a positive impact on global growth in 2023, but the impact will be fleeting. Bottom Line: The underlying debt-deflationary context will prevail before long in China, weighing on global growth and inflation expectations on a cyclical basis. Middle East: Why Did Biden Go And What Will He Get? President Biden traveled to Israel and now Saudi Arabia because he wants Saudi Arabia and the Gulf Arab members of OPEC to increase oil production to reduce gasoline prices at the pump for Americans ahead of the midterm elections (Chart 5). Chart 5Biden Goes To Israel And Saudi Arabia Biden Goes To Israel And Saudi Arabia Biden Goes To Israel And Saudi Arabia True, fears of recession are already weighing on prices, but Biden embarked on this mission before the growth slowdown was fully appreciated and he is not going to lightly abandon the anti-inflation fight before the midterm election. Biden also went because one of his top foreign policy priorities – the renegotiation of the 2015 nuclear deal with Iran – is falling apart. The Iranians do not want to freeze their nuclear program because they want regime survival and security. While Biden is offering a return to the 2015 deal, the conditions that produced the deal are no longer applicable: Russia and China are not cooperating with the US and EU to isolate Iran. Russia is courting Iran, oil prices are high and sanction enforcement is weak (unlike 2015). The Iranians now know, after the Trump administration, that they cannot trust the Americans to give credible security guarantees that will last across parties and administrations. The war in Ukraine also underscores the weakness of diplomatic security guarantees as opposed to a nuclear deterrent. Hence the joint US and Israeli declaration that Iran will never be allowed to obtain nuclear weapons. The good news is that this kind of joint statement is precisely what needed to occur – the underscoring of the red line – to try to change Ayatollah Ali Khamenei’s calculus regarding his drive to achieve nuclear breakout. In 2015 Khamenei gave diplomacy a chance to try to improve the economy, stave off social unrest, prepare the way for his eventual leadership succession process, and secure the Islamic Republic. The bad news is that Khamenei probably cannot make the same decision this time, as the hawkish faction now runs his government, the Americans are unreliable, and Russia and China are offering an alternative strategic orientation. The Saudis will pump more oil if necessary to save the global business cycle but not at the beck and call of a US president. The drop in oil prices reduces their urgency. The Americans can reassure the Saudis and Israel as long as the deal with Iran is not going forward. That looks to be the case. But then the US and Israel will have to undertake joint actions to underline their threat to Iran – and Iran will have to threaten to stage attacks across the region so as to deter any attack. Bottom Line: If a US-Iran deal does not materialize at the last minute, Middle Eastern instability will revive and a new source of oil supply constraint will plague the global economy. We continue to believe a US-Iran deal is unlikely, with only 40% odds of happening. Europe: Will Russia Turn Back On The Natural Gas? Russia’s objective in cutting off European natural gas is to inflict a recession on Europe. It wants a better bargaining position on strategic matters. Therefore we assume Russia will continue to squeeze supplies from now through the winter, when European demand rises and Russian leverage will peak. If Russia allows some flow to return, then it will be part of the negotiating process and will not preclude another cutoff before winter. It is possible that Russia is merely giving Europe a warning and will revert back to supplying natural gas. The problem is that Russia’s purpose is to achieve a strategic victory in Ukraine and in negotiations over NATO’s role in the Nordic countries. Russia has not achieved these goals, so natural gas cutoff will likely continue. Russia also hopes that by utilizing its energy leverage – while it still has it – it will bring forward the economic pain of Europe’s transition away from reliance on Russian energy. In that case European countries will experience recession and households will begin to change their view of the situation. European governments will be more likely to change their policies, to become more pragmatic and less confrontational toward Russia. Or European governments will be voted out of power and do the same thing. Other states could join Hungary in saying that Europe should never impose a full natural gas embargo on Russia. Russia would be able to salvage some of its energy trade with Europe over the long run, despite the war in Ukraine and the inevitable European energy diversification. In recent months we highlighted Italy as the weakest link in the European chain and the country most likely to see such a shift in policy occur. Italy’s national unity coalition had lost its reason for being, while the combination of rising bond yields and natural gas prices weighed on the economy. The Italian bond spread over German bunds has long served as our indicator of European political stress – and it is spiking now, forcing the European Central Bank to rush to plan an anti-fragmentation strategy that would theoretically enable it to tighten monetary policy while preventing an Italian debt crisis (Chart 6). The European Union remains unlikely to break up – Russian aggression was always one of our chief arguments for why the EU would stick together. But Italy will undergo a recession and an election (due by June 2023 but that could easily happen this fall), likely producing a new government that is more pragmatic with regard to Russia so as to reduce the energy strain. Chart 6Italy's Crisis Points To EU Divisions On Russia Italy's Crisis Points To EU Divisions On Russia Italy's Crisis Points To EU Divisions On Russia Italy’s political turmoil shows that European states are feeling the energy crisis and will begin to shift policies to reduce the burden on households. Households will lose their appetite for conflict with Russia on behalf of Ukrainians, especially if Russia begins offering a ceasefire after completing its conquest of the Donetsk area. If Russia expands its invasion, then Europe will expand sanctions and the risk of further strategic instability will go up. But most likely Russia will seek to quit while it is ahead and twist Europe’s arm into foisting a ceasefire onto Ukraine. Bottom Line: A change of government in Italy will increase the odds that the EU will engage in diplomacy with Russia in the coming year, if Russia offers, so as to reach a new understanding, restore natural gas flows, and salvage the