FinLight Research - Market Perspectives - Nov 2013

Market PerspectivesNov 2013

October 31st, 2013

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MACRO VIEW

� The Good� U.S. industrial production recorded its largest increase in seven months in September as utilities

output surged after several months of declines, but manufacturing showed signs of cooling.� After record-setting earnings in the first two quarters of 2013, the S&P 500 is on track to hit another

historic high in profits for 3Q13� ISM manufacturing was very strong, the best release in over two years.� China's PMI is stronger and compatible with a growth rate of 7.5%. The private HSBC/Markit PMI is

lower but still shows the same pattern.� Bloomberg's index of financial conditions reached a new all-time high � Case-Shiller home prices increased 12.8%, beating expectations. The latest Case-Shiller Index data

is continuing to demonstrate significant resiliency compared to past years

� The Bad� U.S. economy isn't falling off a cliff, but it also doesn't appear to be accelerating

� US employment releases continue to raise concerns about the health of the U.S. economy. The labor market is stuck in slow growth mode All figures indicate that the U.S. labor market continues to have difficulty creating new jobs

� Other measures of economic activity - such as orders for durable goods and a sales forecast cut from construction equipment company Caterpillar (CAT) - pointed toward slow growth as well.

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MACRO VIEW

� Consumer confidence is terrible. The major decline in the October confidence level is probably attributable to the government shutdown and press focus on the congressional debt-ceiling showdown

� The year-over-year change in retail spending dipped last month to a rate that’s close to the slowest pace in three years.

� Earnings guidance has been weak according to Factset� Contracts to purchase previously owned U.S. homes fell by the most in more than three years in

September, probably due to higher mortgage rates and a softer economy.

� The Ugly� Surprisingly nothing obvious… except the QE "infinity syndrome" that makes the Fed's ultimate

mission of turning off the tap without causing much asset price damage very difficult.


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Industrial Production

� Industrial production increased 0.6% in September vs. August, the best monthly comparison since February

� The upside surprise was, however, due mostly to factors other than manufacturing, which rose a sluggish 0.1% last month. Much of the increase was attributable to a curious 4.4% surge in utilities.

� US Industrial production's 12-month trend turned higher with output expanding 3.2% last month vs. a year earlier

� Is the mismatch between IP and manufacturing ( a cyclically sensitive sector) simply due to the budget crisis? Or is that an advanced sign of troubles ahead?

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Employment

� US employment releases continue to raise concerns about the health of the U.S. economy

� Private-sector employment increased by a net 126,000 jobs last month on a seasonally adjusted basis: very close to the slowest pace this year.

� The annual trend is stable around 2% yoy.

� Unemployment Claims came in at 340 000� The U.S. unemployment rate dipped to 7.2%, a

five-year low, but this does not point to increased employment, as the participation rate remained at 63.8%, its lowest level since 1978.

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Retail Sales

� Retail sales report for the month of September came in weaker than expected, dragged down primarily by weakness in the sales of Autos.

� The headline reading for September declined 0.1% month/month compared to expectations of no change. Ex Autos, the September report was inline with expectations.

� Nominal 'discretionary' retail sales including home furnishings, home garden and building materials, consumer electronics and department store sales also declined 0.1% from August, but still increased 2.1% above the level seen in September 2012

� Adjusted for inflation, 'real' discretionary retail sales declined 0.1% on the month and increased 1.05% since September 2012.

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Retail Sales

� The September release appears as the latest in a string of deteriorating monthly updates � The YoY change came in at 3.2% but seems slipping dangerously close to the lowest level since 2010

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Retail Sales

� The overall YoY trend for both headline and core (Ex-Auto) has been weakening since mid-2011.

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Big Four Indicators

� The overall picture of the US economy remains one of a ploddingly slow recovery from the Great Recession

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Durable Goods Orders

� U.S. releases were a big disappointment, as Core Durable Goods Orders posted its third consecutive decline

� Core Durable Goods Orders dropped -0.1%, well below the estimate of a 0.6% gain. This was the third straight decline for the indicator. Durable Goods Orders looked much better, posting a strong gain of 3.7%.

