Sectors

Highlights Stronger global growth in the wake of continued and expected fiscal and monetary stimulus, and progress against COVID-19 are boosting oil demand assumptions by the major data suppliers for this year.  We lifted our 2021 global demand estimate by 640k b/d to 98.25mm b/d, and assume OPEC 2.0 will make the necessary adjustments to keep Brent prices closer to $60/bbl than not, so as not to disrupt a fragile recovery. We are maintaining our 2022 and 2023 Brent forecasts at $65/bbl and $75/bbl. Commodity markets are ignoring the rising odds of armed conflict involving the US, Russia and China and their clients and allies.  Russia has massed troops on Ukraine’s border and warned the US not to interfere.  China has massed warships off the coast of the Philippines, and continues its incursions in Taiwan’s air-defense zone, keeping US forces on alert.  Intentional or accidental engagement would spike oil prices.  Two-way price risk abounds.  In addition to the risk of armed hostilities, faster distribution of vaccines would accelerate recovery and boost prices above our forecasts.  Downside risk of a resurgence in COVID-19-induced lockdowns remains, as rising death and hospitalization rates in Brazil, India and Europe attest (Chart of the Week). Feature Oil-demand estimates – ours included – are reviving in the wake of measurable progress in combating the COVID-19 pandemic in major economies, and an abundance of fiscal and monetary stimulus, particularly out of the US.1 On the back of higher IMF GDP projections, we lifted our 2021 global demand estimate by 640k b/d to 98.25mm b/d in this month’s balances. In our modeling, we assume OPEC 2.0 will make the necessary adjustments to keep Brent prices closer to $60/bbl than not, so as not to disrupt a fragile recovery. In an unusual turn of events, the early stages of the recovery in oil demand will be led by DM markets, which we proxy using OECD oil consumption (Chart 2). Thereafter, EM economies, re-take the growth lead next year and into 2023. Chart of the WeekCOVID-19 Deaths, Hospitalizations Threaten Global Recovery Upside Oil Price Risks Are Increasing Upside Oil Price Risks Are Increasing Chart 2DM Demand Surges This Year DM Demand Surges This Year DM Demand Surges This Year Absorbing OPEC 2.0 Spare Capacity We continue to model OPEC 2.0, the producer coalition led by the Kingdom of Saudi Arabia (KSA) and Russia, as the dominant producer in the market. The growth we are expecting this year will absorb a significant share of OPEC 2.0’s spare capacity, most of which – ~ 6mm b/d of the ~ 8mm b/d – is to be found in KSA (Chart 3). The core producers’ spare capacity allows them to meet recovering demand faster than the US shale producers can mobilize rigs and crews and get new supply into gathering lines and on to main lines. We model the US shale producers as a price-taking cohort, who will produce whatever the market allows them to produce. After falling to 9.22mm b/d in 2020, we expect US production to recover to 9.56mm b/d this year, 10.65mm b/d in 2022, and 11.18mm in 2023 (Chart 4). Lower 48 production growth in the US will be led by the shales, which will account for ~ 80% of total US output each year. Chart 3Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Core OPEC 2.0 Spare Capacity Will Respond First To Higher Demand Chart 4Shale Is The Marginal Barrel In The Price Taking Cohort Shale Is The Marginal Barrel In The Price Taking Cohort Shale Is The Marginal Barrel In The Price Taking Cohort OPEC 2.0’s dominant position on the supply side allows it to capture economic rents before non-coalition producers, which will remain a disincentive to them until the spare capacity is exhausted. Thereafter, the price-taking cohort likely will fund much of its E+P activities out of retained earnings, given their limited ability to attract capital. Equity investors will continue to demand dividends that can be maintained and grown, or return of capital via share buybacks. This will restrain production growth to those firms that are profitable. We expect the OPEC 2.0 coalition’s production discipline will keep supply levels just below demand so that inventories continue to fall, just as they have done during the COVID-19 pandemic, despite the demand destruction it caused (Chart 5). These modeling assumptions lead us to continue to expect supply and demand will continue to move toward balance into 2023 (Table 1). Chart 5Supply-Demand Balances in 2021 Supply-Demand Balances in 2021 Supply-Demand Balances in 2021 Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Upside Oil Price Risks Are Increasing Upside Oil Price Risks Are Increasing We continue to expect this balancing to induce persistent physical deficits, which will keep inventories falling into 2023 (Chart 6). As inventories are drawn, OPEC 2.0’s dominant-producer position will allow it to will keep the Brent and WTI forward curves backwardated (Chart 7).2 We are maintaining our 2022 and 2023 Brent forecasts at $65/bbl and $75/bbl (Chart 8). Chart 6OPEC 2.0 Policy Continues To Keep Supply Below Demand... OPEC 2.0 Policy Continues To Keep Supply Below Demand... OPEC 2.0 Policy Continues To Keep Supply Below Demand... Chart 7OECD Inventories Fall to 2023 OECD Inventories Fall to 2023 OECD Inventories Fall to 2023 Chart 8Brent Forecasts Rise As Global Economy Recovers Brent Forecasts Rise As Global Economy Recovers Brent Forecasts Rise As Global Economy Recovers Two-Way Price Risk Abounds Risks to our views abound on the upside and the downside. To the upside, the example of the UK and the US in mobilizing its distribution of vaccines is instructive. Both states got off to a rough start, particularly the US, which did not seem to have a strategy in place as recently as January. After the US kicked its procurement and distribution into high gear its vaccination rates soared and now appear to be on track to deliver a “normal” Fourth of July holiday in the US. The UK has begun its reopening this week. Both states are expected to achieve herd immunity in 3Q21.3 The EU, which mishandled its procurement and distribution likely benefits from lessons learned in the UK and US and achieves herd immunity in 4Q21, according to McKinsey’s research. Any acceleration in this timetable likely would lead to stronger growth and higher oil prices. The next big task for the global community will be making vaccines available to EM economies, particularly those in which the pandemic is accelerating and providing the ideal setting for mutations and the spread of variants that could become difficult to contain. The risk of a resurgence in large-scale COVID-19-induced lockdowns remains, as rising death and hospitalization rates in Brazil, India and Europe attest. Cry Havoc The other big upside risk we see is armed conflict involving the US, Russia, China and their clients and allies. Commodity markets are ignoring these risks at present. Even though they do not rise to the level of war, the odds of kinetic