Finlight Research - Market Perspectives - Jul 2016

Market PerspectivesJuly 2016

Jul. 6th, 2016

Post-Brexit: Week Two

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Don't Be Fooled By Optimism!

“Brexit is the thumb pulled from the hole in the

dike”– Lawrence Fuller

“Brexit could be followed by Grexit,Departugal, Italeave, Czechout, Oustria,Finish, Slovakout, Latervia, Byegium. Only

Remania will stay.”– Anonymous

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� One of our 2 potential Black Swans of 2016 has arrived: Brexit. Friday, June 24was a rough day for risk. Gold, Yen and Bitcoin performed best as ‘risk off’ hedges

� No one knows for sure what the economic implications of the UK 's Leavevote will be , but there is a general consensus that it will not be good

� The only certainty is that the UK ‘Brexit’ decision adds another complex layer ofuncertainty to all markets and may weigh on the already lethargic DM economies.

� Following the UK Leave vote, the sell-off episode was rather time-limited and thesurge in volatility was somewhat contained. After a roller coaster ride, we're backwhere we started. But, do not be fooled by optimism…

� Our view is that euphoria won't last too long . The rather violent rally we arewitnessing will run out of steam soon.

� The market remains expensive and needs increased earnings t o move higher .The world economy is more fragile than ever. But the less appealing the UK andEurozone markets appear, the more appealing the US market will be perceived.

� A key concern at this stage remains the lack of diversificati on as most safeassets appear too stretched. Even bonds have become a driver of market fragility

� We reiterate our view that a perfect storm is building… After several years ofequities and bonds rallying together, both are expensive and vulnerable to shocks.Investors would soon be left with almost no place to hide

� We think that investors, by the end of 2016, will begin to price in a recession in2017 as the labor market weakens and corporate profits fail to recover.

� We expect the summer to be volatile and recommend not adding r isk andkeeping a cautious eye on market development.

� We make minor adjustments to our asset allocation this month, except on Goviesand Gold where we’ve turned OW.

� 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 stallingearnings growth may indicate we are in the late stage of the cycle.

� We summarize our views as follows �


MACRO VIEW

� The Good� The consumer confidence index (not taking into account the Brexit vote) rose in June to an 8-

month high (98 versus the prior reading of 92.4) � Personal spending increased 0.4% MoM (5% YoY). � The ISM manufacturing report was strong.

� The Bad� The UK leave vote (one of our black swans of previous months) won the battle� With yields below their previous all-time lows, US 10 year bonds are saying nothing good

about the US economy� The slump of business spending continues.� Banks reaction to Brexit vote was simply impressive . Smart money is probably expecting

huge write-downs in goodwill, big losses on “remain” bets or a coming recession.

� 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 big one …

� 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

� 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 8 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.


ISM Manufacturing

� The ISM manufacturing report was strong.

� At 53.2 (vs 51.3 in May), it looks consistent with GDP growth of above 3%. � New orders increased to 57, new export orders rose to 53.5 and production increased to 54.7


Business Spending

� The slump of business spending continues

� Durable goods orders declined by 2.2% YoY.

� Core capital goods ( nondefense, excluding aircraft) is a key measure of business spending. It has been declining since Sep. ‘14. It’s now down 3.6% YoY, and 12.3% lower than its top reached in Mar. ‘12.

� Core capital goods shipments fell 3.4%, the 10th straight month of contraction, while new orders were down (-2.6%) for the 16th time out of the past 19 months.


Business Investment

� Business investment was soft. It stands at recessio nary levels.

� Commercial real estate dropped 7.9%, declining for the 3rd consecutive quarter� Equipment purchases (at -8.7%), declined for the 2nd consecutive quarter.


Inventories

� US inventory-to-sales ratio has reached post-Lehman crisis levels,

� A double reason for that:� Inventories have ballooned

at historically high levels� Sales continue to disappoint


GS – Global Leading Indicator (GLI)

� The June Final GLI came in at2.2%yoy. Its MoM momentumcame at 0.35% (above lastmonth’s 0.26%)

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

� Eight of the ten underlyingcomponents of the GLIimproved in June

� We continue, however, tothink that the accelerationwe’ve been witnessing sinceJan. ‘15 is quite modest fora typical expansion phase


EQUITY

� Equity markets recovered sharply last week, reversing the Brexit week’s losses. But banks stocks in Europe lagged, which is a bad signal.

� We continue to see this background overall as negat ive for equities and think little of it is priced in already.

