Finlight Research - Market Perspectives - Apr 2016

Market Perspectives

April 2016

Apr. 11th, 2016

www.finlightresearch.com

Who will win the tug-of-war?

“Pronounced fluctuations within the trading

range reflect primarily the tug of war between

a weakening global economy and continuing

liquidity injections from central banks and

corporate balance sheets”– Mohamed El-Erian

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� The more dovish than expected FOMC tone offered equities another leg up, pushed bond yields lower and a put a downward pressure on the dollar which supported oil prices, commodities and EM assets. BCE new round of QE helped Euro credit to recover from its mid-February drawdown, and offered risk assets some respite.

� Nevertheless, our perception is that monetary policy is having less

impact on markets and the real economy.

� We still see rising signs of stress in the financial system globally, with drivers including a worse growth/inflation mix, the maturing US credit cycle, and the risks of a Yuan devaluation and Brexit. We expect

macroeconomic volatility to remain high, other risk-off episodes during the year, and thus, stick to our long volatility positioning into 2Q

� We make minor adjustments to our asset allocation this month. Given the high equity valuations and the poor growth outlook factored in credit (specially US), we now prefer the latter (mainly IG).

� We reiterate our view that a perfect storm is building… It combines historically overvalued stocks with stretched government bonds. Unlike previous storms (2000, 2008), investors would be left with almost no

place to hide

� We reiterate our view that we are sailing a cyclical bull within a secular

bear. The current cyclical bull may go higher for longer. But, rising volatility and stalling earnings growth may indicate we are in the late stage of the cycle.

� We summarize our views as follows �


MACRO VIEW

� The Good

� Q4-2015 GDP was revised upward on Friday (1.4% up from the 1.0%). Consumers were the big reason

� US employment data show strength on every measure (labor participation higher, full-time employment versus part-time improving, and wages increasing). More individuals are getting off the sidelines and trying to find a job again.

� US manufacturing PMI data has finally steadied. The ISM Manufacturing index perked up to close back above the 50.0 level

� Manufacturing production in China increased for the first time in a year

� The Bad

� US Consumer spending disappointed in Jan and Feb. Durable goods orders declined.� Consumer confidence seems in a downtrend since mid-2015� In Q4-2015, corporate profits declined by 15% YoY

� The Ugly

� Main systemic risk resides in China: The credit bubble is unsustainable. Country’s debt-to-GDP ratio exceeds that of Japan at the time it entered into crisis in 1989. Chinese equities seem on the cusp of another impulsive sell-off. Further US dollar strengthening would oblige China to devalue its pegged yuan and accelerate foreign capital outflows.

� We still feel concerned about the credit market liquidity as turnover ratios are well below pre-crisis levels and the bid-ask spreads are much wider.



The Big Four Economic Indicators

� Industrial Production has been the weakest link in the economic recovery since the GFC� The current picture is characterized by relatively strong Employment and Income, a weak Industrial

Production (down in 9 of the last 12 months) 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

� The Industrial

Production indicator

has been revised to the

downside, mainly since

mid-2014.

� Its post-recession recovery peak stands now in Nov. ’14

� On a YoY basis, the IP indicator is now lower than at the beginning of all ten recessions since 1950.


GS – Global Leading Indicator (GLI)

� The March Final GLI came inat 1.6%yoy. Its MoMmomentum came at 0.23% (upfrom 0.20% last month)

� GLI has been in expansionaryterritory since September2015, according to lastestimates

� Seven of the ten underlyingcomponents of the GLIimproved in March

� This month’s data show a substantive shift in the GLI

� We continue, however, to

think that the acceleration

we’ve been witnessing since

Jan. ‘15 is quite modest for

a typical expansion phase


US GDP

� The Atlanta Fed's GDPNow

measure of current growth,

shows a sharp decline over

the last month

� As of Apr. 5th, their modelforecast for Q1-2016 real GDPgrowth (seasonally adjustedannual rate) stands at 0.4%(down from the alreadysluggish 0.7% on Apr. 1st)


