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Dear client, Next Monday, October 19, we will be hosting our quarterly webcast, “From Alpha To Omega With Anastasios”, at 10am EST; Matt Gertken, BCA’s Geopolitical Strategist will be our guest on the eve of the US Presidential Election. Our regular weekly publication will resume on Monday October 26, 2020. Kind Regards, Anastasios Highlights Portfolio Strategy Homebuilders are more than fully priced, discounting high margins as far as the eye can see and no end to demand. The specter of higher interest rates, lumber inflation, stealing demand from the future, unfriendly bankers and uncertainty with regard to a fresh stimulus package more than offset the positives, and compel us to issue a downgrade alert for the S&P homebuilding index. While the price of credit, loan growth prospects and credit quality all weigh on relative bank performance. A fiscal stimulus bill, depressed valuations and a Fed induced resumption of dividend hikes and share buybacks keep us on the sidelines in the S&P banks index.  Recent Changes There are no changes to our portfolio this week. Table 1 COVID Fatigue, Fiscal Fatigue, Election Fatigue COVID Fatigue, Fiscal Fatigue, Election Fatigue Feature Equities seesawed last week as President Trump returned to the White House (WH) and injected fresh volatility in markets signaling that there will be no fiscal deal prior to the elections. The SPX immediately gapped down and we cannot stress enough the importance of our newly configured Fiscal Policy Loop: fiscal hawkishness causes skittishness in markets culminating to a classic BCA riot point and then policymakers relent and fiscal dovishness restores the equity bull market (Figure 1). While we cannot rule out a slimmed-down stimulus package deal by later this month, fiscal policy- and election-related uncertainties remain elevated. The daily back-and-forth on where Congress and the WH stand with passing a new stimulus bill coupled with the prospects of a contested election that would drag on the presidential race likely into December, have caused investor fatigue. The sooner both of these uncertainties recede, the quicker the SPX will climb to fresh all-time highs (Chart 1). Figure 1The Fiscal Policy Loop COVID Fatigue, Fiscal Fatigue, Election Fatigue COVID Fatigue, Fiscal Fatigue, Election Fatigue Chart 1Receding Uncertainty Will Boost Stocks Receding Uncertainty Will Boost Stocks Receding Uncertainty Will Boost Stocks   We have shown in recent research, and update today, that the fourth year of presidential cycles finds the SPX ending the year on average in the green with a calendar return in the high single digits (Chart 2). Peering back in 2016 is instructive as that presidential election cycle year was in some ways similar to the current one. The economy, in particular, was fighting off a manufacturing recession that spread and infected the services sectors as the vast majority of S&P GICS1 sectors saw profit contraction and more importantly revenue declines. Chart 3 shows a number of asset classes and compares 2016 with 2020. The 10-year US Treasury yield appears poised to rebound significantly, especially if Congress passes a fresh fiscal package that aides the parts of the economy that need the stimulus checks most. Fiscal easing uncertainty remains a thorny issue across different markets and if history is an accurate guide, the SPX could glide lower into the November election before rallying into year-end. Chart 2Back Up Near The Average Profile Back Up Near The Average Profile Back Up Near The Average Profile Meanwhile, a number of investors we talk to also experience COVID-19 fatigue (Chart 4). For the better part of the last 10 months media has constantly bombarded the world with pandemic news, and rightly so. However, all this seems dystopian by now, and we cannot wait for a semblance of normality to make a comeback, which a vaccine will definitively bring about. The equity market has been indurated to this news-flow and has shaken-off the recession. When the vaccine does arrive likely next year, profits will also return back to trend, as we have been arguing for some time, because the global economy will fully reopen. Chart 32016 Versus 2020 2016 Versus 2020 2016 Versus 2020 Already, if we juxtapose leading soft economic data surprises with lagging hard economic data surprises, it is clear that a stellar profit recovery looms (second panel, Chart 5). Similarly, within soft the data universe, the ISM new orders-to-inventories ratio paints a rosy picture for an earnings recovery in 2021 (third panel, Chart 5). Even within hard economic data, a simple liquidity indicator we have used in the past comparing industrial production (IP) with M2 money stock signals that S&P profits have troughed (IP vs. M2 shown advanced, bottom panel, Chart 5) Chart 4COVID Fatigue COVID Fatigue COVID Fatigue Finally, the US Equity Strategy’s four-factor macro profit growth model has slingshot higher recently and signals that a return to $162 level of EPS in calendar 2021 is a high probability outcome (Chart 6). Netting it all out, we are in the tail end of the equity market correction and as election and fiscal policy uncertainties ebb, they will pave the way for a robust SPX rally. Chart 5Profit Recovery On Track Profit Recovery On Track Profit Recovery On Track   Chart 6EPS Model Concurs EPS Model Concurs EPS Model Concurs This week, we continue with our strategy of preferring beaten-down cyclicals to defensives and steer the portfolio away from another safe haven staples industry via downgrading a consumer goods subgroup to underweight. We also delve deeper into the banking industry highlighting some cracks in small commercial banks. Put Homebuilders On Downgrade Alert Homebuilders have had a monster run since the depths of the recession back in March and the question a lot of our clients are now asking