� The common belief is that direct impact of Brexit on US / European corporate profitability will likely be contained. But we fear the second order effects due to contagion through political, economic and financial channels.

� Despite the Brexit, the lack of yield elsewhere (with German 10-year bund yields at -6 bp and approximately 30% of the JPM Global Bond Index value already at negative yields) is clearly providing support for equities.

� But, earnings will prove to once again be the key. Any breakout to the upside will prove to be unsustainable in the absence of a real improvement in corporate earnings prospects. Therefore, it is critical to pay attention to what the earnings pict ure shows.

� We see this bull market as old, tired, but not fini shed . We still expect a final leg higher. Technicalsare supportive for a re-test of the highs and even for a (limited) breakout ride…

� An ultimate surge to the upside, before succumbing to the gravity of valuations…


EQUITY

� To sum up, we see limited upside from here, but the S&P 500 may challenge its old highs before turning decisively south (unless we get a new round of QE). The bounce will soon become an opportunity to sell into

� Any substantial move to the downside would be exacerbated by unwind of equity exposure in systematic strategies (Volatility Targeting, Risk Parity, CTAs)

� Our scenarios remain unchanged.

� Our main scenario from here (80% chance) : A massiv e 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. Such a breakout would need a new round of QE and/or a new impulse to earnings growth


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 long as the 2075 level is preserved. We still target new highs around 2150-2170

� We will turn Neutral if the spot breaks below the 2060-2075 range� We will switch to UW as soon as the 2000 – 2010 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 vs. US. � The weakness of earnings combined with the uncertainty newly injected in the UK and Euro area

should imply a substantial correction for European equities. Thus, we move UW Europe vs US.

� We remain UW in US small caps vs large caps. � We remain OW defensive, high dividend and value sto cks vs. cyclical stocks.

� We remain UW EMs vs DMs despite the recent EM outperformance. We expect another (last) leg of USD strengthening. Negative spillovers from China (and RMB one-off devaluation) will also likely have a strong impact on other EMs.


US Earnings

� The S&P500 stands within an earnings recession. For Q2 2016, the estimated earnings decline is -5.3% YoY (-1.8% if energy is excluded).

� If the index reports a decline in Q2 earnings, it will mark the first time the index has seen 5 consecutive quarters of YoY declines since 2008/2009

� For all of 2016, the estimated S&P 500 growth rate is now projected at 0.6% for earnings and 1.7% for revenues.

� For Q2 2016, 81 companies have issued negative EPS guidance and 32 companies have issued positive EPS guidance

� Analysts still expect earnings growth and revenue growth to return in the second half of 2016


US Earnings

� Earnings growth has reached new lows

� Since the start of the financial crisis the rate of growth of profits globally has

� weakened significantly (see Exhibit 2) and valuations have increased to high

� levels


US Sales

� The Price/Sales ratio is near levels last seen during the 2000 bubble, and well above 2007 levels.

� Bulls would explain high P/S levels by elevated operating margins


US Margins

� But even operating margins do not look high enough , compared to 2007 local top, to explain the current P/S levels.

� Moreover, the already large gap between operating margins and reported earnings looks typical of recessionary environments…


Post-Brexit Effect

� With the UK leave vote, European bank stocks just experienced their worst 2-day plunge ever.

� It isn’t just a few UK banks whose stocks have collapsed but the entire index!

� -20% was the “standard” move.

� Besides this immediate sanction, serious concerns are raised about the risk of contagion .

� Contagion could be political (with Anti-EU populist parties calling for the same vote in other countries), but also economic (with an increased uncertainty on trade, corporate earnings, credit, economic growth) and financial (through leverage, among others)


Brexit Financial Impact

� Financial contagion is linked to direct (costs of moving activities to the Continent, cost of raising capital) and indirect (weaker economic growth, lower rates, degradation in credit quality, impact on the real estate market…) impacts on banks.

� Financial contagion could materialize if the banking sector continues to see significant weakness and spread into Eurozone periphery

� At this stage (given the move on the iTraxx Europe Sub Financial Index), the impact seems more on margins and profits than on solvency.


Banks Valuation

� Banks continued to show a sharp valuation discount relative to the market.

� In such an uncertain context, we remain Neutral on Banks . Going UW is touchy given the recent underperformance and the extreme levels reached on the forward P/E ratio.

� We remain more cautious on European banks, projecting cuts in EPS due to weaker GDP growth and uncertainty around passporting of financial services in the post-Brexit era.


Earnings Payout Ratio

� In order to continue to offer attractive yields, companies are paying a larger proportion of their earnings.