US and Global Manufacturing

� The US Manufacturing sector (20% of the US economy) continues to endure its worst spell sincemid-2012, according to Markit US PMI (51.4 in March)

� The JPM Global manufacturing PMI continued its move down, touching 50, a level last seen duringthe Euro crisis in 2012


ISM Manufacturing & Services

� However, the ISM index for themanufacturing sector has finallymoved up to close back above thecritical 50.0 level, following regionalmanufacturing surveys

� The ISM Services Index should movea little higher, as well…

Source: Thomson Reuters


US Employment

� US employment data show

strength on almost every

measure

� Labor-Force Participation andEmployment/Population Ratioare now not only heading up,but seem to be accelerating…



US Employment

� Job growth shows a solidtrend.

� But the Conference Board

Employment Trends Index

(ETI) continues to show

signs of weakening

� According to this index, aslower growth should beexpected in the US labormarket, over the next quarters


Consumer Confidence

� Both the Conference Board'sconsumer confidence and , theMichigan Consumer SentimentIndex continue to trend lower,prolonging a downtrend that

actually began a year

ago.



Chinese Economy

� DB China Real activity index (average of 3ma growth rates in rail traffic, electricity output and steeloutput) stands at a level barely higher than during the GFC. Is it stabilizing? Probably…

� Industrial production growth would follow the same route.


Chinese Economy

� The private sector debt is skyrocketing. The current accommodative monetary policy should bemaintained in order to avoid a bubble burst.

� Yuan devaluation seems unavoidable and should lead to more capital outflows and lower FXreserves.


EQUITY

� In our February report, we argued that the sell-off of the beginning of the year was a correction in an exhausted bull market, rather than the beginning of the next major global bear market, and that the market was poised to bounce, as many indicators were pointing to oversold conditions.

� We see this bull market as tired and old, but not finished. Our target implies limited upside from here, but the S&P 500 may challenge its old highs before crashing.

� It’s worth noting that the rally since the lows of mid-February has been accompanied by strong breadth

readings in the S&P 50: 93% of its stocks were above their respective 50 dma� Nevertheless, we believe that this bounce will soon become an opportunity to sell into

� The stock market has been stuck in the same trading range for a while. Only earnings may spark a break in it.

� US earnings recession continues. For Q1-2016, earnings may have their worst growth since 2009 (-8.5% YoY). Analysts expect the Q1 to mark the bottom for earnings, and earnings growth to turn positive by Q3

� Stocks seem more vulnerable than ever to any external choc (Central Banks action, China, Crude oil…)

� Several signs may be interpreted as a reminiscence of what happened in the late-stage of previous economic expansions:� Large amounts involved in M&A activity and buybacks� Elevated levels reached on Debt/EBITDA for non-financial companies


EQUITY

� Our main scenario from here (80% chance) : A massive top forming around 2135 – 2170 :� US 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.� Recent data shows more evidence of lower productivity, lower potential GDP growth and (later)

higher inflation risk. � This is a bad scenario for stocks

� Our alternative scenario (20% chance) : The S&P500 breaks the 2135-2170 resistance, opening the way to 2225.


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 OW (as we did since the index broke above 1903) as long as the 2028 level

is preserved. We still target 2110 and probably a new high around 2150-2170� Below 2028, we’ll turn Neutral and stay so as far as the ‘09 trend (1800-1850) is preserved� Any clean break below the ‘09 trend would make us move massively to UW

� We like the low US beta. We remain Neutral on Europe and Japan vs. US despite the policy divergence between the Fed and the ECB/BoJ:� Given the significant yen strengthening (despite the BoJ’s move to negative rates in late

January), we have turned cautious on the EPS outlook for Japanese stocks� Brexit/migration concerns are expected to weigh on Eurozone� Weak demand from China is expected to continue to weigh on Japan's production and

exporters in Eurozone.

� We remain UW in US small caps vs large caps.

