Finlight Research - Market Perspectives - Oct 2016

Market PerspectivesOctober 2016

Oct. 14th, 2016

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What the wise do early, a fool does in the end

“Since 1947, every time profits fell this much,or for this long, a recession was eitherunderway or about to begin. […] The onlyexception was the middle of 1986 to early1987. The argument can be made thatcorporate profits fell in 1986/1987 because acollapse in crude oil prices crushed energyprofits. This is similar to the current fall inprofits… Despite this collapse in profits in1986/1987, stock prices marched to new all-time highs. The same is happening now.However, by the fall of 1987 the marketbecame overvalued by most measures andcrashed, reversing all the gains over theprevious 18 months.

”– Jim Bianco (Bianco Research)

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� Markets are relatively too calm, but appear to be at a crucial point.

� Equity market is still locked in a tight range, but breakout seemsimminent

� Equity volatility is unlikely to stay this low. We expect it to increasethrough the US election due to the global uncertainties (Brexit, next USrate hike…)

� EM has been one of the main beneficiaries from the risk appetiterevival following the Brexit vote. Nevertheless, we feel cautious abouthow resilient EM assets would be in the face of rising US rates.

� Looking ahead, fundamentals appear to have improved.. That hasrenewed speculation that the Fed could raise rates as early asDecember

� With elevated valuations and crowded long positioning in equ itiesand bonds, the market appears vulnerable to shocks over thenear term .

� Said another way, current market conditions imply small potentialreturns and big latent risks across almost all asset classes. Thus, weremain defensive in our asset allocation.

� The moral of the story? Be prepared for anything…

� We summarize our views as follows �


MACRO VIEW

� The Good� Jobless claims in the U.S. dropped to the second-lowest level since 1973. � With September data release, the global manufacturing PMI seems to be breaking its downtrend� The ISM Non Manufacturing report was excellent� We are probably at an inflection point on equity earnings

� The Bad� The Atlanta Fed model projects Q3 GDP growth at just 2.1%, down from 2.8% expected a few

days ago. Two months ago, GDPNow was predicting Q3 GDP growth nearly 1% higher� US Commercial real estate (CRE) suffers. The Dodge Momentum Index (a leading indicator for

new non-residential CRE investment) fell 4.3% in September to 129.0 (vs 134.8 in August)

� The Ugly � Main systemic risk resides in China: China is not recovering but rather just re-leveraging.

Chinese debt bomb is ticking. Debt is used to create the illusion of growth. The Chinese banking sector is going to end up needing a bailout.

� A Hard Brexit has become a meaningful risk � Something huge is probably gathering in Japan : Abenomics has failed! Contrary to every

economic theory, debt accumulation, debt monetization and record amounts of currency creation have resulted in a rising yen and falling prices.



The Big Four Economic Indicators

� The current picture is characterized by relatively strong Employment and Income, a weak Industrial Production (probably in recovery mode since its Mar ‘16 lows) and Real Retail Sales hovering around a flat line.

� The average of these indicators has been trending lower since Nov. ‘14, suggesting that the economy is still moving sideways. Industrial Production has been the weakest link in the economic recovery since the GFC. But the picture has been getting mildly better sinc e June.


The Big Four Economic Indicators �

� Looking at an aggregate of the four indicators, we see that:� Things have gotten

much better since the end of the last recession.

� But we are still far from catching up with the secular trend.

� The gap to that secular trend is even getting wider.


ISM Manufacturing & Services ☺

� Both ISM manufacturing andservices indices are now inexpansion territories

� The manufacturing indexrebounded to 51.5 inSeptember, up from 49.4 inAugust. Its new orderscomponent rebounded to 55.1in September from 49.1 inAugust.

� The ISM Non Manufacturingreport was excellent. Theservices index jumped to 57.1from 51.4 in August. Its neworders component soared to60 (up from 51.4)


Global Manufacturing PMI

� The global PMI is alsogetting much better.

� The JPM GlobalManufacturing PMI has beenin a continuous downtrendsince 2013, and clearlypointing to a global recession.

� With the last monthly moves(50.8 in Aug and 51.0 in Sep),the downtrend seems broken,and global recession avoidedfor the moment.