� The earnings payout ratio looks already stretched

� Current dividend yields appear less and less sustainable, even when excluding resources/commodity stocks


Household Equity Holdings

� Two much money has flown in equities since the GFC.

� Despite the weak fundamentals, with corporate earnings contracting for the 5th quarter in a row:

� Mutual fund cash balances remain low (2.4% as of end of April)

� Household equity exposure is close to 2007 highs.

� A double-digit correction should be expected in the near term.


Global Liquidity

� Global liquidity, as measured by Bank of America Global Liquidity Tracker, went negative in July of 2015 (just before a double-digit correction on the S&P 500 and Yuan devaluation). Since then, this liquidity indicator has continued to decline at an increasing rate.

� Negative liquidity means that money is flowing out of the system


S&P500 – A Long-Term Perspective

� Despite the fact that we’re running into 5 straight quarters of earnings contraction, the S&P500 is still flirting with its historical highs.

� The market cap to GDP (known as Buffett's) indicator points to the second highest valuations we've ever seen .

� Markets would have been unable to hold up without central bankers activism.


S&P 500 – A Medium -Term Perspective

� The uptrend from Mar. ‘09 lows is the most important level to watch on the S&P500.

� It stands at around 1800-1850.

� Below, we will enter a new era on stocks…


S&P 500 – A Tech Perspective

� Reminder: we’ve turned from Neutral to OW on the S&P500 as the index broke above the 1903 level

� Over June, and according to our positioning rules, we’ve been OW, Neutral, OW again, Neutral, UW, Neutral and again OW!

� For now, we stay OW , as we see the index ready to resume its uptrend. We expect a final leg up (target ~ 2160 - 2170!).

� Important ranges to watch are 2060-2075 and then 2000 – 2010

� From here, we will turn Neutral if the spot breaks below the 2060-2075 range

� We will switch to a UW stance as soon as the 2000 – 2010 range is materially broken to the downside.


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has turned massively short on Jun 6 (SPX @ 2109.41), then massively long on Jun 24 (@2037.3 ) and Jun 27 (@2000.54).

� Since Jun 30 (SPX @ 2098.86), the model is again flat to modestly short, targetin g 2083 and 2062

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FIXED INCOME & CREDIT

GOVIES

� The Brexit turmoil has pushed central banks of DMs to adopt a more dovish stance.

� The July Fed’s rate hike is most likely off the table. The market is now pricing only one increase in 2H-2016.

� US 10-year yield has broken below its all-time historical lows (of 1.39% during 2012) and is now well below the panic levels reached after the Brexit vote.

� More than 30% of the JPM Global Bond Index value already has negative yield. 30% of European corporate bonds also show negative yields.

� The significant rally and flows into bonds are saying nothing good about the US economy

� Given the current low level of bonds yields, stretched valuations and reduced (if not negative) carry, bonds have become more exposed than ever to a “rate shock”. Bonds are now a source of risk and a driver of market fragility.

� Tactically, and according to our positioning rules (please see our previous MP), we moved to OW on 10y USTs as the 10y yield broke below 1.65.

� We expect realized rates volatility to move up from its current (low) level, given the uncertainties surrounding the pace of Fed’s hikes, the easing interventions of the ECB, Brexit impacts, global growth data and the trend in inflation.

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

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INFLATION-LINKED

� After reaching multiyear lows in mid-February, US TIPS breakevens widened through April as energy prices recovered. Since then, breakevens have narrowed and are now back on their levels at the beginning of the year.

� Last month, we’ve turned from OW to Neutral on 10y- TIPS breakevens. We look for US inflation to continue to firm, but expect risk aversion (due to Brexit outcome) to keep breakevens near their current levels in 2H16

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

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

CORPORATE CREDIT

� The big picture remains unchanged.

� More signs tend to show that the US credit market i s 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 keep our bias towards higher quality. Any unpriced rate hike (and/or dollar strengthening) would weigh on low quality bonds (High Yield and EM debt)


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� European credit reversed partially its initial widening as Brexit-induced fears faded in only two days. But now, these fears are resurging again.

� The Leave decision will likely weaken the macro outlook, both in the UK and the Euro area. We think markets are still not pricing in the entire risk of Brexit, and forecast spreads wider across the board. .

� Credit markets underperformed equities over the past months. But we still see a better value in corporate debt (specially IG) than in equities, as spreads already price a worse growth environment.

� 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 on global growth.

� 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.