� We remain OW defensive vs. cyclical stocks, given the low and/or falling bond yields� We remain UW EMs vs DMs despite the recent EM outperformance. We expect another (alst

leg of USD strengthening. Negative spillovers from China (and RMB one-off devaluation) and Brazil will also likely have a strong impact on other Ems.


US Earnings

� The S&P500 stands within an earnings

recession. For Q1 2016, the estimated earnings decline is -8.5% YoY (-3.7% if energy is excluded).

� If the index reports a decline in Q1 earnings, it will mark the first time the index has seen four consecutive quarters of YoY declines since 2008/2009

� For Q1 2016, 94 companies have issued negative EPS guidance and 27 companies have issued positive EPS guidance.

� For all of 2016, the estimated S&P 500

growth rate is now projected at 2.2%

for earnings and 1.6% for revenues.

� But, Q1 earnings may surprise to the upside


US Corporate Profits

� Corporate profits are sliding. If this move is confirmed, the prospects for capex and employment will come under pressure

� US productivity is struggling. Q4-2015 productivity rose at a sluggish 0.5%.

� Productivity gains and higher prices are needed to absorb the ongoing

higher labor costs. In Q4 2015, employee compensation reached 53.6% of GDP, as unemployment rate dropped to a level consistent with full employment

� The current turning point in NIPA

Profits is pointing to a top

formation in the S&P 500 Index

within the near future


US Equities

� Since early 2015, US equities

have been driven by (forward)

P/E multiple movement, when forward earnings have been plateauing…

� A resumption of earnings growth going into 2016 will be necessary for equities to move substantially higher.

Source: Factset & Neuberger Berman


US Equities

� Equities have “gone nowhere” since early 2015. The beginning of the range has coincided with the beginning of the earnings recession

� It will require major news (on earnings, for example) to break this trading range

� But, at this stage, no earnings/revenue growth is projected (by analysts) before Q3-2016


US Equities

� The moves in the S&P 500 since last year have been closely related to US data

surprises (as summarized by the Citigroup’s US CESI Index)

� US CESI Index currently points to 2100

� Only a period (few months) of positive data surprises seems able to help the S&P 500 making new highs in 2016.


US Equities

� Large amounts have been involved in M&A activity and buybacks, since 2010

� Since then, stock buybacks have

been pulling the S&P500 higher

� But now, the buybacks trend seems to be exhausted…


Investors’ Sentiment

� We see this bull market as tired and old, but not finished…

� Despite the recent rally, investors’ sentiment is still not really bullish.

� On a contrarian basis and from a short-term perspective, this bullishness level points to further upside on US

equities…

Source: Bespoke


S&P500 – A Long-Term Perspective

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

� We see only a few quarters (during the dot.com bubble) with higher valuations� Valuation alone is very rarely a timing tool for a major market top� Nevertheless, all these indicators 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&P 500 – A Medium-Term Perspective

� Last month, we’ve mentioned a topping

pattern on the S&P500 (around its top of mid-2015 ~2135) that is similar to the one already formed in 2008.

� We’ve also said that for this topping pattern to be validated, the 2028 level must be preserved.

� Actually, the 2028 level was broken to the upside but the index is now heading to it again.

� We adjust our positioning rules as follows:

� We remain OW as long as the 2028 level is preserved. We still target 2110 and probably a new high around 2150-2170

� Below 2028, we’ll turn Neutral and stay so as far as the ‘09 trend (1800-1850) is preserved

� Any clean break below the ‘09 trend would make us move massively to UW


S&P 500 – A Short-Term Perspective

� Reminder: we’ve turned

from Neutral to OW on the

S&P500 as the index broke

above the 1903 level

� For now, we stay OW. But, we keep a cautious eye on the 2020 – 2035 range

� We will switch to a Neutral

stance as soon as this

range is broken to the

downside .

� It’s worth noting that oscillators are moving down which provides an additional reason to be cautious.


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has switched to massively short on Mar. 1st S&P500 close (@1978.35), but stopped its short position (and thus its losses) on Mar 11 (@ 2022)

� The model is now completely Neutral.