� Is that a sign of an improvedglobal growth? Just wait andsee...


US Employment – U6 Unemployment Rate vs Wage Growth

� Since the end of the GFC, the U6 unemployment rate (including unemployed + underemployed, suchas involuntary part-time workers) has decreased from 17% to around 10%. However,

� Current levels remain too high (near the peak of the previous cycle).

� Wage increases (at a meager 2.6% YoY in nominal terms) remain pathetic


US Employment – Adjusted for Population Growth

� Labor market improvement cannot go forever…

� When adjusted for population growth, nonfarm Employment data tend to show a similar trend to that of the seventies.

� Given where we stand within the business cycle, the current level may constitute a new interim peak.


US Capex

� US capex picture remainsbleak with nonresidential fixedinvestment continuing its longslip down.


US Capacity Utilization

� One of the main factors weighing on inflation and growth is excess capacity.

� Overcapacity is more and more obvious in the global economy.

� Capacity utilization has been trending lower and stands now a t a level that has been historicallyindicative of recession.

Source: St. Louis Federal Reserve

Capacity Utliization


GS – Global Leading Indicator (GLI)

� The September Final GLIcame in at 2.8%yoy. Its MoMmomentum came at 0.31% (upfrom its last month’s 0.27%)

� The September GLI reading now signals economic expansion after a brief summer excursion in the slowdown quadrant.

� Seven of the ten underlyingcomponents of the GLIimproved in August.

� We continue to think that theacceleration we’ve beenwitnessing since Jan. ‘15 isquite modest for a typicalexpansion phase


EQUITY

� Our equity outlook remains cautious. We see the market more vulnerable than ever to growth,earnings and policy disappointments.

� Stocks have flirted with making a move above the recent highs but conviction seems missing.

� The US equity valuation picture has hardly changed since last quarter. Whatever metrics we consider,US stocks look expensive, making the pressure to deliver a positive earnings growth very substantial

� Relative to alternatives, though, valuations are a lot more reasonable than what many perceive. The S&P500 earnings yield is nearly twice the yield on the 10 year tre asury . Its dividend yield is 0.5% pointshigher than the 10 year UST.

� In order for valuations to cause problems, there has to be a catalyst (a rate hike, a recession,disappointing earnings, a geopolitical event…) to get it started.

� Market volatility remains very subdued. We still expect an increase in VIX futures over the next couple ofmonths and through the U.S. presidential election.

� Given the current congestion in indices, due to a convergence of supports and resistances, a break outof the tightening range is likely coming, but the direction i s uncertain at this time. The trigger forthat movement could be the Q3 earnings season. Given the current VIX level, we think it is less likely asignificant rally will occur from here.

� A stronger dollar will induce another headwind to already weak earnings

� Capital spending continues to contract and to be replaced by stock buybacks and other forms of financialengineering.


EQUITY

� We remain Neutral on S&P 500 but with a bearish bias as we see increasing political uncertainty intothe US elections and some headwinds from the resumption of the Fed rate hike cycle and a strongDollar.

� We remain UW Europe into year-end because of elevated political uncertainty (from Brexit and theItalian referendum) and uncertainty on ECB policy

� We still think that key fundamental data will eventually matter… in a BIG BIG way. For now, investorsare buying the rumor of better future earnings. One day, they will be selling the news of bad effectiveearnings.


EQUITY

� Our scenarios are unchanged.

� Our main scenario from here (70% chance) : A massiv e top forming around 2170-2190� Equities remain expensive, earnings growth poor and profit margins are showing increasing

evidence of peaking. On Price/Sales metric, equities are trading at the top of the historical range. � A resumption of earnings growth going into 2016 will be necessary for equities to move higher.

� Our alternative scenario (30% chance) : The S&P500 breaks the 2170-2190 resistance, opening the way to 2225 - 2300. Such a breakout would need a new round of stimulus and/or a new impulse to macro fundamentals

� A pull back below 2060 is needed in order to confirm our primary scenario!� Above 2200-2225, we’ll be obliged to recognize the alternative scenario is in.


