Sectors

The shares of movie & entertainment firms have been under pressure in the last several weeks, despite what has generally been a positive Q3 earnings print, driven down by speculation the AT&T/Time Warner merger may be blocked by the Department of Justice. Rumors that Disney was interested in acquiring most of Fox were not enough to lift spirits in the beleaguered index. The more important driver is the secular decline in consumer spending on media, which seems likely to continue to weigh on the industry's top line. High operating leverage, which has been a boom to EPS growth in the past, is now swinging the other way, explaining the drop in earnings growth (second panel). The industry has rerated to the downside in 2017, implying that the weak profit outlook is mostly priced in to the index (bottom panel). As such, we continue to recommend a benchmark allocation in the S&P movies & entertainment index. The ticker symbols for the stocks in this index are: BLBG: S5MOVI - DIS, TWX, FOXA, FOX, VIAB.

Highlights Broad Chinese equity market performance since last month's Party Congress is consistent with our view that the pace of reforms over the coming year will not cause a meaningful deceleration in China's industrial sector. Stay overweight Chinese stocks. After accounting for idiosyncrasy, divergent sector performance is largely consistent with the stated intentions of Chinese policymakers. Our new China Reform Monitor, which is based on sector performance, should help investors identify whether the pace of reforms is moving too rapidly to be consistent with a benign growth outlook. We are adding two new reform-themed trades this week, and closing one existing position (with a healthy profit). Feature BCA's China Investment Strategy service has presented a relatively benign view of the economic impact of stepped up reform efforts in China over the coming 6-12 months. As we noted in last week's report, while a "status quo" scenario of no significant reforms is highly unlikely over the coming year, the pace of reforms will be structured at a level of intensity that will be sufficient to avoid an outsized deceleration in China's industrial sector. We also highlighted that monitoring reform progress would be an important theme to revisit, and in this week's report we review the response of investors to the Party Congress, both at the broad market and sector level, to judge whether it is consistent with our outlook and positioning. We also introduce two new reform-themed trades, and recommend booking profits on an existing position. Broad Market Performance Post-Congress Before gauging the market's view of the likely impact of refocused reform efforts on the Chinese economy over the coming year, it is worth revisiting what kind of market performance would be consistent with our view. To recap the view of our Geopolitical Strategy service,1 President Xi's reform agenda is likely to intensify over the next 12 months, suggesting that Chinese policymakers will make meaningful efforts to: Pare back heavy-polluting industry Hasten the transition of China's economy to "consumer-led" growth2 Deleverage the financial sector Continue to crack down on corruption and graft From the perspective of BCA's China Investment Strategy service, a rapid and intense pace of these reforms would likely be a net negative for Chinese equities, as well as for emerging markets (EM) and other plays on China's industrial sector. For example, in terms of the impact on Chinese stock prices, we highlighted in last week's report that MSCI China ex-tech earnings have been closely correlated with the Li Keqiang index, which would likely decline non-trivially in the face of a very pressing reform push. In addition, the potential for a policy mistake would presumably raise the risk premium on Chinese equities, which would reverse at least some of their meaningful re-rating vs the global benchmark since late-2015. As such, to be consistent with our view, broad market performance (relative to emerging market or global stocks) should have been largely unaffected in the immediate aftermath of the Party Congress, but somewhat divergent at the sector level, given the likely creation of at least some industry "winners" and "losers" from renewed reforms. For the overall market, Chart 1 shows that this is exactly what has occurred over the past month. The chart presents the relative performance of Chinese equities versus the emerging market (EM) and global benchmarks, both in US$ terms and rebased to 100 on the day of President Xi's speech at the Party Congress. The initial reaction to the speech was modestly negative, with Chinese stocks falling a little over 2% in relative terms versus their global peers. But this loss disappeared less than three weeks following the speech, underscoring that market participants agree with our assessment that a rebooted reform effort will not threaten the economy as a whole. Investors should stay overweight Chinese stocks relative to their benchmark. Chart 1No Sign That Stepped Up Reforms Will Be A Net Negative For Chinese Economic Growth The Sector Implications Of Renewed Reforms Chart 2 shows that the sector effects of President Xi's speech have indeed been more divergent, which is also in line with our perspective of view-consistent performance. The chart shows that the past month's performance of the 11 level 1 GICS sectors relative to the broad market can be grouped into three distinct categories: Chart 2China's Reforms Will Create Some Winners##br## And Losers Clear outperformers, which include health care, energy, information technology, and consumer staples, Neutral to modest underperformers, which include utilities, telecom services, and financials, and Clear underperformers, which include industrials, real estate, consumer discretionary, and materials Several of these results are not surprising, as they clearly resonate with the stated intensions of Chinese policymakers. In particular, the outperformance of health care, technology, and consumer staples stocks and the underperformance of capital-goods intensive industrials straightforwardly reflects the goal of re-orienting "old China" towards a new, consumer-focused economy. While energy stocks are viewed as a traditionally cyclically-sensitive carbon-intensive sector, oil prices have risen over the past month and China's share of global energy consumption is much smaller than that of base metals. However, the relative return profiles of a few sectors mentioned above are at least somewhat counterintuitive. On this front, several observations are noteworthy: At first blush, the significant underperformance of Chinese consumer discretionary stocks is counterintuitive if policymakers are aiming to reduce the country's reliance on investment and increase the share of private consumption. However, as Table 1 shows, Chinese consumer discretionary stocks have likely sold off due to the automobile & components industry group, which is potentially at risk of being negatively impacted by the environmental mandate of President Xi's proposed reforms. The table shows that the automobiles & components industry group accounts for a full 1/3rd of Chinese consumer discretionary market capitalization, which is non-trivially larger than in the case of the global benchmark. Table 1 also highlights that China's retailing industry group is as large as that of automobiles & components, which in theory should have provided an offset to the latter's weakness. However, in market capitalization terms, retailers in the MSCI China index are dominated by two large players, one of which is active in providing corporate travel management services. The continuation and expansion of China's anti-corruption campaign was a key message from the Party Congress, and it would appear that investors are concerned about the potential for anti-graft efforts to negatively impact the demand for goods & services that could be potentially linked to corruption or largesse. The underperformance of the materials sector is seemingly reform-consistent, although here too the details of China's investible indexes matter. Table 2 presents a sub-industry breakdown of the MSCI China materials index, as well as an indication whether rebooted reform efforts are a clear negative for