is: does it make sense to chase them higher at the current juncture? The short answer is no. Before we get into the details of our analysis a brief recap of our recent residential real estate-related moves is in order. Going into the March carnage we were cyclically underweight the niche homebuilding index. Moreover, last December we had identified homebuilders as a high-conviction underweight in our annual Key Views report. We monetized relative gains of 41% and 43%, respectively from both positions and lifted exposure to a benchmark allocation. While in retrospect we should have upgraded all the way to overweight, we did manage to participate in the V-shaped housing-related returns by opting to go overweight the mega cap home improvement retail index instead. In addition, this summer we eked out another 10% return from a long homebuilders/short REITs pair trade. Homebuilders are enjoying the single family home renaissance as the pandemic has turbo-charged the work from home movement and employees are rushing to move into comfortable spaces in the suburbs as the traditional office is literally declared dead. Indeed, housing starts and permits have renormalized, the drubbing in interest rates has boosted affordability and caused a knee jerk reaction in the mortgage application purchase index, and sell-side analysts are fighting hand-over-fist to upgrade profit projections for the homebuilding group (Chart 7). The end result has been a boom in new home sales that are trouncing existing home sales, and the NAHB’s survey of prospective homebuyers continues to paint a rosy picture for additional demand for new single family homes especially given the low inventory of homes (top & third panels, Chart 8). Chart 7Housing Tailwinds Housing Tailwinds Housing Tailwinds Chart 8Price Concessions Generate Volume Price Concessions Generate Volume Price Concessions Generate Volume This is where all the good news ends. With respect to selling prices, homebuilders are making price concessions compared with existing homes and also in absolute terms new home prices are deflating (second & bottom panels, Chart 8). Therefore, at close to 15%, homebuilding profit margins are near all-time highs and under threat especially from a firming industry wage bill (second & third panels, Chart 9). Tack on surging lumber inflation and a profit margin squeeze is a high probability outcome (bottom panel, Chart 9). As a reminder framing lumber, on average, comprises 15% of a new single family home’s total input costs. While the NAHB survey points to brisk demand for new homes, the sister Conference Board survey shows that consumers’ appetite for a new home has crested (second & third panels, Chart 10). With consumers rushing to move to the suburbs due to the pandemic, there is an element of bringing housing demand forward. Chart 9Beware Margin Squeeze Beware Margin Squeeze Beware Margin Squeeze Chart 10Good News Fully Priced Good News Fully Priced Good News Fully Priced Worrisomely, if the economy continues to open up then interest rates should continue to back up. From all the major asset classes the 10-year Treasury yield is the one that has yet to discount a V-shaped economic recovery. The implication is that rising interest rate would dent affordability and at the margin weigh on housing demand (10-year Treasury yield shown inverted, top panel, Chart 10). Moving on to the credit backdrop, while demand for residential real estate loans has recovered, bankers refuse to extend mortgage credit (second & third panels, Chart 11). According to the latest Fed H8 weekly credit release, residential real estate loans are on the verge of contraction (bottom panel, Chart 11). Finally, the tug-of-war on the fiscal package front is also threatening to sustain the unemployment rate near double digits, which could jeopardize the housing recovery. Historically, housing starts have been near perfectly inversely correlated with the unemployment rate and the current message is for a leveling off in residential construction activity (middle panel, Chart 12). The recent homebuilding run has pushed relative valuations from undervalued to overvalued. The relative P/S ratio trades roughly 30% above the historical mean (a three-year high), and leaves no cushion for any mishaps (bottom panel, Chart 12). Chart 11Bankers Refusing To Dole Out Loans Bankers Refusing To Dole Out Loans Bankers Refusing To Dole Out Loans Chart 12In Desperate Need Of Fiscal Help In Desperate Need Of Fiscal Help In Desperate Need Of Fiscal Help Netting it all out, homebuilders are more than fully priced, discounting high margins as far as the eye can see and no end to demand. The specter of higher interest rates, lumber inflation, stealing demand from the future, unfriendly bankers and uncertainty with regard to a fresh stimulus package more than offset the positives, and compel us to issue a downgrade alert for the S&P homebuilding index. Bottom Line: Stay neutral the S&P homebuilders index, but it is now on our downgrade watch list. The ticker symbols for the stocks in this index are: BLBG: S5HOME – LEN, PHM, DHI, NVR. A Few Words On Banks Pundits around the globe focus on Eurozone and pan-European banks and argue that these outfits have been value destroyers since the history of the data series in late-1986 (bottom panel, Chart 13). Similarly, US banks relative share prices peaked in the mid-1970s and have never looked back, and very recently have tumbled to fresh all-time lows whether one uses monthly, weekly or daily data (top panel, Chart 13). Meanwhile, the recent drubbing in relative share prices suggests that loan loss provisioning is not over. In fact, Q3 loan loss reserves will surpass the level hit in the GFC, and likely close in on the $300bn mark (provisions shown inverted, Chart 14). Chart 13Banks, The World Over, Are Value Destroyers Banks, The World Over, Are Value Destroyers Banks, The