EQUITY

� Bottom line :

� De-risking should continue . A higher allocation to cash is sensible in this late-stage stock bull.� We adjust our positioning rules on the S&P 500 as follows:

� We remain Neutral above 2106� To switch to OW again, we need a material break higher than 2170 - 2190� We will switch to UW as soon as the 2100-2106 range is materially broken to the downside. � Any clean break below the ‘09 trend would make us move massively UW

� We like the low US beta. We remain Neutral Japan and UW Europe vs. US.

� We remain UW in US small caps vs large caps. � We stay OW defensive vs. cyclical and value stocks vs growth stocks.

� In our previous report, we’ve turned Neutral on high dividend stocks . As expected, utilities, and dividend focused stocks have experienced selling pressure. Our view is that low vol/min volstocks are increasingly vulnerable.

� EM has been one of the main beneficiaries from the risk appetite revival following the Brexit vote. Nevertheless, we feel cautious about how resilient EM assets would be in the face of rising US rates. We remain UW EMs vs DMs .


US Earnings

� The S&P500 stands within an earningsrecession.

� For Q3 2016, the estimated earnings decline is -2.1% YoY (+1.3% if energy is excluded), marking the first time the index has seen 6 consecutive quarters of YoY declines in earnings since 2008/2009

� For all of 2016, the estimated S&P 500 growth rate is now projected at -0.1% for earnings and +2.1% for revenues.

� For Q3-2016, 80 companies have issued negative EPS guidance and 34 companies have issued positive EPS guidance

� The forward 12-month P/E ratio is now 16.7, which is well above the 5-year (14.9) and 10-year (14.3) averages.

� Analysts still expect earnings growth to return in Q4 2016


US Earnings

� For each quarter since 2014, EPS estimates have been revised down

� If the trend of earnings revisions continues, earnings growth for all of 2016 would hardly be positive

� It’s worth noting that the picture is much better if you exclude energy

� We also notice that earnings estimate fall before the season begins, but the final growth rate tends to beat estimates


End of Earnings Recession?

� According to Factset data,actual earnings have alwaysbeaten analyst's estimatessince 2014

� Given the usually positivedifference between actualand estimated earningsgrowth, we may expect thatthe final reports for Q3-2016 will break the streakof lower earnings


S&P500 – A Long-Term Perspective

� S&P 500 to be valued pretty aggressively relative to historical valuations:

� Equity markets still appear at lofty valuations, whatever the valuation metric we use.

� All the indicators we use suggest a cautious long-term outlook and weak long-term return expectations � These measures are consistent with flat (0%) 12 year S&P 500 nominal total returns


S&P500 – Market Breadth

� Since July, the index has been diverging from its 50d-MA breadth.

� Divergence is substantial and surely will not last.

� Re-convergence could be done either with the S&P500 breaking out the symmetrical triangle to the downside, or with the breadth breaking to the upside

� The market continues to hesitate (the consolidation triangle is getting tighter) and will likely break on one side or the other, very soon .

� This break will be followed by an impulsive movement in the same direction.


S&P500 – A Medium -Term Perspective

� Since Q3-2015, the VIXmoving range widened andcorrective actions in the indexbecame more painful.

� Convergence of support andresistance is creating atightening range aroundcurrent levels. A break outseems imminent.

� Given the current low level ofthe VIX, a break to thedownside looks moreprobable.


S&P 500 – A Short-Term Perspective

� Over the short-term, the next level to watch is 2106. Any clean break below it will open the door to a more impulsive decline towards 2060 and even 2000.

� On the topside, we need to go through the 100-dma at 2140 to feel more confident about the end of the correction.

� But only a material break above the trend across the highs since Aug. ‘16 (~2170) would make the setup constructive enough to consider a bullish stance.


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has been flat since mid-August.

� 3 systems are targeting a break above 2189. � 3 others are targeting a break below 2083� Bottom line: There is no conviction there!


S&P500 – Implied Vol

� S&P 500 implied volatilitystill appears somewhat lowwhen compared with thepotential move (as measuredby 1-year beta to the MSCIWorld) in a risk-off scenario

� More generally, DM volsappear more attractive thanEM vols.

� On a risk-return basis, wecontinue to prefer DM toEms equities.

