United States

Highlights Oil demand expectations remain high. Realized demand continues to disappoint. This means OPEC 2.0's production-management strategy – i.e., keeping the level of supply below demand – will continue to dictate oil-price levels. US producers will remain focused on consolidation via M&A and on returning capital to shareholders, in line with the Kingdom of Saudi Arabia's (KSA) expectation. Going forward, shale producers will focus on protecting and growing profit margins. The durability of OPEC 2.0's tactical advantage arising from its enormous spare capacity – ~ 7mm b/d – is difficult to gauge: Tightening global oil markets now in anticipation of Iran's return as a bona fide exporter benefits producers globally, and could accelerate the return of US shales if that return is delayed or re-opening boosts demand more than expected. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. Feature While the forecasted rebound in global oil demand continues to drive expectations for higher prices, it is the production discipline of OPEC 2.0 and capital discipline imposed on US shale producers that has and will continue to super-charge the recovery of prices. Continued monetary accommodation and fiscal stimulus notwithstanding, realized global oil demand has mostly flatlined at ~ 96mm b/d following its surge in February, as uncertainty over COVID-19 containment keeps governments hesitant about reopening their economies too quickly. Stronger demand in Asia, led by China, has been offset by weaker demand in India and Japan, where COVID-19 remains a deterrent to re-opening and recovery. The recovery in DM demand generally stalled over this period even as vaccine availability increased (Chart 2). Chart of the WeekOPEC 2.0 Comfortable With Higher Prices Chart 2Global Demand Recovery Stalled That likely will change in 2H21, but it is not a given: The UK, which has been among the world leaders in COVID-19 containment and vaccinations, delayed its full reopening by a month – to July 19 – in an effort to gain more time to bolster its efforts against the Delta variant first identified in India. In the US, New York state lifted all COVID-19-induced restrictions and fully re-opened this week. Still, even in the US, unintended inventory accumulation in the gasoline market – just as the summer driving season should be kicking into high gear – suggests consumers remain cautious (Chart 3). Chart 3Unintended Inventory Accumulation in US Gasoline Market We continue to expect the re-opening of the US and Europe (including the UK) will boost DM demand in 2H21, and wider vaccine availability will boost EM oil demand later in the year and in 2022. For all of 2021, we have lifted our demand-growth estimate slightly to 5.3mm b/d from 5.2mm b/d last month. We expect global demand to grow 4.1mm b/d next year and 1.6mm b/d in 2023. Our 2021 estimates are in line with those of the US EIA and the IEA. OPEC is more bullish on demand recovery this year, expecting growth of 6mm b/d. We continue to believe the risk on the demand side remains to the upside; however, given continued uncertainty around global COVID-19 containment, we remain circumspect. Supply-Side Discipline Drives Oil Prices OPEC 2.0 remains committed to its production-management strategy that is keeping the level of supply below demand. Compliance with production cuts in May reportedly was at 115%, following a 114% rate in April.1 Core OPEC 2.0 – i.e., states with the capacity to increase production – is holding ~ 7mm b/d of spare capacity, according to the IEA, which will allow it to continue to perform its role as the dominant supplier in our modeling (Chart 4). Earlier this year, KSA's Energy Minister Abdulaziz bin Salman correctly recognized the turn in the market that likely ensures OPEC 2.0's dominance for the foreseeable future – i.e., the shift in focus of the US shale-oil producers from production for the sake of production to profitability.2 This is a trend that has been apparent for years as capital markets all but abandoned US shale-oil producers. Chart 4OPEC 2.0 Remains Dominant Producers outside OPEC 2.0 – what we refer to as the "price-taking cohort" – have prioritized shareholder interests as a result of this market pressure, and remain focused on sometimes-forced consolidation via M&A, which we have been expecting.3 The significance of this evolution of shale-oil production is difficult to overstate, particularly as the survivors of this consolidation will be firms with strong balance sheets and a focus on profitability, as is the case with any well-run manufacturing firm. We also expect large producers to opportunistically shed production assets to