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ISM Manufacturing Index

� The ISM manufacturing index (PMI) suggests manufacturing expanded at a faster pace in October. The PMI was at 56.4% in October, up from 56.2% in September and above expectations of 55.0%. The employment index was at 53.2%, down from 55.4%, and the new orders index was at 60.6%, up from 60.5% in September.

� It is worthwhile noting that ISM Manufacturing represents less than 10% of USA employment, and approximately 20% of the business economy. The ISM non-manufacturing index was down.

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Euro PMI

� Euro PMIs were weak across the board. PMI numbers of Germany, France and the eurozone were below their estimates

� All, except French Flash Manufacturing PMI remained above the 50 level� French PMI has been below the 50 level since January 2012, indicating ongoing contraction in the French

manufacturing sector

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China’s PMI

� The data shows that manufacturing activity is expanding. China’s official manufacturing Purchasing Managers Index (PMI) rose to an 18-month high in October, to 51.4 (51.1 in September)

� Details show that the headline increase was led by stronger output, but new orders and new export orders both pulled back in October, suggesting slower demand growth in the coming months

� The private index from HSBC/Markit which gives more weight to small businesses climbed to 50.9 from 50.2

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Consumer Confidence

� The Latest Conference Board ConsumerConfidence Index was based on datacollected through October 17. The 71.2reading was 9.0 below the September 80.2.The index is at its lowest level since April.

� The government shutdown is probably thekey driver in the plunge.

� Consumers' expectations decreasedsharply in October. Those expectingbusiness conditions to worsen increased to17.5 % from 10.3%.

� Consumers' outlook for the labor marketwas also more pessimistic. Thoseanticipating fewer jobs increased to 22.7%from 19.1%.

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Consumer Confidence

� The small business sentiment (as read in the National Federation of Independent Business Small Business Optimism Index) seems to track very closely the consumer confidence

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Consumer Confidence

� A similar mood was observed on the Michigan Consumer Sentiment Index

� UoM Consumer Sentiment dropped from 77.5 to 73.2 points, its weakest showing in 2013. The estimate stood at 78.2 points.

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Financial Conditions

� Bloomberg's index of financial conditions reached a new all-time high. According to Scott Granis Blog, “Swap, muni, agency and credit spreads are generally low, liquidity conditions are excellent, the yield curve is positively sloped, implied equity index volatility is relatively low, and yields on Treasuries and corporate bonds are relatively low”.

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GS - GLI

� The October Final GLI places theglobal industrial cycle in theexpansion phase, characterized bypositive and increasing Momentum,but not so far from the slowdownphase...

� 7 of the 10 underlying componentsimproved in October


EQUITY

� This is No Time to be Asleep at Wheel. It seems that investors are once again, exceedingly confident that stocks are the only place to be for now.

� An extreme bullish consensus is forming now, in an obvious contradiction with the famous “everybody hates this market”

� Future earnings growth through margin expansion seems unlikely, as an improving labor market and higher interest rates will most likely squeeze margins. However, stable revenue growth, share buybacks and the additional use of debt financing should support modest earnings gains in the year ahead

� Bottom line:

� We bet on a limited correction. we're set up for a test of 1700 and 1650 on the S&P 500

� We continue to like Europe and EM which we overweight vs. the US and Japan.

� We prefer more defensive high-yielding stocks and focus on investing in the pockets of strength in the market. We like the technology sector. Tech companies remain reasonably priced. We dislike financials

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Earnings

� With nearly half the companies in the S&P 500 Index reporting results, 75% beat earnings expectations. That’s above the average for the last four quarters of 70% and the average for the last four years of 73%, according to FactSet.

� Here’s the rub, though … the rate at which companies are beating expectations is hardly impressive.

� Earnings came in a mere 0.8% above expectations. That compares to an average surprise of 3.7% over the last four quarters and 6.5% over the last four years.