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FIXED INCOME & CREDIT

GOVIES & INFLATION-LINKED

� Recent data suggests that the US economic recovery is gathering momentum The Fed seems on track to raise rates in December

� The rumor that the ECB may taper its bond purchases in advance of the scheduled end date impacted negatively stocks and bonds. The induced volatility in markets should be seen as a warning signal of what is to come when interest rates ultimately start to go up.

� Low interest rates are causing significant damage to financial institutions (banks, pension funds, insurance companies). The amplitude of this damage will become evident in the next recession

� The sell-off in Govies should continue as bond valuations are still stretched and Central Banks outlook appears less supportive for duration. ECB/BoJ QE programs may be replaced by fiscal policies.

� G3 government yields are inconsistent with fundamentals. Eurozone (like Japanese) yields appear too low when compared to nominal GDP growth. In our view, this is a bubble inflated by investors who think that central banks will support such prices indefinitely.

� The endgame will be disastrous given the extreme levels reached by valuation and market positioning in FI.

� We are Neutral on 10y-USTs and will remain so as lo ng as the 1.85 resistance isn’t breached.

� The U.S. curve looks likely to steepen from here, especially if the 10y-UST yield goes above 1.85. We prefer to get out of our long flatteners positions on the UST curve.

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INFLATION-LINKED

� Inflation isn't on anyone's radar right now. Inflation expectations haven't moved up yet. Any surprise on the inflation front would make a lot of damage on the market.

� Inflationary signs should be watched closely as the y will foreshadow a steepening decline in Govies .

� We remain Neutral HICP Inflation as we see breakevens trading sideways

� We move to OW 10y-TIPS. The US labor market is late in the cycle and should drive wage inflation. Moreover, and from a tech perspective, the US 10y-breakeven has broken its downtrend since ’13 (~1.60) to the upside and seems to target 1.75 and even 1.85.


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CORPORATE CREDIT

� Credit is expensive relative to the fundamentals . fundamentals continue to deteriorate, with EBITDA growth continuing to decline and net leverage rising furth er (especially in the US). But central bank QE from Europe and Japan remains a support.

� We still see significant interest in USD credit given the low level of Euro HG credit yields. But we expect demand for USD credit will slow because of the rising cost of FX risk hedging

� Concerns around European banks, combined with a hard Brexit stance from the UK made European credit markets underperform their US counterparties.

� We remain overweight US vs EUR credit (more on IG than HY) because of our fundamentally bearish view on European credit, the relative yield disadvantage and the fact that the re-leveraging cycle looks more mature in the US.

� In high yield , bonds rallied sharply after OPEC Algiers meeting. We keep, nevertheless, our bias towards higher quality. Any unpriced rate hike (and/or dollar strengthening) would weigh on low quality bonds (High Yield and EM debt). We remain UW on HY and Neutral on IG.


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EM DEBT

� The dollar strengthening we still expect would weigh on EM debt

� We remain Neutral on EM bonds, because of all the macro challenges facing the EM economies at a time when the Fed is likely to be more hawkish

� Bottom line : Neutral Govies, UW US vs Eurozone Govies, get out of our long flatteners on the US yield curve, but remain short duration in 2y USTs, UW credit mainly through HY and Neutral on IG (duration hedged), UW Eurozone vs US in IG & HY credit, OW 10y-TIPS breakevens and Neutral HICP Inflation, UW High Yield vs High Grade, Neutral on EM sovereigns with a little preference for hard currencies bonds.


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US Govies – 10y UST

� The divergence between USbond yields and the globalPMI seems too wide to last.

� Convergence can come fromeither side. But, given theglobal context (CB actions,monetary policies…), it is moreprobable to see it coming fromhigher yields.

� Closing the gap needs acatalyst that may come fromECB/BoJ ineluctable tapering(or just rumors of).

� We feel more cautious on allyield sensitive assets: Govies,HY credit, EM debt…


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US Govies – 10y UST

� Our positioning rules remainunchanged:� OW below 1.65� Neutral above 1.65 and

remain so as long as the1.80 level is preserved.

� Move to Neutral around1.25-1.28

� Above 1.80, move to UW.

� In September, and accordingto these rules, we’ve movedfrom OW to Neutral, then toOW again before turningNeutral above 1.65 on Oct.6th.