engagement – planes being shot down or ships engaging in battle in the South China Sea – are rising on a daily basis. This is not unexpected, as our colleagues in BCA Research’s Geopolitical Strategy pointed out recently.4 Indeed, our GPS service, led by Matt Gertken, warned the Biden administration would be tested in this manner by Russia and China from the get-go. Russia has massed troops on Ukraine’s border and warned the US not to interfere. China has massed warships off the coast of the Philippines, and continues its incursions in Taiwan’s air-defense zone, keeping US forces on alert. Political dialogue between the US and Russia and the US and China is increasingly vitriolic, with no sign of any leavening in the near future. Intentional or accidental engagement could let slip the dogs of war and spike oil prices briefly. Finally, OPEC 2.0 is going to have to accommodate the “official” return of Iran as a bona fide oil exporter, if, as we expect, it is able to reinstate its nuclear deal – i.e., the Joint Comprehensive Plan of Action (JCPOA) – with Western states, which was abrogated by then-President Donald Trump in 2018. This may prove difficult, given our view that the oil-price collapse of 2014-16 was the result of the Saudis engineering a market-share war to tank prices, in an effort to deny Iran $100+ per-barrel prices that had prevailed between end-2010 and mid-2014. OPEC 2.0, particularly KSA, has not publicly involved itself in the US-Iran negotiations. However, it is worthwhile recalling that following the disastrous market-share war launched in 2014, KSA and the rest of OPEC 2.0 did accommodate Iran’s return to markets post-JCPOA.   Robert P. Ryan Chief Commodity & Energy Strategist rryan@bcaresearch.com Ashwin Shyam Research Associate Commodity & Energy Strategy ashwin.shyam@bcaresearch.com   Commodities Round-Up Energy: Bullish Brent and WTI prices rallied sharply following the release of the EIA’s Weekly Petroleum Status Report showing a 9.1mm-barrel decline in US crude and product stocks for the week ended 9 April 2021. This was led by a huge draw in commercial crude and distillate inventories (5.9mm barrels and 2.1mm barrels, respectively). These draws came on the back of generally bullish global demand upgrades by the major data services (EIA, IEA and OPEC) over the past week. These assessments were supported by EIA data showing refined-product demand – i.e., “product supplied” – jumped 1.1mm b/d for the week ended 9 April. With vaccine distributions picking up steam, despite setbacks on the Johnson & Johnson jab, the storage draws and improved demand appear to have catalyze the move higher. Continued weakness in the USD also provided a tailwind, as did falling real interest rates in the US. Base Metals: Bullish Nickel prices fell earlier this week, as China’s official Xinhua news agency reported that Chinese Premier, Li Keqiang stressed the need to strengthen raw materials’ market regulation, amidst rising commodities prices, which been pressuring corporate financial performance (Chart 9). This statement came after China’s top economic advisor, Liu He also called for authorities to track commodities prices last week. Nickel prices fell by around $500/ ton earlier this week on this news, and were trading at $16,114.5/MT on the London Metals exchange as of Tuesday’s close. Other base metals were not affected by this news. Precious Metals: Bullish The US dollar and 10-year treasury yields fell after March US inflation data was released earlier this week. US consumer prices rose by the most in nearly nine years. The demand for an inflation hedge, coupled with the falling US dollar and treasury yields, which reduce the opportunity cost of purchasing gold, caused gold prices to rise (Chart 10). This uncertainty, coupled with the increasing inflationary pressures due to the US fiscal stimulus will increase demand for gold. Spot COMEX gold prices were trading at $1,746.20/oz as of Tuesday’s close. Ags/Softs: Neutral The USDA reported ending stocks of corn in the US stood at 1.35 billion bushels, well below market estimates of 1.39 billion and the 1.50 billion-bushel estimate by the Department last month, according to agriculture.com’s tally.  Global corn stocks ended at 283.9mm MT vs a market estimate of 284.5mm MT and a Department estimate of 287.6mm MT.  Chart 9Base Metals Are Being Bullish Base Metals Are Being Bullish Base Metals Are Being Bullish Chart 10Gold Prices To Rise Gold Prices To Rise Gold Prices To Rise   Footnotes 1     Please see US-Russia Pipeline Standoff Could Push LNG Prices Higher, which we published on 8 April 2021 re the IMF’s latest forecast for global growth.  Briefly, the Fund raised its growth expectations for this year and next to 6% and 4.4%, respectively, nearly a full percentage-point increase versus its January forecast update for 2021 2     A backwardated forward curve – prompt prices trading in excess of deferred prices – is the market’s way of signaling tightness.  It means refiners of crude oil value crude availability right now over availability a year from now.  This is exactly the same dynamic that drives an investor to pay $1 today for a dollar bill delivered tomorrow than for that same dollar bill delivered a year from now (that might only fetch 98 cents today, e.g.). 3    Please see When will the COVID-19 pandemic end?, published 26 March 2021 by McKinsey & Co. 4    Please see The Arsenal Of Democracy, a prescient analysis published 2 April 2021 by BCA’s Geopolitical Strategy.  The report notes the Biden administration “still faces early stress-tests on China/Taiwan, Russia, Iran, and even North Korea.  Game theory helps explain why financial markets cannot ignore the 60% chance of a crisis in the Taiwan Strait. A full-fledged war is still low-probability, but Taiwan remains the world’s preeminent geopolitical risk.”   Investment Views and Themes Recommendations Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades Higher Inflation On The Way Higher Inflation On The Way

Critical Condition Critical Condition Underweight (High-Conviction) Pharmaceutical stocks are melting in line with the broader macro-economic rebound, and given our cyclical and structural bullish market outlooks, we continue to recommend investors fade this defensive sector (CLI and ZEW shown inverted, middle & bottom panels). JNJ’s recent negative blood clotting vaccine news further accelerated the wholesale liquidation of this key health care sub-group. Should the number of vaccine-caused fatal cases rise, more and more countries will be banning this US-manufactured vaccine, putting additional earnings strains on drug stocks. As a reminder, we are currently underweight the S&P pharma index both within our cyclical and high-conviction universes and the positions are up 12.4% and 10%, respectively. Bottom Line: Stay underweight the S&P pharma index. The ticker symbols for the stocks in this index are: BLBG: S5PHAR – JNJ, PFE, MRK, LLY, BMY, ZTS, CTLT, VTRS, PRGO.  

