Global

Dear Client, Owing to BCA’s 40th Annual Investment Conference in New York City next week, we will not be publishing a report on Friday, September 27. We will return to our regular publishing schedule on Friday, October 4, when we will be sending out our quarterly Strategy Outlook. Best regards, Peter Berezin, Chief Global Strategist Highlights The spike in oil prices underscores the vulnerability of key Saudi oil facilities. The fact that OPEC spare capacity is on the low side is an added source of concern. Fortunately, if oil prices do rise again, the impact on the global economy will be mitigated by the following: 1) the amount of oil necessary to produce one unit of real GDP is much lower than in the past; 2) oil prices are currently nowhere near restrictive levels; 3) higher oil prices will boost investment in the energy sector; and 4) unlike in the past, central banks will not need to hike rates to quell oil-induced inflationary pressures. The Federal Reserve is likely to cut rates once more in October and then keep rates on hold through 2020. The Fed will also begin expanding the size of its balance sheet to alleviate tensions in funding markets. Investors should remain overweight equities relative to bonds and start tilting exposure towards EM assets and cyclical stocks later this year. Feature All Aboard The Crude Oil Roller Coaster Chart 1A Price For The Books After gapping up by nearly 20% to $72/barrel on Monday morning – the biggest one-day spike in history – Brent oil prices have retreated to the $64-$65 range, representing a markup of around 7% over last Friday’s close (Chart 1). The near-term direction of oil prices will be governed by how quickly the Saudis are able to restore lost output. Brent fell by over $3/barrel on Tuesday following news reports quoting key Saudi sources saying that state-run Saudi Aramco would be able to bring production back to normal in the next two-to-three weeks. Bob Ryan, BCA’s chief commodity strategist, is skeptical of this reassurance. He notes that the drone attacks destroyed highly sophisticated “one-of-a-kind” equipment that had been specially built for the Abqaiq facility. Beyond the near-term impact, the longer-term question is whether Sunday’s pre-dawn strike is the start of a new violent trend. The fact that much of Saudi Arabia’s oil infrastructure is densely concentrated in the eastern part of the country makes it vulnerable to further attacks. The proliferation of drone technologies is also a source of concern since such devices can be used to wreak significant havoc at minimal cost.  Chart 2Limited Availability Of Spare Capacity To Offset Outages Chart 3Key Strategic Petroleum Reserves Iran’s apparent involvement in the attack further complicates matters. As Matt Gertken, BCA’s chief geopolitical strategist, has argued, the drone strike may have been orchestrated by hardliners in Iran who regard President Rouhani’s efforts to restart negotiations with the United States as evidence of appeasement (some of these hardliners are also profiting from the sanctions by smuggling crude out of the country). President Trump’s decision to sack John Bolton over Bolton’s opposition to making any deal with the Iranians may have created a sense of urgency among the hardliners. In this respect, attacking Iran would probably give the hardliners what they want. All this has occurred at a time when OPEC spare capacity – the difference between what the cartel is capable of producing and what it is actually producing – is below its historic average (Chart 2). Crude oil reserves have also been trending lower within the OECD. Saudi Arabia’s own reserves have fallen by over 40% since peaking in 2015 (Chart 3). Oil And The Economy: How Big A Risk? While a major spike in oil prices is not our base case, it cannot be ruled out completely. If the price of crude were to increase significantly, how much damage would this do to the global economy? History is certainly not encouraging: Every single U.S. recession since 1970 has been preceded by  a large jump in oil prices (Chart 4). Chart 4Oil Spikes And Recessions Chart 5The Global Economy Is Less Oil Intensive The fact that we are dealing with a potential supply disruption only makes things worse. It is one thing if oil prices are rising in response to stronger global growth; it is quite another if prices rise at a time, such as the present, when global growth is under pressure. Despite these concerns, there are four reasons to be optimistic that higher oil prices will not precipitate a major global economic downturn. First, the global economy is less reliant on oil than in the past. Chart 5 shows that the amount of oil necessary to produce one unit of real GDP has fallen by half since 1990. Second, oil prices are still quite low by historic standards. Even after this week’s jump, Brent is still 24% below where it was last October (Chart 6). In real terms, both Brent and WTI are more than 60% below their 2008 highs. Chart 6Oil Prices Are Well Off Their 2008 Peak Third, if oil prices do stay elevated, this will encourage investment in the oil patch, which will eventually bring prices back down. It is worth remembering that rising oil prices reduce aggregate demand in part by shifting wealth from oil consumers, who tend to spend most of their disposable income, to oil producers, who are often inclined to save the windfall from higher oil prices in such entities