� We remain Neutral as longas the 1.85 resistance isn’tbreached.

� Breaking above 1.85 seemsunlikely, at least for now.


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Credit Fundamentals

� We continue to feel cautious about US corporate leverage and its disconnection from credit spreads.

� Corporate indebtedness is back to its previous peak, when measured as a percentage of net revenues.

� The picture is made more bearable by low interest rates and low debt servicing . This will remain true as far as corporations are able to refinance maturing debt easily.

� The ultimate risk for such an instable equilibrium: liquidity vanishing under a severe risk-off scenario.


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Credit Fundamentals

� Upgrade-to-downgrade ratio and default rate have has reached levels last seen in H2-2008.

� And this not just an oil/energy story.

� This is again a sign that we are in the late stage of the credit cycle.


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US Credit – Relative Positioning

� We have been OW US vs European credit since Jul. ‘16 on HY and since Apr ‘15 on IG.� In September, we made money on this position as European indices have underperformed US

indices, mainly driven by worries about European banks

� We maintain our current relative positioning


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US Credit – Is Active Hedging On?

� At around 11.5%, CDX.IG pull-call skew is close to its 3 monthhighs

� OTM CDX put options are quiteexpensive relative to calloptions. This is probably thesign of active credit riskhedging.


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EXCHANGE RATES

� Central banks remain the key driver of foreign exchange , We remain structural Dollar bulls� As expected, the dollar is now supported by the Fed’s hawkish rhetoric and bets on a rate hike in Dec

‘16.

� The technical picture for the EUR-USD remains rangy and mess y. The U.S./German 10-yearspread is starting to widen, which is normally bearish for EUR-USD

� We remain UW for the moment . We will move to Neutral above 1.14, and to OW if the spot breaksabove the 1.156 resistance to target 1.18

� Our positioning rules remain unchanged:� Move to Neutral within the 1.14 - 1.156 range� Move to OW if the spot breaks above the 1.156 resistance to target 1.18� Remain UW below 1.14.

� Over the medium-term (Q4-2016 and H1-2017), we maintain our downside projections towards 1.07-1.04-parity . For that, we need a clean break through the strong support area at 1.0910-1.0950 area, then through 1.06 (the floor of the triangle pattern).

� Hard Brexit has become a meaningful risk . The value of the British pound has plummeted since the referendum vote and seems to be saying that the British (tough) strategy to deal with Brexit is not the good one.


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EXCHANGE RATES

� The downtrend since January has been broken and we’ve moved f rom Neutral to OW around104 on Oct. 11. Next targets to watch: 104.8 and 108.

� We adjust our positioning rules on USD-JPY as follows:� Remain OW as far as the downtrend from Jan. ‘16 isn’t reintegrated.� Move to Neutral below� Only a break below of 99.50 and bearish momentum, would make us move to UW

� EM currencies have weakened since the middle of August as Fed risks have been repriced. � We anticipate that pressure on EM currencies will resume and continue until we see a more

constructive / fundamental improvement for global growth and commodities supply/demand imbalances.

� We remain UW EM and Commodity FX


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EUR-USD

� The U.S./German 10-year spread is starting to widen, which is normally bearish for EURUSD.

� The technical picture for EUR-USD remains rangy and messy.

� We remain UW for the moment .We will move to Neutral above1.14, and to OW if the spotbreaks above the 1.156resistance (the ceil of the trianglepattern formed since Mar. ‘15) totarget 1.18

� Over the medium-term (Q4-2016and H1-2017), we maintain ourdownside projections towards1.07-1.04-parity . For that, weneed a clean break through thestrong support area at 1.0910-1.0950 area, then through 1.06(the floor of the triangle pattern).


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USD-JPY

� In our previous report, we said: “Theimportant area to watch standsaround the trendline formed acrossthe highs since January ~103.94”

� The downtrend since January hasbeen broken and we’ve movedfrom Neutral to OW around 104on Oct. 11. Next targets to watch:104.8 and 108.

� We adjust our positioning rules onUSD-JPY as follows:� Remain OW as far as the

downtrend from Jan. ‘16 isn’treintegrated.