� So far this quarter, actual earnings are on track to increase 2.3% in the third quarter. Yet third-quarter sales are only on pace to grow 2%.

� Most top-down market forecasters approached Q3 13 expecting flat to no growth year over year in earnings from continuing operations. Even the bottom-up compilation of analyst estimates - usually a more bullish number, based on analysts' too-comfy relationships with CFOs - indicated flat to no annual EPS growth in Q3 13.

� Over the past few quarters, margins have stagnated, limiting their contribution to earnings growth

� Future earnings growth through margin expansion seems unlikely, as an improving labor market and higher interest rates will most likely squeeze margins. However, stable revenue growth, share buybacks and the additional use of debt financing should support modest earnings gains in the year ahead.

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Revenues

� S&P 500 company revenues grow at about the same rate as nominal global GDP growth. Revenue growth hasn’t been spectacular but still steady

Sources: Standard & Poor's, J.P. Morgan Economics, J.P. Morgan Asset Management. Data are as of 10/28/13.

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SPX

� The stock market is strong, with a clear trend, a momentum that is in a pretty good shape and earnings at a record high. With the economy still growing the bulls get the benefit of the doubt.

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SPX

� The stock market is strong, with a clear trend, a momentum that is in a pretty good shape and earnings at a record high. With the economy still growing (even if it is at a low pace), the bulls get the benefit of the doubt.

� A short-term retracement appears increasingly probable as the percentages the index stands above its usual daily moving averages become extreme.

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SPX

� Our previous bias to be long S&P500 is no longer valid. As said in our previous report, our trading model becomes short as soon as the S&P500 breaches 1722.

� The market seems to be approaching potential congestion at 1774 – 1792. The model calls for a pullback targeting 1757 – 1739 and 1671.

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Caterpillar as an alarming signal

� Caterpillar is clearly lagging the market.

� Caterpillar has reported negative earnings surprises in all the past four quarters. Guidance for 2014 is uninspiring enough to make analysts downgrade the stock to a "strong sell“

� Under real economic recovery and sustainable organic growth, companies like Caterpillar usually report very strong profits in many fields. Unfortunately, they do not!

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Equity Fund Inflows

� So far this year, $277 billion have flowed into equity funds. Investors have apparently put almost as much money into equity mutual funds as in 2000, which continues to be the record year for inflows

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Enterprise value

� The enterprise value (value of corporate equity plus debt net of cash) to revenues ratio is at the highest value ever, except for the 2000 peak.

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Market Sentiment

� A new record high in speculative net long exposure has just been recorded. This extreme bullish consensus is rare.

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Market Sentiment

� Another red flag:The amount of assets held in Rydex money market funds is at the very low end of the historical range

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Market Sentiment

� The bear percentages of the Investors Intelligence and American Association of Individual Investors polls, declined to near record low levels.

� Mark Hulbert's HNNSI (Hulbert Nasdaq newsletter sentiment index) is also at an extreme, showing a rare peak in the bullish consensus of newsletter writers

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US Stocks

� Nothing new since last report. The RAI stands in neutral territories.

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Equity Volatility

� Volatility continued to trend down. VIX is back on its lowest regime according to our HMM model.

� In the same time, hedging activity has intensified during the past month. We are seeing the highest volume of VIX contracts on record

� The vol of vol has collapsed.

� There is not a lot of room for the market to keep moving higher with the VIX at this level.

� Higher real rates and lower inflation will drug the volatility higher �

� Volatility will become more volatile very soon.

� The VIX at 13 is attractive. Buying it through futures is less because of the contango term structure and the negative roll-down.

� The S&P 500 term structure steepened sharply to close to its steepest slope this year, as short-dated ATM volatilities fell heavily during the post-shutdown rally

VIX Vs.10-Year Inflation Premium

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Equity Volatility

� Short-dated implied volatilities have fallen near cycle lows � Put on stock replacement trade (sell long stock positions and replace them with call options to keep upside exposure) to lock your gains and extract cash.