as sovereign wealth funds. However, if higher oil prices cause producers to expand production, the positive “investment effect” could offset much of the negative “consumption effect” on aggregate demand. Ironically, this means that a transfer of production from easily accessible oil deposits, such as those in Saudi Arabia, to less accessible shale or deep-sea deposits has the effect of increasing overall energy-sector capital spending, even if it does entail a loss of average efficiency. Fourth, higher oil prices today are unlikely to dislodge long-term inflation expectations. This represents a critical difference between the 1970s, 80s, and early 90s when central banks often felt the need to hike rates in the face of rising oil prices (Chart 7). These days, central banks are more likely to see oil price increases – especially those due to supply-side disruptions – as negative income shocks. Such shocks warrant looser, rather than tighter, monetary policy. Chart 7Core Inflation No Longer Driven By Oil Prices FOMC Cuts Rates As Expected This brings us to this week’s Fed meeting. As widely expected, the Fed cut rates by 25 basis points. It also lowered the projected policy rate path. Compared to the Summary of Economic Projections released in June – which suggested no rate change in 2019, one rate cut in 2020, and one rate hike in 2021 – the median dots in the September Summary of Economic Projections released this week show two cuts in 2019, no rate change in 2020, one rate hike in 2021, and one rate hike in 2022. Seven out of 17 participants penciled in a projected third cut for 2019. Judging from the tone of his post-meeting press conference, Jay Powell, dressed in his trademark bipartisan purple tie, was likely among those advocating for further easing. While it is far from a done deal, an additional rate cut in October appears more likely than not. In total, we expect 75 basis points in cuts, equivalent to the amount of easing orchestrated during both the 1995/96 and 1998 mid-cycle slowdowns (Chart 8). The Fed appears to be using these two episodes as a template for its current thinking. Chart 8Will The Fed Follow The 1990s Template Of 75 Bps Of Mid-Cycle Easing? The Fed is also likely to start expanding the size of its balance sheet starting in November. The spike in funding rates this week, while not at all related to the sort of counterparty risk that prevailed during the financial crisis, still underscored the fact that bank reserves are becoming increasingly scarce. To the extent that the Fed creates bank reserves when it purchases assets, this would help alleviate funding pressures. We are assuming that rate cuts beyond 75 basis points in total are possible. However, this would require a significant deceleration in U.S. growth, which looks unlikely. Real personal consumption spending is on track to increase by 3.1% in Q3, according to the Atlanta Fed’s GDPNow (Chart 9). While business capex spending continues to be weighed down by the manufacturing recession, rays of light are emerging. Industrial production rose by 0.6% in August, well above the consensus forecast of 0.2%. Despite an ongoing drag from the auto sector, manufacturing output rose by a solid 0.5%. Chart 9Inventories And Net Exports Have Subtracted From Growth Chart 10Easier Financial Conditions Will Boost Global Growth Globally, the growth picture remains shaky. Looking out, the sharp easing in financial conditions should boost activity (Chart 10). The nascent de-escalation in trade tensions, if sustained, should also help. As such, we continue to expect global growth to stabilize in the coming months and accelerate into year-end. Investment Conclusions Oil prices are likely to rise over the next 12 months. Geopolitical tensions could contribute to any upward pressure on the price of crude, but most of the increase in prices will probably be driven by stronger global growth. If global growth does pick up, the dollar will probably weaken (Chart 11). A weaker dollar will further boost oil prices, along with other commodity prices (Chart 12). Chart 11The Dollar Is A Countercyclical Currency Chart 12A Weaker Dollar Bodes Well For Commodities Stronger global growth, rising commodity prices, and a weaker dollar will hurt safe-haven government bonds but boost stocks. EM and cyclical equity sectors should gain disproportionately.   Peter Berezin, Chief Global Strategist Global Investment Strategy peterb@bcaresearch.com   Strategy & Market Trends MacroQuant Model And Current Subjective Scores Strategic Recommendations Closed Trades

Special Report

Highlights Investors should pay particular attention to definition and methodology when evaluating value versus growth strategies, both academically and in practice. Value investors should focus on non-U.S. markets, especially the emerging market small-cap universe. Growth investors should focus on large caps, especially the U.S. large-cap universe. Small-cap investors should focus on value. Large- and mid-cap investors should not be making bets between value and growth strategically. Tactical style rotation should be done only when valuation spreads reach extreme levels.  