� Move to Neutral below� Only a break below of 99.50

and bearish momentum, wouldmake us move to UW


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COMMODITY

� We continue to view upward moves since Jan. ‘16 more as technical adjus tments than as a fundamentally-driven ones.

� We don’t see any sustainable recovery without a pic k-up in global growth or a material tightening on the supply side. It is likely that supply destruction (due to pull-back in capital investment) will be the main catalyst for the next sustainable recovery in prices.

� We also expect a considerable volatility along the way

� We remain UW commodities over 3-6 months as we believe the recent rally might be short-lived� The supply side has adjusted but still has a way to go in many commodities before erasing

current imbalances. In order to get more cuts in supply, we think there needs another legdown in prices to force capitulatio n

� US dollar strengthening should resume . Dollar will dictate both direction and velocity incommos. We expect the stronger dollar to put downward pressure on commodities despitesupportive fundamentals for some of them

� The downtrend in commodities looks about to bottom out . We see one last leg down in energyand metals.


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COMMODITY

� Bottom Line :Energy:

� OPEC agreement in Algiers has supported markets. OPEC surprised markets by agreeing to cut production (to a range of 32.5-33.0 mbd at some point after the November meeting) for the first time in eight years. However, much uncertainty remains around a finalized OPEC dea l.

� Another good news for oil: Inventories showed an unexpected decline.

� Ample supply remains the major problem plaguing the oil market. US shale production continues to weigh on price.

� Despite the recent decline in inventories, crude oil stockpiles are still above levels they were at this time last year and much higher than the average levels of the last ten years or going all the way back to 1984

� We think that the bottom is in for oil, but we don’t expect a significant rally from here. Any growing evidence that the downtrend in U.S. crude production is ending, would induce another sharp drop in prices.

� $40-$50 per barrel is the range for WTI over the sh ort-term . Only an unexpected exogenous event could cause oil to break out of it, on one side or the other..

� We actually expect the spot to test again the 25-30 area before putting in a permanent rebound. At this stage, we watch a few key levels ($40, $36, $31, $25). We need to see how the price behaves around these levels to make our projections.


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COMMODITY

� According to our positioning rules, we turned to Neutral on WTI as the spot broke above $50 (Oct 11)� Our bearish bias is still intact. Only a material break above 52.5 would open scope for a rally.� Our tactical rules are adjusted as follows:

� Remain Neutral above $50� Move to UW below $49.8-$50� Move to OW above $52.5 (to target 60 – 65) or below $29 (to play the rebound).


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COMMODITY

Precious Metals:

Outlook for precious metals continues to be dominat ed by Fed rhetoric, macroeconomic and political uncertainties and the subsequent impact on US dolla r, real yields and sovereign credit.

� As expected in our previous report, price weakness has shown up again in the gold market. The losseswere sudden and severe on Oct. 4th. A number of explanations were proffered for the sell-off. Most ofthem turned around the rally in the US dollar and the reversal in US long-term yields.

� Applying our positioning rules (please have a look to our Sep. Report), we’ve moved from OW toNeutral on Gold as the spot broke below 1295 (on Oct. 4th)

� Our positioning rules are adjusted as follows:� Remain Neutral between 1210 and 1300� Go OW above 1300, targeting 1380 and even 1430� Turn UW if the spot breaks below 1210 and go OW again below 1070

� Over the medium term, we think that gold / silver are still due for a final leg down . Our ultimatetarget was raised to 1000 – 1040 on gold and 12.5-13 on silver. The main risk to our scenario is theresurgence of DM sovereign risk (starting with UK?).


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COMMODITY

Base Metals: .

� Despite the macro-driven rally started in Jan ‘16, we remain UW on base metals on continuing excess supply, weak prospects for demand and cost deflation.

� Industrial metals have remained range bounded since July. We believe that lower prices are still needed to induce more supply adjustments.

� From a longer-term point of view, we believe that metals prices are headed for multi-year decl inesas the current China-driven super-cycle appears to have peaked

Agriculture:

� The S&P GSCI Agri TR Index posted a decent gain (+4.5%) in September.