World Over, Are Value Destroyers Chart 14More Loan Losses Loom… More Loan Losses Loom… More Loan Losses Loom… Historically, loan loss provisions are the mirror image of bank net operating income and most importantly bank profits decline as provisioning increases (Chart 15). Worrisomely, the longer the new stimulus checks take to arrive, the longer it will take banks to rebound. Banks have been semi-sheltered from the recession courtesy of eviction/foreclosure moratorium as well as mortgage forbearance agreements. Absent a fresh stimulus package, the unemployment rate will remain elevated, warning that lagging non-performing loans will skyrocket (bottom panel, Chart 16). Chart 15…Which Will Weigh On Profits …Which Will Weigh On Profits …Which Will Weigh On Profits Chart 16Fiscal Policy Easing To The Rescue? Fiscal Policy Easing To The Rescue? Fiscal Policy Easing To The Rescue? Tack on the year-to-date more than halving in the 10-year US Treasury yield and the earnings outlook remains grim for banks (top & middle panels, Chart 17). The transmission mechanism is through net interest margins (NIMs). The fourth panel of Chart 17 highlights that the pair have been joined at the hip and all-time lows in the 10-year US Treasury yield have sank bank NIMs below 3%, which is another all-time low since the history of the FDIC data. Credit growth has crested and our loans and leases model suggests that loan growth will continue to decelerate into 2021 (second panel, Chart 17). Not only is there lack of appetite for new overall loan uptake, but bankers are stringent with extending credit to businesses and consumer alike, according to the most recent Fed Senior Loan Officer survey (Chart 18). Chart 17Credit Growth Blues Credit Growth Blues Credit Growth Blues Chart 18Lack Of Loan Demand And Tightening Credit Supply Lack Of Loan Demand And Tightening Credit Supply Lack Of Loan Demand And Tightening Credit Supply However, there are three significant offsets to all these stiff headwinds that prevent us from downgrading banks to an underweight stance. First, the 10-year US Treasury yield is one of the few assets that has yet to discount any economic recovery. Thus, as uncertainty lifts post the November election, the economy continues to open up and Congress and the new President manage to pass a fresh fiscal stimulus bill, all this could catalyze a catch up phase in the long bond yield. Second, valuations offer a deep enough discount to absorb a little bit of more negative news as analysts and investors alike have thrown in the towel in banks (bottom panel, Chart 19). Finally, the credible Fed’s stress test loom by year-end and assuming banks pass them with flying colors a resumption of shareholder friendly activities will boost the allure of owing banks and unwind extremely oversold conditions (middle panel, Chart 19). In sum, while the price of credit, loan growth prospects and credit quality all weigh on relative bank performance. A fiscal stimulus bill, depressed valuations and a Fed induced resumption of dividend hikes and share buybacks keep us on the sidelines in the S&P banks index. Chart 19Unloved And Under-owned Unloved And Under-owned Unloved And Under-owned Bottom Line: Stay neutral the S&P banks index, but keep it on the downgrade watch list. The ticker symbols for the stocks in this index are: BLBG: S5BANKX – JPM, BAC, C, WFC, USB, TFC, PNC, FRC, FITB, MTB, KEY, SIVB, RF, CFG, HBAN, ZION, CMA, PBCT.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Drilling Deeper Into Earnings Drilling Deeper Into Earnings Size And Style Views July 27, 2020 Overweight cyclicals over defensives April 28, 2020  Stay neutral large over small caps June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth

Buybacks Will Be Back Buybacks Will Be Back Most recent Standard and Poor’s data show that SPX buybacks collapsed to $88bn in Q2, from roughly $200bn in Q1, which is a whopping 67% quarter-over-quarter fall. Such a corporate buyer’s strike is negative for the near-term prospects of the S&P 500, but we expect buybacks to come back as the V-shaped economic recovery all but guarantees a rebound sometime in 2021 (top panel). Importantly, CEO confidence has also slingshot higher and coupled with the overall economic recovery, will pave the way for a resumption of shareholder friendly activities (middle panel). Bottom Line: Artificial EPS boosting via equity retirement will come back in 2021, especially in light of the ZIRP that is here to stay for the next five-seven years. For more details, please refer to this Monday’s Weekly Report.

Underweight Avoid REITs Avoid REITs We remain bearish on the prospects of the S&P real estate sector as the pandemic will continue to severely bruise REITs. Already, YTD relative share prices are down 10%, and were it not for the tech/communications-laden – tower and digital storage – REITs that the S&P specialized REITs subgroup houses, then the relative underperformance would sink to 25%. According to the latest Q2 Fed release, CRE delinquencies are on the rise (not shown) and CRE prices are on the verge of contracting (bottom panel). A fresh stimulus bill could come to the rescue, but recent news of President Trump halting negotiations jeopardizes chances for near-term relief. Refinancing risk is another threat that could cause a gap down in CRE prices, as bankers remain unwilling to dole out CRE loans despite a collapse in interest rates. Once the underlying asset gets repriced lower, then the debt related house of cards comes crumbling down (top & middle panels). Bottom Line: We remain underweight the S&P real estate sector. The ticker symbols for the stocks in this index are: BLBG: S5RLST-AMT, EQIX, PLD, CCI, DLR, PSA, SBAC, AVB, WELL, ARE, O, SPG, WY, CBRE, EQR, ESS, FRT, PEAK, VTR, BXP, DRE, EXR, MAA, UDR, AIV, HST, IRM, KIM, REG, SLG, VNO. For more details, please refer to this Monday’s Weekly Report.

