Finlight Research - Market Perspectives - May 2016

Market Perspectives

May 2016

May. 9th, 2016

www.finlightresearch.com

Is the Bull just Smoke and Mirrors?

“Bull markets are born on pessimism, grow on

skepticism, mature on optimism, and die on

euphoria”– Sir John Templeton

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� Economic data have been mixed globally. But the levitation in stocks

held up mostly thanks to the strength in oil and the weakness in the US dollar.

� Falling earnings, declining growth forecasts, and macro uncertainties have kept markets range bounded in a context where “If bad news is not

awful news, it must be good news”. We are just planting the seeds of the next BIG correction.

� The degree of skepticism of the bull market seems to back up a final leg higher on the S&P500

� 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

� US employment growth remains positive and wages improving (+2.5% YoY for average hourly / weekly earnings)

� Q1 Eurozone GDP was stronger than expected at 0.6% quarter-over-quarter

� The Bad

� Markit PMI data suggested weakness in manufacturing. Philly Fed’s manufacturing index took a dive in April.

� The Advance Estimate for Q1 US GDP came in at 0.5%, down from 1.4% in Q4-2015� April flash PMIs for manufacturing and services in Eurozone were both weaker than expected.

Composite PMI declined to 53.0 (vs 53.3 consensus)

� The Ugly

� Main systemic risk resides in China: China is not recovering but rather just re-leveraging. Debt is used to create the illusion of growth. And that hardly ends well. 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.


US Manufacturing

� The US Manufacturing continues to struggle.

� April estimate of Markit’s Manufacturing PMI slept to its lowest reading in more than 6 years

� The April ISM manufacturing index was down 1 point from the March reading and a bit lower thanexpectations (50.8 vs. 51.4), but it is still at levels which are consistent with overall growth in theeconomy of 2% or better.


US Capital Goods

� The picture for CapitalGoods / New orders isflashing that something wasoff

� Similar negative orderslevels are usually seen in arecession.


GS – Global Leading Indicator (GLI)

� The April Final GLI came in at1.7%yoy. Its MoM momentumcame at 0.28% (up from0.27% last month)

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

� Five of the ten underlyingcomponents of the GLIimproved in April

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

� We continue, however, to

think that the acceleration

we’ve been witnessing since

Jan. ‘15 is quite modest for

a typical expansion phase


Chinese Credit Bubble

� Within the market for inter-bankborrowings, borrowing, Chinesebanks are now pledging bondpositions larger than the entireonshore bonds as collateral fortheir short-term borrowing needs!

� Since mid-2011, the onshorebond market has almost doubled.In the same time, pledgepositions has more thanquadrupled.

� This expansion of "money-like"

financial claims is typical of

the terminal phase in the credit

cycle.


Cross-Asset Volatility

� As the Fed decided to keep its dovish tone and delay its rate tightening, volatility went down across

asset classes

� UST yield vol (as measured by BoA-ML MOVE Index) stands at a level not seen since end of 2014


EQUITY

� We see this bull market as tired and old, but not finished. The market once again failed at the top of the trading range. But, we still expect a final leg higher. The degree of skepticism of the bull market seems to back up this view.

� 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. The fact that the market remains expensive doesn’t preclude a breakout to the upside into new record high territory

� But any breakout to the upside will prove to be unsustainable in the absence of a real improvement in corporate earnings prospects

� Thus, 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

� Earnings reports were mixed:� US earnings recession continues. But analysts expect the Q1 to mark the bottom for earnings,

and earnings growth to turn positive by Q3� Earnings reports are slightly beating (significantly reduced) expectations

� US Dollar appears as the main factor providing a (temporary?) lift for earnings. The weaker dollar has boosted earnings expectations for multinationals, commodity prices and commodity stocks

� We should keep in mind the gravity of the ongoing earnings recession in the context of very high corporate debt levels.


EQUITY

� 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. U.S. corporate debt to

earnings ratios are at a 12-year high

� 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. 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 we did since the index broke above 1903) as long as the 2020 level

is preserved. We still target 2110 and probably a new high around 2150-2170� Below 2020, 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 (last)

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 -7.1% YoY (-1.9% 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 Q2 2016, 55 companies have issued negative EPS guidance and 24 companies have issued positive EPS guidance.

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

growth rate is now projected at 0.9%

for earnings (down from 2.2% a

month ago) and 1.5% for revenues.


US Earnings

� A common story is a company beating on the bottom line, but missing on sales

� Among the (87%) S&P500 companies that have already reported earnings, the beat rate was 71% for earnings (above the 5-year average of 67%) and 53% for sales (below average).