� Last week, wheat and corn futures soared, amid talks of hedge funds struggling to close short positions,with good US export sales data, and talk of Chinese demand for wheat

� For grains, a bullish shift in sentiment from here, would require a significantly larger-than-expected cut toUS yields.

� We choose to remain Neutral on Agris, as we have no conviction at this stage and given biguncertainties around forecasts for 2016-17


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Crude – A Fundamental Perspective

� In Algiers meeting, OPEC oil ministers agreed in principle to cut production to a cap of 32.5-33.0mbd. At this stage, the agreement is nothing more than the formation of a study group to considerhow to enact such a reduction in November meeting..

� In the meanwhile, OPEC output rose to a record 33.75 million in September� The targeted cap remains some 10% higher than OPEC productio n when oil first reached the

$60 level.


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Crude – A Medium -Term Perspective

� The downtrend is still intact.� Moreover, oil prices are now at extreme overbought levels, which may provide a long-term sell signal

with $30-35/bbl as a target.� As long as the spot remains below the downtrend line, the pressure remains to the downside.


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Crude – Tech. Perspective

� According to our positioningrules, we turned to Neutral onWTI as the spot broke above$50 (Oct 11)

� Our bearish bias is still intact.Only a material break above52.5 would open scope for arally.

� Our tactical rules are adjustedas follows:� Remain Neutral above $50� Move to UW below $49.8-

$50� Move to OW above $52.5

(to target 60 – 65) or below$29 (to play the rebound).


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Gold – Tech. Perspective

� The move on Oct. 4th was sudden and severe. Gold fell to the lowest in almost 4 months andbreached the key technical level of 200-dma.

� A material break below the 200dma may mean that the current up trend is over.


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Gold – Tech. Perspective

� Applying our positioning rules(please have a look to our Sep.Report), we’ve moved fromOW to Neutral on Gold as thespot broke below 1295 (on Oct.4th)

� The next level to watch is 1249.A break through will open thedoor to a test of 1210.

� Only a move above 1300 wouldsignal a recovery.

� Our positioning rules areadjusted as follows:� Remain Neutral between

1210 and 1300� Go OW above 1300,

targeting 1380 and even1430

� Turn UW if the spot breaksbelow 1210 and go OWagain below 1070


51

Copper – Tech. Perspective

� Within the industrial metalscomplex, we’ve UW Copper fora while now. From afundamental point of view,Copper is still one of the mostoversupplied markets.

� But, from a technicalperspective, we think the metalwill soon find a near-termsupport around 4620 (the floor ofthe current triangle pattern)

� We switch to Neutral with abullish bias, for now .

� We’ll move to OW if the spotbreaks up (above 4950, target~5400 where we’ll movemassively UW) and to UW againif it breaks down (below 4620)


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ALTERNATIVE STRATEGIES

� The HFRI Fund Weighted Composite Index posted gain s of 0.6% in September (+3.0% QoQ and 4.2% YoY). Gains were led by Equity Hedge (+1.1% MoM) and Relative Value (+0.9% MoM, with RV : Volatility Arbitrage making 1.6% MoM) strategies.

� Both CTA and Discretionary Macro strategies showed mixed performance in September, with -0.7% on HFRI Systematic Diversified Index and a meager +0.1% on HFRI Macro: Discretionary Thematic Index

� Global Macro managers have largely benefitted from recent market movements , as they continue to play the growth divergence thesis between the US and the rest of the world. Thus, they posted substantial gains since Oct. 1st, benefitting from their long USD positions, the sharp decline of the GBP/USD and their short duration trades in fixed income. These views have finally proved profitable as markets increasingly price in a Fed rate hike by December.

� CTAs accentuated their losses in October, as a result of their long fixed income and mixed performance in the commodity bucket, and despite their short positioning in Pound.

� We believe that diversifying portfolios with an increased allocatio n to alternatives is particularly attractive at this stage of the cycle, given the current macroeconomic and interest rate uncertainties.

� Within the hedge fund universe, we continue to prefer strategies with moderate mark et directionality (“risk diversifiers” type) such as L/S Equity Market Neutral, Global Macro and CTAs. The reason behind that is that we continue to consider traditional asset classes as richly valued.