reduce their carbon footprints, so as to come into compliance with court-ordered emission reductions and shareholder demands to reduce pollution.4 With the oil majors like Shell, Equinor and Oxy divesting themselves of shale properties, production increasingly will be in the hands of firms driven by profitability.5 We expect US shale-oil production to end the year at 9.86mm b/d and to average 9.57mm b/d next year; however, as the shales become the marginal global supply, production could become more volatile (Chart 5). The consolidation of US production also will alter the profitability of firms continuing to operate in the shales. We expect breakeven costs to fall as acquired production by stronger firms results in high-grading of assets – only the most profitable will be produced given market-pricing dynamics – while less profitable acreage will be mothballed until prices support development(Chart 6). Chart 5US Producers Focus On Profitability Chart 6Shale Breakevens Likely Fall As Consolidation Picks Up Supply-Demand Balances Tightening The current round of M&A consolidation and OPEC 2.0's continued discipline lead us to expect continued tightening of global oil supply-demand balances this year and next (Chart 7). This will allow inventories to continue to draw, which will keep forward oil curves backwardated (Chart 8). Chart 7Supply-Demand Balances Will Continue To Tighten Chart 8Tighter Markets, Lower Stocks The critical factor here will be OPEC 2.0's continued calibration of supply in line with realized demand and the return of Iran as a bona fide exporter, which we expect later this year. OPEC 2.0's restoration of ~ 2mm b/d of supply will be done by the beginning of 3Q21, when we expect Iran to begin restoring production and visible exports (i.e., in addition to its under-the-radar sales presently). The return of Iranian supply – and a possible increase in Libyan output – will present some timing difficulties for OPEC 2.0's overall strategy, but they will be short-lived. We continue to monitor output to assess the evolution of balances (Table 1). Table 1BCA Global Oil Supply - Demand Balances (MMb/d, Base Case Balances) Investment Implications Oil demand will increase over the course of 2H21, as vaccines become more widely distributed globally, and the massive fiscal and monetary stimulus deployed worldwide kicks economic activity into high gear. On the supply side, markets will tighten on the back of continued restraint until Iranian barrels return to the market. The balance of risk is to the upside, particularly if the US and Iran are unable to agree terms that restore Iran as a bona fide exporter. In that case, the market tightening now under way will result in sharply higher prices. That said, realized demand growth has stalled over the past three months, which can be seen in unintended inventory accumulation in the US gasoline markets just as the summer driving season opens. We are raising our average Brent forecast for 2021 to $66.50 vs. $63/bbl earlier, with 2H21 prices averaging $70/bbl. We are moving our 2022 and 2023 forecasts up slightly as well to $74 and $81/bbl (Chart of the Week). WTI will trade $2-$3/bbl lower. We remain long the S&P GSCI Dynamic Roll Index ETF (COMT) and the S&P GSCI, expecting tight supply-demand balances to further steepen backwardations in forward curves. The big risk, as highlighted above, remains an acceleration of COVID-19 infections, hospitalizations and deaths, which force governments to delay re-opening or impose localized lockdowns once again. In this regard, KSA's strategy of calibrating its output to realized – vice forecasted – demand likely will remain in place.   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 China's refinery throughput surged 4.4% to 14.3mm b/d in May, a record high that surpassed November 2020's previous record of 14.26mm b/d, according to S&P Platts Global. The increased runs were not unexpected, and were largely accounted for by state-owned refiners, which operated at 80% of capacity after coming out of turnaround season. Turnarounds will fully end in July. In addition, taxes on niche refined-product imports are due to increase, which will bolster refinery margins as inventories are worked down. China's domestic crude oil production was just slightly more than 4mm b/d. Base Metals: Bullish China's Standing Committee approved the release an undisclosed amount of its copper, aluminum and zinc stockpiles via an auction process in the near future, according to reuters.com. The government disclosed its intent on the website of National Food and Strategic Reserves Administration on Wednesday; however, specifics of the auction – volumes