economy. This would leave NATO enlargement unresolved but a shift in favor of a ceasefire in Ukraine in 2023 would be less negative for European assets and the euro. UK: Who Will Replace Boris Johnson? Last week UK Prime Minister Boris Johnson fell from power and now the Conservative Party is engaging in a leadership competition to replace him. We gave up on Johnson after he survived his no-confidence vote and yet it became clear that he could not recover in popular opinion. The inflation outburst destroyed his premiership and wiped away whatever support he had gained from executing Brexit. In fact it reinforced the faction that believed Brexit was the wrong decision. Going forward the UK will be consumed with domestic political turmoil as the cost of stagflation mounts, and geopolitical turmoil as Scotland attempts to hold a second independence referendum, possibly by October 2023. Global investors should focus primarily on Scotland’s attempt to secede, since the breakup of the United Kingdom would be a momentous historical event and a huge negative shock for pound sterling. While only 44.7% of Scots voted for independence in 2014, now they have witnessed Brexit, Covid-19, and stagflation, producing tailwinds for the Scots nationalist vote (Chart 7). Chart 7Forget Bojo's Exit, Watch Scotland Questions From The Road Questions From The Road There are still major limitations on Scotland exiting, since its national capabilities are limited, it would need to join the European Union, and Spain and possibly others will threaten to veto its membership in the European Union for fear of feeding their own secessionist movements. But any new referendum – including one done without the approval of Westminster – should be taken very seriously by investors. Bottom Line: Johnson’s removal will only marginally improve the Tories’ ability to manage the rebellion brewing in the north. A snap election that brings the Labour Party back into power would have a greater chance of keeping Scotland in the union, although it is not clear that such a snap election will happen in time to affect any Scottish decision. The UK faces economic and political turmoil between now and any referendum and investors should steer clear of the pound. (Though we still favor GBP over eastern European currencies). Britain will remain aggressive toward Russia but its ability to affect the Russian dynamic will fall, leaving the US and EU to decide the fate of Russian relations. Japan: What Is The Significance Of Shinzo Abe’s Assassination? Former Japanese Prime Minister Shinzo Abe was assassinated by a lone fanatic with a handmade gun. The significance of the incident is that Abe will become a martyr for a certain vision of Japan – his vision of Japan, which is that Japan can become a “normal country” that moves beyond the shackles of the guilt of its imperial aggression in World War II. A normal country is one that is economically stable and militarily capable of defending itself – not a pacifist country mired in debt-deflation. Abe stood for domestic reflation and a proactive foreign policy, along with the normalization of the Japanese Self-Defense Forces (JSDF). True, economic policy can become less dovish if necessary to deal with inflation. Some changes at the Bank of Japan may usher in a less dovish shift in monetary policy in particular. But monetary policy cannot become outright hawkish like it was before Abe. And Abe’s fiscal policy was never as loose as it was made out to be, given that he executed several hikes to the consumption tax. Japan’s structural demographic decline and large debt burden will continue to weigh on economic activity whenever real rates and the yen rise. The government will be forced to reflate using monetary and fiscal policy whenever deflation threatens to return. Debt monetization will remain an option for future Japanese governments, even if it is restrained during times of high inflation. Chart 8Shinzo Abe's Legacy Questions From The Road Questions From The Road ​​​​​​​ This is not only because Japanese households will become depressed if deflation is left unchecked but also because economic growth must be maintained in order to sustain the nation’s new and growing national defense budgets. Japan’s growing need for self defense stems from China’s strategic rise, Russia’s aggression, and North Korea’s nuclearization, plus uncertainty about the future of American foreign policy. These trends will not change anytime soon. Indeed the Liberal Democratic Party’s popularity has increased under Abe’s successor, Prime Minister Fumio Kishida, who will largely sustain Abe’s vision. The Diet still has a supermajority in favor of constitutional revision so as to enshrine the self-defense forces (Chart 8). And the de facto policy of rearmament continues even without formal revision. Bottom Line: Any Japanese leader who attempts to promote a hawkish BoJ, and a dovish JSDF, will fail sooner rather than later. The revolving door of prime ministers will accelerate. As Japan’s longest-serving prime minister, Shinzo Abe opened up the reliable pathway, which is that of a dovish BoJ and a hawkish foreign policy. This is important for the world, as well as Japan, because a more hawkish Japan will increase China’s fears of strategic containment. The frozen conflicts in Asia will continue to thaw, perpetuating the secular rise in geopolitical risk. We remain long JPY-KRW, since the BoJ may adjust in the short term and Chinese stimulus is still compromised, but that trade is on downgrade watch. Investment Takeaways Russia’s energy cutoff is aimed at pushing Europe into recession so as to force policy changes or government changes in Europe that will improve Russia’s position at the negotiating table over Ukraine, NATO, and other strategic disputes. Hence Russia is unlikely to increase the natural gas flow until it believes it has achieved its strategic aims and multiple veto players in the EU will prevent the EU from ever implementing a full-blown natural gas embargo. Chinese stimulus cannot be fully effective until it relaxes Covid-19 restrictions, likely beginning in December or next year when Xi Jinping uses his renewed political capital to try to stabilize the economy. However, China’s government powers alone are insufficient to prevent the debt-deflationary tendency of the property bust. The Middle East faces rising geopolitical tensions that will take markets by surprise with additional energy supply constraints. The implication is continued oil volatility given that global growth is faltering. Once global demand stabilizes, the Middle East’s turmoil will add to existing oil supply constraints to create new price pressures. The odds are not very high of the Federal Reserve achieving a “soft landing” in the context of a global energy shock and a stagflationary Europe and China.   Matt Gertken Chief Geopolitical Strategist mattg@bcaresearch.com ​​​​​​​ Strategic Themes Open Tactical Positions (0-6 Months) Open Cyclical Recommendations (6-18 Months) Regional Geopolitical Risk Matrix "Batting Average": Geopolitical Strategy Trades () Section II: Special (EDIT this Header) Section III: Geopolitical Calendar