GAA remains neutral on value versus growth, but prefers to use sector positioning (cyclicals versus defensives, financials versus tech and health care) and country positioning (euro area versus U.S.) to implement style tilts. Feature Investing by way of style is as old as investing itself. Value versus growth has been one of the most frequently asked questions among our clients of late, particularly given the sharp style reversal in recent weeks. In this report, we attempt to answer some of the most often-asked questions on value versus growth. We have arranged these questions into five separate sections: First, we look at 93 years of history of the Fama-French value and growth portfolios to see how value, growth, and size have interacted over time, because academics have mostly used the Fama-French framework. Second, we look at how comparable U.S. style indices are, including the S&P, the Russell and the MSCI, since practitioners mostly use these commercial indices as their benchmarks. Third, we investigate if international markets share the same value-growth performance cycles as the U.S., using the MSCI suite of value-growth indices (since MSCI is the only index provider that produces value-growth indices for each market under its global coverage). Fourth, we investigate if pure exposure to value and growth can actually improve the value-growth performance spread by comparing the pure style indices from the S&P and the Russell to their standard counterparts. Finally, we present the GAA approach to style tilts in a section on our investment conclusions. 1. Is It True That Value Outperforms Growth In The Long Run? There has been overwhelming academic evidence supporting the existence of the value premium.1 Academically, the “value premium”, also known as the HML (high minus low) factor premium, or the value outperformance, is defined as the return differential between the cheapest stocks and the most expensive. Even though Fama and French used book-to-price as the sole valuation criterion,2 many researchers have combined book-to-price with other valuation measures such as earnings-to-price, sales-to-price, dividend yield,3 and so on.  There is also academic evidence suggesting that “value outperformance is almost non-existent among large-cap stocks.”4 What is more, in 2014 Fama and French caused a huge stir by publishing “A Five-Factor Asset Pricing Model” working paper demonstrating that “HML is a redundant factor” because “the average HML return is captured by the exposure of the HML to other factors” (such as size, profitability, and investment pattern) based on U.S. data from 1963 to 2013.5 For non-quant practitioners, especially the long-only investors, value and growth are two separate investment styles, even though the style classification shares the same principle as the academic “value factor.” Their definitions vary, as evidenced by how S&P Dow Jones, FTSE Russell, and MSCI define their value and growth indexes (see next section on page 7). In general, value stocks are cheap, with lower-than-average earnings growth potential, while growth stocks have higher-than-average earnings growth potential but are very expensive. The indices published by commercial index providers do not have very long histories, however. Fortunately, Fama and French also provide value-growth-size portfolios on their publicly available website.6  Table 1 shows that for 93 years, from July 1926 to June 2019, U.S. value portfolios in both large-cap and small-cap buckets based on the well-known Fama-French approach have returned more than their growth counterparts, no matter whether the portfolios are equal-weighted or market-cap-weighted. Most strikingly, equal-weighted small-cap value outperformed its growth counterpart by over 10% a year in absolute terms, and has more than doubled the risk-adjusted return compared to its growth counterpart. Table 1Fama-French Value-Growth-Size Portfolio Performance* Some media reports have claimed that value stocks are “less volatile” because they are on average “larger and better-established companies.”7 This may be true for some specific time periods. For the 93 years covered by Fama and French, however, this common belief is not supported. In fact, value portfolios in both the large- and small-cap universes have consistently had higher volatility than growth portfolios, no matter how the components are weighted. The excess returns, however, have more than offset the higher volatilities in three out of four pairs, with the exception being market cap-weighted large-cap growth, which has a slightly higher risk-adjusted return due to much lower volatility than its value counterpart. From a very long-term perspective, the value outperformance does come from taking higher risk. Further investigation shows that the superior long-run outperformance of value relative to growth came mostly in the first 80 years of Fama and French’s 93-year sample. In more recent years since 2007, however, value has underperformed growth significantly in three out of the four Fama-French value-growth pairs, with the equal-weighted small-cap value-growth pair being the sole exception, as shown in Table 2. Even though the equal-weighted small-cap value has still outperformed its growth counterpart in the most recent period, the hit ratio drops to 54% compared to 76% in the first 80 years, while the magnitude of average calendar-year outperformance drops to a meager 1.3%, compared to 12.5% in the first 80 years. Table 2The Fight Between Value And Growth* Statistical analysis is sensitive to the time period chosen. How have value and growth been performing over time? Chart 1 shows the long-term dynamics among