� But this EPS beating story is

misguiding. Corporate earnings

reports have been beating REDUCED

expectations

� And it’s NOT just an energy problem,

as earnings expectations are being revised significantly lower across most sectors


US Earnings

� Based on declining earnings, we may expect a topping formation on the S&P 500.

� But, for the moment, most analysts expect earning growth to resume in H2-2016. The market would resume its upside move after a short consolidation.


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


Equity Market Breadth

� The breadth in stocks is improving, but it is probably nearing a top.


Equity vs Financial Stress

� The chart below puts the S&P500 next to a composite index (compiled by Financial Sense) of widely followed financial stress indicators.

� Financial conditions have been favorable for stocks till mid-2014. But since then:� they have diverged from the S&P500 uptrend

� they have deteriorated and finally went negative in 2016


Market Sentiment

� The current low bullish readings in the AAII index point to a significant

skepticism from investors

� From a contrarian point of view, prevailing bearishness is usually a bullish omen for the market

� This excessive skepticism

may indicate that the

cyclical bull is not finished

yet.


Market Sentiment

� Bearishness is also visible in Newsletter Writers views

� Newsletter writers are the most bearish they have been since 2008.

� Such a pessimistic reading is

hardly compatible with a top.


Market Sentiment

� The amount of shares outstanding in the VXX (VIX Short-Term Futures ETN) has jumped up, showing that

investors have already protected

themselves against another

selloff.

� They did so despite the high cost of carry of the VXX, due to the sharp contango in the VIX futures curve.


Market Sentiment

� Based on the Hulbert Nasdaq Newsletter Sentiment Index (HNNSI), short-term Nasdaq-oriented

stock market timers have reduced aggressively their recommended equity exposure.

� The average Nasdaq market timer is now allocating 27% of his equity portfolio on the short side, down from a 70% long position at the end of April.


Market Sentiment

� Because of low returns on cash,Mutual fund managers havereduced their cash holdings to thelowest level in 50 years.

� Given these meager cash

reserves, any sharp selloff

would be amplified by forced

selling induced by redemptions


S&P 500 – A Short-Term Perspective

� In the same time, householdsare already massively investedin equities.

� At 38%, the proportion ofhousehold financial assetsinvested in stocks stands at alevel never seen since the 2000tech bubble.

� Little money is left on the

sideline for additional

investing in stocks.


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, as we expect a final leg up (target ~ 2160!).

� But, we keep a cautious eye on the 2020 – 2035 range

� We will switch to a Neutral

stance as soon as this

range is materially broken

to the downside.


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has been mildly short over April and switched to mildly long on May 4 S&P500 close (@2051.12)

� The model is now Long SPX, targeting 2082

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FIXED INCOME & CREDIT

GOVIES

� The Fed left interest rates unchanged during its last meeting. The market is betting on another hike in September. But the possibility of a hike in June/July is still alive, and we feel the market unprepared

for such a rate hike.

� Treasuries have been range-bound for the past three months, and we see no obvious catalyst to break out of this range

� For now, government bond yields are back on the range lows. Valuations appear to be so stretched

that it seems reasonable to keep away from the asset class.

� We see US inflation higher over 6-12 months horizon and we see little reason for US 10-year yields totrade 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 move up from its current (low) level, 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

FinLight Research | www.finlightresearch.com

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INFLATION-LINKED

� 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 remain strong in recent weeks, suggesting that breakevens havefurther 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

CORPORATE CREDIT

� 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.

� 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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� 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.

� The aggressive QE in Europe and Japan is also weighing on spreads and pushing HG credit higher

� For high-yield bonds, the rally 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.

� As expected, credit markets outperformed equities over the last few weeks. 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 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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� We expect volatility to go up again 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.

� 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 as:� we think that more attractive spread valuations and higher carry should fuel a stronger bid for US

credit.� We think that the ECB effect is already priced in and would be balanced by an increased corporate

supply� we see a gap between what the ECB is technically allowed to buy, and what it is really doable

given liquidity constraints


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EM DEBT

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

� The dollar strengthening that we expect would erase some of the gains in EM debt

� 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 : We change nothing to our previous positioning: 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 – TIPS & Inflation

� Despite the mild growth,

inflation expectation is

trending up after having

reached extremes in early

2016.

� TIPS breakevens imply thehighest inflation expectationsince Aug. '15

� We've been OW on TIPSbreakevens since Dec ’15,given their historically-lowlevels.