Executive Summary Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Markets remain alert for indications of what Russia will do next. Last week, President Vladimir Putin threatened “catastrophic consequences” if G7 states are able to impose a price cap on Russian oil sales. A sharp drop in output – more than 3mm b/d – would send prices sharply higher, and could not be replaced in 2H22. KSA and the UAE are signaling their limited ability to significantly increase oil output ahead of US President Joseph Biden’s visit to the region later this week. Our simulation of demand losses of ~500k b/d in 2H22 and ~1.0mm b/d in 2023 suggests Brent could fall $7/bbl to $108/bb in 2H22 and $8/bbl to $109/bbl in 2023, all else equal. A Russian court decision last week briefly halted flows on the Caspian Pipeline Consortium’s (CPC) 1.3mm b/d line moving Kazakh oil to the Black Sea through Russia, adding a new variable into supply-side modeling. A trivial fine was levied, but a larger message was delivered. Sporadic force majeure declarations and output losses in Libya, where Russian mercenaries actively support Khalifa Haftar’s Libyan National Army (LNA), continue to make supply assessments difficult. Bottom Line: Tight supply fundamentals will keep oil markets volatile and biased to the upside, despite recurrent recession fears overwhelming demand expectations.  While a deep recession cannot be discounted, we remain focused on the objective fact of physically tight markets, and Russia's political-economy considerations affecting the evolution of prices. Feature Anyone who has spent time in trading markets will appreciate the implications of a $65-at-$380/bbl bid-ask spread on Brent. This two-way quote represents worst cases scenarios on the demand and supply sides of the market. And huge uncertainty. The bid comes from Citi’s recession-driven view, while the offer is courtesy of JP Morgan’s worst-case supply-shock assessment – i.e., Russia pulling 5mm b/d off the market if G7 states impose a price cap on its exports.1 Related Report  Commodity & Energy StrategyCopper Prices Decouple From Fundamentals Of late, demand-side concerns are driving markets, along with other technical factors we discussed in last week’s report on copper: low liquidity in trading markets; elevated global policy uncertainty, as seen by the two-way quote above; worries Fed tightening will overshoot the mark as it attempts to control hotter inflation, and an expansion of Russia’s economic war that now engulfs Ukraine.2 The latter point touches on events that cross commodity markets globally: Russia is threatening “catastrophic consequences” if G7 states impose a price cap on its oil sales. This goes directly to the supply side, as it most likely entails a dramatic gesture to reduce crude oil output sharply – i.e., more than 3mm b/d – which would send prices soaring. Russia’s coffers are in excellent shape at present, given the high prices its oil, gas and coal producers have been able to fetch since it invaded Ukraine.3 In our modeling, if Russia were to cut the 2.3mm b/d of crude and condensate it sent to Europe last year, Brent prices would move above $140/bbl.4 Higher volumes taken off the market would result in higher prices. These factors all interact with each other producing feedback loops – e.g., higher uncertainty causes lower liquidity in hedging markets and wider bid-ask spreads on smaller volumes – affecting decisions on everything from capex levels to headcounts. Demand Concerns Consume Markets Last month, we lowered our Brent forecast for this year and next to $110/bbl and $117/bbl, respectively, on the back of a sharp downgrade in global growth expectations from the World Bank. The Bank’s forecast prompted us to reduce our 2022 oil demand growth forecast to 2.0mm b/d this year vs 4.8mm b/d in our January forecast, and, for next year, to 1.8mm b/d. Given the obvious concern in markets, we simulated another hit to demand of 500k b/d in 2H22 and 1.0mm b/d next year, due to a further markdown in real GDP growth. This scenario brings our demand growth expectation down to 1.5mm b/d this year and 800k b/d next year. In this simulation, the lower GDP growth takes our average price expectation for 2H22 to $108/bbl and $109/bbl next year, or $7/bbl and $8/bbl lower, respectively (Chart 1). The lower demand we model here is offset to some degree by our maintained hypothesis that OPEC 2.0 – particularly its core producers Saudi Arabia and the UAE – will temper production somewhat (Chart 2), so as not to produce very large unintended inventory accumulations (Chart 3). Chart 1Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower Further GDP Weakness Would Push Brent Lower This concern is particularly acute if these producers receive new information that demand is slowing more than they expected. We are certain this will come up when US President Biden is in Riyadh later this week to meet Saudi Crown Prince Mohammed bin Salman Al Saud (MBS), to again discuss, among other things, the Kingdom’s ability and willingness to increase supply. Chart 2Core OPEC 2.0 Will Temper Production Increases... Core OPEC 2.0 Will Temper Production Increases... Core OPEC 2.0 Will Temper Production Increases... Chart 3...To Avoid Unintended Inventory Accumulations ...To Avoid Unintended Inventory Accumulations ...To Avoid Unintended Inventory Accumulations Russia Exerts Supply-Side Influence Russia is at war with Ukraine and the West – i.e., the G7 and NATO states arming and actively seeking to limit its access to revenues from the sale of hydrocarbons. Russia is treating this as a war, and it is operating on multiple fronts, in addition to its kinetic engagement with Ukrainian forces. In a market as finely balanced and uncertain as the current one, small, unexpected shifts in supply or demand can have outsized effects. Last week, for example, a decision by a Russian court briefly halted flows on the Caspian Pipeline Consortium’s (CPC) 1.3mm b/d line moving Kazakh oil to the Black Sea. This boosted prices more than 5% over the ensuing couple of days. Flows were allowed to resume after trivial fine was paid and prices fell. But a larger message was delivered. This remains a powerful lever Moscow can use at a moment’s notice to tighten supplies. Opportunities elsewhere in oil-producing provinces also are continuously