Highlights Biden will host a global summit for Earth Day on April 22-23, giving public attention to his climate change policy push. Investors should count on Biden’s green infrastructure package becoming the bulk of his climate push, given uncertainty over the 2022 midterm elections. However, over the long run, American public opinion is shifting in favor of renewables and the US will seek to maintain its technological edge via participating in the green tech race. Go long our “Biden Fiscal Advantage Basket” versus the Nasdaq 100.  Feature The Biden administration’s $2.3 trillion American Jobs Plan is often referred to as a “green infrastructure” package and in this report we take a look at what makes it green – and what are the investment implications. Biden will virtually host a global climate summit on April 22-23, Earth Day, which the Chinese President Xi Jinping is expected to attend, thus providing momentum to the green investment theme. The stock market anticipated Biden’s electoral victory last year and renewable energy stocks rallied exorbitantly, with ultra-easy monetary and fiscal policy as a fundamental support. The market’s reaction to Biden’s official outline of his plan last month suggests that investors are energized about Biden’s infrastructure package but already suffering from some green fatigue (Chart 1). However, this bill’s passage will initiate the US’s official entrance into the global green energy race and from that point of view renewable plays should recover. Once the American Jobs Plan passes, likely sometime this fall, Biden’s climate agenda will be virtually finished, from an investment perspective. Investors have little visibility beyond 2022 as the president’s party rarely hangs onto the House of Representatives in his first midterm election. However, over the long run, American public opinion is shifting in favor of renewable energy. And Biden also has regulatory tools to push the Democratic Party’s climate agenda from 2022-24 regardless. Chart 1Biden's AJP Already Priced Biden's AJP Already Priced Biden's AJP Already Priced Chart 2Biden’s First Budget: Boom In Non-Defense Discretionary Spending Biden's Green Initiatives Biden's Green Initiatives Biden’s first presidential budget, released on April 13, also highlights the US’s attempt to boost climate policy (the Environmental Protection Agency’s funding would go up by 21%). More broadly it highlights the US’s ongoing sea change in fiscal policy. Discretionary spending turned around under President Trump’s populism and will continue under Biden’s populism. The difference lies in social spending versus defense. Biden proposes a 15.2% increase in non-defense discretionary spending, with education, commerce, health, and environment while the departments of defense and justice see much smaller increases (Chart 2). But we doubt that even defense spending will be curtailed given the US’s global strategic challenges. The president’s budget proposals are drops in the bucket compared to the trillions in his economic stimulus packages. Biden’s American Family Plan will be outlined in detail later this month but it only has a 50/50 chance of passing by the 2022 midterm election. This leaves us with the American Jobs Plan as the real macro policy factor to watch. And in the case of green energy, in particular, the Democrats may not have another opportunity to pass major legislation for many years. The US’s Strategic Basis For Green Energy The American Jobs Plan is billed as a $2.3 trillion green infrastructure package but in reality the package should be broken into traditional infrastructure ($784 billion for roads and bridges), social welfare ($647 billion  for elderly care, education, etc), green initiatives ($370 billion for electrical grid and retrofits, etc), tech initiatives ($280 billion for broadband, semiconductors, research and development), and small business support, in order of dollar value (Chart 3). The implication is that climate policy is important but not the top priority. Still, $370 billion is the biggest green package the US has ever launched. It consists of $150 billion for “hard” green infrastructure, such as new electricity grid and $220 billion for “soft” green infrastructure, such as tax credits for buying EVs (Chart 4). Chart 3Biden’s AJP: Green Initiatives Total $370 Billion Biden's Green Initiatives Biden's Green Initiatives Chart 4Biden’s AJP: Green Initiatives Mostly Rebates/Incentive Biden's Green Initiatives Biden's Green Initiatives The US has moved slowly on green energy policy – relative to Europe or China – because it does not face the same strategic necessity. China faces domestic social unrest if it does not reduce pollution, it faces American strategic containment if it does not reduce its dependency on the Middle East (35% of total oil consumption), and it faces the middle-income trap if it does not increase innovation and productivity. Europe is similarly dependent on a geopolitical enemy for its energy supply – Russia provides 35% of its oil consumption and 38% of its natural gas – and it must also increase productivity. Europe and China are net energy importers who have a great strategic interest in making energy supply a matter of manufacturing prowess rather than divine natural resource endowment (Chart 5). The US is late to the green energy game in part because it does not share the same degree of strategic necessity. Like the EU, the US took care of its most pressing pollution problems decades ago. But unlike the EU, the US is a net energy exporter thanks to the fracking revolution. However, the US is not truly energy independent – an Iranian closure of the Strait of Hormuz would cause global oil prices to spike and trigger a recession. And the US also has a powerful strategic interest in maintaining its global leadership and its edge in technology, innovation, and productivity (Chart 6). The US cannot afford to miss out on the green tech race even if starting from a more secure natural resource base. Chart 5US Green Focus Less Motivated By Energy Security Than China, EU Biden's Green Initiatives Biden's Green Initiatives US public opinion is also following European opinion regarding climate change and environmental protection. True, voters are more urgently concerned about the economy, jobs, and health care over the environment – as we showed in our Special Report on health care earlier this year. But the administration has decided not to rehash the health care battles of the Obama administration – having seen Republicans fail to repeal Obamacare – and instead to open up a new policy domain with climate change. Even if the environment is low priority for most voters, they do not oppose green projects in principle – in fact, they favor renewable energy over fossil fuels when it comes to the US’s energy future (Chart 7). And voters strongly favor infrastructure, which means they are more susceptible to green energy projects when presented as part of a broader infrastructure buildout – as opposed to a transformative “Green New Deal” designed to revolutionize every aspect of US life. Chart 6US Green Focus Motivated By Global Innovation/Tech Race Biden's Green Initiatives Biden's Green Initiatives Chart 7US Public Supports Renewable Energy Biden's Green Initiatives Biden's Green Initiatives The US shift to green energy is well underway, with renewables ready to surpass coal in the national energy mix (Chart 8). The natural gas boom of the past decade has worked wonders in reducing coal dependency and hence overall carbon emissions (Chart 9). Chart 8Shift To Renewables Well Underway Biden's Green Initiatives Biden's Green Initiatives Chart 9US Carbon Emissions To Fall Further Biden's Green Initiatives Biden's Green Initiatives Bottom Line: The US does not have the same energy security problems as China and the EU, which is one reason the US trails these competitors in green energy production and policy. But the US has a powerful interest in maintaining its technological edge and productivity growth. So policymakers will continue to push the green agenda even as the public follows Europe in becoming more favorable toward it over the long run. US Climate Policy Will Advance In Fits And Starts The fact that the US lacks the same strategic urgency as Europe and China suggests that the green energy push in the US will progress in fits and starts rather than in a straight line. Popular opinion cited above is supportive enough to allow a political party to push a green agenda if it has control of both the White House and Congress. The Biden administration has moderate-to-strong political capital based on our Political Capital Index (Appendix). But this could change with the next election, which would introduce a ruffle in the current narrative in which Biden saves planet earth. One factor that helps Biden is that his presidency is entirely about economic stimulus and recovery, which enables him to minimize the regulatory and punitive side of his party’s energy agenda. While the American Jobs Plan includes corporate tax hikes, his climate policy in itself is all about spending rather than taxation. There is no carbon pricing scheme anywhere to be seen. And Biden’s Transportation Secretary, Pete Buttigieg (“Mayor Pete,” a center-left politician from Indiana), immediately reversed his recent suggestion that the government levy