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FIXED INCOME & CREDIT

� Government bonds continued to move higher, but valuations are so stretched that it seems reasonable to keep away from the asset class.

� We expect 2 or 3 Fed hikes this year, when the market prices only one. We see US inflation higher over 6-12 months horizon, and see little reason for US 10-year yields to trade below current levels for long. Over the medium-term, we maintain our bearish directional view on duration in the US

� Tactically, however, we remain Neutral on 10y USTs as long as the 1.97 level is preserved. Above,

we’ll move to UW again. Our ultimate target on US 10y yields was revised down to 2.45 by H2-2016

� We expect realized rates volatility to remain elevated given the uncertainties surrounding the pace of Fed’s hikes, the easing interventions of the ECB, global growth data and the trend in inflation.

� We maintain our relative view of US Treasuries underperforming Bunds and JGBs

� Inflation data start to show some signs of revival in the US (but not in Europe). Breakeven mayhave structurally bottomed here. Reflation should gain the upper hand in H2-2016

� Thus, in the US, we expect an increase in the market pricing of long-term inflation. Inflationary signsshould be watched closely as they will foreshadow a steepening decline in Govies.

� Inflows into TIPS-related ETFs have been very strong in recent weeks, suggesting thatbreakevens have further room to widen

� We remain Neutral HICP Inflation as we expect breakevens to trade sideways in the Eurozone

� We remain OW on 10y-TIPS breakevens

FinLight Research | www.finlightresearch.com

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� More signs tend to show that the US credit market is already in the late-cycle stage. Credit quality is deteriorating, but at a measured pace. Financing gap has turned strongly negative, making corporates more and more dependent on external sources of liquidity.

� But low cost of funding and continued investor demand have kept the asset class afloat…

� We still expect more pressure on corporate ratings (particularly in troubled sectors like energy and materials) given the uncertain macro, revenues / earnings weaknesses, the deteriorating credit cycle, the rising idiosyncratic risk and the increasing net leverage.

� The rally in high-yield bonds has extended alongside a climb in oil and stocks, higher inflows, a drop in market volatility and an attenuation of global fears (global growth, CNY devaluation, equity earnings…).

� We remain concerned about the outlook for the US HY market, where default rates continue moving up and balance sheets are deteriorating. Renewed weakness in oil prices will bring this issue under the spotlights again.

� We expect volatility to stay elevated and think that an additional liquidity premium is needed to make HY attractive. A high volatility justifies wider spreads, in our view, even if default risk remains benign.

� We expect the focus on liquidity to remain. As said in previous reports, we feel concerned about the

credit market liquidity as the rate of turnover in corporate bonds has steadily declined since 2009, despite the huge inflows.


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� In our previous report, we’ve considered that the probability of an ECB corporate QE was relatively low (for technical reasons). We were proven wrong. The ECB expanded its policy of QE in size, and by the inclusion of corporate debt, as well.

� As a consequence, we missed the substantial move tighter in European credit but would not

chase it here. With central bank easing shifting from bonds towards credit, credit spreads should be more anchored. But, the ECB effect is already priced in and would be balanced by an increased corporate supply.

� With spreads already at past recession levels and already pricing a worse growth environment, we may see a better value in corporate debt (specially IG) than in equities.

� We prefer to trade up in quality. We still prefer IG over HY on a risk-adjusted basis as we expect volatility on spreads to remain elevated and we believe IG corporates better positioned to absorb the impact of rising rates and bad news from China

� We remain UW on HY and Neutral on IG, due to valuation, to rising volatility, to position within the credit cycle and given the weak total return forecast for credit as a whole.


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� Within the credit pocket, we remain Neutral on USD vs. EUR HY spreads, but we prefer USD on a

total return basis, despite its higher beta to energy sector.

� Within the HY pocket, we see a more favorable risk/reward tradeoff in the BB and B rating buckets

� We stick with our preference for US IG over Eurozone.IG, as we missed the recent ECB QE effect and think that more attractive spread valuations and higher carry should fuel a stronger bid for US credit.

