“CHIEF INVESTMENT OFFICE Capital Market Outlook “Thecpinian ae those ofthe authors andsubjet to charge, IN THIS ISSUE + Macro Strategy—Recent volatility in the money market shows the Federal Reserve's (Feds) provision of reserves has been insufficient. As the Fed reverses its quantitative tightening program and begins to provide more liquidity to the glabal financial markets, we believe economic data should continue to improve, making a US. recession increasingly less likely. Global Market View—Looser fiscal policy may help improve glum investor sentiment Yet it treats the symptoms of slowing global growth, nat the root causes: uncertainty ‘over the future rules of international trade and politica risk in the European Union (EU), among other matters. + Thought of the Week—Some short-term rates rose significantly last week for very technical reasons. While the move was a surprise, we do not think it portends any systemic stress, and think the Fed is able to address it. + Portfolio Considerations—We believe eqiities remain more attractive than fixed income despite the long list of concerns from a macro and geopolitical perspective. Therefore, we remain overweight equities with a preference for US. large-capitalization stocks relative to the rest of the world, Investors should consider ‘searching for appropriate yield in equities in the months ahead the further yields head lower in Fixed income. MACRO STRATEGY Just in Time Chief Investment Office Macro Strategy Team [As we expected, the Citi US. Economic Surprise Index has consistently increased (Gahibit 1), helping alleviate fears of recession, as reflected in the ise in 10-year Treasury note yields since early September. Better-than-expected incoming data support our view that US. economic conditions are improving as a result of the Fed's gradual pivot away from an overly restrictive policy stance this year, and that 2 recession is likely to be avoided if Fed policy remains accommodative enough to restore the yield curve to ’ positive spread between long-term and short-term rates. Merlyn Pee, eaner&Sit ncarpated alo refered as "MLPFAS‘or ‘Meri res wile cea Irvestrent press sponsored managed dbued pode by caroarcs tht aise of nko erin Ccrprotan Boi ap) MLPFAS a repsered broker dels repsteredinvestrt ads Member SPCarda holy ced subsidary of BI Com. Invest pau: Are Not FICInsured “Ae Mot Bok Guaranteed May Lose Vale Ficase se back page for inportantdscosure Information. |ARMLHLPY 912019 MERRILL (oS [ABANK OF AMERICA COMPANY September 23, 2019 MACRO STRATEGY Chief Investment Office Macro Strategy Team GLOBAL MARKET VIEW Rodrigo C. Serrano, CFA® Director and Senior Investment Strategist Kirsten Cabacungan Investment Analyst ‘THOUGHT OF THE WEEK Matthew Diczok Managing Director and ClO Fed Income Strategist Dstaas of 9232018 subject changeExhibit 1: Easier monetary policy stimulating stronger economic data. ‘ai fconomi Surprise Index Urited States fae 10 Thea Pe 0 Bre the ear ie Fed Stirling ‘he fearon FES EEozEs os 22 83 38 FEF ELE LE KEI PEPE CIR E Source lorberg. Monthly datas f September 18, 209, Past performance ino guarantee of future results. ererane wou feria fleet tire period wes dpe Short perfance Shoat ute are ecant wend ‘While slow, we believe the first steps in the right direction have been made, with financial markets increasingly acknowledging the progress in staving off a recession and the September 18 Fed rate cut Further boosting the likelihood of a favorable outcome. Positive ‘economic signals in this direction include: the increase in the yield curve spread closer to positive territory; the August surge in retail sales on the heels of a whopping July increase: strengthening mortgage applications for home purchases; the homebuilders’ sentiment index reaching a new high; consumer and smal-business confidence remaining elevated: surging homebuilding permits; and a bigger-than-expected jump in housing stats. In addition, the National Federation of Independent Business survey continues to show an elevated proportion of businesses unable to fll available job openings, an elevated share of businesses reporting that now is a good time to expand, and rising earnings. \While the August Institute for Supply Management ((SM) manufacturing index was dismal, with dropping new orders, employment and production subcomponents into conivaction teritory, actual manufacturing output rose solidly