a gasoline tax or vehicle mileage tax. Biden cannot get any revolutionary green measures passed through the Senate, given that moderate Democrats like Senators Joe Manchin of West Virginia and John Tester of Montana hail from coal-heavy states. The Democrats must also pay heed to the swing states for future elections. Biden only narrowly won his home state of Pennsylvania, after pledging to phase out oil and natural gas in the last presidential debate. True, Biden’s American Jobs Plan will remove subsidies for the oil and gas sector – but these subsidies are not very large. Notably, subsidies for renewables already overwhelm those for traditional infrastructure, even under the Trump administration (Chart 10). Chart 10Subsidy Reform Will Promote Renewables Biden's Green Initiatives Biden's Green Initiatives Chart 11Green Policy At Risk In 2022 Midterm Biden's Green Initiatives Biden's Green Initiatives These points underscore the fact that US climate policy is uncertain over the medium term, when the pandemic fades and the Democrats attempt more ambitious climate proposals. The Republican Party supports the traditional energy sector and is skeptical about climate change. The GOP could easily make a net gain of five seats in the 2022 midterm elections and take back control of the House of Representatives. They would not be able to repeal Biden’s laws or regulations, given his veto and likely Democratic majority in the Senate, but they would be able to pare back green funding. Republicans are not uniform on the issue of climate but more than half of Trump supporters in 2020 considered climate change unimportant. Young party members, moderates, and women were more split on the issue, with 60% of moderate Republicans viewing climate change as somewhat or very important (Chart 11). The takeaway is that Republicans would obstruct but not repeal future climate policy. Climate policy would be limited to Biden’s regulations until at least 2024. Hence investors can expect US climate policy to plow forward in the short run but to encounter resistance in the medium run. This is also likely to be the case as various other crises will emerge and soak up government attention and resources (most likely geopolitical conflicts). Chart 12Green Policy More Likely Over Long Term Biden's Green Initiatives Biden's Green Initiatives Over the long run climate policy will have more reliable support. Younger Republicans support federal environmental policy more than their elders, are increasingly favorable toward government regulation to that end, and prefer renewables to fossil fuels (Chart 12). The millennials and younger generations will make up more than half of the electorate by around 2028. Even then the government’s focus on climate will wax and wane given the other pressing matters of the day. Investment Takeaways A tsunami of money has been created, a lot of it is finding its way into the stock market, and a lot of it is finding its way into green and sustainable energy companies – companies that now have a privileged position in terms of both government support and conspicuous consumption. Combine this with a tidal wave of institutional funds pouring into anything and everything labeled ESG (environmental, social, and governance) – and the stigma attached to climate skepticism and denialism – and investors should fully expect irrational exuberance and stock bubbles. Consider the US’s premier EV maker, Tesla. The vertical run-up in Tesla stock has occurred alongside the run-up in US money supply. Tesla’s price trend conforms with the profile of a range of stock market bubbles of the past (Chart 13), as shown by our US Equity Strategy. Chart 13ALow Rates And Vast Money Growth... Low Rates And Vast Money Growth... Low Rates And Vast Money Growth... Chart 13B...Will Fuel Green Bubble ...Will Fuel Green Bubble ...Will Fuel Green Bubble That being said, renewables stocks surged throughout 2020 on the back of stimulus and Biden’s likely election – and have since fallen back. They have underperformed cyclical and defensive sectors alike this year to date (Chart 14). As highlighted above, the Democrats’ climate ambitions could yet be pared back in the Senate. However, given the argument in this report, there is sufficient political capital for the climate provisions of the American Jobs Plan to pass. Renewable plays should recover, at least on a tactical, “buy the rumor, sell the news” basis. To play Biden’s American Jobs Plan, our US Equity Strategist Anastasios Avgeriou constructed a “Biden Fiscal Advantage Basket” comprising eight ETFs and one stock, all equal weighted (Chart 15, top panel). Instead of buying specific stocks, Anastasios opted for ETFs so as to diversify away company-specific risk. Chart 14Renewables Corrected But Will Recover Renewables Corrected But Will Recover Renewables Corrected But Will Recover Chart 15Introducing The Biden Fiscal Advantage Basket Introducing The Biden Fiscal Advantage Basket Introducing The Biden Fiscal Advantage Basket The goal was to filter for ETFs that hold mostly US companies and that offered the highest possible liquidity. From a portfolio construction perspective, he aimed to match the different spending segments of Biden’s White House proposal with an ETF. The ticker symbols included in the basket are: PAVE, PHO, QCLN, TAN, WOOD, SOXX, HAIL, GRID and SU. We choose SU as there is no pure play Canadian oil sands ETF trading in USD. Granted there is some replication of stocks included in these ETFs. In certain ETFs there is also a sizable international stock exposure, including EM and Chinese stocks. One final caveat is that these ETFs have a high concentration of technology stocks. Our sense is that this basket should outperform the S&P500 on a cyclical and structural basis albeit not tactically (Chart 15, middle panel). However, given the high-tech exposure, our preferred way to express this trade is via a long/short pair trade versus the QQQ high-tech ETF, which tracks the largest 100 companies on the Nasdaq stock exchange (Chart 15, bottom panel). Table 1 shows a number of related ETFs that did not make the cut but that readers may find intriguing and that deserve further research. Later this month we will publish a joint special report with our US Equity Strategy service, updating our views on Biden’s proposals and elaborating on this equity basket. Table 1Infrastructure and Renewables Related ETFs Biden's Green Initiatives Biden's Green Initiatives More broadly, US equities are still enjoying a positive cyclical backdrop, whereas the passage of the American Jobs Plan later this year has a 50% chance of marking peak stimulus (the American Families Plan may not pass). Tactically, however, we are more cautious. There are also several pronounced foreign policy stress tests facing the Biden administration imminently, including serious Russia/Ukraine, Israel/Iran, and China/Taiwan saber-rattling that we fully expect to engender volatility and safe-haven flows. At least one FOMC member, Saint Louis Fed President Jim Bullard, is now openly thinking about thinking about the Fed’s tapering asset purchases – that is, once the US vaccination rate reaches 75%. Our US Investment Strategy recently showed that this rate of vaccination could be reached as early as September.     Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.Kuri@bcaresearch.com Anastasios Avgeriou US Equity Strategist anastasios@bcaresearch.com   Appendix Table A1Political Risk Matrix Biden's Green Initiatives Biden's Green Initiatives Table A2Political Capital Index Biden's Green Initiatives Biden's Green Initiatives Table A3APolitical Capital: White House And Congress Biden's Green Initiatives Biden's Green Initiatives Table A3BPolitical Capital: Household And Business Sentiment Biden's Green Initiatives Biden's Green Initiatives Table A3CPolitical Capital: The Economy And Markets Biden's Green Initiatives Biden's Green Initiatives Table A4Biden’s Cabinet Position Appointments Biden's Green Initiatives Biden's Green Initiatives

Cyclical Software Theme Is Intact Cyclical Software Theme Is Intact Overweight Our long-held view that digitalization of the economy is still in the early innings remains intact, and hence we reiterate our cyclical (and structural) preference for software companies. The recent pullback in the relative share price ratio also offers a compelling entry point for investors to further augment their overweight stance. Importantly, generationally low interest rates along with ample software companies’ free cash flow has emboldened the industry to embark on a new M&A frenzy that effectively reduces the supply of stocks available to investors and pushes prices higher (top panel). Already, the average M&A premium paid is probing new highs since the GFC at the same time as the actual count of deals is going through the roof. Both of these dynamics bode well for the future earnings power of software stocks. As a reminder, we are currently employing a barbell portfolio strategy within the GICS1 technology sector by preferring defensive software- and services-related stocks over more aggressive hardware and equipment equities. Bottom Line: Stay overweight the S&P software index. The ticker symbols for the stocks in this index are: BLBG: S5SOFT – MSFT, ADBE, CRM, ORCL, INTU, NOW, ADSK, ANSS, SNPS, CDNS, FTNT, PAYC, CTXS, NLOK, TYL.  