Neutral - Downgrade Alert Small Bank Trouble Brewing Small Bank Trouble Brewing Absent another fiscal package, banks risk digesting a new wave of credit defaults, further increasing their loan loss provisions as pandemic wounds remain open. Importantly, according to the latest Fed data, small banks1 are at the forefront of sloppy lending activity, warning that those weaker banks have higher exposure to defaults than large banks.2 Small bank C&I loan growth reached a whopping 50% per annum growth rate (second panel). Commercial real estate (CRE) loans are also expanding at a higher rate in small banks compared with large banks (third panel). With regard to concentration, small banks have been making inroads in feverishly doling out loans versus large banks. The former now comprise 40% of total C&I loan books (the largest credit category, bottom panel) and 2/3 of CRE loans – the second largest loan category with $2.4tn outstanding. Inevitably, some loans will sour because of the pandemic and the longer it takes Congress to pass a fresh stimulus bill the higher the pain for banks. One way out of this mess will likely be via much needed industry consolidation. As a reminder the US still has 4,400 banks. Bottom Line: We remain neutral the S&P banks index, which is also on our downgrade watchlist since early September. The ticker symbols for the stocks in these indexes are: BLBG S5BANKX – JPM, BAC, C, WFC, USB, TFC, PNC, FRC, FITB, MTB, KEY, SIVB, RF, CFG, HBAN, ZION, CMA, PBCT.    Footnotes 1 Small banks are defined as all commercial banks excluding top 25 banks ranked by domestic assets. 2 Large banks are defined as top 25 commercial banks ranked by domestic assets.

Dear Client, Next week I will present our outlook on China’s economic recovery, the direction of economic policy and financial markets for the rest of the year and beyond in two live webcasts. The webcasts will take place next Wednesday, October 14 at 10:00AM EDT (English) and Friday, October 16 at 9:00 AM Beijing/HK/Taipei time, 12:00 PM Australian Eastern time (Mandarin). Best regards, Jing Sima, China Strategist   Feature We have changed the format of our monthly China Macro And Market Review to deliver our messages more concisely and effectively. This week’s report consists of charts that are the most market relevant. Many charts are either self-explanatory or convey a message with brief comments. These charts present macro fundamentals as well as price signals and valuation profiles of China’s financial markets. Our key observations and investment conclusions are as follows: Recent economic data points to a broadening economic recovery in China. The demand side continues to accelerate, and its pace has outstripped production for three consecutive months. Both external and domestic demand measures jumped to above the 50 boom-bust threshold in September’s manufacturing PMI. Service PMI saw the largest monthly uptick since 2013. Credit expansion remained robust through August. Medium- and long-term bank loans to corporates have partially offset the dwindling short-term loans since May, suggesting that near-term liquidity constraints among corporates may be easing. Moreover, an improving bank loan structure will help to boost corporates’ Capex investments. As noted in last month’s China Macro and Market Review,1 the consistent outperformance in production recovery relative to demand in H1 this year has led to an inventory buildup. The ongoing inventory destocking has impeded China’s imports of major commodities and led to a weakening of commodity prices in the past two weeks. The continued destocking of commodities suggests that China’s demand for commodities will remain soft into Q4. Beyond Q4, however, the acceleration in both domestic and external demand should provide solid support to the ongoing economic recovery. Local governments still hold a substantial amount of unspent proceeds from special-purpose bonds issued earlier this year; the funds must be invested in infrastructure projects. We expect China’s imports of industrial raw materials to bounce back in Q1 2021 once the current inventory destocking runs its course. We remain overweight Chinese domestic and investable stocks in a global portfolio in the coming six to nine months. Even though Chinese share prices have run ahead of the country’s business cycle and have priced in an earnings recovery, they are still less overbought than their global peers. China’s economic recovery remains solid compared with other economies, thanks to its successful containment of the domestic COVID-19 outbreak. In absolute terms, we think Chinese stocks still have ample upside potential, as both monetary and fiscal stances remain historically accommodative and the economic recovery is accelerating. Recent setbacks in onshore and offshore stocks were due to the ripple effects from global equity selloffs. Escalating Sino-US frictions have had a very limited effect on China’s overall market because US sanctions are mostly targeted at individual technology companies. There is an elevated risk of a near-term correction in global equity prices, particularly in the next four weeks leading up to November’s US presidential election. In our view, these corrections will provide good buying opportunities. Both Chinese government bonds and onshore corporate bonds remain attractive in a global fixed-income portfolio, based on their higher yields and better risk-reward profile relative to their global peers. Within China’s onshore bond portfolio, returns on corporate bonds have consistently outperformed their duration-matched government bonds. We continue to recommend onshore corporate bond positions in the next 6-12 months.   