the sub-industry. The table highlights that the likely impact of a renewed reform push is mixed: construction materials firms and copper producers (at least in terms of output) are like to suffer, but there are no obvious negative implications for aluminum,3 gold, and paper products producers. The impact on commodity chemicals producers is ambiguous, given that packaging for consumer goods is a significant end market for the petrochemical industry. Table 1Autos Make Up A Significant Share Of ##br##China's Consumer Discretionary Sector Table 2Impact Of Renewed Reforms ##br##On The Materials Sector Is Mixed Finally, there appears to be at least somewhat of a discrepancy between the benign performance of Chinese financials and the underperformance of the real estate sector. Attempts to curb "excessive" financial risks and debt could certainly hurt the real estate sector, but this would also negatively impact banks via a slowdown in credit growth. For now, the significant valuation gap between Chinese financials and real estate appears to be the only explanation for this divergent performance post Party Congress, but we will continue to watch these sectors for signs of a wider market implication. Sector idiosyncrasies aside, the broad conclusion from China's equity market performance over the past month is that investors acknowledge that there are likely to be winners and losers from a rebooted reform mandate, but that overall economic growth in China is not likely to significantly decelerate. This is consistent with our view that the pace of reform efforts over the coming year will not be so intense as to trigger a meaningful decline in the growth rate of China's industrial sector. But the potential for an aggressive pace of reforms is a clear risk to our view that the ongoing slowdown in China's economy is likely to be benign and controlled. Chart 3 introduces our China Reform Monitor as one way to monitor this risk, which is calculated as an equally-weighted average of the four "winner" sectors highlighted above relative to an equally-weighted average of the remaining seven sectors. Significant underperformance of "loser" sectors could become a headwind for broad MSCI China outperformance (especially ex-tech), and we will be watching closely for signs that our monitor is rising largely due to outright declines in the denominator. Chart 3Our China Reform Monitor Will Help Us Track The Impact Of A Renewed Reform Push Two New Reform-Themed Trade Ideas, And One Trade Closure We have new two trade ideas for investors given the performance of Chinese equities in the wake of the Party Congress: Long investable consumer staples / short investable consumer discretionary Long investable environmental, social and governance (ESG) leaders / short investable benchmark The basis for the first trade stems from our earlier discussion of the current limitations of China's investable consumer discretionary index as a clear-cut play on retail-oriented consumer spending. In addition, while consumer staples stocks are reliably low-beta, they have recently been rising vs consumer discretionary in relative terms despite a rise in the broad investable market (Chart 4). The odds favor a continuation of this trend if a renewed reform push continues to appear likely (i.e., we are banking that this trade will be driven by alpha rather than beta). Chart 4Staples Are A Better Consumer Play Chart 5ESG Leaders Should Fare Quite Well In A Reform Environment The basis for the second trade is to overweight stocks that are best positioned to deliver "sustainable" growth. Our proxy for this trade is the MSCI ESG Leaders index, which favors firms with the highest MSCI ESG ratings in each sector (using a proprietary ranking scheme). The index maintains similar sector weights as the investable benchmark, which limits the beta risk of the trade. Chart 5 highlights that MSCI's ESG Leaders index has outperformed the broad market by almost 7% per year since 2010, with current valuation levels that are broadly similar to the benchmark. To us, this trade represents an attractive risk-reward profile even if the pace of China's reforms are not aggressive over the coming year. Chart 6Close Our China / DM Materials Trade Finally, we recommend closing our long MSCI China investable materials sector / short developed markets materials trade. A scenario where China continues to shrink the domestic production capacity of metals without significantly curtailing its overall import volume may be modestly positive for global base metals prices, but it would appear that DM materials producers would benefit more from this outcome than Chinese producers (owing to the impact of production constraints on the volume of product sold). While the Chinese material sector remains grossly undervalued versus its DM peer, the bottom line is that the outlook for this trade is cloudier than before at a time when it is correcting sharply from previously overbought conditions (Chart 6). We suggest that investors close the trade for now, booking a healthy profit of 11%. Jonathan LaBerge, CFA, Vice President Special Reports jonathanl@bcaresearch.com 1 Please see BCA Special Report, "China: Party Congress Ends ... So What?" dated November 2, 2016, available at bca.bcaresearch.com. 2 Investors should note that BCA's China Investment Strategy service has long been skeptical of calls to shift China's economy to a consumption-driven growth model, because it significantly raises the odds that the country will not be able to escape the middle-income trap. For example, please see Please see China Investment Strategy Special Report, "On A Higher Note", dated October 5, 2017, available at cis.bcaresearch.com 3 In our view, the use of aluminum in transportation is consistent with an environmental protection mandate, given that its light-weight properties allow for reduced energy consumption. For example, in the U.S. in 2014/2015, Ford Motor Company switched the production of the F150 from a steel to an aluminum frame, resulting in a significant improvement in fuel economy. Cyclical Investment Stance Equity Sector Recommendations

Highlights The current mini-upswing in the global mini-cycle started in May and is likely to end around January. On a 6-month horizon, lean against the rally in industrial metals. Equity investors should underweight Basic Resources, and especially Industrial Metals and Mining. The contrasting economic fortunes of Spain and Italy may switch. The peak bank credit impulse for Spain is almost certainly behind it, while for Italy it likely lies ahead. On this hope, we will dip our toes into a small pair-trade: long Italian BTPs versus French OATs. Feature Key to the medium-term behaviour of markets is the existence of what we call 'mini-cycles' in global activity. The evolution of these perpetual mini-cycles explains much of what has happened, what is happening, and what will happen, to financial markets both in Europe and more broadly. Chart of the WeekExpect A Trend-Reversal In The Metals Market Mini-cycles are not a hypothesis. They are an indisputable empirical fact. Just look at the global bond yield (Chart I-2), metal price inflation (Chart I-3), global inflation (Chart I-4), and the bank credit impulse (Chart I-5 and Chart I-6). The regular mini-cycles shout out at you! Furthermore, given that these clearly observed mini-cycles show the same half-cycle length of about 8 months, Investment Reductionism strongly suggests that there is a common over-arching driver. Chart I-2The Global Bond Yield Exhibits Mini-Cycles Chart I-3Metal Price Inflation Exhibits Mini-Cycles Chart I-4Inflation Exhibits Mini-Cycles Chart I-5The Global Credit Impulse Exhibits Mini-Cycles Chart I-6Individual Credit Impulses Exhibit Mini-Cycles Explaining Mini-Cycles Previously,1 we explained that the distinct mini-cycles are interconnected parts of the same never-ending feedback loop. A lower bond yield accelerates bank credit flows... which boosts economic growth... which pushes up commodity inflation and overall inflation... causing the bond market to raise the bond yield, at which point the cycle reverses. And then the alternate cycles repeat ad perpetuam (see Box I-1). Box I-1The Mathematics Of Mini-Cycles One common question we get is: why focus on bank credit