� We keep our OW

positioning


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US Govies – Curve Flattening

� We have been long flatteners (2-10y) on

the US yield curve since Dec. ’14, playingthe view that “when the Fed hikes, the yieldcurve flattens”

� In our Monthly Report of Dec. ‘15, we alsosaid “We remain long flatteners on the USyield curve, targeting 50 to 75bps flatteningover H1-2016.”

� We’ve proven right on both bets.

� Over April, the 2-10yr curve has flattened again as long duration outperformed.

� We keep our flattening bet as we think

that the market is not prepared for a rate

hike in June or July.


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US Credit – IG Basis

� In Nov. ‘15, we started warning against thesignificantly negative CDS-Cash basis (onIG, but especially on HY), induced bysupply fears and the increasing use of CDSindices to get (through protection selling)exposed to the credit market with areasonable liquidity

� But since the February bottom, bonds haveoutperformed their CDS, significantlynarrowing the negative CDS-Bond basis.We are back to levels last seen in Jun. ’15.

� This basis tightening may be explained

by the dovish tone of the Fed (like otherCBs) that created more demand for bondsand pushed swap spreads higher.

� Given our cautious view on credit

liquidity, we think that this basis

normalization is only temporary.


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US Govies – 10y-UST

� We change nothing to ourprevious positioning.

� Tactically, we remainNeutral on 10y USTs as

long as the 1.94 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.


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EXCHANGE RATES

� Nothing new under the sun…� We moderate our view for the dollar as the (dovish) Fed keeps pressure on it, capping any higher

yields attempts.

� But, the long-term dollar bull trend 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.

� We remain Neutral on the EUR-USD. But we expect a downtrend to develop from here. To gain confidence in such a scenario, the spot needs to break below 1.13.

� Our positioning rules are adjusted as follows:� Remain Neutral within the 1.13 - 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 1.13. Target = 1.0725 and then 1.04 to parity over 2H


38

EXCHANGE RATES

� Last month, we turned to Neutral on USD-JPY, “watching for signs of near-term stability orbasement somewhere between 108 and 106”.� Only a clean break above 111 could make us turn to OW

� On the other side, a break below the 105.75 – 106.00 area could make us switch to UW as it may open downside risks to 102. Such a breakout would indicate that Japan's fiscal and monetary stimulus is doomed and induce a risk-off behavior globally.

� The more dovish tone from the Fed has certainly halted the USD’s rapid rise, giving EM currencies some respite

� 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

� Like the advance in oil, the recentdecline in the USD was extreme,but an impulsive reversal

seems to be imminent

� Our primary scenario remains

a reversal formation in the

92.5-93.5 area. The oscillatorswe watch seem to signal that alow is already in place.

� We will gain confidence in this scenario if the resistance of 94.16 is exceeded.

� Breaking the support area of92.5-93.5 to the downside willopen the door to a much moresubstantial correction.


40

EUR-USD

� In our previous Monthly Report,we said “Over the short-term, weexpect a local correction towards1.12 before moving higher.”.We’ve got both…

� The picture on EUR-USD is notclear. But, given our view on theDXY index, we expect a

downtrend to develop from

here.

� To gain confidence in such a

scenario, the spot needs to

break below 1.13.

� We remain Neutral for now.

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


41

USD-JPY

� Last month, we turned to

Neutral, “watching for signs ofnear-term stability or basementsomewhere between currentlevels (~108) and 106”.

� We change nothing to ourprevious positioning. We remainNeutral.

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

� On the other side, a break below the 105.75 – 106.00 area could make us switch to UW as it may open downside risks to 102


42

COMMODITY

� The softness in the dollar has provided a perfect ground for commodities to move up during the month. The DJ Commodity and S&P GSCI total return indices gained 9.1% and 10.1%, respectively, in April.

� But all commodities except four (copper, gold, cotton, lean hogs) are now in backwardation, implyingthat the move is not supported by better supply/demand fundamentals

� 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� 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.


43

COMMODITY

� Bottom Line :

Energy:

A technical look at oil prices suggests near-term profit taking in energy-related positions is likely a

good idea. As the contango disappears, the incentive to buy and store crude decreases.

� 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), some relief inChinese economy and a reduction in short specs positions

� 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.

� Last month, we switched from OW to Neutral as WTI broke above 39. We remain Neutral.

� We’ve adjusted our tactical rules accordingly:� Remain Neutral if the spot stays between 36 and 47� Turn UW below 36� Move to OW if the WTI breaks above the Feb uptrend channel (currently ~ 47) or below 29.