cultivated by Russian operatives to influence supplies. Sporadic public demonstrations and force majeure declarations have led to output losses in Libya, where Russian mercenaries actively support Khalifa Haftar’s Libyan National Army (LNA). This continues to make supply assessments difficult. Libya currently produces ~ 650k b/d, according to the US EIA, down from ~ 1.12mm b/d in 4Q21. As in many things, Russia’s playing a game of chess with its opponents and forcing them to react to its threats and decisions. And this strategy is not limited to Ukraine, the EU or oil. For example, the seizure of Shell’s ownership in the Sakhalin-2 LNG facilities by Russia’s state-owned Gazprom was described by The Journal of Petroleum Technology (JPT) as a “backdoor” nationalization of Shell’s interest. This will have long-term consequences far removed from the Ukraine War, and could affect LNG deliveries to Japan and South Korea, which will become critical in a super-tight LNG market going into winter. This couldn’t be more timely, as Japan and South Korean – in a first-ever event – attended the end-June NATO meeting.5 Investment Implications Russia’s war against Ukraine has multiple dimensions, all of which can impact oil and gas prices going forward. Despite the obvious concerns over a deep recession reducing global oil demand – and commodity demand generally – we continue to focus on the objective fact of physically tight markets, and Russia's political-economy considerations affecting the evolution of prices. This informs our view that prices will remain volatile with a significant bias to the upside. Small, unexpected shocks in a fundamentally tight market on the supply side support our view prices will move higher.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Analyst Commodity & Energy Strategy ashwin.shyam@bcaresearch.com Paula Struk Research Associate Commodity & Energy Strategy paula.struk@bcaresearch.com     Commodities Round-Up Energy: Bullish Whether the EU can avoid rationing – and fill its natural-gas storage – ahead of winter will depend on what Russia does with its exports of the gas exported on Nord Stream 1 (NS1) and other pipes (Chart 4). We believe Russia will cut off most of its exports to the EU before winter sets in. It likely will use use the current 10-day maintenance on NS1, which began Monday, as a pretext to cut supplies, in retaliation for the EU cutting off crude oil and refined products imports. President Putin of Russia most likely will offer to keep the gas flowing so inventories can be refilled, in return for the EU lifting sanctions it imposed following Russia's invasion of Ukraine. Precious Metals: Bullish June headline US CPI was reported at 9.1% yoy, continuing the streak of rising prices. The Fed will need to aggressively hike rates to bring price levels lower, raising the risk of plunging the US into a recession. Recession fears will reduce long-term bond yields and should support gold prices. While high inflation is good for gold, the yellow metal saw investment outflows during May and June, as investors opt for the USD as a safe-haven asset. Ags/Softs: Neutral Food prices fell for the third straight month in June, but still are near historic highs following Russia’s invasion of Ukraine.6 Wheat prices fell by 5.7% in June but was still higher by 48.5% compared to 2021 (Chart 5).7 This might be down to recession fears, or, more likely, due to better crop conditions, seasonal availability from new harvests in the northern hemisphere, and more exports from Russia. The UN’s FAO warned factors that drove global prices higher still persist. Russia is expected to harvest one of its largest wheat crops since the fall of the Soviet Union.8 According to the 2022/23 USDA outlook, there will be less supplies and consumption, higher exports and stocks.9 Chart 4 Russia Pulls Oil, Gas Supply Strings Russia Pulls Oil, Gas Supply Strings Chart 5 Wheat Price Level Going Down Wheat Price Level Going Down   Footnotes 1     Please see Citigroup says oil prices could tumble to $65 by the end of the year if a recession whacks demand, published by businessinsider.com on July 5, 2022, and Oil could hit $380 if Russia slashes output over price cap, J.P.Morgan says, published by reuters.com on July 4, 2022. 2     Please see Copper Prices Decouple From Fundamentals published on July 7, 2022. 3    Please see Russia sees extra $4.5 billion in July budget revenue on higher oil prices published by reuters.com on July 5, 2022. 4    Please see Oil, Natgas Prices Set To Surge, which we published on May 19, 2022.  It is available at ces.bcaresearch.com. 5    Please see Japan and South Korea's Attendance at the Upcoming NATO Summit Could Worsen Global Tensions, published by time.com on June 16, 2022. 6    Please see Global food prices may be falling, but economist warns Asia’s food costs could still soar published by CNBC on July 11, 2022. 7     Please see Wheat, Corn Prices Tempered- Easing Global Food Cost Concerns published by University of Illinois on July 1, 2022 . 8    Please see Dollar rises to 20-year highs, sends grains lower published by FarmProgress on July 12, 2022. 9    Please see Grain: World Market and Trade published by USDA on July 12, 2022.   Investment Views and Themes Strategic Recommendations Tactical Trades Trades Closed in 2022

Executive Summary Following an unprecedented exodus by foreign investors, Indian stocks’ absolute valuations have cheapened significantly. A breakdown in crude oil prices will help put a floor under Indian firms’ profit margins. India’s decent domestic fundamentals indicate that non-financial firms’ topline (revenues) should hold up. That entails only a limited drop in EPS, given that margin compression is late. Lower commodity and crude prices will help tame inflationary pressures; and will necessitate less rate hikes from the Reserve Bank of India (RBI). The rupee might be at a risk in the near run as the broad US dollar overshoots, but the currency’s medium- and long-term outlooks are positive. That said, Indian stocks’ relative valuations versus their EM and Emerging Asian peers remains far too expensive to recommend an upgrade just yet. Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Bottom Line: Equity investors should stay underweight this bourse in EM and Emerging Asia portfolios for now, but place this market on an upgrade watchlist. Absolute return investors should remain on the sidelines given the strong headwinds faced by global equities. Fixed-income investors should continue to accord a neutral allocation to India in EM and Emerging Asian domestic bond portfolios. Feature Indian equity markets witnessed an unprecedented exodus of foreign investors over the past nine months. Net equity outflows, at $36 billion since October last year, have now reversed the entire foreign equity inflows of $38 billion that took place during the preceding 18 months. Indian stock prices – which are highly sensitive to foreign investor inflows – have fallen in tandem (Chart 1). Chart 1Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Indian Markets Have Witnessed An Unprecedented Exodus By Foreign Investors Chart 2India Has Rcecntly Underperformed As China Has Outperformed India Has Rcecntly Underperformed As China Has Outperformed India Has Rcecntly Underperformed As China Has Outperformed The large selloff by foreigners has been instrumental to India’s recent mild underperformance relative to its EM and Emerging Asian counterparts (Chart 2, top panel). We had tactically downgraded Indian stocks to underweight in March this year, which has so far worked out well.  Notably, India’s recent underperformance versus the EM benchmark has been mostly due to investors rushing back into Chinese stocks, which had fallen to very low levels earlier this year. Indian stocks’ performance has been at par with EM ex-China equities in recent months (Chart 2, bottom panel). That said, global macro backdrops are changing gradually. Oil prices have begun to break down, which is a net positive for India, a large crude oil importer. India’s domestic growth indicators also appear to be decent – pointing to a steady top-line (revenues) outlook. This bourse therefore might begin to look attractive again to foreign investors whose Indian equity holdings are now quite low. On the negative side, India’s relative valuations versus EM and Emerging Asia remains very stretched – both by regular measures and in cyclically adjusted terms (Chart 3). Weighing all the pros and cons, we recommend that equity investors stay underweight this bourse in EM and Emerging Asia portfolios for the time being, but put it on an upgrade watchlist. Absolute return investors should remain on the sidelines given the strong headwinds faced by global equities.  Is The Multiple Compression Over? The ongoing selloff in Indian stocks can be attributed to derating (Chart 4). The trailing P/E ratio has fallen substantially from a pandemic high of 39 to 21; whereas the forward P/E has also fallen from 24 to 19. Chart 3Indian Markets Are Still Very Expensive In Relative Terms Indian Markets Are Still Very Expensive In Relative Terms Indian Markets Are Still Very Expensive In Relative Terms Chart 4The Ongoing Selloff In India Can Be Attributed To Multiple Derating The Ongoing Selloff In India Can Be Attributed To Multiple Derating The Ongoing Selloff In India Can Be Attributed To Multiple Derating   That said, the contraction of multiples, one of the two drivers1 of stock prices, appears to be at a late stage. The reasons are as follows. Chart 5Falling Commodity Prices Will Help Put A Floor Under Indian Firms' Profit Margins Falling Commodity Prices Will Help Put A Floor Under Indian Firms' Profit Margins Falling Commodity Prices Will Help Put A Floor Under Indian Firms' Profit Margins As we explained in our previous report on India, commodity prices are the sole source of current inflation in this economy. Receding global commodity prices will therefore rein in the inflationary pressures in general, and producer prices in India in particular. The top panel of Chart 5 is showing that Indian producer prices track global commodity prices closely. Hence, the former is set to decelerate significantly in the next few months. What this means for Indian firms is that their cost of raw materials will ease up. At the same time, since global commodity prices have much less of an impact on India’s consumer inflation, the latter will not subside as much. In other words, CPI will rise relative to PPI, as shown in the middle panel of Chart 5. When this happens, it is usually a positive for firms’ profit margins (Chart 5, bottom panel). As such, in the coming months, one can expect firms’ margins to have some support. If we consider only crude oil, we see a similar dynamic. Any drop in crude prices (shown inverted in Chart 6) do help boost Indian firms’ margins, albeit with a few months lag. Hence, in the months ahead, as crude prices break down, firms’ margins will also find a floor sooner rather than later.  Profit margins, in turn, are a major driver of stock multiples (Chart 7). India’s multiples have already fallen to pre-pandemic levels in anticipation of more margin compression in the future. If margins do not compress as much, it’s reasonable to expect that further multiple contractions would also be limited. Chart 6Weaker Crude Prices Are Also Positive For Indian Firms' Margins Weaker Crude Prices Are Also Positive For Indian Firms' Margins Weaker Crude Prices Are Also Positive For Indian Firms' Margins Chart 7As Margins Compression Ends, So Will Equity Multiple Derating As Margins Compression Ends, So Will Equity Multiple Derating As Margins Compression Ends, So Will Equity Multiple Derating   The message is the same if we look at India’s cyclically adjusted P/E (CAPE) ratio: it too has cheapened to the lower end of the past 10-years’ range – thereby already discounting a massive amount of EBITDA margins compression (Chart 8). Chart 8India's CAPE Has Fallen Meaningfully, Already Discounting Material Margin Compression India's CAPE Has Fallen Meaningfully, Already Discounting Material Margin Compression India's CAPE Has Fallen Meaningfully, Already Discounting Material Margin Compression A similar argument can be made in regard to firms’ interest costs. Indian firms’ interest expenses might not rise as much if inflation can be reined in without substantial rate hikes by the RBI. Indeed, India’s headline and core CPI remain largely range-bound (Chart 9) − unlike in most developed economies as well as in Latin America and EMEA. Odds are that they would subside marginally with easing commodity prices. If so, the central bank would be less inclined to raise interest rates considerably. Chart 9Rangebound Headline And Core CPI Mean Too Many Rate Hikes Are Unlikely Rangebound Headline And Core CPI Mean Too Many Rate Hikes Are Unlikely Rangebound Headline And Core CPI Mean Too Many Rate Hikes Are Unlikely Chart 10 shows that India’s trailing P/E has fallen to pre-pandemic averages – already discounting a significant amount of future rate hikes. If interest rates do not rise as much as feared previously, further derating of stocks will also be limited.   