Initiating a long S&P semis/short S&P technology hardware storage & peripherals (THS&P) pair trade is the ultimate reflationary play given its tight positive correlation with the 10-year US Treasury yield (top panel). Not only does the bond market spell more upside for this relative share price ratio, but the trade also captures a significant early supply chain advantage of chip stocks over their hardware brethren. Switching from macro to industry level data, and the news on the operating front is equally enticing. Chip capital outlays trounce THS&P stocks’ investments by a wide margin, which should further boost relative revenue prospects (bottom panel). In fact, chip sales already have the upper hand compared with tech hardware storage and peripherals revenues and a relative reacceleration phase looms as the chip industry’s bottlenecks get resolved in the back half of the year (not shown). Tack on recent news of President Biden’s preliminary infrastructure plans that include a $50bn sum for semiconductors in order to bolster US based manufacturing and research and development and the demand profile for chip stocks brightens further. Bottom Line: We initiated a long S&P semis/short S&P THS&P pair trade in a recent Special Report. The ticker symbols for the stocks in the S&P semiconductors and S&P THS&P indexes are BLBG: S5SECO – INTC, TXN, ADI, AMD, MXIM, XLNX, MCHP, NVDA, AVGO, QCOM, MU, SWKS, QRVO, NXPI, MPWR, and BLBG: S5CMPE – AAPL, HPQ, HPE, WDC, NTAP, STX, respectively. Intra-sector Reflationary Trade Intra-sector Reflationary Trade

How To Play Biden’s $2.4 trillion “American Jobs Plan” How To Play Biden’s $2.4 trillion “American Jobs Plan” We have been inundated with client requests on how to best position for President Biden’s sweeping infrastructure spending package. We therefore constructed the BCA Biden Fiscal Advantage Basket, which comprises eight ETFs and one stocks, all equal weighted (top panel). Instead of buying specific stocks we opted to go the ETF way in order to diversify away company specific risk. Our goal was to filter for ETFs that hold mostly US companies and that offered the highest possible liquidity. From a portfolio construction perspective, we tried to match the different spending segments of Biden’s preliminary bill (that our sister BCA US Political Strategy expects to pass Congress with high conviction) with an ETF. The ticker symbols of the eight ETFs and one stock we included in this Equity Basket are: PAVE, PHO, QCLN, TAN, WOOD, SOXX, HAIL, GRID and SU. We choose SU as there is no pure play Canadian oil sands ETF trading in USD. Granted there is some replication of stocks included in these ETFs, and in certain ETFs there is a sizable international stock exposure including EM and Chinese stocks. One final caveat is that these ETFs have a high concentration of technology stocks. Our sense is that this Basket should outperform the SPX on a cyclical and structural basis (middle panel). However, given the high tech exposure, our preferred way to express this trade is via a long/short pair trade versus the QQQ (bottom panel). Bottom Line: Initiate a long BCA Biden Fiscal Advantage Basket/short QQQ pair trade. On April 26, 2021 we will publish a joined SR with our sister US Political Strategy service on President Biden’s infrastructure spending bill proposal and elaborate further on this Equity Basket. The ticker symbols for the stocks in the BCA Biden Fiscal Advantage Basket are: PAVE, PHO, QCLN, TAN, WOOD, SOXX, HAIL, GRID and SU. The table in the appendix on the next page shows a number of other related ETFs that did not make our cut, but that you may find interesting to research further.   How To Play Biden’s $2.4 Trillion "American Jobs Plan" How To Play Biden’s $2.4 Trillion "American Jobs Plan"

Bon Voyage! Bon Voyage! Overweight We have been overweight the niche (0.33% of the S&P 500) airlines sector going into the pandemic, and while it has been slow to recover, there is little doubt that soon airline stocks will reclaim their pre-COVID-19 altitude. The top panel of the chart on the right highlights that travelling is making a comeback as a larger and larger proportion of the world population is becoming inoculated. Consequently, air travel is springing to life. Another services industry that COVID-19 wrecked also confirms that the path of least resistance is higher for airlines: indoor dining is en route to rebound to pre-pandemic levels (middle panel). Finally, business and consumer travelling is slated to make a huge comeback following months of “staycations”. Consumers and businesses alike have amassed significant excess savings and stand ready to draw them down when the opportunity arises, likely some time after Memorial Day. This will further underpin the recovery in airlines and other savaged services stocks. Bottom Line: Stay overweight the S&P airlines index that will be gaining altitude as fiscal checks trickle down through the economy at a time when the US at large reaches herd immunity. The ticker symbols for the stocks in this index are: BLBG: S5AIRL - DAL, LUV, AAL, UAL, ALK. ​​​​​​​

Put A Rolling Stop On The "Back-To-Work" Versus "COVID-19 Winners Trade" Put A Rolling Stop On The "Back-To-Work" Versus "COVID-19 Winners Trade" We nearly fully captured the economic reopening theme through our long “Back-To-Work”/short “COIVD-19 Winners” baskets pair trade. As a brief summary, we first initiated this trade in the September 8th, 2020 Strategy Report, and subsequently closed it earlier this year for a gain of 21.5% via a rolling stop trigger, until we reopened it once again on February 3. Fast-forward to today, and this pair trade has vaulted another 25.5% since the second inception. Now that the US equity market is euphoric on the back of stimulus news and more importantly given that the bond market is no longer responsive having already priced in four Fed hikes by the end of 2023, we opt to re-introduce a 5% rolling stop as a risk management tool in order to protect handsome profits. Bottom Line: Institute a 5% rolling stop in the long “Back-To-Work”/short “COIVD-19 Winners” baskets pair trade today. ​​​​​​​

Highlights Our 80% odds that Biden will pass the $2.3 trillion American Jobs Plan stem from public opinion as well as Democratic control of Congress. Voters favor both higher taxes on corporations and higher infrastructure spending, as well as Biden’s proposal to pay for the latter by means of the former. A bipartisan consensus favors infrastructure spending, including “soft” infrastructure. Republicans who campaigned on the need for infrastructure over the past five years will not gain voter support by opposing it now. The Senate parliamentarian’s recent ruling on budget reconciliation procedures enables the Democrats to pass a second reconciliation bill, as expected. This puts Biden’s American Families Plan, to be detailed this month, officially into play for FY2022. Our initial premise remains a 50/50 chance that the $1.9 trillion bill passes before the 2022 midterms. Infrastructure plays benefit from a rising budget deficit but will also face a global headwind as China’s stimulus and growth momentum wane. Feature The market cheered the Biden administration’s $2.3 trillion American Jobs Plan despite the confirmation that corporate tax rates will go up as expected (Chart 1). The details of the plan are shown in Table 1, which makes it clear that $760 billion can easily be subtracted from the plan during negotiations as not having to do with infrastructure. However, investors should wager that most of the new spending, including the social welfare components, will pass, since Democrats will use the budget reconciliation process. Chart 1Market Response To Biden, Infrastructure, Tax Hikes Market Response To Biden, Infrastructure, Tax Hikes Market Response To Biden, Infrastructure, Tax Hikes Table 1Biden's 'American Jobs Plan' Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? The bigger question is tax hikes. Senator Joe Manchin of West Virginia reiterated that a 25% corporate tax rate is as high as he is willing to go. Since Democrats cannot spare a single vote in