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Best Contrarian Trades David Hauner, CFA Ezequiel Aguirre MLI (UK) MLPF&S david.hauner@baml.com ezequiel.aguirre@baml.com Mark Cabana, CFA Rohit Garg MLPF&S Merrill Lynch (Singapore) mark.cabana@baml.com r.garg@baml.com Kamal Sharma MLI (UK) ksharma32 @baml.com What if populism is too popular? ¢ G10: Short inflation/long duration through US 3-year 0% US inflation floors as stimulus may falter. Short EUR/GBP as “sending the letter” may be the low point. ¢ EM: Short JPY/KRW, short BRL/MXN as US policies may hurt EM less than feared. Long Turkey Eurobonds as sentiment may improve by the referendum in spring. “Long populism” becoming consensus While we received a lot of pushback for pointing out the risks ahead of the US elections, now “long populism” is quickly becoming consensus. The naysayers may argue that the establishment could reassert itself: conservatives may constrain fiscal stimulus and protectionism, and central bankers may stay dovish (remember the ECB too). We suggest five trade ideas: 1) short inflation/long duration; 2} short EUR/GBP; 3) short JPY/KRW; 4) short BRL/MXN; and 5) long Turkey sovereign where populism may calm. Populism is getting popular 5y5y US inflation swaps have spiked 60bp since summer to about 2.5% — the biggest move since 2009. As a consequence, EM has sold off sharply. Our pre-election sentiment surveys partly explain the violence of the moves since 8 November: investors were long EM bonds and equities and neutral duration in the US (Chart 40). The latest CFTC data show a similar picture, with short GBP and long BRL, Crude, RUB and even MXN most extreme vs history; note also a short in US Treasuries. Purely statistically speaking, the shorts in GBP and US Treasuries are most vulnerable to a near-term reversal — though momentum may prevail for a while in Treasuries (Chart 41). When the dust settles, the contrarian may find opportunities in “short populism” trades. Chart 40: Our pre-election surveys show investors bearish GBP, duration Chart 41: CFTC data show positioning is very short GBP Cash y 10yUS EM Duration 65% T y USD FX reasury EM equities Notes Commod 60% rs JPY FX GBP JPY Duration BRL EUR FX 559, ¢ USD Duration 9 | @ RUB US equities @ Crude oil Japan equities Eurozone equities 50% ® JPY Bonds Equities EM FX 9 GBP Duration 45% UK equities EUR Duration GBP FX 40% 4 4 2 4 { 2 = 0 { 2 3 ss Note: positioning score relative to history. Source: BofA Merrill Lynch Global Research Note: x-axis: ly z-score of net long spec positioning as of November 8; y-axis: probability of a price reversal in the week after. Source: BofA Merrill Lynch Global Research, Bloomberg, CFTC BankofAmerica <2” 22 Global Rates, FX & EM 2017 Year Ahead | 16 November 2016 Merrill Lynch HOUSE_OVERSIGHT_014752