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FIXED INCOME & CREDIT

� On the short term, overall risks seem skewed towards lower rates in the US. Some signals point to increased chances of a material retrace of the recent up move in UST yields

� We stay biased towards higher yields over the medium-term, but wait for better levels to put on our shorts.

� Eurozone disinflation will persist for some time, provoking a rate cut from the ECB (in December?) � As a tactical position, OW German Schatz / Bobl

� The US curve continues its flattening movement that we’ve mentioned in our previous report. We should keep the US 10yr-2yr spread on the radar.

� We have changed our view on overall credit from OW to neutral after a pronounced� tightening in the third quarter.� Spreads continue to tighten across all credit but mostly in higher-yielding credits: US HY and EM

sovereign credit spreads. The current slow growth conditions (with low default rates) are enough to make the high yield market (as a source of carry) attractive. The current search-for-yield environment remains strong and may push spreads a bit tighter from here. But on the medium term, the downside risk looks predominant there � We are OW High-Yield vs Investment Grade

� Bottom line : OW Govies and wait for better levels to enter shorts, set curve flatteners, Neutral credit, keep our OW High Yield and EM sovereigns vs High Grade

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FIXED INCOME & CREDIT

� We maintain our last month view.� The retrace of the recent up move

in UST yields seems to continue. � Our important pivot at 2.53 was

reached.� With daily oscillators at the base of

their range it’s important to watch for any confirmation of a base

� Next big pivot / support to watch ~ 2.42-2.27.

� We’re still waiting for the best entry point go short treasuries.

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US Treasuries

� As said last month, the U.S. 10-yr/2-yr curve has potentially begun a trend flattening

� Given the technical setup in place, the curve should flatten quite materially over time.

� The next notable pivot to watch ~205 bps. But ultimately a move to 121bps looks quite possible.

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High Yield

� The spread difference between bonds rated BBB and BB is 28bp, compared with the long term average of 103bp.

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High Yield

� At this stage, the biggest risk for credit seems to be higher leverage

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EXCHANGE RATES

� The weak readings in US statistics have been putting pressure on the U.S. dollar, which finds itself at two-year lows against the euro

� However, the recent rally on EUR-USD is fading. It seems an attractive time to look for signs of EURUSD topping

� Given the exhaustion patterns we saw on it, the DXY also seems to be close to its range base…� We continue to see commodity linked currencies losing their luster, pressurized by central bank governor

rhetoric

� Bottom line: the Euro enjoyed a strong surge higher, breaking from its sideways range, to move through to its highest level in nearly two years just above 1.38. The hesitation we’ve seen at this level is enough for us to have a long bias towards the US Dollars against EUR with a target at 1.3460 – 1.32 (stop at 1.4000) and JPY with a target at 101.40 (stop at 96.85).


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EUR-USD

� EURUSD seems topping as we close below the prior interim high from 1st Feb. at 1.3711.

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DXY

� We’re still bullish on the DXY. With weekly oscillators attempting to turn up from near oversold levels, the DXY seems to form a range base around 78.60 – 78.92.

� Only a clear break above 79.63 would stop the downtrend and confirm our favorite scenario.

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USD-JPY

� USD-JPY is moving in a triangle range. Given the clustering in MAs, the market seems increasingly “trend ready”.

� Pivots to watch are at 99.01-26 and 97.13-96.94. A break in either direction is imminent.� We still have a bias towards an eventual upside push. We target 101.40

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EUR-USD

� USD/EUR exchange rate movements can be explained by:� changes in the size of the Fed's balance

sheet relative to the size of the balance sheet of the ECB

&� changes in the short-term interest rate

differential between the US and Europe(Germany).

� At this stage, these factors have opposite effects on the EUR-USD

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Commodity Currencies

� The commodity currency bloc (CAD, AUD and NZD) continues to be pressurized by central bank governor rhetoric:� CAD had weaker support from Poloz last week, � the AUD had Stevens saying that AUD level isn’t supported by costs and productivity in the economy

(and that it seems quite likely that the AUD will be materially lower than its current level)� the NZD had their governor Wheeler suggesting that a strong Kiwi would delay a rate-hike.