� The rally in EM fixed income has gained momentum over the month, across both EM hard and local currency

� For long-term investors, EM bonds denominated in local currencies offer the most value,

especially for currencies that suffered the most against USD

� Bottom line : Neutral Govies, UW US vs Eurozone Govies, remain long flatteners on the US yield curve and short duration in 2y USTs, UW credit mainly through HY and Neutral on IG, Neutral Eurozone vs US HY credit, UW Eurozone vs US IG credit, OW 10y-TIPS and Neutral HICP Inflation, UW High Yield vs High Grade, Neutral on EM sovereigns with a little preference for local bonds


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US Govies & Inflation

� Despite the dovish tone from the Fed, westill expect 2 to 3 Fed hikes this year,(nominal) Us 10-year yields to go higherfrom their current level (~1.70) and inflationto rise over the coming months.

� Since mid-February bottom, nominal yieldsmoves were mainly driven by inflationexpectations.

� Real yields may continue to decline (asthey did year-to-date) due to further CBeasing and weak global growthperspectives.

� But we remain OW on 10y-TIPSbreakevens as we think that current pricingis too pessimistic and we see strong inflowsinto TIPS-related ETFs


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US Govies – 10y-UST

� Tactically, we remainNeutral on 10y USTs as

long as the 1.97 level is

preserved. Above, we’ll

move to UW again.

� Our ultimate target on US10y yields was reviseddown to 2.45 by H2-2016

� A base may developanywhere inside the 1.60-1.77 range.

� Only a retracement backabove 1.77 may confirmthat a base is already inplace.


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Credit – The Liquidity Issue

� We’ve seen signs of deterioration in some measures of liquidity since the GFC

� Average trade size for US credit, German bunds has declined 30% to 40% from pre-crisis. Is thata sign that the ability to execute trades in size (without affecting prices) is reduced?

� Actually, the daily average trading volume for US corporate bonds has increased by 40%, but thenumber of daily trades has doubled in the same time (because of electronic trading, among others)

� A more scaring signal: Trading volumes as a % of market size (market turnover) have fallen for mostassets, except US equities: -50%-60% on US credit versus 2005.


Average trade size

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US High Yield

� The rally in high-yield bonds has extended alongside a climb in oil and stocks, higher inflows, a drop in market volatility and an attenuation of global fears (global growth, CNY devaluation, equity earnings…).

� We remain concerned about the

outlook for the US HY market, where default rates continue moving up and balance sheets are deteriorating.

� Renewed weakness in oil prices

will bring this issue under the

spotlights again.


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EXCHANGE RATES

� We moderate our view for the dollar based on a more dovish FOMC rate path and tone.

� But, the dollar rally is not over. We continue to believe the USD should rally from current levels as the Fed normalizes its policy and the ECB / BoJ both move the other way.

� Historically, USD cycles have been persistent, lasting 5-6 years in the appreciation phase. We thus see further medium term USD gains against the major crosses (especially EUR) and expect a cyclical low in EUR/USD somewhere in H2-2016 (before the ECB tapering)

� Besides the Fed being in hiking mode, we expect the US dollar to be supported by the fears of a global recession, weaker-than-expected inflation dynamics and “Brexit” risks in Europe. The risks to our

view reside in delayed Fed action and disappointing ECB action. But we think that most of that is already priced in.

� During March, and according to our positioning rules on EUR-USD, we’ve moved from Neutral to OW as the spot broke above the 1.1060 resistance, and then to Neutral again above 1.1250

� Our positioning on EUR-USD remains driven by (almost) the same trading rules:� Remain Neutral within the 1.08 - 1.15 range� Move to OW if the spot breaks above the 1.15 resistance to target 1.165-1.17� Move to UW after a clean break below 1.08. Target = 1.0725 and then 1.04 to parity over 2H


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EXCHANGE RATES

� On USD-JPY, we turned from Neutral to UW in February, as the spot broke below the 113.50-

114 area.