and auction schedule, in particular – were not disclosed. Prices had fallen ~ 9% from recent record highs in the lead-up to the announcement, which we flagged last month.6 Prices rallied from lows close to $4.34/lb on the COMEX Wednesday (Chart 9). Precious Metals: Bullish After a worse-than-expected US employment report, we do not expect the Federal Reserve to lift nominal interest rates in Wednesday’s Federal Open Market Committee (FOMC) meeting. The Fed will only raise rates once the US economy reaches a level consistent with its definition of "maximum employment." Wednesday’s interest rate decision will be crucial to gold prices. If the Fed does not mention asset tapering or an interest-rate hike, citing current inflation as a transitory phenomenon, gold demand and prices will rise. On the other hand, if the Fed indicates an interest rate hike sooner than the previously stated 2024, this will weigh on gold prices (Chart 10). Ags/Softs: Neutral As of June 13, 96% of the US corn crop had emerged vs. the five-year average of 91%, according to the USDA. 68% of the crop was rated in good to excellent condition, slightly below the five-year average. In the bean market, 94% of the crop was planted as of 13 June, vs. the five-year average of 88%. The Department reported 86% of the crop had emerged vs. the five-year average of 74%. According to the USDA, 52% of the bean crop was in good-to-excellent condition vs the five-year average of 72%. Chart 9 Chart 10   Footnotes 1     Please see OPEC+ complies with 115% of agreed oil curbs in May - source published by reuters.com on June 11, 2021. 2     Please see Saudis raise U.S. and Asian crude prices for April delivery published by worldoil.com on March 8, 2021. 3    Please see US shale consolidation continues as Independence scoops up Contango Oil & Gas published by S&P Global Platts on June 8, 2021. 4    We discuss this in A Perfect Energy Storm On The Way, published on June 3, 2021.  Climate activism will become increasingly important to the evolution of oil and natural gas production, and likely will lead to greater concentration of supply in the hands of OPEC 2.0 and privately held producers that do not answer to shareholders. 5    Please see Interest in Shell's Permian assets seen as a bellwether for shale demand published by reuters.com on June 15, 2021. 6    Please see Less Metal, More Jawboning, which we published on May 27, 2021.  It is available at ces.bcaresearch.com. Investment Views and Themes Strategic Recommendations Tactical Trades Commodity Prices and Plays Reference Table Trades Closed in 2021 Summary of Closed Trades

Highlights The US Innovation and Competition Act shows that the US is rediscovering industrial policy amid domestic populism and foreign geopolitical risk.  Fiscal accommodation is a basis for the economy to improve, political polarization to moderate, and Congress’s approval rating to continue to normalize.  Biden’s infrastructure bill still has a subjective 80% chance of passage, despite bipartisan talks faltering and his own caucus growing restive. The price tag is still around $1-$1.5 trillion. Senate passage will mark peak US stimulus for this cycle. Close long consumer staples for a gain of 6%. Cut losses on long materials/tech. Close our fiscal advantage trade relative to the NASDAQ. Feature Bipartisanship is not dead in the 117th Congress, though a bipartisan deal on infrastructure may not come together. Investors should still expect Congress to pass the president’s signature legislative proposal, the American Jobs Plan. Our subjective odds remain 80% with high conviction. The bill’s price tag is still ranging from $1-to-$1.5 trillion in deficit spending this year, or 4.4%-6.7% of GDP – i.e. not a number that financial markets can ignore. A budget resolution is being drafted with a rough headline value of $1.5 trillion. Financial markets are experiencing an inevitable period of doubts over whether the bill will actually pass. In the short run investors should stay invested in infrastructure plays, cyclical equity sectors, and value stocks. However, market dynamics are shifting and there is a basis for upgrading the tech and health sectors. The Senate’s passage of Biden’s infrastructure bill, in whatever form, will mark the peak of US fiscal stimulus for this cycle. Meanwhile our theme of bipartisan structural reform is apparent in the Senate’s passage of the Innovation and Competition Act on June 8 (Chart 1). This bill marks a rare bipartisan achievement in Congress and a sea change in American policymaking. The sea change is the US’s need to revive industrial policy in order to compete with adversaries abroad – a mission that