Qingyun Xu, CFA Senior Analyst qingyunx@bcaresearch.com Jing Sima China Strategist jings@bcaresearch.com   Chart 1A Widening Economic Recovery A Widening Economic Recovery A Widening Economic Recovery Chart 2Credit Expansion Will Likely Peak In October, But Its Impetus For The Economic Recovery Will Continue Through 1H2021 Credit Expansion Will Likely Peak In October, But Its Impetus For The Economic Recovery Will Continue Through 1H2021 Credit Expansion Will Likely Peak In October, But Its Impetus For The Economic Recovery Will Continue Through 1H2021   Chart 3ALocal Governments Still Have Plenty Of Unspent Fiscal Firepower Local Governments Still Have Plenty Of Unspent Fiscal Firepower Local Governments Still Have Plenty Of Unspent Fiscal Firepower The divergence between total social financing and M2 growth during the past two months was mainly due to the lack of synchronization between government bond issuances and fiscal spending. Bond issuances are included in social financing and have pushed up fiscal deposits. Fiscal deposits do not derive M2 until they are eventually transferred into fiscal spending. Therefore, we expect that M2 growth will catch up in a few months. Most of the proceeds from government bond issuance have not been dispensed. Local governments have more than enough firepower to continue to support infrastructure spending in the next two quarters. Chart 3BChina's Bank Loan Structure Is Improving China's Bank Loan Structure Is Improving China's Bank Loan Structure Is Improving Chart 3CLoan Demand And Loan Approvals Have Revitalized Loan Demand And Loan Approvals Have Revitalized Loan Demand And Loan Approvals Have Revitalized Chart 4AChina's Resilient And Competitive Export Sector Has Performed Well During The Pandemic-Induced Global Recession... China's Resilient And Competitive Export Sector Has Performed Well During The Pandemic-Induced Global Recession... China's Resilient And Competitive Export Sector Has Performed Well During The Pandemic-Induced Global Recession... Chart 4B...And Will Benefit From A World-wide Economic Recovery ...And Will Benefit From A World-wide Economic Recovery ...And Will Benefit From A World-wide Economic Recovery Chart 5Ongoing Inventory Destocking Will Likely Continue To Impede China's Imports Of Commodities Into Q4 Ongoing Inventory Destocking Will Likely Continue To Impede China's Imports Of Commodities Into Q4 Ongoing Inventory Destocking Will Likely Continue To Impede China's Imports Of Commodities Into Q4 Chart 6A Faster Recovery In Demand In Downstream Industries Should Help To Revive The Manufacturing Sector A Faster Recovery In Demand In Downstream Industries Should Help To Revive The Manufacturing Sector A Faster Recovery In Demand In Downstream Industries Should Help To Revive The Manufacturing Sector   Chart 7AMounting Post-Pandemic Demand In The Property Market Has Invited Tighter Scrutiny From Chinese Authorities... Mounting Post-Pandemic Demand In The Property Market Has Invited Tighter Scrutiny From Chinese Authorities... Mounting Post-Pandemic Demand In The Property Market Has Invited Tighter Scrutiny From Chinese Authorities... Chart 7B...But Near-Term Real Estate Construction Should Still Hold Up ...But Near-Term Real Estate Construction Should Still Hold Up ...But Near-Term Real Estate Construction Should Still Hold Up As noted in last month’s China Macro And Market Review,2 recently tightened financing regulations on real estate development3 are not game changers. Historically, the government’s financial rules and land sales have not had a strong positive correlation with real estate investment growth. So far, Chinese authorities have kept property policies flexible, allowing most local governments to have their own housing policies. We expect property restrictions will tighten on tier-one and tier-two cities that are facing upward pressure on housing prices. Housing demand in smaller cities, however, remains soft and may see increased policy support next year.  Chinese policymakers will continue to keep an eye on real estate speculation. In the near term, however, real estate developers need to complete their existing projects, which will support construction activities into H1 next year.   Chart 8AHousehold Consumption Continues To Recover Household Consumption Continues To Recover Household Consumption Continues To Recover Chart 8BRising Employment Should Further Lift Consumption Rising Employment Should Further Lift Consumption Rising Employment Should Further Lift Consumption   Chart 9AChina's Offshore And Onshore Forward Earnings Have Ticked Up China's Offshore And Onshore Forward Earnings Have Ticked Up China's Offshore And Onshore Forward Earnings Have Ticked Up Chart 9BValuations In A Shares Are Not Too Extreme Valuations In A Shares Are Not Too Extreme Valuations In A Shares Are Not Too Extreme   Chart 9CChinese Stocks Are Not Expensive Compared With Global Benchmarks Chinese Stocks Are Not Expensive Compared With Global Benchmarks Chinese Stocks Are Not Expensive Compared With Global Benchmarks Chart 10AChina's Cyclical Stocks Are Advancing Against The Backdrop Of Improving Economic Fundamentals China's Cyclical Stocks Are Advancing Against The Backdrop Of Improving Economic Fundamentals China's Cyclical Stocks Are Advancing Against The Backdrop Of Improving Economic Fundamentals China offshore cyclical stock prices have been driven by hefty valuations since 2016, mostly because investable cyclicals are heavily weighted in high-flying tech stocks. Chinese tech stock prices will likely be extremely volatile in the next one to three months. We expect a tougher stance on China from the US in the next four weeks leading up to the presidential election. Furthermore, even if Trump does not get reelected, the “lame duck” President may still impose sanctions on China before he leaves the White House in January 2021. We are staying the course with our constructive cyclical view on Chinese stocks, even though the market will be more volatile during the next few months. Chinese tech company stocks have been shaken by negative surprises relating to frictions with the US.  