the Senate (not to mention six or seven votes, which Manchin claims to have on his side), the corporate tax rates may be compromised. Still, investors should prepare for the worst, i.e. the 28% rate that Biden presented or only slightly less. While Manchin is the critical marginal voter – his vote will turn the balance of power in the Senate – nevertheless there will be enormous pressure on him not to “betray” his party and vote against the signature legislative proposal of the Biden presidency. Insofar as Manchin succeeds, he presents a “less bad” outcome for equity sectors that stand to suffer the most from a higher headline corporate tax rate, such as utilities, health care, and information technology (Chart 2). Chart 2Corporate Tax Rates Will Rise To 25%-28%, A Big Increase For Real Estate, Health Care, Tech, Utilities, And Consumer Staples Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? It will take time to draft and negotiate the spending and tax provisions and then get them passed in both the House and Senate. The Democrats also face tight margins in the House, where they can only lose four votes (the balance in the House is 218-211 after the death of Florida Representative Alcee Hastings). The earliest possible passage – based on historical precedent – is in May. The average length of time would put passage in November. In the worst case the negotiations could drag on till Christmas but we highly doubt the Democrats will take that long (Diagram 1). We attach an 80% subjective probability to the view that the American Jobs Plan will pass by end of year. Diagram 1Time Line For Congress To Pass American Jobs Plan By End Of 2021 Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Where we are less certain is in the second part of Biden’s economic plan, the $1.9 trillion American Families Plan, which contains social welfare spending, an expansion of the child tax credit and other tax cuts for the lower and middle classes, and the tax hikes on upper-middle class and wealthy individuals and households. This program will be outlined this month. It will be a challenge to pass it prior to the 2022 midterm elections, depending on how fast infrastructure flies through Congress. Our subjective 50% odds received initial support on April 5 when the Senate parliamentarian, Elizabeth MacDonough, ruled that the Democrats can indeed pass more than one budget reconciliation bill per fiscal year, contrary to previous practice. This bill is just as likely to be the Democratic campaign platform for 2022 as to be passed in early 2022 under the current Congress. Senate Parliamentarian Enables Democrats To Bypass Filibuster We must pause here to note that the parliamentarian’s ruling is highly consequential as it erodes the checks and balances on passing legislation in the Senate. The new ruling holds that under Section 304 of the Congressional Budget Act of 1974 the annual budget resolution can be revised. If it can be revised, then a new budget reconciliation bill can be crafted according to the new budget resolution. And reconciliation enables the ruling party to push through bills on a simple majority (51 votes) in the Senate. It will be hard for the Senate, as a body, to limit the ramifications of this decision in future. If the Democrats can pass two reconciliation bills in FY2021, then who is to say that some later Congress cannot pass three? Regardless, it is hard for a party to pass more than three major pieces of legislation in a single year, so the window is just wide enough to enable major breakthroughs in legislation (and, whenever the opposing party regains the House and Senate, big reversals of legislation). We have argued that Democrats would eventually, if not immediately, remove the Senate filibuster (the rule that requires 60-votes to end debate on regular legislation). At the moment there are still not enough votes to remove the filibuster entirely, although moderate Democrats are looking at technical ways of diminishing its influence, such as via the “talking filibuster” that would increase the difficulty of the process and thus reduce its use in the Senate.1 But this new ruling on budget reconciliation process substantively bypasses the filibuster. While the reconciliation process will still come with various technical limitations (the “Byrd rule,” and relevance to the budget), they are pliable. Clearly the ruling party calls the shots – especially if it is a party in synch with the political establishment in Washington. The Public Favors Tax Hikes For Infrastructure Where do we get our 80% subjective probability that Biden’s American Jobs Plan will pass Congress? Why so confident? First, Democrats have control of Congress, albeit narrowly. Second, public opinion not only favors infrastructure but also favors tax hikes on corporations – especially if they are to pay for infrastructure. The solution has been to rebrand renewable energy, broadband Internet, subsidized housing, and a range of other government programs as “infrastructure,” and meanwhile to rebrand social welfare as “human infrastructure.” Consider the following: The public favors higher taxes on corporations: 69% of Americans believe corporations pay too little in taxes, while only 6% believe they pay too much (Chart 3). While this is a general view, and does not reflect regional variations, it calls into question Joe Manchin’s opposition to a corporate tax rate of 28%. Manchin has his eye on the economic recovery, small business owners, as well as the particular industries and political orientation of his state. But the point is that opposition to corporate tax hikes is politically weak and therefore we continue to expect the result to be closer to Biden’s 28% than to Manchin’s 25%. The public favors higher taxes on high-income earners: As for Biden’s second slate of tax hikes, on individuals and households under the yet-to-be detailed American Families Act, 62% of Americans believe that upper-income earners pay too little in taxes and again only 9% believe they pay too much (Chart 4). Since Biden’s proposals amount to only a partial repeal of President Trump’s Tax Cut and Jobs Act, which was itself unpopular in opinion polling, investors should also have a presumption in favor of individual tax hikes. However, as noted above, the American Families Plan only has a 50% chance of passing prior to the midterms due to the time crunch. Chart 3Public Favors Tax Hikes On Corporations Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Chart 4Public Favors Tax Hikes On The Rich Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Government is not seen as incompetent on infrastructure: Net public approval of the government’s performance on infrastructure is positive, just barely, unlike immigration, health care, or the environment. This means Biden can tap into a greater level of trust in government on this policy, while still calling on a general belief that infrastructure needs to be improved (Chart 5). Chart 5Public Gives Government Decent Grades On Infrastructure Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Chart 6No Partisan Gap On whether Infrastructure Should Be Prioritized Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Infrastructure is bipartisan: The gap in the views of Republicans and Democrats is narrow when it comes to infrastructure, unlike other policy issues that are extremely polarized. The gap is narrow whether infrastructure should be prioritized (Chart 6), whether government should play a larger role (Chart 7), and whether the federal government does a good job in this area (Chart 8). Democrats are more supportive of these propositions and they are currently in charge. But even Republicans tend to agree, as indicated by President Trump’s own emphasis on infrastructure, which the grassroots of his party supported despite establishment Republican hesitations due to concerns about the deficit. These charts also suggest that voters, especially Democratic voters, will not be bothered by the presence of non-traditional or “soft” infrastructure in Biden’s package as long as it can be successfully pitched as helping the economy, jobs, and