How Much Of An Earnings Squeeze Lies Ahead? Indian firms’ raw material and interest costs are likely to alleviate somewhat. Unit labor costs are also unlikely to rise much as wages remain subdued, and robust capital investments suggests that labor productivity gains would remain decent. All this will stop profit margins from contracting much further. And yet, for corporate earnings growth to continue, firms need rising revenues too. So, the next question is, how much top-line growth can be expected? Chart 11 shows the revenues of major non-financial corporations in India. They have already far surpassed their pre-pandemic levels in both local currency and US dollar terms. The outlook for their future revenues also appears to be satisfactory:  Chart 10Multiple Derating May Stop, As Already Discounted Rate Hikes Do Not Materialize Multiple Derating May Stop, As Already Discounted Rate Hikes Do Not Materialize Multiple Derating May Stop, As Already Discounted Rate Hikes Do Not Materialize Chart 11Indian Firms' Top Line Outlook Is Satisfactory Indian Firms' Top Line Outlook Is Satisfactory Indian Firms' Top Line Outlook Is Satisfactory   The purchasing managers’ indices for manufacturing and services are all at decent levels of expansion (Chart 12, top panel). Further, if the order books are of any indication, the expansion should continue in the foreseeable future (Chart 12, bottom two panels). Notably, India is not a major exporter of manufactured goods; and therefore, an impending contraction in global consumer goods consumption would not hurt it as much as it would many other EM economies. An industrial outlook survey by the RBI indicates that firms are expecting their capacity utilization and employment count to rise markedly in the near future. This points to a robust economy ahead (Chart 13). Chart 12Robust Order Books Indicate Economic Growth Will Stay Decent Robust Order Books Indicate Economic Growth Will Stay Decent Robust Order Books Indicate Economic Growth Will Stay Decent Chart 13Firms Are Expecting Rising Capacity Utilization And Employment Firms Are Expecting Rising Capacity Utilization And Employment Firms Are Expecting Rising Capacity Utilization And Employment         India’s bank credit impulse has accelerated strongly – which indicates rising economic activity. Industrial production usually follows suit with a couple of months lag, and this time should be no different (Chart 14). Chart 14Accelerating Bank Credit And Industrial Productions Indicate A Robust Economy Accelerating Bank Credit And Industrial Productions Indicate A Robust Economy Accelerating Bank Credit And Industrial Productions Indicate A Robust Economy Finally, strong post-pandemic capex growth indicates that bank loans have much further to accelerate. Notably, leverage in the Indian economy is still low. Bank credit has hovered at around only 50 - 55% of GDP over the past decade. Total debt levels including bond issuance by non-financial firms have also been flattish at a mediocre level of 65 - 70% of GDP. Limited leverage means there is plenty of room to borrow and kickstart a new capex cycle.  If that transpires, it will be very bullish for Indian stocks in general, and bank stocks in particular – which has the largest weight in the MSCI India index at 23% More importantly, a capex-led growth would boost Indian firms’ competitiveness and profits in the long run. Capex boosts labor productivity, which helps keep unit labor costs down. That, in turn, improves both competitiveness and profit margins. It will also contribute to alleviating structural inflationary pressures in the economy – as lower unit labor costs would keep prices down. The bottom line is that, given the decent economic growth outlook, the top line of most Indian corporations is unlikely to see a contraction in nominal terms. In that case, a minor drop in their profit margins from current levels would entail that EPS contraction, if any, will also be limited. In sum, the outlook for both drivers of India’s stock prices, multiples and EPS, is not as dire as it appeared earlier this year. That at least warrants to place India on an ‘upgrade watchlist’ in an EM equity basket from the current underweight status. The reason we are hesitant to upgrade it outright is that although India’s absolute valuation has eased, its relative valuation vis-à-vis EM and Emerging Asia remains highly stretched.  Finally, in terms of absolute stock prices, the risk-reward of global stocks remains poor as the Fed and US equity markets are on a collision course. As such, investors should wait out the ongoing turbulence before getting back to market. What About The Rupee?  Chart 15Peaking Crude Prices Will Help Ameliorate Trade And Current Account Deficits Peaking Crude Prices Will Help Ameliorate Trade And Current Account Deficits Peaking Crude Prices Will Help Ameliorate Trade And Current Account Deficits The Indian currency has been depreciating versus the US dollar as both current and capital accounts were under downward pressure. That said, both are likely to get marginally better in the months ahead. High global commodity prices caused India’s trade deficits to slide to new lows in June. The current account balance is also weakening (Chart 15, top panel). If, however, commodity prices have peaked in this cycle (which is our view), India’s trade and current account deficits would ameliorate in the months to come. In regard to the capital account balance − which slipped into a rare deficit recently − the deterioration can be attributed to portfolio outflows. FDI and other capital flows, which are more stable in nature, continue to report decent inflows (Chart 15, bottom panel). Given that foreign portfolio repatriation has largely run its course, odds are that the capital account balance will switch back to surplus in the coming quarters. This is because while net portfolio outflows would recede significantly from current high levels, other components of the capital account will likely stay in surplus given the country’s decent long-term growth outlook. If so, that could mean that the depreciation of the rupee is also late. Chart 16 shows that changes in India’s capital flows greatly impact the Indian currency. While the ongoing risk-off sentiment globally may cause the dollar to overshoot in the near term, the rupee outlook is quite positive over the medium to long term.  Chart 16As Portfolio Outflows Wane, Capital Account Will Be Back In Surplus, Benefitting The rupee As Portfolio Outflows Wane, Capital Account Will Be Back In Surplus, Benefitting The rupee As Portfolio Outflows Wane, Capital Account Will Be Back In Surplus, Benefitting The rupee Chart 17The Rupee Is Extremely Cheap In PPP terms Vis-à-vis The US Dollar The Rupee Is Extremely Cheap In PPP terms Vis-à-vis The US Dollar The Rupee Is Extremely Cheap In PPP terms Vis-à-vis The US Dollar Incidentally, the rupee is already extremely cheap vis-à-vis the US dollar in PPP terms. Further depreciation, if any, should therefore be limited. It also makes the rupee attractive for long-term investors (Chart 17).   