analysis and not on bond-intermediated credit analysis too? The simple answer is that bank credit expands the broad money supply whereas bond-intermediated credit usually does not. When a bank issues a new loan, fractional reserve banking allows it to create money 'out of thin air'. In contrast, when a company or government issues a new bond, no new money is created, unless the primary issue is financed by the central bank - which is generally forbidden. Usually, when a bond is issued, existing money just moves from one account - that of the bond buyer - to another account - that of the bond issuer. This means that bond-intermediated credit cannot increase demand by creating new money, but only by increasing the velocity of existing money. Whereas bank credit can increase demand by increasing both the amount of money and its velocity. Therefore, changes in bank credit are the much bigger driver of the mini-cycle in economic activity. If a bank issues 100 euros of credit today, then we know that this new money will be spent in the coming days and weeks - because nobody borrows money just to sit on it. If, in the previous period, the bank had issued 90 euros which was spent, it means that economic activity in the coming period will grow by 10 euros. But if the bank had previously issued 110 euros, it means that economic activity in the coming period will contract by 10 euros. In this way, the cycles in credit and activity are interconnected. Mini-upswings in the credit impulse mini-cycle tend to signal mini-upswings in commodity inflation (Chart I-7), overall inflation and bond yields. So if we can identify turning points in the credit impulse then we can correctly position the cyclical stance of our investment strategy. Chart I-7The Same Mini-Cycle: The Global Credit Impulse And Metal Price Inflation The problem is that the bank credit data is slow to come out. For example, although we are in the middle of November, the last bank credit data for the euro area refers to September. This means that if the mini-cycle is turning now, we might not find out until January. Nevertheless, we can still use the mini-cycle framework. We know that the current mini-upswing started in May and that mini-upswings have an average length of 8 months. Hence, we can infer that the mini-upswing is likely to end around January. That said, upswing lengths do have some degree of variation: the current upswing might be longer or shorter than the average. How to avoid being too early or too late? Combining Mini-Cycles With Fractal Analysis To optimise our proprietary mini-cycle framework, we propose combining it with our proprietary fractal analysis framework. As regular readers know, fractal analysis measures whether herding in a specific investment has become excessive, signalling the end of its price trend. The combined mini-cycle and fractal framework works best if we use a 130-day herding indicator (fractal dimension), as it broadly aligns with the mini half-cycle length. Excessive herding signals that an investment's trend is approaching exhaustion because the liquidity that has fuelled the trend is about to evaporate. Liquidity is plentiful when the market is split between different herds - say, short-term momentum traders and long-term value investors. This is because the herds disagree with each other. If the price fluctuates up, the momentum trader wants to buy while the value investor wants to sell; and vice-versa. So the herds trade with each other with plentiful liquidity. But liquidity starts to evaporate when too many value investors join the momentum herd. Instead of dispassionately investing on the basis of value, value investors get sucked into chasing a price trend, and their buy orders add fuel to the trend. The tipping point comes when all the value investors have joined the momentum herd. If a value investor then suddenly reverts to type and puts in a sell order, he will find that there are no buyers left. Liquidity has evaporated, and finding new liquidity might require a substantial reversal in the price to attract a buy order from an ultra-long-term deep value investor. Earlier this year, our combined frameworks signalled that the aggressive rise in bond yields was likely to reverse (Chart I-8). Therefore, on February 2 we correctly advised: "Lean against the rise in bond yields and bank equities." Chart I-8Excessive Herding In Bonds Always Signals A Trend Reversal Today, we see the same dynamic in parts of the commodity rally - and specifically the move in the LME Index (Chart of the Week). Hence, on a 6-month horizon, lean against the rally in industrial metals. Equity investors should underweight Basic Resources, and especially Industrial Metals and Mining. Could Italy Be A Good Surprise? Returning to the concept of the bank credit cycle, the evolution of longer-term impulses also explains the contrasting recent fortunes of Spain and Italy. In 2013, Spain recapitalized its banking system and ring-fenced bad assets within a 'bad bank'. In effect, it finally did what other economies - most notably the U.S., U.K. and Ireland - had done several years earlier in response to their own housing-related banking crises. As Spanish banks' aggressive deleveraging ended, the bank credit impulse rebounded very sharply and has remained positive for several years. This undoubtedly explains why Spanish real GDP has grown by 13% since mid-2013 (Chart I-9). In contrast, Italy's banking system remained dysfunctional - which meant that its own credit impulse stayed much more muted and barely positive over the past four years (Chart I-10). But now, the Italian banking system is slowly recuperating. Italian banks' equity capital is rising, their solvency is improving, and the share of non-performing loans has fallen sharply this year. Chart I-9Spain's Peak Credit Impulse##br## Is Probably Behind It Chart I-10Italy's Peak Credit Impulse##br## Is Likely Ahead Of It So the contrasting economic fortunes of Spain and Italy may switch. The peak bank credit impulse for Spain is almost certainly behind it, while for Italy it likely lies ahead. On this hope, we will dip our toes into a small pair-trade: long Italian BTPs versus French OATs. Dhaval Joshi, Senior Vice President Chief European Investment Strategist dhaval@bcaresearch.com 1 Please see the European Investment Strategy Weekly Report 'Credit Slumps While Animal Spirits Soar. Why?' March 30, 2017 available at eis.bcaresearch.com Fractal Trading Model* There are no new trades this week, leaving us with six open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment's fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-11 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report "Fractals, Liquidity & A Trading Model," dated December 11, 2014, available at eis.bcaresearch.com Fractal Trading Model Recommendations Equities Bond & Interest Rates Currency & Other Positions Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch -##br## Interest Rate Expectations Chart II-6Indicators To Watch - ##br##Interest Rate Expectations Chart II-7Indicators To Watch -##br## Interest Rate Expectations Chart II-8Indicators To Watch -##br## Interest Rate Expectations

U.S. home sales have been soaring, with new single-family homes reaching a 10-year high in September, driven by still-low financing costs and peaking consumer sentiment. This surging housing demand which includes temporary hurricane rebuilding related sales, has already shown up in earnings; HD reported a 7.9% same store sales increase in Q3 yesterday, a stunning number relative to the current malaise in the overall retail landscape. This elevated demand, coupled with the impact of countervailing duties on Canadian imports, has pushed lumber to the stratosphere. High lumber prices benefit home improvement retailers' top lines (third panel), but serve to crimp builders' margins. With a much better profit outlook and a still reasonable valuation (bottom panel), we think the best way to gain exposure to the healthy domestic housing market is via the S&P home improvement retail index, not the S&P homebuilders. Accordingly, we reiterate our respective overweight and neutral recommendations. The ticker symbols for the stocks in these indexes are: BLBG: S5HOMI - HD, LOW and BLBG: S5HOME - PHM, DHI, LEN.