in August. This boosted its 3-month annualized growth rate to 2.7%, the strongest since December and sharply better than the 5.5% 3-month drop through April. The strong production advance was equally driven by durables, including business equipment, and nondurable goods and supports our view that the U.S. manufacturing recession is ending, with industrial production likely up about 1.5% to 2.0% year over year by the end of 2019, Hurt by structural changes in the Chinese economy and a botched implementation of tight ‘motor-vehicle emission standards in Germany, China and India, the global industrial cycle appears likely to take longer to bottom, but we believe that the US. uptumn should help it start healing by early 2020 as well, in our opinion ‘The big increase in the US. ISM services index back into stronger growth territory in August following two months of large declines also corroborates our view that the economy still has a chance to avoid recession in spite of the yield-curve inversion, which ‘tended to precede recessions in the past. Importantly, the gain was broad-based across industries and led by a surge in new orders to the highest level since February, io doubt contributing to the upturn in the 10-year Treasury note yield from its early-September near-record low. Indeed, in all manufacturing downturns outside of recessions, service- ‘sector purchasing managers’ surveys (PMs) remained relatively strong compared to the ‘manufacturing counterpart (Le, service PMl fall less. and more gradually. as has been the case this year) The pronounced current divergence between the downturn in the rmenufacturing PMs and the much more muted siowing in service PMs in both the US. and the Eurozone reflects the wide gap between a healthy consumer sector, as reflected in strong retal sales growth, and weak manufacturing conditions 2.0f 9. September 23,2019 ~ Capita! Maret OutlookBecause the retall sales cycle tends to drive manufacturing cycles (rather than the other way around), healthy consumer spending growth helps service PMls hold up better, keeping the manufacturing cycle downturn from ending in an economy-wide recession. Current divergence between retail sles/ISM services strength and weak ISM manufacturing readings, along with Fed and other central banks’ easing and stabilizing leading indicators of global growth, suggest that US. and Euro area manufacturing PMs should also stabilize and start moving up in 2020. Ie remains to be seen how much more the Fed wil cut rates, If at al to prevent falling persistently shor of its 2% “core” Personal Consumption Expenditures (PCE) inflation target ahead. Importantly, better-than-expected current inflation readings are the result of past economic strength and a softening dollar. We believe that those past trends. will ikely contirue to boost inflation through the end of 2019, with “core” consumer price index (CP) inflation likely to hover around current 2.4% levels, the strongest in this expansion. As it typically tracks the “core” CP inflation trend, “core” PCE inflation is also likely to continue to rebound from its weak 1.46% year-over-year low in May. Since inflation peaked in July 2018, “core” PCE inflation dropped more than "core" CPI inflation, which also rebounded faster ths year. causing a big gap to open betwen the two measures, Based on past pattems, our research suggests that ths gap is poised to narrow over the next year. With “core” CP inflation likely fading in 2020 ina lagged response to this year’s manufacturing slowdown, weakening pricing power, increased uncertainty and dollar strength (which keeps downward pressure on import prices) a brief convergence of the two inflaton measures around 286s likely around mid-2020. This suggests that “core” PCE inflation i key to stay in a 1.5% to 2% range over the next year. However, because inflation isa lagging indicator, the outlook beyond that depends on Fed policy and Future economic conditions. As things curently stand, the inflation trend remains sft in our view and is likly to fll shore of sustaining a 2% pace as 2020 progresses absent a meaningful rebound in US. and global growth, an easier Fed policy, and steeper yield curve. In addition to rate cuts that should eventually normalize the yield curve, we believe the Fed needs to start increasing its balance sheet, which has shrunk dramatically over the past two years, causing a