the political establishment supports after being snapped out of its slumber by President Trump’s populist rebellion. In this report we take a look at the domestic consequences of this bill. We leave the international consequences to our sister Geopolitical Strategy service. Chart 1Newsflash: Bipartisan Bill Passes Senate Via Regular Order! We also look at the surprising recovery in Congress’s popular approval rating. While the US remains at “peak polarization” from a historic point of view, there is a cyclical drop in polarization after the quadruple crisis of 2020 (pandemic, recession, social unrest, contested election) (Chart 2). This cyclical drop may well become a secular decline over the coming decade, as fiscal accommodation at home and geopolitical risk abroad will generate domestic policy consensus on the topics of trade, manufacturing, industry, and technology. This trend will support Congress’s approval rating. Chart 2Polarization Subsides From Crisis Peaks While Congress will never be loved, it will not be as hated in the coming decade as the past decade. The reason is that Congress is taking a more active role in the economy. This is positive for markets in the short run but adds policy uncertainty over the long run. The Return Of Industrial Policy The US Innovation and Competition Act (USICA) is the outcome of a crisis in the American political system two decades in the making. The hyper-globalization of the Bill Clinton presidency, combined with the profligate economic and foreign policies of the George W. Bush presidency, led to the Great Recession. While the US was distracted with foreign wars and financial crisis, China emerged as a challenger to the US’s strategic dominance (Russia also revived and undermined US stability). The Obama administration began taking tougher action on China in 2015 but by then it was too late to accomplish much. The sluggish recovery and loss of national status triggered a populist rebellion in the form of the Trump administration, which provoked an even greater backlash from the political establishment in 2020. The Republicans imposed fiscal austerity, took power, then abandoned austerity and declared a trade war on China. The Democrats took back power, abandoned austerity, and are continuing the trade war. Now the two parties agree on the need to increase government support for the economy (infrastructure, industrial policy, protectionism) and to redirect foreign policy to confront major powers like China and Russia (as opposed to wasteful forever wars in the Middle East and South Asia). Public opinion has been coalescing around these twin goals since 2008 and the Biden administration so far can be said to represent a kind of synthesis of the Obama and Trump administrations. Even more powerful is the formation of a new consensus in Congress, which is the “first branch” of the US government and represents popular attitudes. Congress has always been more nationalist and more protectionist in its leanings than the executive and judicial branches, which represent policy elites and technocrats.1 While Congress is fickle when it comes to passing fancies of the day, it can be incredibly stubborn when it comes to a nationwide, once-in-a-generation popular consensus. Moreover China does not present a fleeting challenge like Iraq or Al Qaeda. It is more like the Soviet Union and will motivate a congressional consensus and policy consensus for decades. Great power competition will work against US political polarization. A Productivity Mini-Boom The USICA consists of about $115 billion in federal research and development funding, $52 billion in funding for the US semiconductor industry, and $10 billion for regional tech hubs. Funding will flow to the National Science Foundation, NASA, the Department of Energy, and the Defense Advanced Research Projects Agency (DARPA), among others. There are also specific measures to counter China (including intellectual property protections) as well as a regulatory overhaul to codify “Buy America” provisions and require that materials used in federally funded projects are produced in the United States (Table 1). Table 1US Senate Passes Bipartisan ‘Innovation And Competition Act’ To Counter China In research and development, the USICA formalizes the key technologies that the federal government should focus on and fund. These include: AI, machine learning, and autonomy High performance computing Quantum science and technology Natural and anthropogenic disaster prevention and mitigation Advanced communication technology Biotech, medical tech, genomics, and synthetic biology Data storage and cybersecurity Advanced energy, industrial