value, growth, and size. The following conclusions are clear: Value investors should favor small caps over large caps, while growth investors should do the opposite, favoring large caps over small caps, albeit with much less potential success (Chart 1, panel 1). Small-cap investors should favor value stocks over growth stocks (panel 2). Value outperformance in the large-cap space (panel 3) is much weaker than in the small-cap space (panel 2). Chart 1Fama-French Value-Growth-Size Peformance Dynamics* Asset owners and allocators should pay special attention when selecting benchmarks for value and growth. Fama and French define small and large caps based on the median market cap of all NYSE stocks on CRSP (Center for Research In Security Prices), then use the NYSE median size to split NYSE, AMEX and NASDAQ (after 1972) into a small-cap group and a large-cap group. The value and growth split is based on book-to-price, with stocks in the lowest 30% classified as growth, and the highest 30% as value. Interestingly, small-cap value and small-cap growth account for only a very small portion of the entire universe, as shown in Charts 2A and 2B. Chart 2ASmall-Cap Value-Growth Portfolios* Chart 2BLarge-Cap Value-Growth Portfolios* Value stocks’ average market cap is about half of that of growth stocks, in both the large- and small-cap universes (panel 3 in Charts 2A and 2B). Again, this does not support some media claims that value stocks are larger and better-established companies. However, it does add further support to the claim that all investors should favor small-cap value stocks. Unfortunately, “small-cap value” is a very small universe. As of June 2019, the CRSP total U.S. equity market cap was $26.2 trillion, with small-cap value accounting for only 1.5% (about $383 billion); even large-cap value comprises only a relatively small weight, 13% (US$3.5 trillion). The U.S. market is dominated by large-cap growth stocks with a heavy weight of 56% (US$14.7 trillion, as of June 2019). This is encouraging because academic research does show that the value premium among large caps is weak. But the large-cap value weakness mostly started from 2007, after 80 years of strength relative to large-cap growth (Chart 1, panel 3). The Fama-French approach is widely used in academic research, partly due to its long history from 1926. For non-quant practitioners, especially long-only investors, however, commercial indexes from FTSE Russell, S&P Dow Jones, and MSCI are more often used as performance benchmarks. In this report, we study a series of commercial value-growth indexes in the U.S. and globally to shed light on value-growth dynamics, and how asset allocators can incorporate them into their decision-making processes. 2. Not All U.S. Style Indexes Are Created Equal Three major index providers have style indices. They are FTSE Russell (which launched the industry’s first set of value-growth indexes in 1987), S&P Dow Jones, and MSCI. MSCI is the only provider that has a full suite of value-growth indices for all individual markets under coverage. While all three provide “standard” style indices that include the full component of the parent index, the FTSE Russell and the S&P Dow Jones also provide “pure” style indices. There are two major differences between “standard” and “pure” style indices: 1) the standard indices are market-cap weighted, while the “pure” indices are weighted based on style score. 2) Standard value and standard growth have overlapping components, while pure value and pure growth do not share any common components. Other than book-to-price, the value variable used by the Fama-French approach, the three providers have added different variables in the determination of value and growth, as shown in Table 3. This also reflects the evolution of the industry’s understanding on value and growth. For example, when MSCI first launched its style index in 1997, it used only book-to-price, but changed its approach in May 2003 to the current “multi-factor two-dimension” framework. Table 3Value-Growth Index Criteria Because of the differences in index construction methodology, value-growth indices for the U.S. have behaved differently. The S&P 500, the Russell 1000, and the MSCI standard (large and mid-cap) indices are widely followed institutional benchmarks, with back-tested history dating to the 1970s. Chart 3 shows the relative value/growth performance dynamics from the three index providers, together with that from Fama and French (market value-weighted, to be consistent with the approach from the index providers). One can observe the following: Chart 3Which Value/Growth? None of the three pairs looks exactly like Fama-French’s market-cap value-weighted value/growth. This raises the question of how historical analysis based on the long history of Fama-French value/growth portfolios can be applied to the commercial indices. In the first cycle from 1975 to February 2000, all three index pairs made a round trip, with flat performance between value and growth. Also, even though the S&P 500 and Russell 1000 were more closely correlated with one another than with the MSCI, the three were quite similar. In the current cycle that began in February 2000, however, Russell value/growth has rebounded much more strongly than the other two. But in the down period that started in 2007, the three indices performed in line with each other, as shown in Table 4. Table 4U.S. Style