� In our previous reports, we said “We think that this break below 114-113.50 may open the way for a much more impulsive decline towards 109.00”

� Now that our target has been reached and exceed, we turn to Neutral again and watch for

signs of near-term stability or basement somewhere between current levels (~108) and 106

� Only a clean break above 111 could make us turn to OW

� The more dovish tone from the Fed has certainly halted the USD’s rapid rise, giving EM currencies some respite (3 to 8% Ytd)

� 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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US Dollar Index

� After rising at the fastest pace onrecord in 2014, the US dollar hasbeen in a range over the last year

� We expect the DXY Index toremain rangy, and a bottom toform in the area between 92.5and 93.5.

� Our primary scenario remains areversal formation in the 92.5-93.5 area.

� Breaking this area to thedownside will open the door to amuch more substantialcorrection.


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EUR-USD

� Technically, the next area towatch closely is 1.145-1.15.Above, the spot may target 1.17-1.18.

� Over the short-term, we expect alocal correction towards 1.12before moving higher.

� Over the medium-term (2H-2016), we maintain our downsideprojections towards 1.04-parity.


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USD-JPY

� Last month, we turned fromNeutral to UW, as the spot brokebelow the 113.50-114 area,expecting a much more impulsivedecline towards 109.00.

� Our target has been reached

and exceed. We turn to Neutral

again and watch for signs of

near-term stability or basement

somewhere between current

levels (~108) and 106.

� Only a clean break above 111could make us turn to OW


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COMMODITY

� Commodity prices finally posted gains in Q1-2016, mainly driven by the fall in the US Dollar (due to the more dovish tone from the Fed), Chinese stimulus and the rebound of precious metals and oil.During the quarter, energy and metals show some revival, but agricultural and soft commodities were losers.

� 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 leg

down in prices to force capitulation� With contango structures, negative roll yields will continue to weigh on returns� US dollar strengthening should resume. Dollar will dictate both direction and velocity in commos� Despite the dovish tone from the Fed, the tightening cycle will continue in the US (with 2 or 3

hikes over 2016). Higher rates are usually bearish for commos as they put a higher cost oncarrying them in inventories

� China’s investment slowdown continues

� We don’t see any sustainable recovery without a pick-up in global growth or a substantial

shrinkage in supply. It is likely that supply destruction will be the main catalyst for the next recoveryin prices.

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


44

COMMODITY

� Bottom Line :

Energy:

� Oil remains a wild card but a bottom may be forming with supply/demand imbalances coming toan end by mid-2017

� Oil prices rallied, in large part due to a weaker US dollar (due to the dovish Fed tone) and somerelief in Chinese economy

� Fundamentals (oversupply, global inventories, mild growth and demand, OPEC failure to reach anybinding production cuts, Iran return to markets) continue to put pressure on prices.

� We think that the bottom is in for oil, but we don’t expect a significant rally from current

levels (~$40 for WTI). We expect the spot to test again the 25-30 area before putting in apermanent rebound

� We expect oil to remain within the US$25-45 range for a while, and volatility to persist.

� According to our positioning rules, we’ve switched from OW to Neutral as WTI broke above 39

� We’ve adjusted our tactical rules accordingly:� Remain Neutral if the spot stays between 35 and 48� Turn UW below 35� Move to OW if the WTI breaks above 48 or below 29.


45

COMMODITY

Precious Metals:

� Gold just finished the best quarter in three decades with 16.41% in Q1� The rally was mainly due to mild US growth perspectives, a weaker USD dollar, lower US real yields and

higher perceived risks in the global financial system� Outlook for precious metals continues to be dominated by the potential hiking pace of the Fed

and the subsequent impacts on US dollar and real yields.

� Stronger US dollar and higher real rates should drive gold prices lower� At this stage, we think that gold / silver are still due for a final leg down. Our ultimate target was

raised to 1000 – 1040 on gold and 12.5-13 on silver.� The gold-to-silver ratio moved higher to near 80 (close to its highs over 15 years), increasing the

divergence between the two metals. As an industrial precious metal, silver continues to be disadvantaged by current concerns about global growth.