efficiency, batteries, nuclear energy Advanced material science The $81 billion allocated to the National Science Foundation, covering fiscal 2022-26, will be allocated as shown in Table 2. The Department of Energy will focus on energy-related supply chain issues within the key technological areas of focus. Table 2NSF Gets Additional Dole Private research and development amount to more than twice the R&D spending of the federal government (Chart 3). Higher spending will augment private R&D, rather than substitute for it. It will likely boost US productivity, which has been in the doldrums over the past few years. Chart 3A Boost To R&D Spending While it is speculative to say whether the revival of industrial policy will cause productivity to break out of its long-term structural decline, a mini-boom seems warranted, especially when considering that foreign competition will remain a constant impetus (Chart 4). There is ample pork-barrel spending and plenty of potential for boondoggles, as will always be the case with fiscal spending splurges. But a rise in productivity will have a greater macro impact. Chart 4US Productivity Boom, Or At Least Mini-Boom Another aspect of the bill consists of funding for regional technology hubs. The office of Economic Development Administration will oversee three tech hubs in each region covered by the EDA’s regional office. These must be areas that are not already tech centers. No less than one third of the funding will go to small and rural communities and at least one consortium must be headquartered in a low-population state. The info-tech revolution and de-industrialization have created a problem of regional inequality, which these measures attempt to address. The USICA also funds the incentives for the domestic semiconductor industry first outlined in the national defense appropriations last year. The CHIPS Act, for example, helps incentivize investment in facilities and equipment for computer chip fabrication, assembly, testing, advanced packaging, and R&D. This funding was subject to the availability of appropriations but is now authorized under the USICA to the tune of $52 billion. Substantial breakthroughs in the 1980s-90s, in software and other areas, followed on much smaller public investments in education and research.2 The semiconductor industry is capital-intensive. For every one dollar in sales, 15 cents of capital expenditures are needed, compared to just seven cents in the tech sector as a whole and six cents across companies in the S&P 500 index. The capex requirement for the energy sector grew from six cents in 2004 to 17 cents in 2015, almost tripling in a decade due to the capital intensity of the shale boom (Chart 5). Thus lowering the cost of investment for the semiconductor companies will have a major positive impact. Quarterly capex for the chip makers stands at around $25 billion. An infusion of $52 billion in government incentives over five years amounts to $2.6 billion per quarter or roughly 10% of current capex. Chart 5A Boon For US Semi Capex Finally, the USICA consists of notable “Buy America” or protectionist measures. The bill holds that public works must be produced by American workers and funding should not be used to reward companies that “offshore” their operations, especially to countries that do not share US regulatory standards on workers, workplace safety, and the environment. The USICA gives a big sop to US manufacturing: all manufactured goods purchased with the bill’s funding must be made in the USA or have at least 55% of their total components sourced in the country. All iron and steel manufacturing processes, from melting through coatings, must occur in the United States. Buy America provisions will stir up some quarrels with US allies and trading partners but ultimately the US will need to increase imports as a result of the USICA. Private non-residential investment in the US moves closely with import growth, whereas US government investment has less of a relationship with imports (Chart 6). Chart 6Supply Constraints Amid US Fiscal Stimulus The Buy American provision will put new pressures on a supply chain that is already strained by the pandemic and the Trump administration’s tariffs. Industrial production is at an all-time high and so are producer prices, which means that producers have high pricing power. This is beneficial for the industrial and materials sectors over the medium term, even if the short-term inflation scare proves overdone (Chart 7). Buy American provisions will even improve the pricing power of the machinery sub-sector, as contractors will be forced to buy American-made machinery. The bottom line is that the Biden administration