Index Performance* In addition, the difference between S&P and Russell does not just lie between the S&P 500 and the Russell 1000. It actually exists in every market-cap segment, as shown in Chart 4. Unfortunately, MSCI does not provide history from 1975 for the detailed cap segments. In the current cycle since February 2000, S&P value rebounded the least between 2000 and 2006. Why? Chart 4Know Your Benchmark Further investigation reveals some interesting observations, as shown in Chart 5. Chart 5Value/Growth: Russell Vs. S&P At the aggregate level, the S&P 1500, the Russell 3000 and their respective style indices have performed largely in line with one another in the most recent cycle starting from February 2000 (Chart 5, panel 4), reflecting the industry trend of index convergence. In different market cap segments, however, the divergence is still prominent, especially in the small-cap space (panel 1). The S&P 600 has consistently outperformed the Russell 2000 in both the value and growth categories. In addition to different style factors, this consistency also reflects different universes, size distribution, and sector exposure, as explained in an earlier GAA Special Report on small caps.8 Managers with Russell 2000 as their performance benchmark could simply beat it by doing a total-return-performance swap between the Russell 2000 and the S&P 600. Bottom Line:  Asset owners and allocators should pay special attention when selecting benchmarks for value and growth.  3. How Have Value And Growth Performed Globally? MSCI is the only index provider that also produces value-growth indices for each equity market under its global coverage, using the same methodology. Unfortunately, only the “standard” (i.e., large- and mid-cap) universe has a long history, dating from December 1974. Charts 6A and 6B show the value/growth dynamics in major DM and EM markets. The relative performance of MSCI DM value versus growth shares a similar pattern to that of the U.S. in the latest cycle since 2000, but looks very different in the period before 2000 (Chart 6A). The ratio of EM large- and mid-cap value versus growth did not peak until February 2012, about five years after the peak of its DM peer (Chart 6B, panel 1). On the other hand, EM small-cap value has resumed its outperformance versus growth since early 2016 after having peaked around the same time as its large-cap counterpart. Chart 6AIs Value Dead In DM? Chart 6BIs Value Dead In EM? The global value/growth dynamics also show that the “value outperforming growth” effect is more prominent in the small-cap space. But why has small value also underperformed small growth in most DM markets? Our explanation is that the EM universe is much less efficient than the DM universe because there are not many quant funds dedicated to the EM small-cap space –  in addition to the fact that, in general, EM small caps are much smaller than those in DM markets. This is also in line with our finding that, in general, factor premia are more prominent in the EM universe.9 Bottom Line: Value premium is more prominent in non-U.S. markets, especially the EM small-cap universe. 4. Do Pure Style Indices Improve Performance? Both S&P Dow Jones and FTSE Russell provide pure-value and pure-growth indices. Unlike the standard value-growth indices, which target about 50% of the parent market cap, the pure-style indices include only stocks with the strongest value and growth characteristics. There is no overlap between the two. We prefer to use sector and country positioning to implement style tilts tactically. In theory, the pure-style indices should outperform the standard-style indices because of their concentrated exposure to style factors. How do they do in reality? Table 5 shows that in terms of absolute return, this is indeed the case for 14 out of the 18 pairs of indices from S&P and Russell for the period between 1998 and 2019. However, the higher returns from greater exposure to style factors have largely come from much higher volatility in 17 out of the 18 pairs. Pure style has higher volatility than standard style in general, the only exception being the Russell mid-cap value space. As such, on a risk-adjusted basis, pure style is not necessarily better. Table 5Purer Is Not Necessarily Better Charts 7A and 7B show the different performance dynamics for the S&P and Russell families of style indices. For the S&P indices, pure growth has outperformed standard growth for the entire period in all three market-cap segments, but only the S&P 500 pure value outperformed its standard counterpart. Therefore, more concentrated exposure to style characteristics has improved the value-growth spread only in the large-cap space, but it has actually worsened the value-growth spread in the mid- and small-cap universes (Chart 7A). Chart 7AS&P Pure Styles* Chart 7BRussell Pure Styles* For the Russell indices, it’s clear that there were a lot more tech stocks in its pure-growth indices leading up to the 2000 tech bubble, because pure growth shot up significantly more than the standard growth before the bubble burst, and also crashed more severely following it. Overall, only in the small-cap space did the value-growth spread improve by the more concentrated exposure to style factors. However, this improvement was not because of the outperformance of the pure-style relative to the standard indices. In fact, both pure value and pure growth in the small-cap universe underperformed their standard counterparts, but pure growth performed even worse (Chart 7B and Table 5). 