Notably, the rupee did well compared to other EM currencies over the past several years − in line with our view. It should continue to do so, as growth in India will likely stay stronger than most EM economies. That will attract capital from the rest of the world − beyond any near-term jitters − propping up the currency.  Finally, as the rupee will be under less downward pressure with the improvement in the balance of payments, the RBI will be less intent to raise policy rates in a bid to mitigate currency depreciation. Less rate hikes, as explained before, is positive for stock prices. Investment Conclusions Currency: Amelioration in both terms-of-trade shock and in portfolio outflows will ease up the downward pressures on the rupee in the months ahead. It will also likely remain among the best performers in the EM world even as an overshoot in the broad US dollar in the near term remains a risk. Equities: The key risk to Indian equities are global developments: the rate hike cycles underway globally, slumping DM growth, a strong US dollar, mediocre Chinese growth, and the negative ramifications of the war in Ukraine. As such, Indian absolute stock prices remain vulnerable in the months ahead. Absolute return investors should therefore stay on the sidelines. India’s relative performance versus its EM counterparts has been highly contingent on relative multiple expansions (Chart 18). The recent diversion between them is therefore untenable. And if history is any guide, the relative multiples and relative stock prices should converge to the downside. This argues for staying cautious on India’s relative performance too. We recommend remaining underweight India in EM and Emerging Asian equity portfolios for now; but put this bourse on an upgrade watchlist in view of decent macro fundamentals in India and falling crude prices. Domestic Bonds: Indian government bonds are not as attractive to EM fixed-income investors as the yield differential vis-à-vis other EMs has already narrowed substantially. Going forward also, the yield differential might not move in India’s favor. The reason is that Indian yields will likely inch up, or at least stay firm, with the economy gaining traction (Chart 19). Chart 18India's Relative Performance Remains At Risk India's Relative Performance Remains At Risk India's Relative Performance Remains At Risk Chart 19Indian Bond Yields May Not Fall Much,As They Move With Economic Growth Indian Bond Yields May Not Fall Much,As They Move With Economic Growth Indian Bond Yields May Not Fall Much,As They Move With Economic Growth   Notably, an imminent slowdown in global trade will not hurt India’s growth as much as it would most other EM countries. That reduces the odds of Indian yields falling more relative to its EM counterparts. Chart 20Stay Neutral On Indian Bonds As Their Yield Advantage Has Narrowed Substantially Stay Neutral On Indian Bonds As Their Yield Advantage Has Narrowed Substantially Stay Neutral On Indian Bonds As Their Yield Advantage Has Narrowed Substantially We downgraded Indian government bonds from overweight to a neutral allocation in EM and Emerging Asian domestic bond portfolios in March this year. That recommendation still makes sense (Chart 20). Rajeeb Pramanik Senior EM Strategist rajeeb.pramanik@bcaresearch.com Footnotes 1     The other driver being the EPS (Earnings-per-share); discussed in the next section.

Executive Summary No Funding For Property Developers, No Land Sales No Funding For Property Developers, No Land Sales No Funding For Property Developers, No Land Sales Beijing’s plan to bring forward RMB 2.6 trillion of financing for infrastructure expenditures in H2 2022 is a considerable stimulus. However, this new funding will not result in new investments. Rather, it will, by and large, offset the drop in local government (LG) revenues from land sales this year. In short, there is little new stimulus for infrastructure beyond what has been approved in the budget plan earlier this year. Not only is the credit and fiscal impulse smaller in this cycle than in the previous ones, but also the multiplier effect will be lower. This will hinder the recovery in domestic demand. After the one-off rebound in economic activity following the lockdowns in April and May of this year, China’s business cycle recovery will be more U shaped rather than V shaped. Bottom Line: For absolute-return investors neither A-shares nor investable stocks offer an attractive risk-reward profile. Within a global equity portfolio, we continue to recommend a neutral allocation to China’s A-shares and an underweight allocation to Chinese investable stocks. Relative to the EM equity benchmark, investors should continue to overweight A-shares and remain neutral on investable stocks. Maintain the long A-shares / short offshore investable Chinese stocks position.   Alleged plans of an additional RMB 1.5 trillion local government (LG) special bond issuance in H2 2022 have prompted investors to speculate about whether this stimulus initiative is sufficient to produce a considerable acceleration in infrastructure investment.  This stimulus would be added to RMB 800 billion and 300 billion of policy bank funding for infrastructure that the government approved earlier in Q2 this year. Hence, the combined new infrastructure financing made available by Beijing is RMB 2.6 trillion. Below, we elaborate on how this RMB 2.6 trillion of additional infrastructure financing will be largely offset by a drop in LG revenues from land sales. In short, the stimulus will preclude downside in infrastructure investment rather than herald a major acceleration.  In addition, the economic recovery still faces substantial headwinds from other segments of the economy. We believe that, approached as a whole, China’s business cycle recovery will be more U shaped than V shaped. Quantifying Infrastructure Stimulus The degree of new financing for infrastructure is considerable. This RMB 2.6 trillion in new financing in H2 2022 is equal to 7% of planned 2022 LG aggregate expenditures, 6% of planned 2022 aggregate total central and local government spending including budgetary and managed funds, 14% of fixed-asset investment (FAI) in traditional infrastructure, and 2% of GDP.  