widespread slowing in global economic activity. Recent disruptions in the money market show an inadequate supply of bank reserves, Faster rmoney-supply growth will require a resumption of growth in the monetary base. The Fed Chairman reluctantly acknowledged as much at his September 18, press conference, where he suggested “organic” growth in the balance sheet is likely to resume soon. This would remove the last impediment to more positive global economic momentum, GLOBAL MARKET VIEW Fiscal to the Rescue? Rodrigo C. Serrano, CFA® Director and Senior Investment Strategist Kirsten Cabacungan, Investment Analyst Let's begin with the backdrop: The extent of the global economic slowdown. especially cutside the US. has surprised most expectations. According to Bloomberg, since the start of the year through Septemiber 20, the consensus 2079 forecast for global teal gross domestic product (GDP) has declined by 0.3%, or 30 basis points, to 32%. ‘Addressing rising worries, the Fed has backpedalled an tightening monetary policy, cutting the range of its benchmark interest rate by 0.25% twice this year to 1.759% to 2.008%. Meanwhile, the European Central Bank (ECB) has cut its deposit rate forthe frst time since March 2016, 1 -0.50%, while restarting its quantitative easing program, Emerging market central banks, observing cues of these shifts, have cut their policy interest rates in August by the most in a decade. * own down they x Emeringcental banks ever maste sina decade—Reutrs(Septenber 2.2018). Chartered Franc nays and Ca® ae registered waders owned by lst, ol September 23,2019 ~ Capital Market OutlookYet, according to the latest Fund Manager Survey, ‘monetary policy Impotence” Is now the second highest tall sk cited by institutional investors, while fiscal policy is seen as the most restrictive since December 2016? This consensus suggests that the onus is increasingly on governments to take advantage of low financing costs and respond with {greater fiscal measures. These would emulate more expansive measures in the U.S. which have historically allowed for greater productivity and resent economic growth, More countries in Asia are cautiously heeding these calls, as low government debt and greater savings rates, denoted by the regions current account surplus, provide a greater latitude 10 respond (Exhibit 2). Together with preliminary discussions in the EU to review the bloc’s strict budgetary rules, expectations for loosened fiscal policy may rise further. In our view, greater measures out of China and Germany would provide the most impact globally |s fiscal stimulus coming to the rescue? Thus far, the current measured approach remains insufficient in decisively turing the tide for the global economy and suggests that there are constraints, ranging from worries over deteriorating budgetary dynamics 10 legal restrictions, in our opinion. Meanwhile, lacking investor enthuslasm may be attributable to the observance of high hurdles for a conclusive shift. Be that as It may, the trend favoring looser fiscal policy may help improve glum investor sentiment, particulary if relations between the US. and China stabilize. Exhibit 2: For emerging markets, current account surpluses and low government debt burdens provide scope for fiscal stimulus. Th GirerccountBce Genel Gover Goss De (5) " pennant 1 eannannannan “ 2 % ao a 5 ge 2 gs = 8 Ba 8 1 2 a 0 2 » “ 3 fal ogee Ch LY A & Sources: Det stck—Inerrationl Monetary Fund Fiscal Manito year data asf 2018 Curent acount balance Wold Bark Word ceramic Outlook yearly eats a of 2018 stared tig for 2017: Bomibergas of Seatember 208 1 Emerging Nake and Dereleped Market Asia has been responding... An escalating trade war with the US, leading to a slowdown in trade, and weak economic performance have prompted Chinese authorities to unvell both monetary and fiscal stimulus this year. Alongside three cuts in the required reserve ratio, a rollout of tax cuts for businesses and households plus an increase in the quota for “special bonds,” hich are used by local governments primarily for infrastructure spending, amount to ‘an increase of roughly $400 bilion, or almost 3% of China's 2018 nominal GDP'S® The State Council—China’s cabinet—approved front loading the quota for 2020 Into the last three months of this year, according to Nikkei Asian Review. Cob Fur Managers Survej—Bonkof America Meri Lynch Global esearch (Septebe: 