5. Investment Conclusions Value and growth can mean very different things and behave very differently. Investors should pay special attention to the definitions and methodologies when evaluating style indices or strategies, both academically and in practice.  Depending on an investor’s mandate, the following is recommended: Value investors should focus on non-U.S. markets, especially the emerging market small-cap universe. Growth investors should focus on large caps, especially the U.S. large-cap space. Small-cap investors should focus on value. Large-and mid-cap investors should not make bets between value and growth strategically. Tactical style rotation should be done only when valuation spreads reach extreme levels. Price-to-book is the only common variable used in the determination of value and growth by academics and practitioners. Its track record as a systematic return predictor has been poor, as shown in panel 2 of Charts 8A and 8B. Another factor we have a long history for is dividend yield. Its predictive power is even worse than that of price-to-book (panel 3). Chart 8AValuation Is A Poor Timing Tool In The U.S. Chart 8BValuation Is A Poor Timing Tool Globally Many factors have been used in conjunction with price-to-book by both academics and practitioners to time the rotation between value and growth. However, the results have been mixed. Regression models that correctly predicted in the past may not work in the future. For example, a regression model based on valuation spread and earnings-growth spread using data from January 1982 to October 1999 successfully predicted the rebound of value outperformance starting in early 2000,10 but the universal suffering of value funds over the past several years implies that this model may have given many false signals. Chart 9 demonstrates how difficult it is to use regression models as a timing tool for value and growth rotation. A simple regression is conducted between value and growth return differentials (subsequent 60-month returns) and relative price-to-book. For data from December 1974 to July 2019, the r-squared for the MSCI world is 0.38 and for the U.S. it is 0.09. In hindsight, both models predicted the value outperformance starting in early 2000. However, the gaps between actual value and fitted value started to open, long before 2000. By late 1998, the gaps were already wider than the previous cycle lows, yet they continued to widen as value continued to underperform growth until February 2000.  Chart 9How Good Is The Fit? What should investors currently do, based on these models? The gaps are large, but not as large as in early 2000. At which point should investors start to shift into value given its more than 12 years of underperformance? We have often written that we prefer to use sector and country positioning to implement style tilts.11, 12 This preference has not changed. Value and growth indices have sector tilts that change over time. Currently, the S&P Dow Jones large- and mid-cap value indices have a clear overweight in financials but an underweight in tech and health care compared to their growth counterparts (Table 6). Table 6Sector Bets In Value And Growth Indices* Chart 10Prefer Sector And Country Positioning To Style Tilts We have been neutral on value and growth, but would likely change this view if we change our country equity allocation between the U.S. and the euro area, and our equity sector allocation between cyclicals and defensives as well as between financials and information technology (Chart 10).     Xiaoli Tang, Associate Vice President xiaoliT@bcaresearch.com Footnotes 1Antti Ilmanen, Ronen Israel, Tobias J. Moskowitz, Ashwin Thapar, Franklin Wang, “Factor Premia and Factor Timing: A Century of Evidence,” AQR Working Paper, July 2, 2019. 2Eugene F. Fama and Kenneth R. French, “Common risk factors in the return on stocks and bonds,” Journal of Financial Economics, 33 (1993). 3Clifford Asness, Andrea Frazzini, Ronen Israel and Tobias Moskowitz, “Fact, Fiction, and Value Investing,” The Journal of Portfolio Management, Vol. 42 No.1, Fall 2015.  4Ronen Israel and Tobias J. Moskowitz, “The Role of Shorting, Firm Size and Time on Market Anomalies,”Journal of Financial Economics, Vol 108, Issue 2, May 2013 5Eugene F. Fama and Kenneth R. French, “A Five-Factor Asset Pricing Model,” Working Paper, University of Chicago, September 2014. 6Fama-French value-growth-size portfolios. 7Mark P. Cussen, “Value or growth Stocks: Which are Better?” Investopedia, Jun 25, 2019. 8Please see Global Asset Allocation Special Report titled “Small Cap Outperformance: Fact or Myth?” dated April 7, 2017, available at gaa.bcaresearch.com. 9Please see Global Asset Allocation Special Report titled, “Is Smart Beta A Useful Tool In Global Asset Allocation?” dated July 8, 2016, available at gaa.bcaresearch.com 10Clifford S. Asness, Jacques A Friedman, Robert J. Krail and John M Liew, “Style Timing: Value versus Growth,” The Journal of Portfolio Management, Spring 2000. 11Please see Global Asset Allocation Quarterly Portfolio Outlook, “Quarterly - March 2016,” dated March 31, 2016, and available at gaa. bcaresearch.com. 12Please see Global Asset Allocation Quarterly Portfolio Outlook, “Quarterly - April 2019,” dated April 1, 2019 available at gaa.bcaresearch.com.  