However, investors also cheer on even the slightest easing of tensions between the two countries.4 We expect this risk-on and -off sentiment to intensify through Q4. Onshore cyclical stocks have consistently underperformed defensives, driven by a downtrend in relative earnings per share. However, improvements in economic fundamentals of late suggest that the uptick in domestic cyclicals may be strengthening. We remain long on onshore and offshore consumer discretionary and materials relative to their respective broad market indexes. The investment calls are in place until policy dividends on those sectors subside, which we expect in mid-2021. Chart 10BChina's Equity Sectors In Perspective China's Equity Sectors In Perspective China's Equity Sectors In Perspective Chart 10CChina's Equity Sectors In Perspective China's Equity Sectors In Perspective China's Equity Sectors In Perspective Chart 11AA Solid Economic Recovery, A Relatively Stable Currency Exchange Rate And Higher Yields, All Have Made China's Stocks and Bonds Attractive To Foreign Investors A Solid Economic Recovery, A Relatively Stable Currency Exchange Rate And Higher Yields, All Have Made China's Stocks and Bonds Attractive To Foreign Investors A Solid Economic Recovery, A Relatively Stable Currency Exchange Rate And Higher Yields, All Have Made China's Stocks and Bonds Attractive To Foreign Investors Chart 11BChinese Bonds Offer A Better Risk-Reward Profile In An Ultra-Low Yield Global Environment Chinese Bonds Offer A Better Risk-Reward Profile In An Ultra-Low Yield Global Environment Chinese Bonds Offer A Better Risk-Reward Profile In An Ultra-Low Yield Global Environment Table 1China Macro Data Summary China Macro And Market Review China Macro And Market Review Table 2China Financial Market Performance Summary China Macro And Market Review China Macro And Market Review   Footnotes 1Please see China Investment Strategy Weekly Report "China Macro And Market Review," dated September 9, 2020, available at cis.bcaresearch.com 2Please see China Investment Strategy Weekly Report "China Macro And Market Review," dated September 9, 2020, available at cis.bcaresearch.com 3China's widely circulated but unofficial "three red lines" policy sets limits on bank borrowings: a 70% ceiling on a developer’s debt-to-asset ratio after excluding advance receipts; a 100% cap on the net debt-to-equity ratio; and a requirement that short-term borrowing does not exceed cash reserves, according to S&P Global Ratings. 4Please see China Investment Strategy Weekly Report "Sticking With Chinese “Old Economy” Stocks In A Widening Tech War," dated August 12, 2020, available at cis.bcaresearch.com Cyclical Investment Stance Equity Sector Recommendations

Reminiscences Of 2016? Reminiscences Of 2016? We have shown in recent research that the fourth year of presidential cycles finds the SPX ending the year on average in the green with a calendar return in the high single digits. Peering back in 2016 is instructive as that presidential election cycle year was in some ways similar to the current one. The economy, in particular, was fighting off a manufacturing recession that spread and infected the services sectors as the vast majority of S&P GICS1 sectors contracted profits and more importantly revenues. The chart shows a number of asset classes and compares 2016 with 2020. The 10-year US Treasury yield appears poised to rebound significantly, especially if Congress passes a fresh fiscal package that aides the parts of the economy that need the stimulus checks most. Fiscal easing uncertainty remains a thorny issue across different markets and if history is an accurate guide, the SPX could glide lower into the November election before rallying into year-end. Bottom Line: We are in the tail end of the equity market correction and as election and fiscal policy uncertainties recede they will pave the way for a robust SPX rally. ​​​​​​​

Highlights Portfolio Strategy Buybacks are down but not out. While financials have been weighing heavily on the S&P buybacks index, we would not write off the artificial engineering of higher EPS via equity retirement, especially in a world of ZIRP likely for the next five-to-seven years. COVID-19 has permanently scarred demand while non-residential construction is elevated. This combination will deflate commercial real estate (CRE) prices further, which risks unraveling a CRE debt deflation spiral. Continue to avoid the S&P real estate sector. Recent Changes There are no changes to our portfolio this week. Table 1 Of Buybacks And Bonds Of Buybacks And Bonds Feature Equities sunk late last week, as diminishing chances of fiscal easing coupled with news that the POTUS and the First Lady tested positive for COVID-19 more than offset buyers taking advantage of oversold conditions. Our sense is that the SPX will bounce around key moving averages during October (Chart 1), until the election outcome breaks the stalemate. In the back half of the month, banks also kick-start Q3 earnings season, which is important because banks’ wellbeing rests on a fresh stimulus bill. Peering over at the bond market is instructive in order to try to make sense of these crosscurrents. Two weeks ago, we first highlighted that the corporate bond market was waving a yellow flag. The selloff in the LQD ETF will continue to weigh on equities (top panel, Chart 2) and corroborates our view that the Fed is now a bystander, which puts added pressure on fiscal authorities to act. It is not a coincidence that the Fed’s balance sheet impulse peaked first and soon thereafter so did the LQD. Chart 1Trapped Between Moving Averages Trapped Between Moving Averages Trapped Between Moving Averages Worrisomely, the total return stock-to-bond ratio failed to break out to fresh all-time highs and has likely formed a head and shoulders pattern. The implication is that stocks are not out of the woods yet (bottom panel, Chart 2). Chart 2Bond Market… Bond Market… Bond Market… Junk spreads are also firing a warning shot. The high-yield option-adjusted spread (OAS) was in a tight range between 2017 and 2019. Then spreads exploded higher because of the pandemic. However, unlike the SPX making new all-time highs, junk spreads failed to make new all-time lows and more importantly have not settled back down to the 2017-2019 range (middle panel, Chart 3). The VIX index is following a similar pattern to the high-yield OAS, which is quite unnerving for equity bulls. Put differently, still elevated VIX futures in the 30s warn that in the near-term more turbulence lies ahead for the SPX (bottom panel, Chart 3). As a reminder, we first recommended buying the December VIX futures on July 27 in a joined Special Report with our sister Geopolitical Strategy service, and we continue to recommend such a hedge to long equity exposure. Chart 3…And VIX Signal Trouble For Stocks …And VIX Signal Trouble For Stocks …And VIX Signal Trouble For Stocks Bye-Bye Buybacks? According to the flow of funds data, a large dichotomy has taken shape between corporate debt issuance and net equity retirement. Up to