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EUR-USD

� Net non-commercial futures positions is more compatible with a level of 1.40-1.50 on the EUR-USD

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EUR-USD

� Compared to the sovereign spread between Germany and US, EUR-USD stays too expensive.

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COMMODITY

� On precious metals (gold and silver), and after an expected consolidation to the upside, the market seems increasingly at risk of resuming its prior trend lower with a target at 1200 on gold and 17 on silver! � UW gold & Silver. Wait for a trend to develop before entering the market

� Keep an eye on the bullish pattern that develops on gold miners

� With inflation fears fading, financial demand for commodities will weaken further � Neutral commodities overall. and look for a single digit total return (~3%) over the next 12 months

� On the ST, we stay OW base metals, copper (because of China’s PMI) and energy but see significant downside risk on Copper an Aluminium on the MT.

� We are OW livestock


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Gold

� The long-term trend has been broken over the past year. The gold fell sharply regardless of the high debt ceiling and increasing money supply

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Gold Miners

� Are we finally reaching a bottom in precious metal?

� The Market Vectors Gold Miners (GDX) is hitting new lows when the RSI and the MACD are making higher lows

� This diverging configuration is a classic bullish pattern

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Precious Metals

� � Our theoretical price (using US$, sovereign CDS and Real Rates) stands at 1270, versus a market price at 1314.

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1150

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1550

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1950

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28/05/2005 10/10/2006 22/02/2008 06/07/2009 18/11/2010 01/04/2012 14/08/2013 27/12/2014

GO

LDS

Inde

x

GOLDS Index

GOLD Fair Value (USTW$+CDS+Real Rates adjusted)

Source : Bloomberg data, FinLight Research calculations

� Real yields increase explains a big part of the downside move on gold �

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Precious Metals

� Technically, another ABC correction seems possible with 1420 as a target. But according to GS chartists, this configuration should ultimately suggest an eventual move significantly lower (1200 – 1170 ?)

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Crude Oil

� A top is building on the Brent. The big downside pivot to watch is around 102.67 (200w MA)

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Live Cattle

� Live cattle prices continue to rise, as a big winter storm wiped out entire herds in the US northwest.

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ALTERNATIVE INVESTMENTS

� We are OW on AI as we expect a 10% return in the coming year versus 5% on a traditional balanced portfolio (stocks + bonds+ cash).

� Our overweight position focuses on Commercial Real Estate (even if the current message is still mixed) � We are OW Equity long-short market-neutral, Convertible arbitrage, CTA’s


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Real Estate

� Last release of the S&P/Case-Shiller home price indices for August reported that the non-seasonally adjusted Composite-10 price index rose a notable 1.33% since July and 1.32% for the Composite-20 index.

� The 10-city composite index increased 12.75% as compared to August 2012 while the 20-city composite increased 12.82% over the same period.

� Both of the broad composite indices still show significant peak declines slumping around -20% from the peak.

� Contracts to purchase previously owned U.S. homes fell by the most in more than three years in September, probably due to higher mortgage rates.

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Bottom Line: Global Asset Allocation

� UW equity overall. OW EM stocks and European stocks vs US and Japanese stocks. OW defensive high-yielding stocks

� UW VIX because of the cost of carry. Put on stock replacement trade to lock gains and extract cash

� OW Govies and wait for better levels to enter shorts, keep curve flatteners

� Neutral on credit. OW High Yield and EM sovereigns vs High Grade

� Neutral commodities overall. OW base metals, copper, livestock and energy. Underweight precious metals.

� OW Alternative Inv (OW Equity long-short market-neutral, Convertible arbitrage, CTA’s) + Commercial real estate.


FinLight Research - Market Perspectives - Nov 2013

Economy & Finance

Transcript of FinLight Research - Market Perspectives - Nov 2013