� Given the large carry differential between the US and other DM markets and negative yields on Goviesin Europe / Japan, we expect the foreign bid to be very supportive for US HG credit , especially if less M&A induces a lower primary bond supply.

� Adding Brexit-related uncertainties to the global picture makes us prefer US vs European credit


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

� We expect the focus on liquidity to remain. As said in previous reports, we feel concerned about the credit market liquidity a s the rate of turnover in corporate bonds has steadily declined since 2009, despite the huge inflows.

EM DEBT

� The dollar strengthening that we 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 : OW 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, UW Eurozone vs US in IG & HY credit, Neutral 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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Brexit Impact on Rates Policy

� At the beginning of the year,the Fed was predicting fourrate hikes for 2016.

� The picture has completelychanged since then.

� While a rate hike is stillpossible, it appears to beincreasingly unlikely afterthe Brexit vote

� For the first time,tightening appears as lesslikely than easing .

� Guys, we got…


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US Govies – Rate Volatility

� Given the current low level of bonds yields and stretched valuations, bonds have become moreexposed than ever to a “rate shock”.

� GS produces 2 very interesting charts putting into perspective the recent increase in rate volatility :� The first shows the number of days over the prior year with daily moves (positive or negative) of 2

and 3 standard deviations (using 1-year rolling windows)� >>> At the end of 2015, Govies had experienced more extreme days t han during the

financial crisis� The second shows the number of days over the prior year with daily moves of positive and

negative 3 standard deviations� >>> At the end of 2015, days with large negative moves exceeded (i n number) those with

large positive moves in a way never seen before (since 86)


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IG Credit

� The gap between USD and EUR corporate credit is stillwidening.

� We’ve been OW US IG over Eurozone .IG for a while, now.

� We continue to see better macro fundamentals in the US, compared to Europe.

� We also see the foreign bid for US credit to continue, providing support to USD spreads (vs EUR spreads)

� The Leave vote has exacerbated this view .


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US Govies – 10y-UST

� We’ve been wrong AGAINon Govies!

� We were expecting a baseto develop somewhereinside the 1.65-1.77 range

� Our ultimate target of 2.45by H2-2016 seems moreand more unrealistic.

� Tactically, and according toour positioning rule, wemoved to OW as the 10yyield broke below 1.65.

� We’ll turn Neutral againabove 1.65 and as long asthe 1.90 level is preserved.

� We’ll move also Neutralaround 1.25-1.28

� Above 1.90, we’ll move toUW.


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EXCHANGE RATES

� The long-term dollar bull trend is not over . 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)

� We’ve already moderated our view for the dollar as the (dovish) Fed has kept pressure on it, capping any higher yields attempts. But, we still expect the US dollar to remain on the stro ng side (vs most DM currencies + Yuan, except the Yen), at least for 2 reasons:

� The large carry differential between the US and other DM markets, combined with negative yields on Govies in Europe / Japan, is moving money into US Treasuries, pushing the US dollar higher against most currencies.

� The flight-to-safety sentiment induced by the Brexit-induced uncertainties

� Last month, we’ve moved to UW on EUR-USD as it broke below 1.13 . We remain UW for the moment

� Our positioning rules remain unchanged:� Move to Neutral within the 1.14 - 1.165 range� Move to OW if the spot breaks above the 1.165 resistance to target 1.18� Remain UW below 1.14. Target = 1.08 and then 1.04 to parity over 2H


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EXCHANGE RATES

� On USD-JPY, we’ve been watching for signs of near-term stability or basement somewhere between108 and 106. But the 105.75 – 106.00 area (please see our previous MP) was broken to the downsideand we moved from Neutral to UW (targeting 102), according to our positioning rules.� In our June MP, we said “Such a breakout would indicate that Japan's fiscal and monetary

stimulus is doomed and induce a risk-off behavior globally”� Since then, the target of 102 was reached. And we decided to turn Neutral again .

� Our positioning rules on USD-JPY are adjusted as follows:� Remain Neutral below 106.6� Move to OW above

� 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

� The US dollar has been in arange over more than a year

� Two months ago, we said: “Likethe advance in oil, the recentdecline in the USD was extreme,but an impulsive reversalseems to be imminent. Ourprimary scenario remains areversal formation in the 92.5-93.5 area…”

� The expected reversal hasoccurred. The index has alsobroken from a downward slopingchannel started off the Dec. ‘15highs. Next target ~97.10. Onlya break above would open theway towards 99-100

� Breaking the support level of 92.7to the downside will open thedoor to a much more substantialcorrection.