has coopted the Trump administration’s agenda on China, trade, and manufacturing, which itself was an attempt to steal thunder from the Obama administration. However, Biden and the Democrats bring a defensive and domestic-oriented approach rather than an offensive and foreign-oriented approach. Tariffs and investment restrictions will stay on China but they are not being increased or tightened (at least not yet). Instead the emphasis falls on fiscal largesse for US industry and manufacturing as well as research and development, promotion of STEM education (science, technology, education, and mathematics), and semiconductor subsidies. Chart 7Sustained Proactive Fiscal Policy Is Inflationary The goal is to increase the pace of US innovation, notwithstanding the fact that countries will continue to borrow, spy, and steal from each other. The international context of competition – and the widespread resort to debt monetization – will have a positive impact on productivity over the long run. But the protectionist regulations will combine with US supply constraints to put upward pressure on material and industrial prices over the short and medium run. Will Americans Hate Congress Less? A bipartisan industrial agenda in Congress raises the question of whether a bipartisan infrastructure deal can also be achieved. We remain optimistic, though the talks are currently wobbling. Biden’s approval among Democrats is falling as the Democratic caucus abandons his attempt to forge a bipartisan infrastructure deal and presses for a Democrat-only reconciliation bill. However, his overall approval rating is not likely to settle at a lower level than that of Presidents Obama and Trump. His approval rating on handling the economy has probably already hit its floor (Chart 8). He still has the ability to pass a signature piece of legislation, according to our Political Capital Index (Appendix). Chart 8Biden Struggles With Democratic Party Chart 9US Public Approving Of Congress?!? The sharp increase in public approval for Congress is another signal of Biden’s political capital (Chart 9). About 36% of Americans now say they approve of the job Congress is doing while 61% disapprove. This is not very good in absolute terms but relative to Congress’s history it is notable. The sharp uptick is due in large part to the expanded unemployment benefits, stimulus checks, and other social subsidies doled out during the pandemic. A fleeting spike in approval also occurred around the GFC-era stimulus, only to give way to new lows. Yet there is a deeper source. Approval of Congress has risen continually since the bruising debt ceiling standoffs and government shutdowns of 2010-14, when the Obama administration squared off against a Republican Congress in the context of a sluggish economy (Chart 10). With Gallup polling data going back to the 1970s, the big picture is that Americans lost faith in Congress during the stagflationary 1970s, the first Gulf War and recession of the early 1990s, and especially the Iraq/Afghanistan wars and Great Recession. It is now slowly recovering to normally low (rather than abnormally low) levels. Chart 10A Longer View Of Public Attitudes Toward Congress Aside from fleeting rallies around the flag, such as after the September 11, 2001 terrorist attacks, public approval of Congress rarely rises above 50%. The reasons are obvious: Congress is an institution in which power-hungry politicians engage in endless and petty quarrels over the minutiae of public policy in full view of the world. Its job is inherently unpopular.3 But as partisanship and polarization have increased dramatically since the 1980s, Congress has lost effectiveness at its primary function of forging compromises and passing laws. The public differs on what laws should be passed but it generally disapproves of the lack of compromise (Chart 11). A clear uptrend in congressional approval has emerged since the near-recession of 2015. The one overriding change in national policy since that time has been the activation of the fiscal lever. Trump unleashed a bipartisan spending binge as well as tax cuts. COVID-19 encouraged a Trump-Biden spending binge. Now Biden’s measures are adding to this anti-austerity blowout. While voters rewarded Congress for balancing the budget in the 1990s, the Great Recession marked a secular change. Disapproval rose with the process of fiscal tightening from 2010-14 (budget sequestration) and fell as the fiscal deficit has widened since then (Chart 12). Chart 11Public Approves Of Lawmakers Who … Make Laws Chart 12Public Approves Of Spendthrift Congress? Voters do not approve of Congress based on wonky policy views. Their