Commodity demand appears to be turning up, based on our assessment of global industrial activity. As demand picks up, we expect industrial commodity prices will move higher (Chart of the Week, top panel). For all practical purposes, central banks and numerous governments have moved into recession-fighting mode, following the contraction in manufacturing activity brought on by the U.S. Fed’s rates-normalization policy last year, and China’s deleveraging campaign in 2017-18. Together, these policies severely retarded credit and liquidity available to markets, and drove the USD higher, to the detriment of commodity demand (Chart of the Week, middle panel). Current policy responses will support a revival of manufacturing, and with it, global trade (Chart of the Week, bottom panel). While we continue to expect a weaker USD on the back of additional Fed easing this year and recovery of ex-U.S. economic growth in line with our House view, we remain wary uncoordinated global monetary accommodation by a large number of central banks could leave the dollar well bid. This could stifle the commodity-demand revival by keeping local-currency commodity costs high (Chart 2). This would be especially bearish for base metals prices.1 Chart of the WeekGlobal Industrial Activity Moving Higher Chart 2USD Strength Will Pose Risk To Industrial Commodity Demand Highlights Energy: Overweight. The appointment of Prince Abdulaziz bin Salman as the Kingdom of Saudi Arabia’s (KSA) new Energy Minister signals the royal family will push harder to manage production and reduce global oil inventories ahead of the IPO of Saudi Aramco. The prince brings more than 30 years of experience to the role, making him something of an outlier among KSA’s ministers – technocrats typically have occupied the position, and he is the first royal to serve as Energy Minister. We believe the prince’s immediate goal is to get Brent into the mid- to high-$70/bbl ahead of the IPO later this year or early next year. The first leg of the IPO reportedly will be done locally in the Kingdom, with Saudi investors taking ~ 1% of the Saudi Aramco float. Base Metals: Neutral. China imported 1.82mm MT of copper concentrates in August, a 9.3% increase y/y, as smelters continue to buy partly processed ores to feed expanding capacity. Concentrate imports in July were a record 2.07mm MT. Precious Metals: Neutral. The World Platinum Investment Council (WPIC) forecasts a 9% increase in platinum demand this year, driven primarily by ETF investors. This “more than offsets expected demand decreases in the automotive and jewellery segments of 4% and 5% respectively.” WPIC reduced its expected physical surplus this year to 345k ounces, from its earlier expectation of 375k ounces. Our tactical long platinum position recommended August 29, 2019 is up 1.9%. Separately, we are taking profits on our Long 10-year TIPS position at tonight’s close. It was up 9.3% on September 10, 2019. The position was recommended July, 27, 2017. Ags/Softs: Underweight. A wet start to the planting season points to lower corn and bean yields this year vs. 2018. AccuWeather expects 2019 corn yields will fall 7.35% y/y to 13.36 billion bushels, and soybean yields will be down 19.5% y/y to 3.658 billion bushels. Besides stressing crops at the beginning of the season, weather-related delays also increase the risk some of this year’s crop will be exposed to frost at the end of the season before it is harvested. Weather effects continue to be apparent in the USDA’s crop conditions report, particularly for corn, where the USDA now rates 55% of the U.S. crop good or excellent, vs. 68% a year earlier. Last week, the USDA rated 58% of the corn crop good or excellent. Feature Leading indicators are signaling the slowdown in global growth – i.e., aggregate-demand growth – likely bottomed ex-Europe (Chart 3). The chart shows easing global financial conditions, along with fiscal stimulus, most likely have arrested the slowdown in industrial commodity demand (Chart 4). Chart 3Manufacturing Downturn Likely Arrested Following Broad Monetary Stimulus Chart 4Global Financial Conditions Are Supportive Easier Financial Conditions Will Benefit Global Growth We expect the recovery in demand will be most visible in the LMEX base metals index and in oil markets. Base metals demand is highly concentrated in China – accounting for ~ 50% of global demand – and EM Asia.  