American supply chains. Chart 7Government Role In Infrastructure Not Too Partisan Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Chart 8Government Performance On Infrastructure Not Too Partisan Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? The public approves of Biden’s corporate-tax-hikes-for-infrastructure tradeoff: About 54% approve outright, in line with Biden’s overall approval rating, including 52% of independents and a non-negligible 32% of Republicans. A further 27% support infrastructure spending without raising taxes, including 42% of Republicans (Chart 9). This poll does not stand alone but corroborates a range of polling over the past decade on both taxes and infrastructure. It strongly implies that the median voter will support Biden’s plan. (And again it suggests that while Senator Manchin may turn the balance in the Senate he is not standing on solid rock in calling for Biden to pare back his corporate tax hikes.) Chart 9Voters Back Tax Hikes For Infrastructure Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? No need to rely on polling – look at how people vote: Ballot measures on the local level for transportation funding usually win high levels of voter approval, meaning that people vote to increase their own taxes if they think traditional infrastructure will be improved. The average approval for such measures stood at 74% in 2016 and rose to 94% in the 2020 election cycle (Chart 10). And voters clearly understood that this combination is what they would get in voting for Biden, given that he did not shy away from his tax proposals in the presidential debates (although he insisted no tax hikes on those who earn less than $400,000 per year). Chart 10Voters Accept Higher Taxes For Infrastructure Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? The Democrats have the votes for an infrastructure package, they have the votes for at least some degree of corporate tax hikes, and they have popular opinion behind the principle of tax hikes in exchange for infrastructure upgrades. Furthermore the rise of geopolitical struggle abroad and populism at home have given Biden and the traditional Democrats extraordinary impetus to pass this bill. If they fail, they will have wasted precious congressional time, they will be less likely to pass the American Families Plan, and they will be more likely to lose control of the House or even the Senate in 2022, as their failure would energize both the democratic socialists on their left and the Trump Republicans on their right. It is unlikely that Senator Manchin alone is willing or able to cause such a train wreck for his party given the popularity of the proposals.2 The implication is that corporate tax hikes will be compromised only somewhat. It is also possible that non-infrastructure components of the bill, such as housing or some social spending, could be pared back, although these are not the controversial parts of the bill and we would not bet on the overall size of spending to be reduced by much. A bill with Biden’s spending measures and only half of the tax hikes would increase the budget deficit by $1.4 trillion, as we showed last week. A bill with all spending and all tax hikes would increase the deficit by $400 billion. Bottom Line: Biden has an 80% chance of passing the American Jobs Act, although some non-infrastructure provisions could be pared back and the corporate tax hike may not reach all the way to 28%. Most likely the final bill will be substantially similar to Biden’s proposal on spending, while the tax hikes will be compromised, reflecting the populist and proactive fiscal turn in US politics. Investment Takeaways A basket of the 50 companies in the S&P 500 with the highest median effective tax rates outperformed the S&P500 upon Trump’s election and subsequent tax cuts (Chart 11). Since Biden’s election they have also outperformed on the expectation of post-pandemic reopening and economic stimulus. However, the high-tax companies and high-tax sectors have underperformed on an equal-weighted basis since the Democratic Party won control of the Senate and tax hikes became inevitable. Tax hikes are largely but not fully priced from this point of view. Historically a rising budget deficit does not have a clear or positive correlation with the S&P 500, cyclical sectors, value stocks, or small caps. Fiscal thrust normally surges during recessions and bear markets. Nevertheless infrastructure plays – by which we include building products, construction materials and services, environmental services, metals and mining, machinery, and steel – tend to perform better when the deficit blows out. That trend looks to be intact today (Chart 12). Chart 11High-Tax Companies Rallied Despite Biden's Tax Hikes (But Not On Equal-Weighted Basis) High-Tax Companies Rallied Despite Biden's Tax Hikes (But Not On Equal-Weighted Basis) High-Tax Companies Rallied Despite Biden's Tax Hikes (But Not On Equal-Weighted Basis) Chart 12US Budget Blow-Out Positive For Infrastructure Plays US Budget Blow-Out Positive For Infrastructure Plays US Budget Blow-Out Positive For Infrastructure Plays The budget deficit is generally a stronger predictor of the performance of these sub-sectors than global manufacturing surveys and leading economic indicators, although the improvement in global sentiment and growth is clearly a positive backdrop (Chart 13). Europe and countries other than China will soon improve their vaccinations, reopen, and start catching up to the US economic rebound. China’s fiscal-and-credit impulse is closely correlated with US infrastructure plays and this has not changed since the trade war began (Chart 14). Importantly, China is tapping on the policy brakes and its economy is set to decelerate in the second half of the year, which has important implications for our BCA Infrastructure Basket and long trades. This indicator suggests that the relative performance of infrastructure plays will face a gradually rising headwind from abroad even as the US economy continues to provide a tailwind. Chart 13Global Sentiment Positive But Not A Big Driver Of US Infrastructure Plays Global Sentiment Positive But Not A Big Driver Of US Infrastructure Plays Global Sentiment Positive But Not A Big Driver Of US Infrastructure Plays Chart 14Infrastructure Plays Face Headwind From China's Waning Stimulus Infrastructure Plays Face Headwind From China's Waning Stimulus Infrastructure Plays Face Headwind From China's Waning Stimulus Infrastructure plays shown here – which consist of goods and services that fall under greater demand when infrastructure is built – should not be confused with infrastructure companies themselves, which tend to be classified under the much more defensive utilities and telecommunication sectors (Chart 15). This ratio is looking very toppy, in keeping with the general rollover in cyclical equity sector performance relative to defensives.   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.Kuri@bcaresearch.com Chart 15Infrastructure Plays Versus Utilities And Telecoms Infrastructure Plays Versus Utilities And Telecoms Infrastructure Plays Versus Utilities And Telecoms   Appendix Table A1Political Risk Matrix Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Table A2Political Capital Index Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Table A3APolitical Capital: White House And Congress Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Table A3BPolitical Capital: Household And Business Sentiment Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Table A3CPolitical Capital: The Economy And Markets Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure? Table A4Biden’s Cabinet Position Appointments Will Biden Get The Votes For Infrastructure? Will Biden Get The Votes For Infrastructure?   Footnotes 1     Molly E. Reynolds, “What is the Senate filibuster, and what would it take to eliminate it?” Brookings Institution, September 9, 2020, brookings.edu. 2     On the contrary, while the bill will pass via party-line voting, it is still conceivable that one or two moderate Senate Republicans could be brought to endorse Biden’s American Jobs Plan.  