approval, like their approval of the president, tracks with the state of the nation. There is a fairly close correlation between the two approval ratings. A major deviation emerged in 2010-14 when President Obama partially restored public faith in the presidency (albeit with historically low approval ratings) while Congress sank to even lower lows than it witnessed during the Iraq war on the back of Republican obstructionism and Obama’s second-term legislative failures (Chart 13). The current trend is for presidential approval to remain flat at its post-2010 levels while Congress regains some support. Chart 13Approval Of Congress Tracks Approval Of President Congressional infighting will resume after Biden passes the American Jobs Plan. His American Families Plan is much less likely to pass. Opposition Republicans have a subjective 75% chance of retaking the House of Representatives in 2022, which would result in gridlock. However, congressional approval is normalizing from the depths of the disinflationary 2010s to around the 30%-40% range. It will probably continue tracking presidential approval. And history shows that presidential approval ultimately hinges on peace and prosperity as opposed to war, recession, and scandal (Chart 14). This will dictate the direction under the Biden administration and beyond. Chart 14Approval Of President Tracks ‘Peace And Prosperity’ A critical factor is whether polarization will continue to subside. High polarization makes it so that voters identify the passage or failure of government policy exclusively with the ruling party; this incentivizes the opposition to obstruct.4 Lower polarization enables bipartisan deals and thus forces the two parties to share the praise and the blame of new policies. Compromise and lawmaking increase congressional approval; higher congressional approval increases the odds of compromise. The current legislative agenda reveals several areas of emerging consensus, not only on industrial policy and manufacturing but also on anti-trust law and infrastructure (Table 3). Table 3Pending Legislation In Congress Under Biden The Biden administration may only get one or two more major bipartisan legislative accomplishments. Polarization is still at historically elevated levels. In the next two-to-five years polarization could easily re-escalate, given the ongoing power struggle between the two dominant parties and the grievances over the 2020 election. However, over the next five-to-ten years, polarization should settle at levels beneath the record highs witnessed in 2020 due to foreign competition and fiscal accommodation. The USICA shows how this trend could take shape. Investment Takeaways The macro implications of Biden’s political capital and Congress’s rising approval rating consist of trends and themes that we have emphasized before: the return of Big Government; populist monetary and fiscal policy; protectionist industrial policy; nation building at home; and geopolitical struggle abroad. There is no direct market impact of a less unpopular Congress – the implication can be positive or negative depending on the policies, assets, and time frames in question. For example, the congressional effect, in which markets rally while Congress is at recess, is debatable.5 Congress is least active in January, July, August, and December and yet this recess schedule manifestly has no consistent impact on well-known equity market calendar effects (Chart 15). Chart 15Calendar Effects But No Congressional Calendar Effect Markets under congressional gridlock often outperform markets under single-party sweeps but the difference is small and debatable (Chart 16). Markets dislike both effective congresses that pursue market-unfriendly policies and ineffective congresses that would be pursuing market-friendly policies. The pandemic and recession required an effective congress, bipartisan stimulus resulted, and approval has gone up. Sustaining this approval will require avoiding both deflationary and stagflationary environments in the coming years, as well as gratuitous wars and massive scandals. That will be difficult. Chart 16Sweeps Don’t Always Underperform Gridlock Still, a floor in congressional approval has probably been established over the past decade as the US political establishment has rediscovered proactive fiscal policy at home and nationalism abroad. These two key trends create cross-currents for the dollar. The macroeconomic backdrop for the dollar is bearish but the political and geopolitical backdrop is bullish. At present the dollar stands at a critical juncture. Any increase in global policy uncertainty and geopolitical risk abroad should push the dollar