Our EM Commodity-Demand Nowcast continues to signal oil demand also will revive in 2H19 as GDP growth picks up (Chart 5). Markets still could wobble, which is why the evolution of EM import volumes remains important, given their high correlation with GDP levels. A number of gauges we follow closely – particularly those associated with the movement of good on the sea (Chart 6) and in the air (Chart 7) – have turned up in 3Q19. We expect this to continue into 4Q19 and next year. Chart 5Monetary, Fiscal Stimulus Will Lift Oil Demand   Chart 6Shipping Gauges Signal Uptick in Movement of Goods Chart 7Air Freight Gauges Signal Uptick in Movement of Goods USD Strength Keeps Us Wary The contraction in manufacturing and EM trade volumes is largely the result of the Fed’s rates-normalization policy last year, and China’s deleveraging campaign in 2017-18, in our view. These policies raised the value of the USD, which raised local-currency costs of dollar-denominated commodities, and all other goods and services invoiced and funded with dollars (Chart 8). Indeed, as Chart 2 shows, oil prices and base metals prices in local-currency terms ex-U.S. are closer to their earlier highs when Brent was trading above $100/bbl. This redounded to the detriment of commodity demand.2 The Sino-U.S. trade war certainly does not help commodity demand. For the most part, however, we believe this affects demand expectations – i.e., capex- and investment-driven demand. We believe firms and households will reduce outlays and increase precautionary savings, as a buffer against an expansion of the trade war into a larger global conflict, which likely would impair global supply chains and growth prospects. Chart 8Strong USD Keeps Us Wary While we expect the USD to weaken as the Fed cuts its policy rate, in line with our House view, we reiterate the non-trivial risk that global monetary accommodation still could leave the dollar well bid.3 Rising negative yielding debts globally makes U.S. yields relatively attractive despite the ongoing easing, supporting capital inflows in U.S. fixed income markets. Investment Implications The coincidence of fiscal and monetary policy easing is showing up in our gauges of global economic activity and in our leading indicators. We remain long oil exposure and precious metals – gold on a strategic basis, silver and platinum on a tactical basis. As we see industrial commodity demand picking up, we will look to go long copper. Bottom Line: Our gauges of economic activity continue to point to a bottoming of the global ex-U.S. slowdown in industrial activity, particularly in manufacturing, which has been hard-hit by a downturn in auto output. We expect USD weakness to become a tailwind for industrial commodities; however, we are wary continued strength in the dollar – it is above its 1Q02 peak – could crimp industrial metals, and maybe even oil, prices (Chart 9). Chart 9USD TWIB Strength Hampers Industrial Commodity Demand   Robert P. Ryan, Chief Commodity & Energy Strategist rryan@bcaresearch.com   Footnotes 1      We use base metals demand, particularly for copper, as an indicator of EM industrial activity in our modeling. These markets are somewhat removed from the idiosyncratic forces driving oil supply-demand dynamics, particularly on the supply side, where OPEC 2.0 continues to maintain its policy of production discipline to reduce global inventory levels. OPEC 2.0 is the name we coined for the producer coalition lead by KSA and Russia, which was formed in 2016 with the explicit mission of reducing the global oil-inventory overhang resulting from the 2014-15 market share war launched by the original OPEC states in 2H14. 2      Last week we discussed USD strength vis-à-vis oil demand. Please see Central Bank Easing Key To Oil Prices. It is available at ces.bcaresearch.com. 3      A non-trivial risk is bounded at the lower end by Russian-roulette odds – i.e., 1:6 – in our usage of the phrase. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades TRADE RECOMMENDATION PERFORMANCE IN 2019 Q2 Commodity Prices and Plays Reference Table Trades Closed in 2019 Summary of Closed Trades