Highlights There are a number of cracks emerging in global risk assets. Not only have U.S. junk bond prices recently posted sharp declines, but a number of economic and financial market developments within EM also warrant investors' close attention. In particular: Feature The EM manufacturing PMI has rolled over at relatively low levels, despite continued strength in advanced economies' manufacturing PMI (Chart 1). Importantly, the trend in relative manufacturing PMIs heralds EM equity underperformance against DM bourses (Chart 2). Chart 1EM Manufacturing: Rolling Over Chart 2EM Stocks To Underperform DM Stocks The Shanghai Container Freight Index has relapsed in recent months. This index has been a good indicator for EM/Asian export volumes (Chart 3, top panel). That said, DRAM semiconductor prices continue to surge (Chart 3, bottom panel). DRAM prices have jumped five-fold in less than two years, justifying the massive rally in semiconductors' stock prices. It is hard to know how long and how far the ascent in DRAM prices will continue. Nevertheless, our hunch is that non-technology exports in Asia will slow down, regardless of what happens in the global technology sector. Consistently, we expect EM non-technology stocks to relapse sooner than later, even as tech stocks remain a wild card. Global and EM tech stocks rallied exponentially and appear to be in a mania phase that could make any reasonable assessment and investment strategy off-mark. Weighing the pros and cons, we continue to recommend overweighting the tech sector within the EM universe, even as the outlook for their absolute performance remains highly uncertain. Within EM tech, we favor semi stocks (Samsung and TSMC) versus internet and social media stocks. The sheer magnitude of the EM equity rally has been driven by a few names such as Tencent, Alibaba, Baidu, Samsung and TSMC. Their combined market cap as a share of the overall MSCI EM equity index has risen to 19%. Remarkably, the equal-weighted MSCI EM stock index has massively underperformed the market cap-weighted MSCI EM equity index (Chart 4, top panel). In contrast, the same measure for DM equities has held up much better (Chart 4, bottom panel). Chart 3Asian/EM Exports At Risk Chart 4A Perspective On Internal Equity Dynamics: EM And DM EM stock prices have been firm so far despite the rebound in the broad trade-weighted U.S. dollar (Chart 5). As the greenback continues to advance, odds are that EM share prices will dive, as occurred in 2014 and 2015. In China, the effects of triple tightening - the liquidity squeeze by the central bank, the regulatory clampdown on banks and shadow banking by the Banking Regulatory Commission, and the anti-corruption drive that is targeting the financial industry - are gaining momentum. Onshore corporate bond yields and credit spreads over government bonds have risen further since the end of the most recent Party Congress. One of the reasons why policymakers are tightening is to rein in the enormous excesses prevalent in the credit, money and property markets that have developed in recent years. Given that advanced economies have now recovered, the Chinese authorities feel more confident to tighten domestically. Finally, while less recognized by the investment community, inflationary pressures have been rising in China. Although still at 2.25%, core consumer price inflation is clearly trending up, warranting a policy response (Chart 6, top panel). This is especially true given that real deposit rates - deflated by core consumer price inflation - have plummeted into negative territory (Chart 6, bottom panel). Chart 5U.S. Dollar Rebound = EM Pullback Chart 6China: Beware Of Rising Inflation Consistent with tightening, China's official broad money growth has decelerated to an all-time low (Chart 7, top panel). In the meantime, narrow money (M1) growth is falling rapidly. Remarkably, M1 growth has been correlated with Chinese H-share prices (Chart 7, bottom panel). We have extensively documented in past reports1 that China's money and credit impulses are good leading indicators of the mainland's business cycle. The current readings of these indicators signal considerable growth deceleration. In addition, general (central and local) government spending growth has already slowed a lot (Chart 8). Chart 7China: Broad Money Growth Is At Record Low Chart 8China: Aggregate Fiscal Spending Growth Is Also Weak The fundamentally weakest EM currencies such as the South African rand and the Turkish lira have already broken down. Some others have so far been only marginally weak. A chain, however, typically cracks at its weakest link. Hence, it makes sense that the selloff has begun with the fundamentally weakest currencies. We expect other EM currencies to follow. Currency depreciation in EM will undermine returns for foreign investors, and the latter will become marginal sellers in both EM equity markets and local currency bonds. Meanwhile, EM currency depreciation and potentially falling commodities prices will trigger credit spread widening in EM sovereign and corporate bonds. Investment Positioning Global equity portfolios should continue underweighting EM versus DM. The risk-reward profile for EM stocks' absolute performance is extremely unfavorable. We continue to recommend underweighting EM credit markets relative to U.S. investment grade bonds. Our strongest conviction shorts are a basket of the following currencies: ZAR, TRY, BRL, IDR and MYR. We are also shorting the COP and CLP. For traders who prefer a market neutral currency portfolio, our recommended longs are TWD, THB, SGD, ARS, RUB, PLN and CZK. INR and CNH will also outperform other EM currencies. Unlike in 2014-2015, EM currencies will depreciate not only versus the U.S. dollar but also the euro. This will erode EM returns for European investors, and temporarily halt or reverse capital inflows into EM. Among local currency bond markets, the most vulnerable are Turkey, South Africa, Indonesia and Malaysia. The least vulnerable are Korea, Russia, India, Argentina2 and Central Europe. Arthur Budaghyan, Senior Vice President Emerging Markets Strategy arthurb@bcaresearch.com 1 Please refer to the Emerging Markets Strategy Weekly Report, titled "Questions From The Road", dated September 20, 2017. 2 Please refer to the Emerging Markets Strategy Special Report, titled "Argentina: A Genuine Bull Market", dated October 25, 2017. Equity Recommendations Fixed-Income, Credit And Currency Recommendations

Managed health care stocks have performed exceptionally well since our early-April 2016 overweight recommendation, besting the market by roughly 24%. This begs the question: Is the time ripe to lock in impressive profits and move to the sidelines or is there more upside left? Leading profit indicators suggest that more gains are in store for the relative share price ratio. After petering out in 2016, our managed care cost proxy has plummeted by over 350bps from the recent peak (shown inverted, second panel). Given that premiums are set on a trailing cost basis, profit margins should surprise to the upside. Further, drug price deflation should prove a boon to managed care providers' bottom lines and the pharmaceutical sector's pain this year will be the managed health care industry's gain (bottom panel). Bottom Line: Melting input costs should augment managed health care profits, supporting a durable valuation expansion phase. Stay overweight and see this week's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5MANH - UNH, AET, ANTM, CI, HUM, CNC.