very recently, the two moved in tandem. But now, the pandemic has caused a knee jerk reaction in non-financial corporate businesses that are tapping their credit lines and issuing debt at a breakneck pace. Worryingly, very little of these funds are used for equity retirement, which is a big break from recent past behavior (Chart 4). Not only does the Fed’s flow of funds data signal that buybacks have nearly ground to a halt, but also Standard and Poor’s data show that SPX buybacks collapsed to $88bn in Q2, from roughly $200bn in Q1. Crudely put, SPX buybacks have fallen by a whopping 67% quarter-over-quarter. Such a corporate buyer’s strike is negative for the near-term prospects of the S&P 500 (top panel, Chart 5). Chart 4Unsustainable Dichotomy Unsustainable Dichotomy Unsustainable Dichotomy Chart 5Buybacks Are Down… Buybacks Are Down… Buybacks Are Down… True, buybacks have come under intense scrutiny especially for bailed out sectors of the economy, nevertheless, the V-shaped economic recovery all but guarantees a rebound in depressed share buybacks sometime in 2021 (Chart 6). While our conservative $125/quarter buyback estimate proved overly optimistic in Q2, we maintain such an estimate for the next year (which it is the past decade’s average). On a cyclical 9-12 month horizon we have high conviction that SPX profits will return close to trend EPS of $162, and recovering CEO confidence should pave the way for a resumption of shareholder friendly activities, including equity retirement (middle panel, Chart 6). Drilling deeper beneath the surface is revealing. When we disaggregate the headline buybacks number into GICS1 sectors, we observe that once again the tech titans (comprising the S&P technology and the S&P communication services indexes) are doing all the heavy lifting accounting for 70% of the overall number (Chart 7). Q2 was the first time in recent memory where tech accounts for more buybacks that all the other sectors put together (bottom panel, Chart 5)! Chart 6But Not Out But Not Out But Not Out Chart 7GICS1 Sector Buyback Breakdown: Q1 & Q2 Of Buybacks And Bonds Of Buybacks And Bonds Chart 8 shows the ebbs and flows of sectoral SPX buybacks since late-2006. In order for our estimate to prove accurate in 2021, the Fed will have to allow financials to resume their buybacks, which collapsed from over $45bn in Q1 to just above $5bn in Q2 (Chart 7). Chart 8GICS1 Sector Buyback Breakdown: An Historical Perspective Of Buybacks And Bonds Of Buybacks And Bonds With regard to investable buyback indexes, financials dominate both the S&P 500 buyback index (Chart 9) and the NASDAQ US buyback achievers index. However, if the Fed does not relent and sustains a tight noose around banks’ shareholder friendly activities next year, then this index composition will change significantly in the 2021 rebalancing. While financials have been weighing heavily on the S&P 500 buyback index, its equal weighting methodology also partially explains why it has trailed the market cap weighted SPX by roughly 20% year-to-date (YTD). Nevertheless, in the long-haul buyback achievers come out on top. In fact, the S&P 500 buyback index has more than doubled the SPX’s return since the turn of the century (top panel, Chart 10) and such a portfolio tilt typically manages to shake off recession-related wobbles. Chart 9S&P 500 Buyback Index Sector Composition Of Buybacks And Bonds Of Buybacks And Bonds Bottom Line: We would not write off the artificial engineering of higher EPS via equity retirement, especially in a world where ZIRP is likely for the next five-to-seven years. Already buyback announcements have troughed (bottom panel, Chart 10) and factors are falling into place for a sizable resumption of buybacks in 2021 as the economy stands back on its own feet. Chart 10Buyback Comeback? Buyback Comeback? Buyback Comeback? Is CRE The Next Shoe To Drop? Last December in our 2020 Key Views report, the S&P real estate sector was one of our high-conviction underweight sectors for the year. However, frenetic trading in March compelled us to close out all our high-conviction trades and cement average relative gains of 3.4% in our eight high-conviction calls including 1.1% in the high-yielding S&P real estate sector. Nevertheless, we remained bearish on the prospects of this sector levered to commercial real estate (CRE) because the aftermath of the pandemic would leave this niche sector badly bruised. Already, YTD relative share prices are down 10%, and were it not for the tech/communications-laden – tower and digital storage – REITs that the S&P specialized REITs subgroup houses, then the relative underperformance would sink to 25% (Chart 11). In other words, the resilience of these mega cap tech-related REITs masks the carnage ongoing beneath the surface. Chart 11Specialized REITs Masking True Picture Specialized REITs Masking True Picture Specialized REITs Masking True Picture Charts 12 & 13 break down the YTD relative performance of the real estate sector’s sub-groups and it is clear that most REITs categories are in distress with the exception of specialized and industrial REITs. Chart 12REITs Are Weak… REITs Are Weak… REITs Are Weak… Chart 13…Across The Board …Across The Board …Across The Board Not only will the long-term negative ramifications due to the pandemic scar office-, apartment- and mall-exposed REITs, but also uncertainty surrounding the fiscal stimulus bill risks a fresh down-leg in the S&P real estate sector. According to the latest Q2 Fed release, CRE delinquencies are on the rise (not shown) and CRE prices are on the verge of contracting (bottom panel, Chart 14). A fresh stimulus bill could transfer funds directly to unemployed consumers and to cash-strapped business owners and extend the eviction/foreclosure moratorium as well as mortgage forbearance agreements. Absent this help, CRE will remain distressed. Refinancing risk is another threat that could cause a gap down in CRE prices, as bankers remain unwilling to dole out CRE loans despite a collapse in interest rates. Once the underlying asset gets repriced lower, then the debt related house of cards comes crumbling down (top & middle panels, Chart 14). Recent news that “Cerberus repackaged near junk rated CMBS paper into a AAA rated CDO” (effectively creating a AAA security