2019), EU begins rethinking fiscal lesa economy sows Revers (Seperbe 11,2019) China astensbond ses to fuel ifastrotre utp-Nhke An Review [September 12,201). hia Lomas Growth xget od Cuts Taxes. Eanomy Saws~Beaomberg (March 42019), ‘vera annua exchange rat trough September 10 wes fora to US. lurconeson of? wien yuan txcut {-§290 bitin) and 2019 special ond suance quota (+8310 bio) Average anus exchange at fr 2018 sed for ‘cameron of 2018 spe bond ssuace qt (S200 bile) 44.09 September 23, 2019 ~ Capital Maret OutlookHowever officials are tom between further boosting near-term econo) growth at the expense of reducing the large imbalances hampering the financial system’ Cutting the capers engaging in fiscal stimulus to support the property martes oy fuel speculation wile potential exacerbating an upward wend inflation, Another {uel spec reing fom cash-starved local governments which may be eT to thing proceeds earmarked for infrastructure spending to hip ec general expenditure, seceding to some analysts. Despite announced stimulus, downgraded private sector eee vacations suggest a sing rik that Chinese GDP growth m2y fall below 6.0% in 2020. Inadaton to Inia announcing corporate tax cuts, South Korea and Indonesia Mave tty interest rates and have announced recrd spending in thelr 2099 budgets, raising overnment spending by 8% ard 9% YoY respectively in efforts fo boost alternative row divers Yet, fexeral headwinds prove enduring use of isa) stimulus to Foo acne may rage concerns onthe suboptimal use of resources, especialy i ceric weakeess seps tax revenues mare than expected and promised reforms af@ cee afficlentiy Implemented! For trade-dependent Korea, which aso suffers from Torsening tensions with Japan. Is fiscal positon is also poised to come under long ire pressure, due to increased spending for Is aging population. Fr Indonesia Bor Merl Lynch Global Research cautions that revenue projections are optimistic. Similar to India, Indonesia has both fiscal and current account deficits, known as twin deficits Feducing fiscal leeway. Other countries, such as Thailand, have unveiled one-off stimulus programs. If an extensive fscal response were necessary the country could see greater Folia isk in responding. Its government is camposed ofa coalition of 19 political partes, which together hold a slim majority in Parliament (254-246). while debate has begun in Europe. With policy interest rates in negative teritory and rising worry on the fallout to the regior's financial sector, the president-elect of the ECB, Christine Lagarde, 's calling for 2 stronger fiscal response from able governments.° Some argue that with Commitment by the ECB to keep interest rates low over the medium term, governments Could refinance their debt stocks and whittle down their interest costs over time. Gaveksl Research estimates that in aggregate interest cost savings amount to 1.84% ‘of eurozone GDP. For Italy, the savings could be as high as 36% of its GDP. Freed up resources from these policies could be invested in productivity-enhancing efforts. In Germany, the Economist notes that 119 of the country’s bridges are in poor condition, while Its railway system suffers from widespread delays. The country’s internet could 'lso use an upgrade." In a sign that policymakers are starting to listen, German Finance Minister Olaf Scholz has elected Sarah Ryglewski,a critic of the balanced budget policy, as his deputy for parliamentary affairs.” Ongoing negotiations on a climate package ‘may provide optimism for a more significant policy shift” Meanwihile, the Netherlands ‘announced a shift toward more simulative policy in their 2020 budget! However, as Gavekal notes, despite Germany's sou-searching, approving a breach ofthe fisca-dficit cling, contained in the countrys “schwarze Null or “black zero" policy is patty fic wo eqae 3 5 mj ne ve Fast. the Bundestag, {8 deeper contraction than a normal cyclical downturn, plus a plan on repaying the new Sent Seating lw enrely wo reqae amending te contusion resuinge¥2- ‘thirds majorities in te lower and upper house, the Bundesrat. In the Netherlands, despite Reng bight pieces ast 72019, + honors Suen nse Noting Lose~Boobr Oy 2.20 + eSouh Rla ons hie se-Frare Tes apt 27.208 "agen pan peters ictal stefan Tes epee 2019) ens Genta Ter Sea er Seon a 29) "nace Minste Sehol apo cit of German bance budget poly a5 aera y'sbance budget pay a en