� We’ve been OW gold since the spot broke above the 1070-1120 range. Our view was confirmed when the 1200 threshold was broken.

� Tactically and given the impulsive move we’ve seen over the last 2 months, it seems reasonable to

turn Neutral here and watch for a clean break above 1270 to become OW again� Our positioning rules are adjusted as follows:

� Remain Neutral between 1180 and 1270� Turn UW if the spot breaks below 1180� Go OW below 1070 and above 1270 (to target 1380 – 1420)� We will wait for 1050 to progressively start accumulating Gold.


46

COMMODITY

Base Metals:

� We continue to expect industrial metals price weakness due to a combination of excess supply and weak demand

� The developments surrounding Chinese economy will continue to dictate prices in 2016

� Metals prices have rebounded even as fundamental conditions have not improved. The recent priceincreases are more a technically-driven move, mainly linked to the last round of Chinese easing.

� From our point of view, lower prices are still needed to oblige producers to cut production and to

rebalance oversupplied markets.

� We forecast one last leg down in metals prices and decide to move to UW on base metals.

Agriculture:

We think that weak grain prices are here to stay. There are no fundamental reasons for cereals pricelevels to change, given the given large inventories in place and the fact that El Niño effect on markets isalready incorporated in price expectations.

The risk to our view is some new major weather events weighing on grain harvests

� We continue to believe in a limited downside to grain prices from here when upside seems veryinteresting, especially for a medium-to-long-term investor.

� At this stage, we choose to remain Neutral


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Crude – Supply-Demand Imbalances

� Oil production still shows a

substantial surplus. Accordingto EIA data, the supply-demandgap still stands around 2 millionbarrels a day

� US production has declined fromits peak last summer, but thisdecrease was more than offsetby production increases fromOPEC and Russia.

� The EIA expects the imbalance

to narrow down substantially

in H2-2017. In the meanwhile,oil prices should remain rangy.

� The Russia-OPEC freeze is notsupposed to change the picture,as they just agreed to freezeproduction at record highs


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Crude – Tech. Perspective

� According to our positioningrules, we’ve been OW on crudesince Jan. 19th, beforeswitching to Neutral as the

WTI broke above 39 mid-

March.

� Key support levels to watchstand at 35.98-36.17. We needto break below to call for anothertest of the 25-29 range.

� We’ve adjusted our tactical rulesaccordingly:� Remain Neutral if the spot

stays between 35 and 48� Turn UW below 35� Move to OW if the WTI

breaks above 48 or below29.


49

Precious Metals - Gold

� Gold prices have continued tomove with real rates

� The recent dovish tone from theFed, the continued central bankeasing (BCE, BoJ, PBOC), andslowing growth expectations areall positives for gold.


50

Precious Metals - Gold

� On gold, the commitment oftraders shows 2 things:

� Commercial traders (who

tend to be correct) kept /increased their high shortinterest, pointing to a futureprice drop.

� Speculators (small andlarge) are heavily on thelong side.


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Gold – Tech. Perspective

� We’ve been OW gold since

the spot broke above the

1070-1120 range. Our view was confirmed when the 1200 threshold was broken.

� Tactically and given theimpulsive move we’ve seenover the last 2 months, it

seems reasonable to turn

Neutral here and watch for aclean break above 1270 tobecome OW again

� Our positioning rules areadjusted as follows:� Neutral between 1180

and 1270

� Turn UW if the spot breaksbelow 1180

� Go OW below 1070 andabove 1270 (to target 1380– 1420)


52

Base Metals

� Base Metals index has beenmoving in line with ChinaIndustrial Production


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ALTERNATIVE STRATEGIES

� The HFRI Fund Weighted Composite Index posted gains of 1.8% in March. Gains were led by Equity Hedge (as equities reversed steep losses from the first half of Q1), EM strategies, Event Driven and Relative Value strategies (supported by dovish central banks)

� CTAs bad performance (-2.8% in March, +2.2% Ytd) was mainly driven by their defensive positioning (long fixed income, neutral equities, short energy and long JPY) that suffered during the market rebound. Year to date, CTAs are still leading the way.