up (Chart 17). Given the dollar-bearish BCA House View, we are therefore neutral and will revisit the issue in our upcoming third quarter outlook report. We are adjusting our equity sector risk matrix. Our new US Equity Strategist, Irene Tunkel, argues convincingly that investors should continue favoring cyclicals but also take a more optimistic outlook on the tech and health sectors. We agree on health in particular since the Biden administration’s policy risks have largely been passed up. We are closing our long materials / short tech trade for a loss of 8.2% and our long fiscal advantage / NASDAQ trade for a loss of 1.3%. We will also close our long consumer staples trade for a gain of 6.5%. Chart 17Relative Policy Uncertainty Rising, Greenback On Edge   Matt Gertken Vice President Geopolitical Strategy mattg@bcaresearch.com Jesse Anak Kuri Associate Editor jesse.Kuri@bcaresearch.com   Appendix Table A1USPS Trade Table Table A2Political Risk Matrix Table A3Political Capital Index Table A4APolitical Capital: White House And Congress Table A4BPolitical Capital: Household And Business Sentiment Table A4CPolitical Capital: The Economy And Markets Footnotes 1     See David R. Mayhew, “Is Congress ‘The Broken Branch?,’” Boston University Law Review 89 (2009), 357-69, bu.edu. 2     See Danny Crichton, Chris Miller, and Jordan Schneider, “Labs Over Fabs: How The U.S. Should Invest In The Future Of Semiconductors,” Foreign Policy Research Institute, March 2021, www.fpri.org. 3    See John R. Hibbing and Christopher W. Larimer, “The American Public’s View Of Congress,” Faculty Publications: Political Science 27 (2008), digitalcommons.unl.edu/poliscifacpub/27.  4    See David R. Jones, “Partisan Polarization and the Effect of Congressional Performance Evaluations on Party Brands and American Elections,” Political Research Quarterly 68:4 (2015), 785-801, jstor.org. See also Jones, “Declining Trust In Congress: Effects of Polarization and Consequences for Democracy,” The Forum 13:3 (2015), degruyter.com. 5    Some market participants and researchers have uncovered a “Congressional effect” in which stock market returns are higher on average on days when Congress is on recess than on days when it is in session.   

The media went on a hype spree last month forecasting copper prices to the tune of $20,000t ($9.07/lb) on the back of EV-driven demand and supply shortages. While they will likely be right at some point over the next 10 years, such bullishness reminded us of the Goldman Sachs’ $200/bbl crude oil forecast back in May of 2008, followed by Gazprom’s $250/bbl number in June of 2008. By February 2009 crude was trading at $30/bbl. Given this anecdotal evidence and our view about the Chinese economic slowdown, on June 1 we recommended investors to buy crude at the expense of copper (proxied by long S&P oil & gas exploration & production / short S&P metals & mining indexes) as a way to capitalize on the DM/China growth differential. Since then, at the time of writing, the crude/copper ratio is up 17%, while our sector-level proxy is up 18.5%. Bottom Line: We reiterate our long S&P oil & gas exploration & production / short S&P metals & mining market neutral trade. For the full rationale behind this trade, please refer to the following Special Report.  

Overweight (High-Conviction) We remain overweight the S&P real estate index both in our cyclical and high-conviction universes, and both positions are currently up 7% since inception. While our initial rationale for putting the trade on was the flip in the correlation between this relative share price ratio and the 10-year US Treasury yield from negative to positive, now there are new catalysts that underpin this GICS1 sector. First, real assets have historically been a good inflation hedge making the S&P real estate index a popular addition to one’s portfolio in the current inflationary regime. Second, given that the market expects some turbulence thanks to the global growth slowdown, investors are adding real estate holdings as a defensive play (Chart 2). Finally, Chart 1 bottom panel shows that the supply-side of the equation is constrained as US commercial construction spending has been lagging. The implication is that in relative terms, the supply of commercial REITs has been contracting, pushing prices higher (relative construction spending shown inverted).  Tack on the anecdotes that empty offices are converted into apartment buildings, and empty malls into e-commerce fulfillment centers, and there is plenty of room for growth and improvement in the industry. Bottom Line: We reiterate our cyclical and high-conviction S&P real estate overweight calls. Chart 1 Chart 2