Dear Client, Next week on November 20th instead of our regular weekly publication you will receive our flagship publication "The Bank Credit Analyst" with our annual investment outlook. Our regular publication service will resume on November 27th with our high-conviction trades for 2018. Kind Regards, Anastasios Avgeriou Highlights Portfolio Strategy Melting medical care input costs, sustainable enrollment gains and even modest tax relief would augment managed health care profits. Stay long health care insurers. Pharma and biotech stocks suffer from declining pricing power. Continue to avoid both. As a result, the S&P health care index remains in the underweight column. Recent Changes There are no changes to our portfolio this week. Table 1 Feature Equities consolidated recent gains as earnings season drew to a close last week. Recent election results coupled with the revealing of the Senate tax bill raised fresh concerns, unwarranted according to our geopolitical strategists, about the likelihood of a bill passage. While such heightened fiscal policy uncertainty is disquieting, solid EPS growth on the back of synchronized global economic and capex growth should sustain the overshoot phase in stocks. Q3 EPS vaulted to a fresh all-time high (Chart 1) and, were it not for two financials sector sub-indexes - reinsurers and multi-line insurers that were severely hit by the one off hurricane catastrophes - financials EPS growth would have been nil from -7.3%, pushing the overall SPX EPS number to 9.2% from 8.1%. Chart 2 shows that the positive EPS surprise factor remained close to the recent average. Going into earnings season, Q3 EPS growth forecasts collapsed to 4.1%, but actual results ended up 400bps higher. Chart 1Earnings-Led Advance Continues Chart 2Surprise Factor In Line With Recent Average While EPS growth cannot stay in the high teens forever, settling down close to 10%/annum EPS growth rate is possible in the near run. The softness in the U.S. dollar along with the basic resource sector commodity-related comeback, synchronized global economic and capex growth and financials contributing more than sell side analysts expect to overall EPS, suggest that such profit growth is attainable in 2018. Tack on the possibility of fiscal easing and sustained lift in animal spirits (bottom panel, Chart 1), and the odds of low double-digit EPS growth increase further. Meanwhile on the monetary policy front, news of Powell's nomination to take the helm at the Fed barely budged the equity market, but some cracks are appearing in the bond market (Chart 3). Keep in mind that going back to Volcker's late-1970s nomination, Fed Chair transitions have been volatile. In fact, the market has tested the resolve of all four previous Fed leaders (Chart 4). As soon as Volcker come into power he had to deal with the early-1980s recession (and the LatAm crisis in 1982) that saw the market fall by 17% from peak to trough. When Greenspan was confirmed Chairman in August of 1987, two months into his tenure Black Monday happened and he had to step in and reiterate the Fed's function as a lender of last resort. In 2006 Bernanke took over from the Maestro, and a recession hit by the end of 2007 that morphed into the Great Recession. Finally in early-2014, Yellen become the Fed Chairwoman and in late-2015 a global manufacturing recession had taken hold resulting in a 14% drawdown in the SPX. Chart 3Watching The Bond Market Chart 4Testing Times Inevitably, the market will test the new Fed Chairman. This expansion has been long in the tooth and given BCA's 2019 recession view, this testing time is at least a year away. This week we reiterate our underweight stance in a defensive sector and highlight its key sub-components. Stick With Managed Health Care Exposure Following a two year hiatus, managed health care stocks broke out in 2017 and the juggernaut has now resumed (Chart 5). While the recent unsuccessful intra-industry M&A attempts (breakdown of both AET/HUM and ANTM/CI deals) were a mild setback, CVS's latest announcement, to take over AET and further vertically integrate, has brought euphoria back to this health care subgroup. We have added alpha to our portfolio as relative performance is up smartly, roughly 24% since our early-April 2016 overweight recommendation, begging the question: Is the time ripe to lock in impressive profits and move to the sidelines or is there more upside left? Leading profit indicators suggest that more gains are in store for the relative share price ratio. After petering out in 2016, our managed care cost proxy (comprising physician and hospital services and medical care commodity inflation) has plummeted by over 350bps from the recent peak (shown inverted, second panel, Chart 5). Given that premiums are set on a trailing cost basis, profit margins should surprise to the upside, i.e. the industry's medical loss ratio has room to fall. Not only is our medical care input cost proxy melting, but the latest employment cost index release revealed that managed health care wage inflation is also steadily decelerating (third & bottom panels, Chart 6). Taken together, these two cost categories are heralding a solid industry EPS growth backdrop in the coming months (total cost proxy shown inverted, second panel, Chart 6). Chart 5Melting Costs Are A Boon To Margins... Chart 6...And EPS Importantly, health care insurers are also set to benefit from the Trump administration's push toward lowering drug prices and the proliferation of generic drugs. While drug inflation is positive for the pharma/biotech space, it is an expense incurred by managed care providers and vice versa. The upshot is that the pharmaceutical sector's pain will be the managed health care industry's gain (bottom panel, Chart 5). On the legislative front, the failed attempts to repeal and replace the ACA is positive as the newly enrolled will likely remain insured and underpin recurring industry revenues. As long as costs stay in check, the implication is ongoing earnings improvement. Tack on any relief related to a tax bill passage (the managed care index has a 47% effective tax rate or 24% higher than the overall S&P health care sector, see Table 2) and the path of least resistance is higher for profits. Table 2Tax Relief Potential Despite all of these positives, relative valuation remains muted, hovering near the neutral zone. On a forward P/E basis the S&P managed care index is trading on a par with the S&P 500 (Chart 7). If our thesis of sustained earnings outperformance materializes in the coming quarters, then a valuation re-rating phase looms. In sum, melting input costs, sustainable enrollment gains and even modest tax relief would augment managed health care profits. This is a recipe for a durable valuation expansion phase. Bottom Line: While we are underweight the broad health care index, our sole overweight remains the S&P managed health care index. The ticker symbols for the stocks in this index are: BLBG: S5MANH - UNH, AET, ANTM, CI, HUM, CNC. Ailing Pharma We downgraded pharma to an underweight stance on July 31 on the back of weak pricing power fundamentals, soft spending backdrop, a depreciating U.S. dollar and deteriorating industry operating metrics. The S&P pharmaceuticals index relative performance is down 5% since then as our bearish profit thesis is validated. Our dual synchronized global economic and capex growth themes bode ill for defensive pharmaceutical stocks. Nondiscretionary health care outlays jump in times of duress and underwhelm during