� We expect Global Macro funds to be the prime beneficiaries from a change in the Fed’s stance (to hawkish) as they remain long USD and short on commodities.

� In a world where most assets seem highly correlated, the potential for diversification has been limited.� We believe that diversifying portfolios with an increased allocation to alternatives is particularly

attractive at this stage of the cycle, given the current macroeconomic and interest rate uncertainties. The volatile current market environment, mixing powerful trends and sharp reversals, clearly favors CTAs

� We stick to our preference for risk diversifiers (pure alpha generation strategies) over return enhancers. � These strategies offer an interesting risk/return tradeoff, help buffer market shocks and offer

decent returns in rangy markets� We think that the divergence between the Fed and ECB monetary policies (and its subsequent

impacts on US dollar, commodities and Govies) is supportive for CTAs and Global Macros on which we remain overweight


54

ALTERNATIVE STRATEGIES

� We are not changing our recommendations on alternatives which we consider to be suited to current market conditions / dislocations .

� We maintain our OW positioning on:� Equity Market Neutrals both for their “intelligent” beta and their alpha contribution. � CTA’s and Global Macro as a diversifier and tail hedge. � Vol. Arb strategy and prefer funds that trade volatility globally (all assets / all regions). This is our

way to take advantage from the higher volatility regime.


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Volatility

� The number of spikes in implied volatility for US, European equities and FX has trended up, reaching a top since the GFC

� This is an additional proof of the volatility regime change we pointed in early 2015.


56

HF Exposure to Risky Assets

� Hedge fund strategies remain cautiously positioned on risky assets: The median equity beta on the Lyxor platform has recovered since its lows in mid-February , but is still well below its long-term average (~23%)

� In the current (volatile) context, hedge funds try to capture directionality through dynamic positioning and relative-value trades


Bottom Line: Global Asset Allocation

� The more dovish than expected FOMC tone offered equities another leg up, pushed bond yields lower and a put a downward pressure on the dollar which supported oil prices, commodities and EM assets. BCE new round of QE helped Euro credit to recover from its mid-February drawdown, and offered risk assets some respite.

� Nevertheless, our perception is that monetary policy is having less

impact on markets and the real economy.

� We still see rising signs of stress in the financial system globally, with drivers including a worse growth/inflation mix, the maturing US credit cycle, and the risks of a Yuan devaluation and Brexit. We expect

macroeconomic volatility to remain high, other risk-off episodes during the year, and thus, stick to our long volatility positioning into 2Q

� We make minor adjustments to our asset allocation this month. Given the high equity valuations and the poor growth outlook factored in credit (specially US), we now prefer the latter (mainly IG).

� We reiterate our view that a perfect storm is building… It combines historically overvalued stocks with stretched government bonds. Unlike previous storms (2000, 2008), investors would be left with almost no

place to hide

� We reiterate our view that we are sailing a cyclical bull within a secular

bear. The current cyclical bull may go higher for longer. But, rising volatility and stalling earnings growth may indicate we are in the late stage of the cycle.

� We summarize our views as follows �


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Disclaimer


This writing is for informational purposes only and does not constitute an

offer to sell, a solicitation to buy, or a recommendation regarding any

securities transaction, or as an offer to provide advisory or other services

by FinLight Research in any jurisdiction in which such offer, solicitation,

purchase or sale would be unlawful under the securities laws of such

jurisdiction. The information contained in this writing should not be

construed as financial or investment advice on any subject matter.

FinLight Research expressly disclaims all liability in respect to actions

taken based on any or all of the information on this writing.

About Us…

� FinLight Research is a research-centric company focused 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)


Date post:	22-Jan-2018
Category:	Economy & Finance
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Finlight Research - Market Perspectives - Apr 2016

Economy & Finance