44

COMMODITY

Precious Metals:

� 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.

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

� Last month, we decided to turn Neutral and to watch for a clean break above 1270 to become OWagain

� The break above 1270 was short-lived and we remained Neutral.

� Our positioning rules are adjusted as follows:� Neutral between 1200 and 1295

� Turn UW if the spot breaks below 1200� Go OW below 1070 and above 1295 (to target 1380 – 1420)


45

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. Sowhen China's stockpiling ends, these metals will go south

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

rebalance oversupplied markets.

� We still forecast one last leg down in prices. We remain UW on base metals.

Agriculture:

The S&P GSCI Agriculture Index gained 4.5% in April (after 4.5% in March)

� 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.

� We see more weather events weighing on grain harvests specially in Latin America (like soybean inBrazil due to dry weather)

� Nevertheless, we choose to remain Neutral, waiting for a better entry price on crops.


46

Crude Oil

� Fundamentals remain weak for crude oil. This pessimistic fundamental view is confirmed by thelong-end of the futures curve which is getting flatter near US $50

� Production levels in the US have started to decline.� But, the total inventory of crude oil continues to build…


47

Crude Oil

� US oil rig count tends to lead oilfield production by roughly 18months.

� Given this relationship, a plungein US output seems possible,and would imply a bias to higherprices.

� But, on the other hand, andaccording to a Reuters study,most US frackers have “drilledbut uncompleted” wells that theyhalted when oil prices wentdown. As soon as pricesbounce, these wells could bebrought online, weighing onprices again.

� We expect oil price to remain

in its current range, as far as

the fundamental gap between

supply and demand is not

reduced significantly.


48

Industrial Metals

� At current price and profit margins, the Chinese steel industry has no incentive to reduce production.� Chinese steel producers have actually boosted their output by bringing online their spare capacity.� A glut is forming… A collapse in prices should be expected.

� Keep away from steel and other industrial metals.


49

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 around 36. We need tobreak below to call for anothertest of the 25-29 range.

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

stays between 36 and 47� Turn UW below 36� Move to OW if the WTI

breaks above the Febuptrend channel (currently~ 47) or below 29.


50

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 exceeded.

� Last month, we decided to turn

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

� The break above 1270 wasshort-lived.

� Our positioning rules areadjusted as follows:� Neutral between 1200

and 1295

� Turn UW if the spot breaksbelow 1200

� Go OW below 1070 andabove 1295 (to target 1380– 1420)


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ALTERNATIVE STRATEGIES

� The HFRI Fund Weighted Composite Index posted gains of 1.0% in April. Gains were led by credit / fixed-income Relative Value Arbitrage strategies, as credit and arbitrage deal spreads tightened and UST yields headed up.

� CTAs mild performance (-0.8% MoM, +2.3% Ytd) was mainly driven by their long fixed income (in the US and Europe). Over the last two months, they reduced markedly their long fixed income exposure but were still exposed to the rise in bond yields. Losses were partially offset by gains in equities and precious metals. Year to date, CTAs remain among the best performers.

� Global Macro funds advanced +0.9% in April, benefitting from their long equity exposures, partially offset by losses on USD and commos. 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


52

ALTERNATIVE STRATEGIES

� 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

� 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.


53

Equity Long/Short

� It’s worth noting the Equity L/S funds positioning between cyclicals and defensive stocks since end of 2015.

� During Jan-Feb, Equity L/S increased their exposure to cyclicals.

� But since the beginning of March,

Equity L/S cut their net exposure to

Cyclicals and reallocated to

Defensive again (like during 2015)


54

HF Duration Exposure

� According to a JP Morgan analysis (based on betas calculation of investable indices / funds), discretionary macro funds appear to be maintaining their duration shorts near their historical tops.

� But, CTAs and risk parity funds

seem to have significantly reduced

their rate (long) exposure, over the last few weeks

� This clearly reduces the vulnerability in bond markets to position unwinds in a selloff, a risk we warned of in our January Report.


Bottom Line: Global Asset Allocation

� Economic data have been mixed globally. But the levitation in stocks

held up mostly thanks to the strength in oil and the weakness in the US dollar.

� Falling earnings, declining growth forecasts, and macro uncertainties have kept markets range bounded in a context where “If bad news is not

awful news, it must be good news”. We are just planting the seeds of the next BIG correction.

� The degree of skepticism of the bull market seems to back up a final leg higher on the S&P500

� 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 - May 2016

Economy & Finance