The composition of general government spending is presented in Table 1. Table 1Structure And Composition Of Government Spending In China Making Sense Of China’s New Stimulus Making Sense Of China’s New Stimulus However, a caveat is in order: this new funding will not result in new investments. Rather, it will, by and large, offset the drop in LG revenues from land sales. The primary source of financing infrastructure investment is LG managed funds. LG managed funds budgets, however, are under severe stress because of the plunge in revenues from land sales. Notably, proceeds from land sales account for 23% of aggregate LG expenditures (Chart 1). Land sales have contracted by about 30% in the January-June period of this year, and there is little hope that they will pick up in H2 2022. The reason is that property developers’ financing is down by 30% and is unlikely to recover soon (Chart 2). Chart 1Land Sales Are Critical For LG Expenditures Land Sales Are Critical For LG Expenditures Land Sales Are Critical For LG Expenditures Chart 2No Funding For Property Developers, No Land Sales No Funding For Property Developers, No Land Sales No Funding For Property Developers, No Land Sales Chart 3Property Developers Are Facing Debt Deflation Property Developers Are Facing Debt Deflation Property Developers Are Facing Debt Deflation As we have argued in our past reports, property developers carry a substantial inventory of real estate assets funded by a massive debt build-up (Chart 3, top panel). With housing prices beginning to deflate, property developers are about to face debt deflation – falling asset prices and a high debt burden (Chart 3, bottom panel). Thereby, they have little appetite or capacity to expand their assets and leverage. Assuming land sales for the full year will decline by 30%, this drop would lead to an RMB 2.52 trillion reduction in LGs managed fund revenues in 2022 (Table 2). Hence, the new RMB 2.6 trillion infrastructure financing will be used to offset the RMB 2.5 trillion shortfall in LG managed funds budgets because of the plunge in land transfer proceeds. Table 2China: New Stimulus For Infrastructure in H2 2022 Making Sense Of China’s New Stimulus Making Sense Of China’s New Stimulus On the whole, there will be very little new funding available to boost infrastructure spending beyond what has been approved by the 2022 National People’s Congress (NPC) earlier this year. Chart 4The Credit And Fiscal Impulse Will Be Moderate The Credit And Fiscal Impulse Will Be Moderate The Credit And Fiscal Impulse Will Be Moderate Hence, for this full year, there is no change to the aggregate fiscal spending impulse that incorporates central and local government budgetary spending as well as managed funds’ expenditures (Chart 4, top panel). The two scenarios for the non-government credit impulse are shown in the middle panel of Chart 4. The optimistic scenario assumes non-government credit will accelerate to 9.5% from 8.7%, and the pessimistic scenario is based on no acceleration in non-government credit growth. Finally, the bottom panel of Chart 4 illustrates the projections for the combined credit and fiscal spending impulse for the remainder of this year. Although the aggregate fiscal and credit impulse is non-trivial, it is smaller than those in 2020, 2016, 2013, and 2009. Bottom Line: The government has announced RMB 1.1 trillion in infrastructure funding and will likely raise the LG special bond quota by RMB 1.5 trillion. Yet, this RMB 2.6 trillion financing will only offset the shortfall in infrastructure financing from plunging land transfer revenue.  In brief, there is little new stimulus for infrastructure beyond what has been approved in the budget plan from early this year.   Economic Headwinds Chart 5China's Reopening Rebound China's Reopening Rebound China's Reopening Rebound Economic activity in China has rebounded following the reopening of the economy. Chart 5 illustrates that high-frequency data, such as car sales, house sales, commercial truck cargo, and steel production have all recently improved. We expect the one-off renormalization of economic activity following the lockdowns in April and May to give way to more subdued growth. The reason is that the mainland economy is facing several major headwinds: The real estate market is unlikely to recover meaningfully given the “three red lines” policy has not been eased, and many of property market excesses have not been purged. Hence, the question remains whether the Chinese economy can stage a robust recovery without the participation of the property market. We doubt it can because of the vital role that real estate has played in the economy in the past 20 years as the result of its large share in GDP and its impact on consumer and business sentiment. Since 2008, there has been no business cycle recovery in China without the property market firing on all cylinders (Chart 6). Chart 6All Economic Recoveries Were Accompanied By A Revival In The Property Market All Economic Recoveries Were Accompanied By A Revival In The Property Market All Economic Recoveries Were Accompanied By A Revival In The Property Market Chart 7China: The Willingness To Spend And Invest Is Very Low China: The Willingness To Spend And Invest Is Very Low China: The Willingness To Spend And Invest Is Very Low Rolling lockdowns will likely persist. This will weigh on household and private business confidence. Diminishing confidence will undermine the willingness to spend, invest, and hire. Our marginal propensity to spend indicators for households & enterprises remain very depressed (Chart 7). Low propensity to spend entails that the multiplier effect of fiscal and credit stimulus will be lower in this cycle than in the previous ones. Not only is the credit and fiscal impulse smaller than in the previous cycles but also the multiplier will be lower. This will hinder the recovery in domestic demand. Finally, Chinese exports are set to contract in H2 2022 because of shrinking demand for consumer goods (ex-autos) in the US and Europe as well as mainstream EM. Bottom Line: After the one-off rebound in economic activity following the lockdowns in April and May, the business cycle recovery will be more U shaped rather than V shaped. Investment Conclusions For absolute-return investors, neither A-shares nor investable stocks offer an attractive risk-reward profile.   Within the A-share market, our strongest conviction is to overweight interest rate-sensitive sectors like consumer staples, utilities, and healthcare. Consumer discretionary stocks should also be a slight overweight now.   We continue to recommend a neutral allocation to Chinese A-shares and an underweight allocation to investable stocks within a global equity portfolio. Relative to the EM equity benchmark, investors should continue to overweight A-shares and remain neutral on investable Chinese stocks.   Maintain the long A-shares / short offshore investable stocks position.   The yuan, like all other emerging Asian currencies, is still facing near-term downside risk versus the US dollar. Chinese onshore government bond yields will likely drop further.   Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Strategic Themes Cyclical Recommendations