deputy: sources Reuters exc Gemany ees ical Usum ith new bt nance cate pln—Reutr iH une cnat an—Reves (August 2019), uth Brest Debt Citing Habit With an or Ivesrent FundBlorbergSepterbe 17,2019) 5.09. September 23,2018 ~ Capital Market OutlookJooser fiscal policy, the government is still set to run a fiscal surplus, only less so, while it ‘will take time to set up its Investment fund. In the EU more broadly a protracted debate may risk an implementation lag, a worrying prospect if the ongoing economic weakness becomes more acute, Conclusion An easy Fed, together with market-fiendly regulatory end fiscal policies, has contributed to resilient economic growth in the US. thus fa. With growth and productivity lagging internationally, investors are calling for greater fiscal stimulus to improve the outlook Greater use of these policies directed toward investment in new technologies, such as 56, atfcial intelligence, fer optics and green energy itiatives, could ultimately raise sagging potential growth rates globally, especially in markets lke China and Europe, in cour view. However, in addition to potentially aggravating existing economic imbalances, executing fiscal initiatives presents a host of challenges. From legislating to shovels n hand, debates may become prolonged as legal frameworks are adjusted, Potential supply shocks (Brexit, oll, swine flu) could complicate matters If inflationary side effects were to become prolonged, Among other constraints, some countries, such as India and Indonesia face twin deficits. Continued growth in their debt stock may need to be paired with measures to entice investors, such as structural reforms, or risk higher interest rates, which may weigh (crowd out) on private sector borrowing (Exhibit 3). While fiscal measures provide support, fundamentally, a major restraint on growth les in prevailing uncertainty regarding the future rules of global trade, among other matters, such politcal risk in the EU, In our view, fiscal stimulus treats the symptoms of slowing global growth but doesn't address these root causes. Exhibit 3: Funding is cheap for countries without twin deficits, but less so for others with twin deficits —turewore han —s tia To —nearesa 2 0 z° Z Bs o4 2 ° 2 891 BBH ong aon one ans GaNe a7 20H Sources: lamba Oe ivestnetOfie Data of September 20,2012 6 of September 23,2019 - Capital Market OutlookTHOUGHT OF THE WEEK The Life of a “Repo” Man is Always Intense Matthew Diczok, Managing Director and CIO Fixed Income Strategist Short-term rates spiked last week, concerning markets and creating headlines. While ‘we are carefully monitoring, we think this is a technical phenomenon not indicative of systemic stress, and the Fed should be able to address it Many participants finance U.S. Treasury holdings through repurchase (‘reno’) transactions “These are effectively secured borrowings where US. Treasurys are the collateral Two events last week substantially reduced short-term liquidity in the repo market. First, the US. Treasury sold a large amount of Treasury securities, This has the immediate effect of draining reserves from the banking syster. Primary dealers buy securities at Treasury auctions by using their reserves atthe Fed, increasing Treasury supply while decreasing. reserves. (Quantitative easing works exactly in reverse—the Fed remaves securities from the market by injecting bank reserves) Secondly, corporations made ~$100bn in tax payments. This also reduces liquidity; banks use reserves to make these tax payments to the Treasury Reserves leaving the system combined with more USS. Treasurys in the market increased the supply of collateral while simultaneously decreasing demand (as there Is now less cash availabe to invest in rep0's). This increased repo rates to 10%, While optically @ huge number, itis just @ one-day rate that has been annualized, A 10% annual rate is less than 3 basis points (03%) overnight. Credit markets largely ignored this short-term rate spike, evidence that this is not indicative of systemic stress. The overall credit market and financial spreads were unchanged. ‘The Fed is addressing this by engaging in open market operations—essertially temporarily buying securities from the market by re-injecting reserves, Before the crisis, tis type of operation was fairly routine, Longer-term, the Fed can address it by either a standing repo facility, or by increasing bank