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EUR-USD

� In our Monthly Report for May‘16, we said “The picture onEUR-USD is not clear. But, givenour view on the DXY index, weexpect a downtrend to developfrom here… To gain confidencein such a scenario, the spotneeds to break below 1.13.”

� Last month, we moved to UWafter the clean break below1.13.

� We remain UW for the moment.We will move to Neutral above1.14, and to OW if the spotbreaks above the 1.165resistance to target 1.18

� Over the medium-term (2H-2016), we maintain our downsideprojections towards 1.08-1.04-parity.


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COMMODITY

� The EU Leave vote has driven gold prices higher and industrial commodity prices lower� We don’t see any sustainable recovery without a pic k-up in global growth or a substantial

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

� 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 in commos.We expect the stronger dollar to put downward pressure on commodities despite supportivefundamentals for some of them

� We may have a summer sell-off as was the case in both 2014 and 2015.

� 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:

Oil prices have been generally higher lately, driven largely by news of falling oil inventories in the U.S. Themove has been countered by the short-term concerns about growth following the UK’s Brexit vote� Oil remains a wild card but a bottom may be forming with supply/demand imbalances coming to an

end by mid-2017� Oversupply still a major problem, despite the recent tightening. the market is still producing about

500,000 barrels a day above demand. That doesn't include the loss of supply from Canadian and Nigerian outages

� We think that the bottom is in for oil, but we don’t expect a significant rally from here. A pullback fromcurrent levels (~$50 for WTI) seems even needed to digest some of the recent gains.

� We even expect the spot to test again the 25-30 area before putting in a permanent rebound� We expect oil to remain within the US$25-45 range for a while, and volatility to persist.

� Our positioning rules on crude remain unchanged:� We remain Neutral as long as the spot stays within the Feb chan nel (currently at 45 – 53)� Turn UW below the channel support� Move to OW on a clean break above the channel resistance or below 29.


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COMMODITY

Precious Metals:

Outlook for precious metals continues to be dominat ed by the Fed dovish tone, the Brexit-induced fears, and the subsequent impacts on US dollar, rea l yields and sovereign credit.

� The recent rally in gold seems closely linked to the move on UK CDS spreads. Gold is reaffirming its status as a safe-haven

� As the flight-to-safety sentiment and downside bias in interest rates are likely to be persistent, we turned (according to our positioning rules. Please see previous MPs) OW on Gold as it broke above 1295 .

� We feel, however, cautious about the sustainability of the recent rally as Spec net long positons are reaching extreme levels.

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

raised to 1000 – 1040 on gold and 12.5-13 on silver. The main risk to our scenario is the resurgence of DM sovereign risk (starting with UK?).

� Our positioning rules are adjusted as follows:� Remain OW above 1295, targeting 1367 and even 1457� Go Neutral again between 1200 and 1295� Turn UW if the spot breaks below 1200� Go OW below 1070


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COMMODITY

Base Metals:

� Metals prices have rebounded in June but have been rangy since February.

� We remain UW on base metals on continuing excess supply. The recent price increases are more atechnically-driven move, mainly linked to the last round of Chinese easing. So when China's stockpilingends, these metals will go south

� From our point of view, lower prices are still needed to oblige producers to cut prod uction and torebalance oversupplied markets.

� 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

� In base metals, we still foresee weakness in copper in particular, as it appears to be on of the mostoversupplied markets.

Agriculture:

� In our previous MP, we said: “The recent sharp rally in grains may not have far to go, because ofglutted markets especially on soybeans and corn.”. The S&P GSCI Agri TR Index posted a -5% loss inJune.

� Wheat prices tumbled to a 9-year low, and corn futures plunged too (-19% from mid-June highs), afterthe US raised hopes for domestic supplies of both grains.

� We choose to remain Neutral on Agris, with a little preference for Soybean


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Precious Metals – Gold Spec Positioning

� Speculative (net longs)positioning in Gold has reachedits highest level since the CFTCstarted to publish its statisticsback in 2006.

� This is probably driven by themore dovish than expected Fedtone in June.

� Such an extreme level seemsunsustainable, despite the Brexit.The net longs are due for aliquidation.

� The next sign of exhaustion ingold trend would induce astrong wave of selling by ETFand trend-followers .


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Gold as a Safe-Haven Asset

� With the Brexit, gold has reaffirmed its status as a safe-hav en.

� Since the end of 2015, its moves have been highly correlated with the UK sovereign credit


Gold

UK 5y-CDS Sen.