expansions. Currently, the soaring ISM manufacturing index is signaling that pharma profits will remain under pressure in the coming months as the most cyclical parts of the economy flex their muscles (the ISM survey is shown inverted, middle panel, Chart 8). A depreciating currency is also synonymous with pharma profit ails (bottom panel, Chart 8). Historically, a soft U.S. dollar has been closely correlated with global growth, whereas greenback strength tends to slowdown the global economy. In that context, pharma exports should at least provide some top line growth relief during depreciating U.S. dollar phases. However, pharma exports are contracting at an accelerating pace (top panel, Chart 8) despite the U.S. dollar's year-to-date softness, warning that global pharma demand is sick. Importantly, the news on the pricing power front is disconcerting. Both in absolute terms and relative to overall PPI, pharma selling prices are steadily losing steam. In the context of a bloated industry workforce, the profit margin outlook darkens significantly (Chart 9). If the Trump administration also manages to clamp down on the secular growth of pharma selling price inflation, then industry margins will remain under chronic pressure. Worrisomely, were pharma prices to continue to trail overall corporate sector price inflation, as we expect, then the de-rating phase in the S&P pharmaceuticals index has a long ways to go (bottom panel, Chart 9). Finally, even on the operating metric front, the news is mostly grim. Pharma industrial production is nil and our pharma productivity proxy remains muted, warning that profits will likely underwhelm. Industry retail sales growth is also flirting with the zero line and pharma inventories have resumed growing on a short-term rate of change basis across the supply channel. Pharma shipments offer the only ray of hope. But the recent acceleration in the latter may be the result of the hurricane-related catastrophes (Chart 10). Chart 8Counter Cyclical With##br## No Export Relief Chart 9Weak Pricing Power And Bloated##br## Cost Structure Weighs On Margins Chart 10Operating Metrics ##br##Are Also Feeble Netting it out, pharma profit growth is on track to continue to disappoint as the confluence of synchronized global growth, softening U.S. dollar, pricing power losses and deteriorating operating metrics are all profit headwinds. Bottom Line: We reiterate our late-July downgrade in the S&P pharma index to underweight. The ticker symbols for the stocks in this index are: BLBG: S5PHAR - JNJ, PFE, MRK, BMY, AGN, LLY, ZTS, MYL, PRGO. A Few Words On Biotech Biotech stocks are another casualty of weakening pharmaceutical wholesale price inflation, and given that the industry's profits move neck-and-neck with their pharma siblings, revenue and EPS growth are bound to continue to surprise to the downside (Chart 11). We expect such profit woes will weigh on the S&P biotech index relative performance, and re-iterate our high-conviction underweight status. Chart 11Biotech Equities Hate Higher Rates Chart 12Technicals Say Sell Not only are biotech firms modestly concealed Big Pharma, i.e. they manufacture multi-billion dollar blockbuster drugs, and the Trump administration's scrutiny of drug price inflation is a profit negative, but also a rising interest rate backdrop is working against this health care sub-index. Historically, rising interest rates have been inversely correlated with biotech stocks. High flying valuations tend to gravitate back to earth when the Fed embarks on a tightening cycle. The opposite is also true. BCA's U.S. Bond Strategy view remains that in the coming 12 months interest rates will be higher, moving closer to the 3% mark on the 10-year Treasury yield front. If such a selloff materializes in the bond market, then investors will abandon biotech stocks in a heartbeat (Chart 11). Chart 13Heed The EPS Growth Model Signal Meanwhile, according to empirical evidence since the mid-1990s, relative momentum in biotech stocks is nearly perfectly inversely correlated with the global credit impulse (Chart 11). This negative correlation has become more pronounced in the past decade underscoring the non-discretionary/defensive nature of large biotech outfits. In other words biotech stocks behave like counter-cyclicals similar to their pharma brethren. Given BCA's view of a recession hitting some time in 2019, we recommend investors still avoid biotech stocks. Finally, technicals are also waving a red flag. Chart 12 shows that a head-and-shoulders formation has taken root and were the neckline to give way in the coming weeks, relative performance would suffer a substantial setback. Bottom Line: Biotech stocks remain a high-conviction underweight. The ticker symbols for the stocks in this index are: BLBG: S5BIOTX - ABBV, AMGN, GILD, CELG, BIIB, VRTX, REGN, ALXN, INCY. Health Care Sector Implications What does all this mean for the broad S&P health care sector? Our relative profit growth model best encapsulates these forces and is signaling that profits will remain downbeat into 2018 (Chart 13). Managed health care stocks (overweight) comprise 13% of the index, while pharma (underweight) and biotech (underweight) market capitalization weights both add up to 54% of the total. As a result of our intra-sector positioning and given our neutral weightings in the remaining health care sub-indexes, we continue to recommend a below benchmark allocation in the S&P health care index. Bottom Line: Stay underweight the S&P health care sector. Anastasios Avgeriou, Vice President U.S. Equity Strategy anastasios@bcaresearch.com Current Recommendations Current Trades Size And Style Views Favor small over large caps and stay neutral growth over value.

The S&P household products index story in 2014-15 was that a firm U.S. dollar had sapped top-line growth from the key export market and a turnaround in the former would provide a lift in the latter. While that thesis has proven correct (second panel) and consumer goods exports have substantially recovered, earnings growth remains flat and trails the broad market (third panel). In the most recent quarter, organic domestic growth concerns weighed on household products stocks. Further, hurricane-driven input price hikes have temporarily crimped margins. The result is that the S&P household products are at their cheapest level this decade (bottom panel). With compelling valuations and the makings of an export-led EPS recovery, we maintain our overweight recommendation. The ticker symbols for the stocks in this index are: PG, CL, KMB, CLX, CHD.

In early October, we initiated a pair trade long S&P industrials/short S&P consumer discretionary, underpinned by four key drivers: interest rates, relative demand, relative export backdrop and relative sentiment. Importantly, recent consumer credit data reinforces our expectation that, despite a solid showing out of the gate, this late-cycle trade should deliver outsized returns. In the most recent Fed Senior Loan Officer Survey, consumer lenders are firmly in tightening mode, a trend that has been ongoing since the middle of last year (second panel). Insipid personal consumption expenditure (PCE), which has trailed surging capital expenditures by a wide margin, corroborates this trend. The consequence of a shift from PCE to capex should be a swing in earnings growth in favor of S&P industrials (bottom panel); maintain a long S&P industrials/short S&P consumer discretionary sector pair trade and see our Weekly Report from October 9 for more details.