reserves by starting to repurchase Treasurys reguiarly from the market again, or both. While this may complicate the communication message—as the market may confuse this with quantitative easing— we believe the Fed has the tools and experience to manage the overall liquidity in the market and should be able to navigate through this. 709. September 23,2019 ~ Capital Market OutlookMARKETS IN REVIEW Equities Fixed Income! Toa Ratan USD Ton Re UST Gre WD wD Cit wo om WoO" 102176 “Capote Gomme 271 13, asoaa erizey anny aoN 72a Aedes 495 "06009708 Sep 200 [suo MencoSmemoAemeseL ieee Teese yor ‘S&P 400 Mid Cap y94ae4 09 35 184 US. Investment Grade Credit 2.33) os) Jog fase 200 10774168 iat! 28 a8 Scie ansrss gal) aaa) Me Sy mS wsceare tous teas eS Hcl ene sar 7 Ting nen 39 go Curent WaekEndMorthénd Yer ted 30D Yad a a; S&P 500 Sector Returns aes ald 1 io" 7150 28) = Totes et 12190150268 ee 3 ea ald Zig aa yas tre Commodities & Currencies Conse Sines Toa Reo UST (ents Commodiies Corel WI MID YTD ‘ses Boone connodiy Communes wWiicude Sere? naan ald Sut One? ets i coramerbsoenay cunt isonrr ais Sas voc 72708 car Source: lorere Fase otal Return rom the period of 9716/9 99/20/19 Blomberg Bada des! Spe price tums? Aldataas of he 920719 cose Past performance so guarantee of future resus, Asset Class Weightings (as of 8/7/19) Vase earat. OF, ie eee ts ee ssc OPN ee aaa eee Ss anes ear SS seis ee mle * Many produ at purse Aerratveestment sates pccaly Pate qty an Hedge Funes ate vase ot pre ued cats 8.019 September 23,019 ~ Capital Marke Outlook Economic and Market Forecasts (as of 9/20/19) QU2019A @220T9A 2019 QERUTIE 2OTEA_7OISE Toad = ee Rae aE CPI inflation (% yiy) 16 18 W 18 _ 7 i ed EIU ‘Unemployrnent rate (96) "39 36 37 7 39, a7 [rid ol 7 al aug aa an) ‘10-year Treasury. end period (6) 2a 201 135 125268 125 S40 50 epee ala Aa ao | seen Sond > a ems tes eis cat eel nal ian Tas toot] US. dollar/japanese yen, end period = 117 08 10) no 101 Oil (S/barrel, avg. of period, WTI") 5S oo 55. 5 56 “he recast nthe ale sbove the baz new rm BAM. Gl Resch team The ltl Weath Invertmen sagen WN sin Steg Cameras (SC) ray mae aust ths ew oe the ‘usec! he yearend express iselcomsieo hese rest. Past performance sno guarantee of fate results, There canbe me assurance that the Forecasts wil be hieved. Economic or Finacial forecast ar Inherently Waited and should not be relied ona Indicators future investment performance ‘A=Acal E=Cstmst, SEP S00 represent vale estimate for 2019, “West Tras Intemediate ‘Sources ofA Meni lynch ltl Research; GNM SCs of September 20,2018, otk Meri ncn ltl Research ies produced by BoA Sects Inc. BtA ander one or ‘mor of ates, Bol fa registered brctr dealer Meer SPC ard whol onned bs of Eankef merce Coporstn,Index Definitions cenemtuor oo : secarhlesindexes assume reimasinent of a isto an terest payee Indexes 37 wnmanaee and do net take sup 500 gota ack te stock of 00 seckmaets perfomance eporing estrous ef bee hs of $00 gE sans performance by reporting sks ene reek met nxt ck the r eens FS mae toe Pa ee nage ee a ved. nthly survey of membe setrgng tothe Natana Asacatin of Hare les MAKE aes dena rey ey ent rst a acl apd Leon ect ogeton esi eS p US compares represnts tes xe sector companies esol i ta sree acta ee enn “They are defined as weighted NStOrl standard deviations yes of ona the ndexis designed to m0 oyhouscolis. Important Disclosures ‘nema pny hecho 09 nsec tinier Teves peta esl 0 aA eat ‘oma ey reno pd eer mes ansible sug ifr ae ce pa pera tee oe ot bea Bek Po arf ame Cpe The ieee fe wih pes lnesiert ings ie rile co out sor Gl ares pa! erst Salts np (56) of HM Ta ee lea rag Norv: progam seine ndaspanstc inp donot espa LS Seis nent eco pterropnnoeeranse hee ears ed yor anal bay © murat rnin rcs arent itedard shud etersedon sins arenes peo. tsrxpstletotwes dey nan soe eae en ce coc ancgngardatacng det erie apr rect estsin enigma lar cot avg ives otal eset a nn a eo naa ae yu wings contr putas dag peach pc lees Past pufrmances ne grt offre eh tmnt atone erin, sa dra ho gf mesenger ik Senet te smc withequy science he pss hat teva fhe toc s iy scsi heposstity athe le of te tks my facta respons eet pea Scanmnnh reece alow Soman SS RS wenn tec SC ee ee root ty sem one pial eonanic abeGolopnert ese as ogi estan 80 6 MITE ae er cx moy ae ester oat esr 8 ere S eer are © 701seanktbrercaCopaton A eve 49019. September 22,2019 - Capa Market Outlaok