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Precious Metals – A Relative-Value View

� The Gold-Silver ratio has broken its primary uptrend from Nov. ‘12. It even seems to be extending its move to the downside.

� This is usually Bullish for Gold

� Given the current technical picture for Gold, breaking above 1368 (and then targeting 1457) seems a possibility over the short-term.


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Crude – Tech. Perspective

� According to our positioningrules (please see our previousreport), we’ve remainedNeutral since the WTI brokeabove 39 mid-March.

� Our tactical rules areunchanged:� Remain Neutral as long as

the spot stays within theFeb channel (currently at 45– 53)

� Turn UW below the channelsupport

� Move to OW above thechannel resistance or below29.


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ALTERNATIVE STRATEGIES

� Hedge funds remarkably navigated the shockwave due to the UK Leave vote� The HFRI Fund Weighted Composite Index posted gains of 0.8% in June. Gains were led by Macro

strategies (+3.0% MoM) that posted their strongest monthly gain in over five years

� Brexit-induced fears strongly supported CTAs, the c lear winners in the recent risk-off phase.� CTAs were the best performing strategy over June (+4.4% MoM), filling up for most of their recent

losses � CTAs made the most from their defensive positions: longs in European, UK and US Govies� CTAs also gained on their shorts in USD-JPY, on theirs longs on gold, as on their short exposure to

Japanese equities. � Most CTAs managed to capture the uptrend in USD, especially vs. the Euro and GBP.

� Global Macro performance was hit by the shift in mo netary stances . � Managers posted losses on their short positions on the long end of the US, Japan and European

curves. � Macro funds also lost money on their shorts in JPY vs USD and their long exposure to Japanese

equities (opposite positioning of CTAs). Their shorts on GBP contributed positively to the performance.

� Equity Market Neutral funds prove resilient across all regions


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ALTERNATIVE STRATEGIES

� 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.

� 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), like Brexit-induced fears are supportive for CTAs and Global Macros on which we remain overweight

� We reiterate our OW rating on :� Equity Market Neutrals both for their “intelligent” beta and their alpha contribution. � CTAs: We like CTAs as a diversifier in portfolios, a good hedge during risk aversion episodes.

Furthermore, we expect new trends to emerge from here…

� 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 (HFRI RV: Volatility Index: +2.1% MoM, +1.7% Ytd) and prefer funds that trade volatility globally (all assets / all regions). This is our way to take advantage from the higher volatility regime.


50

Managed Futures / CTAs

� CTAs were defensively positioned going into the Brexit vote

� Their gains came mainly from

� their long exposure to DM bonds (especially in 10y-USTs).

� Their longs in USD, especially vs. the Euro and the GBP.

� The behavior of CTAs post-Brexit is exactly the one we’ve been promoting for so long.

� We keep our OW on risk-diversifiers.


Source: SG CTA Index

Bottom Line: Global Asset Allocation

� One of our 2 potential Black Swans of 2016 has arrived: Brexit. Friday, June 24was a rough day for risk. Gold, Yen and Bitcoin performed best as ‘risk off’ hedges

� No one knows for sure what the economic implications of the UK 's Leavevote will be , but there is a general consensus that it will not be good

� The only certainty is that the UK ‘Brexit’ decision adds another complex layer ofuncertainty to all markets and may weigh on the already lethargic DM economies.

� Following the UK Leave vote, the sell-off episode was rather time-limited and thesurge in volatility was somewhat contained. After a roller coaster ride, we're backwhere we started. But, do not be fooled by optimism…

� Our view is that euphoria won't last too long . The rather violent rally we arewitnessing will run out of steam soon.

� The market remains expensive and needs increased earnings t o move higher .The world economy is more fragile than ever. But the less appealing the UK andEurozone markets appear, the more appealing the US market will be perceived.

� A key concern at this stage remains the lack of diversificati on as most safeassets appear too stretched. Even bonds have become a driver of market fragility

� We reiterate our view that a perfect storm is building… After several years ofequities and bonds rallying together, both are expensive and vulnerable to shocks.Investors would soon be left with almost no place to hide

� We think that investors, by the end of 2016, will begin to price in a recession in2017 as the labor market weakens and corporate profits fail to recover.

� We expect the summer to be volatile and recommend not adding r isk andkeeping a cautious eye on market development.

� We make minor adjustments to our asset allocation this month, except on Goviesand Gold where we’ve turned OW.

� 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 stallingearnings growth may indicate we are in the late stage of the cycle.

� We summarize our views as follows �


52

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)


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

Economy & Finance