Highlights Chart of the WeekChina Developments Significant##BR##To Base Metal Prices Reading the tea leaves following China's 19th National Communist Party Congress suggests a looming shift in President Xi Jinping's second term from pro-growth to pro-reform. Having consolidated power, Xi now has the capacity to implement his agenda over the next five years. Given China's outsized role in global base metals production and consumption, the direction of Xi's policy changes will have a profound impact on these markets (Chart of the Week).1 The Party Congress set the tone for economic policy and reforms going forward, from which we can extrapolate future policy direction. However, concrete plans and details will not be revealed until the National People's Congress, scheduled in March 2018. In this report we highlight the main takeaways of the Congress specifically those relevant to base metals. Broadly, these can be summarized as: Xi now has the political capital needed to implement real reform in his second term. Based on Xi's remarks at the Congress during his work-report commentary, we believe the environmental and supply-side reforms initiated during his first five-year term will be continued in his second term. Because these reforms will shrink the domestic production capacity for base metals and steel in China, they likely will be a tailwind for these commodities' prices. However, a focus on sustainable growth - i.e., organic growth that is not dependent on regular injections of credit to keep it going - and the elimination of GDP targets past 2021 risk weighing down base metals demand. Real-estate market fundamentals are more supportive than most perceive. This will prevent tighter policies from triggering a significant construction downturn, which will be supportive for steel and copper prices. China's efforts to expand its economic influence globally through the Belt and Road initiative (BRI) will be insufficient in offsetting a mainland slowdown, should one occur. Feature Balancing Stability And Reform Chart 2Stability Was A Priority...Not Anymore Despite reiterating a need for economic reforms, the focus of Xi's first term was maintaining stability and garnering the political capital necessary to implement his desired reforms. Emphasizing stability is a recurrent theme in Chinese politics, regardless of who is at the helm. The 2015-16 state interventions in the economy - including higher infrastructure spending, provincial government bailouts, currency depreciation and capital controls - illustrated the dominance of stability over reforms, during Xi's first term (Chart 2).2 The 19th Party Congress was the capstone event in Xi's effort to accumulate the support needed to implement long-sought reforms. BCA's Geopolitical Strategy points to three outcomes that support this assessment: With the inscription of Xi Jinping Thought on Socialism with Chinese Characteristics for a New Era in China's constitution, the president has cemented his position as one of the most powerful leaders of modern China. In fact, according to our geopolitical strategists, this induction signals that he is "second only to Chairman Mao as a philosophical guide in the party."3 Practically speaking, this means his economic initiatives will carry more weight than anything China has seen since at least the 1998-99 intense reform period. The leanings of members of the new Politburo Standing Committee (PSC) also are telling. Each of the three most recent presidents is represented by two protégés on the PSC. This is an almost-ideal configuration for reform.4 Finally, the appointment of Xi loyalist Zhao Leji as chief of the Central Commission for Discipline Inspection (CDIC), and the creation of the National Supervisory Commission to oversee the anti-corruption campaign give Xi the tools he needs to implement his policies. Thus, Xi has garnered sufficient ammunition to be much more effective in implementing reform policies during his second term. As such, we expect the pace of reform to accelerate. While the policy details are yet to be known, many of the takeaways from the party congress point toward supply- and demand-side changes. Supply-Side Reforms: Short-Term Sacrifice For Long-Term Benefit? While the aim for environmental regulation is not new - an "ecological" section was included in the work report for the first time by Xi's predecessor Hu Jintao in 2012 - we have reason to believe that, given Xi's focus on sustainable development, he will tackle environmental policies with more fervor than in the past. This signals that Xi may prioritize environmental preservation and pollution-reduction measures going forward, which would continue the efforts begun in his first term. In fact, environmental spending was the fastest growing category in central-government spending at the beginning of Xi's first term (Table 1). Table 1Xi Jinping Favors A Greener China Xi's environmental agenda will get an assist from his anti-corruption campaign. Our Geopolitical strategists highlight Xi's use of the CDIC - the anti-corruption watchdog - in enforcing the reforms as a signal of his resolve to implement change. The stakes are high for noncompliant managers who now risk not only financial penalties, but also arrest and jail time. Chart 3Shifting Gears: From Pro-Growth To Pro-Reform This reinforces the message that Xi is still keen on implementing the supply-side structural reforms first announced in 2015, and that he is willing to change the old-line economic model, forgoing potential growth drivers from traditional industries in favor of greener sectors (Chart 3). As the leading base metals producer in the world, a continuation - and potential intensification - of these reforms will weigh on global production and prop up base metal prices, as they have since last year. In fact, some of these reforms have already materialized in the form of earlier-than-anticipated winter production cuts. Steel production in Tangshan - China's largest steel-producing city - will be halved over the winter, with three other top steel producing cities - Shijiazhuang, Anyang, and Handan - expected to announce similar cuts.5 Similarly, the government of Shandong - a major producer of alumina and aluminum - recently instituted a crackdown program that includes production cuts during the winter months.6 Bottom Line: Xi used his platform at the Party Congress to reiterate his resolve to set China's economy on a more sustainable growth path through supply-side reform. Given that he has accumulated the political capital necessary to implement these changes, we expect to see a renewed push toward a "greener" China. Ceteris paribus, this will weigh on base metals production by reducing global supply and will support prices. "Houses Are Built To Be Inhabited, Not For Speculation" During the party congress, Xi reiterated his resolve to tighten control of the real estate market. In fact, the Chinese government has been trying for years to rein in demand for real estate, which typically involves raising mortgage rates. Tightening measures announced in late September include controls on home sales in eight major cities, which, among other things, prevent the resale of homes within five years of purchase. These controls have weighed on both prices and sales of real estate (Chart 4). More recently, the Ministry of Housing and Urban-Rural Development and the National Development and Reform Commission announced that they will jointly inspect real estate developers and commercial property sales agents, looking for "irregularities," including artificially inflating prices and hoarding unsold homes.7 Nonetheless, our China Investment Strategy desk does not foresee a major slowdown in construction activity.8 Simply put, they argue that strong demand amid declining inventories will prevent a construction slowdown, even in face of tighter policies (Chart 5). In fact, they do not see much excess in China's current property market to begin with, and thus doubt we will witness a major downturn. This will be important to bear in mind going forward, given that construction is the most important source of demand for base metals - copper in particular - and steel in China, accounting for about one-third of copper demand and half of steel demand. Chart 4Real Estate Policies Weigh##BR##On Prices And Sales Chart 5Housing Destocking Becomes Advanced Fundamentals##BR##Will Prevent A Major Real Estate Downturn Bottom Line: Despite efforts to tighten the property market, a sharp downturn in the construction sector, which is a major metals consumer, is unlikely. Structural tailwinds - most notably from China's continued urbanization - will