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ALTERNATIVE STRATEGIES

� We maintain our OW rating on :

� Equity Market Neutral, a strategy we think to be well positioned for a spike of volatility by the fall.

� CTAs: Despite their recent losses, we keep a clear OW stance on CTAs as a diversifier in portfolios and a hedge against future stress. Furthermore, we expect new trends to emerge soon… either from a firmer expansion or more likely from a recession!

� Global Macro: We like this strategy as a diversifier and tail hedge. We have a slight preference for macro funds with a focus on Forex and Fixed-income…

� Vol. Arb strategy and prefer funds that trade volatility globally (all assets / all regions).


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Hedge Fund Alpha Generation

� The hedge fund industry has been producing a negative overall alpha since end-2015

� This underperformance has been driven by several factors: crowded trades, uncertainties about growth and rate policy, lower dispersion…


Bottom Line: Global Asset Allocation

� Markets are relatively too calm, but appear to be at a crucial point.

� Equity market is still locked in a tight range, but breakout seemsimminent

� Equity volatility is unlikely to stay this low. We expect it to increasethrough the US election due to the global uncertainties (Brexit, next USrate hike…)

� EM has been one of the main beneficiaries from the risk appetiterevival following the Brexit vote. Nevertheless, we feel cautious abouthow resilient EM assets would be in the face of rising US rates.

� Looking ahead, fundamentals appear to have improved.. That hasrenewed speculation that the Fed could raise rates as early asDecember

� With elevated valuations and crowded long positioning in equ itiesand bonds, the market appears vulnerable to shocks over thenear term .

� Said another way, current market conditions imply small potentialreturns and big latent risks across almost all asset classes. Thus, weremain defensive in our asset allocation.

� The moral of the story? Be prepared for anything…

� We summarize our views as follows �


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Disclaimer


This writing is for informational purposes only and does not constitute anoffer to sell, a solicitation to buy, or a recommendation regarding anysecurities transaction, or as an offer to provide advisory or other servicesby FinLight Research in any jurisdiction in which such offer, solicitation,purchase or sale would be unlawful under the securities laws of suchjurisdiction. The information contained in this writing should not beconstrued as financial or investment advice on any subject matter.FinLight Research expressly disclaims all liability in respect to actionstaken based on any or all of the information on this writing.

About Us…

� FinLight Research is a research-centric company focu sed on Asset Allocation from a top-down perspective , on Portfolio Construction, and all related quantitative aspects and risk management issues.

� Our expertise expands along 3 axes:

� Asset Allocation with risk control and/or risk budgeting techniques

� Allocation to alternative investments : Hedge funds, rule-based strategies (momentum, value, carry, volatility), real assets (real estate, infrastructure, farmland, timberland and natural resources). Private equity and venture capital should be the next step…

� Allocation with a factorial approach built on the understanding (profiling) of the risk/return drivers of the different asset classes

� FinLight Research is an innovation-oriented company . We target to fill the gap between the academic research and the investment community, especially on real assets and alternatives. We survey on a continuous basis the academic literature for interesting published and working papers related to quantitative investing, non-linear profiling, asset allocation, real assets...


Our Standard Offer

Provide tailor-made quantitative analysis of your

portfolios in terms of asset allocation, risk profiling and risk contribution

Provide tailor-made quantitative analysis of your

portfolios in terms of asset allocation, risk profiling and risk contribution

•Risk Profiling

Offer a turnkey 3-step factor-based process in GAA

with factor selection, risk budgeting and

dynamic portfolio protection

Offer a turnkey 3-step factor-based process in GAA

with factor selection, risk budgeting and

dynamic portfolio protection

•Factor-based GAA Process

Provide assistance with alternative

investments (including real

assets) in terms of profiling, and

integration in a GAA

Provide assistance with alternative

investments (including real

assets) in terms of profiling, and

integration in a GAA

•Alternative Investments

Provide assistance with asset

allocation and related risk control

and/or risk budgeting techniques

Provide assistance with asset

allocation and related risk control

and/or risk budgeting techniques

•Global Asset Allocation (GAA)


Finlight Research - Market Perspectives - Oct 2016

Economy & Finance

Transcript of Finlight Research - Market Perspectives - Oct 2016