Feature The selloff in Chinese stocks since mid-February reflects a rollover in earnings growth and multiples. Lofty valuations in Chinese equities driven by last year’s massive stimulus means that stock prices are vulnerable to any pullback in policy supports (Chart 1A and 1B). Chart 1AGrowth In Chinese Investable Earnings And Multiple Expansions Has Rolled Over Growth In Chinese Investable Earnings And Multiple Expansions Has Rolled Over Growth In Chinese Investable Earnings And Multiple Expansions Has Rolled Over Chart 1BEarnings Outlook Still Looks Promising In The Onshore Market, But May Soon Peak Earnings Outlook Still Looks Promising In The Onshore Market, But May Soon Peak Earnings Outlook Still Looks Promising In The Onshore Market, But May Soon Peak After diverging in the past seven to eight months, Chinese stocks have started to gravitate towards deteriorating monetary conditions index. The market may be beginning to price in a peak in economic as well as corporate profit growth (Chart 2). Defensive stocks in China’s onshore and offshore equity markets have also outperformed cyclicals since February, which confirms that investors expect earnings growth will slow in the coming months (Chart 3). A tighter monetary policy stance, coupled with increased regulations targeting the real estate, banking, and tech sectors have further dampened investors’ appetite for Chinese stocks. Chart 2A-Share Prices Start To Gravitate Towards Tightening Monetary Conditions A-Share Prices Start To Gravitate Towards Tightening Monetary Conditions A-Share Prices Start To Gravitate Towards Tightening Monetary Conditions Chart 3Defensives Have Prevailed Over Cyclicals In Both Onshore And Offshore Markets Defensives Have Prevailed Over Cyclicals In Both Onshore And Offshore Markets Defensives Have Prevailed Over Cyclicals In Both Onshore And Offshore Markets The official PMIs bounced back smartly in March following three consecutive months of decline. However, the strong PMI readings do not change our view that the speed of China’s economic recovery is near its zenith. PMIs in the first two months of the year are typically lower due to the Lunar New Year (LNY), and the improvement in March’s PMI did not exceed seasonal rebounds experienced in previous years. Weakening fixed-asset investments also indicate that economic activity is moderating. We remain cautious on the 6 to 12-month outlook for Chinese stocks, in both absolute and relative terms. Qingyun Xu, CFA Associate Editor qingyunx@bcaresearch.com Jing Sima China Strategist jings@bcaresearch.com     China’s NBS manufacturing and non-manufacturing PMIs in March beat market expectations with sharp rebounds after moderating in the previous three months. The improvement in the PMIs will likely provide authorities with confidence to stay the course on policy normalization. The methodology calculating PMI indexes reflects the net reported improvement in business activities relative to the previous month and there was a notable decline in PMIs in February, due to the LNY holiday and travel restrictions related to the spread of COVID-19.  Additionally, the average reading of China’s official composite PMI in Q1 this year was 2.2 percentage points lower than in Q4 last year and weaker than the Q1 PMI figures in most of the pre-pandemic years. Moreover, Chinese Caixin manufacturing PMI, which focuses on smaller and private corporates, declined further in March as it continued its downward trend started in December 2020. Chart 4Q1 PMIs Slowed By More Than Seasonal Factors Q1 PMIs Slowed By More Than Seasonal Factors Q1 PMIs Slowed By More Than Seasonal Factors Chart 5Caixin PMI Shows Further Deterioration Among Private-Sector Manufacturers Caixin PMI Shows Further Deterioration Among Private-Sector Manufacturers Caixin PMI Shows Further Deterioration Among Private-Sector Manufacturers Growth in credit expansions in February was better than expected, supported by a substantial increase in corporates’ demand for medium- and long-term loans. Travel restrictions during this year’s LNY led to a shorter holiday, a faster resumption in manufacturing activity after the break and stronger credit demand in February. China’s Monetary Policy Committee meeting last week reiterated the authorities’ hawkish policy tone and removed dovish language prevalent in last month’s National People’s Congress, such as “maintaining the consistency, stability, and sustainability in monetary policy” and “not making a sudden turn in policymaking.” Given the strong headline economic and credit data in January and February, the authorities will be unlikely to slow normalizing monetary policy. Therefore, the risk of a policy-tightening overshoot remains high. The PBoC has continued to drain net liquidity in the interbank system since early this year, evidenced by falling excess reserves at the central bank. Excess reserves normally lead the credit impulse by about six months, signaling that the latter will continue to decelerate in the months ahead. In turn, the credit impulse normally leads the business cycle by six to nine months, meaning that China’s cyclical economic recovery will likely peak in the first half of 2021. Chart 6Corporates Demand For Longer-Term Bank Loans Resumed Their Upward Trend Early This Year Corporates Demand For Longer-Term Bank Loans Resumed Their Upward Trend Early This Year Corporates Demand For Longer-Term Bank Loans Resumed Their Upward Trend Early This Year Chart 7Falling Excess Reserves Leads To A Deceleration In Credit And Economic Growth Falling Excess Reserves Leads To A Deceleration In Credit And Economic Growth Falling Excess Reserves Leads To A Deceleration In Credit And Economic Growth Robust industrial activities and improving profitability helped to boost profit growth in January and February. The bounce in producer prices also drove up returns in industrial output, particularly in upstream industries loaded with commodity producers. Nevertheless, weak final demand is limiting the ability of Chinese producers to pass on higher prices to domestic consumers, highlighted in the divergence between Chinese PPI and CPI. In addition, China’s domestic demand for commodities and industrial metals may reach its cyclical peak in mid-2021, following ongoing credit tightening and reduced economic activity. Commodity inventories have surged to historical highs due to soaring imports (which far exceeded consumption) during 2H20. Inventory destocking pressures will weigh on commodity prices with China’s domestic demand reaching its cyclical peak. Disinflation/deflation pressures may re-emerge in 2H21, which will pose downside risks to China’s industrial profits. Chart 8Industrials Posted A Strong Rebound In The First Two Months of 2021 Industrials Posted A Strong Rebound In The First Two Months of 2021 Industrials Posted A Strong Rebound In The First Two Months of 2021 Chart 9Surging Commodity Prices Helped To Boost Upstream Industry Profits Surging Commodity Prices Helped To Boost Upstream Industry Profits Surging Commodity Prices Helped To Boost Upstream Industry Profits Chart 10Domestic Final Demand Remains Sluggish Domestic Final Demand Remains Sluggish Domestic Final Demand Remains Sluggish Chart 11Decelerating Chinese Credit Growth Poses Downside Risks To Global Commodity Prices Decelerating Chinese Credit Growth Poses Downside Risks To Global Commodity Prices Decelerating Chinese Credit Growth Poses Downside Risks To Global Commodity Prices Chart 12Chinas Raw Material Inventory Restocking Cycle May Be Near A Cyclical Peak Chinas Raw Material Inventory Restocking Cycle May Be Near A Cyclical Peak Chinas Raw Material Inventory Restocking Cycle May Be Near A Cyclical Peak Chart 13Real Estate And Infrastructure Investment Losing Steam In 2021 Real Estate And Infrastructure Investment Losing Steam In 2021 Real Estate And Infrastructure Investment Losing Steam In 2021 Investments in infrastructure and real estate drove China’s economic recovery in the second half of 2020. However, growth momentum in both sectors has slowed because of retreating government spending in infrastructure and tightening regulations in the property sector. Both home sales and housing prices, especially in tier-one cities, rose significantly in January-February this year, deepening authorities’ concerns over bubble risks in the property market. The share of mortgages, deposits and advanced payments as a source of funds for property developers reached an all-time high in February. Following the LNY, the authorities introduced a slew of new restrictions on the housing market to curb excessive demand. These were in addition to placing limits on bank lending to both property developers and household mortgages. All of these measures will weigh on housing supply and demand, and the impact is already evident in falling land purchases and housing starts. At the same time, property developers are rushing to complete existing projects. The tighter regulations on real estate financing will likely weaken growth in real estate investment and construction activities in the second half of this year. Chart 14Housing Prices In Top-Tier Cities Have Been On A Tear … Housing Prices In Top-Tier Cities Have Been On A Tear Housing Prices In Top-Tier Cities Have Been On A Tear Chart 15… But Bank Lending To Developers And Mortgage Loans Continue Downward Trend But Bank Lending To Developers And Mortgage Loans Continue Downward Trend But Bank Lending To Developers And Mortgage Loans Continue Downward Trend Chart 16Property Developers Are Rushing To Sell And Complete Existing Projects Property Developers Are Rushing To Sell And Complete Existing Projects Property Developers Are Rushing To Sell And Complete Existing Projects Chart 17Forward-Looking Indicators Suggest A Slowdown In Housing And Construction Activities Forward-Looking Indicators Suggest A Slowdown In Housing And Construction Activities Forward-Looking Indicators Suggest A Slowdown In Housing And Construction Activities   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 Cyclical Investment Stance Equity Sector Recommendations