eventually prevail, and the construction sector will remain a major contributor to China's economy, and base metals and steel consumption. Quality Over Quantity: Deleveraging The renewed focus on "sustainable and sound" growth, especially given the elimination of GDP growth targets beyond 2021, elevates the risk of a potential economic slowdown. The Xi administration has signaled that it is not afraid to prioritize financial regulation - targeting excessive risk and under-regulation - over economic growth. It is likely that it will continue doing so. In fact, Xi singled out systemic financial risk as a hazard to overall stability. While this is not China's first time to announce a deleveraging campaign, given that Xi has consolidated power and will use the CDIC to implement reforms, we expect these efforts to be more effective this time around. Furthermore, China has bounced back from the 2015 - 16 deflationary spiral so well that interest rate hikes and tighter financial controls are now on the table (Chart 6). Chart 6Interest Rate Hikes Are Now On The Table While the reforms are expected to improve Chinese productivity in the long-run, they may shake up the economy in the short run. We are somewhat reassured by the fact that traditionally, Chinese leaders have boosted fiscal spending when faced with slowing credit growth in periods when they aim to combat the negative effects of supply-side structural reforms and deleveraging. However, we remain cautious that, as Xi's priorities have shifted, fiscal stimulus may not be used with the same enthusiasm going forward. Given China's outsized role as a consumer of base metals, a slowdown would have serious repercussions on global markets. Researchers at the IMF find that surprises in the strength of China's economy - measured as the scaled deviation of year-on-year industrial production growth from the median Bloomberg consensus estimates immediately prior to the announcements - have significant impacts on base metals prices.9 This is true for all metals they studied - copper, nickel, lead, tin, and aluminum - with the exception of iron ore, which they put down to the relatively recent financialization of iron ore markets. In fact, they find that the more important China is to a specific base metal's fundamentals, the stronger the impact on prices. Using China's import share as a percent of world total as their measure of China's footprint in each individual market, they find that copper is most impacted by Chinese IP shocks, followed by nickel, lead, tin, and aluminum.10 Bottom Line: Beijing is continuously reassuring markets it will push for reforms - in the form of deleveraging the financial sector, restructuring industry, eliminating overcapacity, and environmental controls - without sacrificing growth. Nonetheless these reforms, which we believe are forthcoming following Xi's consolidation of power post-19th Congress, will be headwinds to growth. It is true that Xi may be willing to tolerate slower growth going forward in order to see his policies go through. Yet in all likelihood, fiscal stimulus will be used if social stability is threatened by reform measures. That said, reform is definitely in the cards. The Revival Of China's Silk Road - Enshrined In The Constitution Along with supply-side reforms, the Belt and Road initiative (BRI) - Xi's solution to a global slowdown through the physical integration of China's trading partners - was written into the constitution. This is a reiteration of Xi's intent to shift China away from being the factory of the world and toward playing a key role in global development. The ambition of the BRI plan is to connect many of China's trading partners in Asia, Europe, the Middle East, and Africa through a modern infrastructure of roads, ports, railway tracks, pipelines, airports, transnational electric grids, and fiber-optic lines. The objectives of the project, although speculative, are believed to be two-fold: It is an opportunity to create new markets for Chinese goods - giving the Chinese economy a push even in the event of a mainland slowdown. This is especially relevant, given the need to export excess capacity, most notably in the cases of steel and cement. In fact, Chinese industrial production will also benefit from the secondary effects of an improvement in demand for consumer goods from countries receiving economic aid from China. Furthermore, Xi hopes the project will help revive the economies of China's border regions. There is a possible ancillary benefit, in that heavy industry - e.g., steel mills and aluminum smelters - could be moved away from population centers to support the BRI. Chart 7BRI Investments On The Ascent Policymakers foresee the project - which was initiated in 2013 - injecting an estimated $150 billion annually into the construction of massive amounts of infrastructure (Chart 7). BCA's Frontier Markets Strategy (FMS) projects the value of Chinese BRI project investments will reach $168 billion in 2020.11 While this would boost China's economy in general, and base metals, steel and iron ore demand in particular, our FMS strategists argue that at ~ $102 billion, China-funded BRI investment expenditure in 2016 is dwarfed in comparison to China's gross fixed-capital formation (GFCF), which amounted to ~ $4.8 trillion last year. Simply put, the BRI is incapable of offsetting a general slowdown in China, were it to occur. In fact, our FMS desk estimates that a 0.4% contraction in GFCF is all that will be needed to offset BRI-related investments in 2018. Bottom Line: With the Belt and Road Initiative written into the constitution, we expect greater follow-through directed toward meeting the goals specified in it. On its own, this is positive for base metals, which will benefit from greater demand from infrastructure projects, as well as the secondary effects in the form of demand for consumer goods from trading partners. However, the BRI, in and of itself, will not super-charge base metals demand. The BRI will counteract some of the negative impacts of a slowdown in China growth on commodity markets generally. However, since the size of BRI investment expenditure accounts for only a small fraction of China's fixed capital formation, we are skeptical of the extent to which it can offset a slowdown, were it to occur in the mainland. Roukaya Ibrahim, Associate Editor Commodity & Energy Strategy RoukayaI@bcaresearch.com 1 In our modelling of base metal prices, we find China's PMI has a large and significant impact on metal prices. Using year-on-year growth rates since 2010, a 1% increase in China's PMI is associated with a 0.54% increase in the LMEX base metals price index. 2 Please see BCA Research's Geopolitical Strategy's Special Report titled "China: Party Congress Ends...So What?," dated November 1, 2017. It is available at gps.bcaresearch.com. 3 Please see BCA Research's Geopolitical Strategy Weekly Report titled "Xi Jinping: Chairman Of Everything," dated October 25, 2017, available at gps.bcaresearch.com. 4 Li Keqiang and Wang Yang are both from Hu Jintao's Communist Youth League, Han Zheng and Wang Huning are Jiang Zemin followers, and Li Zhanshu and Zhao Leji are Xi Jinping loyalists. 5 While this is positive for steel prices, it would dampen demand for iron ore, weighing down on its prices. 6 Alumina, aluminum, and carbon producers that meet emission discharge standards are ordered to cut production by over 30%, around 30%, and over 50%, respectively. Producers that do not meet emission discharge standards are ordered to halt production. 7 Please see "China to launch nationwide inspection on commercial housing sales," published October 25, 2017, available at www.chinadaily.com.cn. Noted "irregularities" include fabricating information on housing sales, publishing fake advertisements and artificially inflating housing prices, market manipulation, and hoarding unsold homes. 8 Please see BCA Research's China Investment Strategy Weekly Report titled "Chinese Real Estate: Which Way Will The Wind Blow?," dated September 28, 2017, available at cis.bcaresearch.com. 9 Please see IMF Spillover Notes, Issue 6 "China's Footprint in Global Commodity Markets," published September 2016, available at www.imf.org. 10 Interestingly, given the U.S.'s role as a harbinger of the global economy, U.S. IP surprises have a similar impact on commodity prices. 11 Please see BCA Research's Frontier Markets Strategy Special Report titled "China's Belt And Road Initiative: Can It Offset A Mainland Slowdown?," dated September 13, 2017, available at fms.bcaresearch.com. Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2017 Summary of Trades Closed in 2016