out of thin air) is eerily reminiscent of the subprime crisis in 2008 and a stark warning that CRE excesses have yet to fully flush out.1 Chart 14More Pain Looms More Pain Looms More Pain Looms Chart 15Deflation Warning Deflation Warning Deflation Warning The downdraft in demand for CRE is already showing up in declining occupancy rates (Chart 15). We fear that there are more skeletons hiding in the closet. First the “amazonification” of the economy is still wreaking havoc on retail/shopping center REITs. Second the new “work from home” reality is putting strains on office landlords. Lastly, lodging will remain in distress at least until a vaccine is readily available. As a result, REITs cash flow growth will remain elusive, which will further dampen prospects of a recovery in the relative share price ratio (Chart 15). Finally, the relentless increase in supply is not showing any signs of abating. Non-residential construction is hovering near previous highs, and multi-family housing starts are perched close to prior cyclical peaks of 400K/annum (Chart 16). Undoubtedly, this excess supply backdrop will continue to weigh on CRE prices. Chart 16Mind The Supply Overhang Mind The Supply Overhang Mind The Supply Overhang Chart 17Valuations Have Yet To Fully Flush Out Valuations Have Yet To Fully Flush Out Valuations Have Yet To Fully Flush Out Despite all this dour news and near all-time lows in relative performance, valuations have only corrected down to the neutral zone, leaving ample room for an undershoot phase (middle panel, Chart 17). Encouragingly, persistent recent selling has pushed our relative Technical Indicator deep in oversold territory signaling that a near-term reflex rebound may be forthcoming. Netting it all out, COVID-19 has permanently scarred demand while non-residential construction is elevated. This combination will deflate commercial real estate (CRE) prices further, which risks unraveling a CRE debt deflation spiral. Continue to avoid the S&P real estate sector. Bottom Line: Stay underweight the S&P real estate sector. The ticker symbols for the stocks in this index are: BLBG: S5RLST-AMT, EQIX, PLD, CCI, DLR, PSA, SBAC, AVB, WELL, ARE, O, SPG, WY, CBRE, EQR, ESS, FRT, PEAK, VTR, BXP, DRE, EXR, MAA, UDR, AIV, HST, IRM, KIM, REG, SLG, VNO.   Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com       Footnotes 1     https://www.bloomberg.com/news/articles/2020-10-01/cerberus-is-repackaging-near-junk-cmbs-into-top-rated-securities   Current Recommendations Current Trades Strategic (10-Year) Trade Recommendations Drilling Deeper Into Earnings Drilling Deeper Into Earnings Size And Style Views July 27, 2020 Overweight cyclicals over defensives April 28, 2020  Stay neutral large over small caps June 11, 2018 Long the BCA Millennial basket  The ticker symbols are: (AAPL, AMZN, UBER, HD, LEN, MSFT, NFLX, SPOT, TSLA, V). January 22, 2018 Favor value over growth

Rotation Rotation Rotation Rotation Rotation Rotation Rotation out of the tech titans is a high probability scenario given that the easy money has already been made as AAPL, MSFT and AMZN each commanded an almost $2tn market capitalization near the peak on September 2. Thus, booking some of these tech gains and redeploying capital in other unloved deep cyclical sectors would go a long way, especially if our thesis that the economic recovery will gain steam into 2021 pans out. Using a concrete rebalancing example to illustrate such a rotation is instructive.1 The tech titans’ (top 5 stocks) market cap weight in the SPX is 22%. Were an investor to take 10% of this weight or 220bps and redeploy it to the materials sector, which commands a 2.7% market cap weight in the SPX, would effectively double the exposure on this deep cyclical sector. The same would apply to the energy sector that comprises a mere 2.2% of the SPX, while industrials with an 8.4% market cap weight would get a sizable 26% lift. Bottom Line: As the economy opens up, it pays to rotate out of fully priced tech titans and into the beaten down deep cyclicals.    Footnotes 1 Our example assumes benchmark allocation in all sectors for illustrative purposes.

Fiscal stimulus has been dominating the news flow of late. This is not surprising as COVID-19 affected consumers and businesses alike are running on empty. The Citi economic surprise index took off when the IRS started making direct payments to households in mid-April and leveled off toward the end of July when the stimulus money coffers ran dry. What is surprising, is haggling for roughly one trillion of stimulus dollars that separates Democrats from Republicans. If Congress fails to pass a new fiscal package by October 16 the latest, now that the Ruth Bader Ginsburg SCOTUS replacement seems to have become the number one priority, we doubt a fiscal package can pass during a contested election. Thus, realistically a fresh stimulus bill is likely only after the new president’s inauguration. Under such a backdrop, the economy will suffer a relapse, and stocks another drawdown. Bottom Line: We continue recommend investors remain patient and not deploy fresh capital just yet. For more details, please refer to this Monday’s Weekly Report. Show Me The Money Show Me The Money

Overweight We have been offside on the S&P industrials sector, but now is not the time to throw in the towel. In contrast we are doubling down on our overweight stance as the ongoing rotation should see some tech sector outflows find their way to under-owned capital goods producers. Over in the currency market, the recent debasing of the US dollar should underpin industrials stocks via the export relief valve (third panel). A depreciating greenback also lifts the commodity complex and hence industrials equities that are levered to the extraction of commodities and other derivative activities (top panel). Historically, an appreciating USD has been synonymous with a multiple contraction phase and vice versa. Looking ahead, the industrials sector relative 12-month forward P/E multiple should continue to expand smartly (bottom panel). Bottom Line: We continue to recommend an above benchmark allocation in the S&P industrials sector. For more details, please refer to this Monday’s Weekly Report. Chart 1 Industrials - Powering Ahead Industrials - Powering Ahead   ​​​​​​​