Market PerspectivesSep 2013

Aug 26th, 2013

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MACRO VIEW

� The Good� Manufacturing in China is improving. The preliminary HSBC PMI jumped to 50.1 points from 47.7 in

July � Copper is showing strength due to reduced inventories and Chinese demand� Jobless claims are holding at a lower level� Existing home sales were solid, but it is too early to tell about the impact of higher mortgage rates on

sales. � The Bad� Current uncertainty about Fed’s intentions as there is no greater clarity for when the Fed might begin

slowing the purchases of Treasuries/MBS that make up its current quantitative easing scheme� though the real estate data we got painted quite a mixed picture. New home sales disappointed,

probably as a reaction to higher mortgage rates� Healthy economy is not there yet… Household income (in real terms) has still not recovered from the

recession� The Ugly� Syria

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Unemployment

� Initial Claims for unemployment have returned to levels not seen since the fall of 2007. Now we need to see more job creation…

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Commercial & Industrial Lending

� C&I Loans are the highest since Feb. 2009. This growth seems to be linked to Fed’s quantitative easing. � Easier financing should induce more capital spending

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Banks’ Treasury Holdings

� US commercial banks are dumping treasuries at the fastest pace since 2000� The move accelerated after Bernanke’s speech in June

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Economic-Policy Confidence

� Prospect of rising capital investment (fixed assets: buildings, equipment, lands…) is encouraged by decreasing economic uncertainty

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Capital Goods Orders

� New orders for capital goods climbed 9% last month to a record annual level, driving activity in the sector.

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Capital Goods vs S&P500

� SPX is coherent with the level of capital goods produced, other than aircraft.

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Capital Goods Orders

� the "real" durable goods orders per capita appear as a coincident macro-indicator of major shifts in demand within the U.S. economy.

� A key driver for healthy growth in durable goods orders is growth in household incomes

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Steel Production

� US crude-steel production is expanding at the fastest pace in half a year � Economic rebound (manufacturing, domestic automotive sales, appliances to homes…)

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Home Sales

� NSA Existing home sales show a clear improvement over the last months

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Home Sales

� New home sales decline sharply to 394 000 annual rate in July� The "distressing gap" appeared mostly because of distressed sales. The flood of distressed sales kept

existing home sales elevated, and depressed new home sales.

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Leading Indicators

� 33% of the data points have beennegative over the last six months.

� ISM new orders printed four straightnegative prints, as did averageconsumer expectations

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GS - GLI

� the Advanced reading signals thatthe GLI remains stuck between the‘Slowdown’ and ‘Expansion’phases for the fourth consecutivemonth

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Earnings

� World EPS is reaching a 2-year plateau. Should we wait for an imminent end for this earning stagnation?

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Earnings

� Two potential sources of earning growth seem to be exhausted� Consumer spending is now needed to meet analyst’s earnings estimates. At this stage, it should be the

driver for US corporates growth

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PCE & DPI

� DPI and PCE advance at rates that are in line with recent updates for the year-over-year comparisons. The growth rates look however sluggish.

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EQUITY

� Fluctuations of consumer / business confidence should be closely monitored.

� One of the most ominous market indicators, the Hindenburg Omen (a highly technical indicator used to predict major market crashes) has reared its ugly head this summer, flashing warning signs about the health of the U.S. stock market..

� Current valuation is based on near-record corporate profit margins. US corps currently report a profit margin of 9.3%. It has gotten only slightly higher than his over the past six decades. In Q4-2011, it was 10%. The average since 1952 is 5.9%. At current high levels, a retreat seems likely. Should profit margins simply revert to mean levels along with valuations stocks could easily lose half their value as they did after the 2000 and 2007 peaks

� Emerging markets are already showing cracks. The last time we saw such market action in Asia was during the 1997 and 1998 crisis

� Bottom line : Neutral to Underweight on stocks. Keep a long VIX as a hedge to long equities.

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US Stocks

� The New Quarterly Lows (that records, each trading day the number of stocks in the S&p500 that are making new quarterly lows) indicated that support has been found around the 50d MA.

� Unfortunately, this support has been broken since…

� The 20-day moving average line at 1680 is going to be the S&P 500′s next make-or-break level.

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US Stocks

� On the short-term, the SPX is expected to bounce on 1622, getting back to 1638 and then to 1671

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US Stocks

� Since its high of May 22nd, the risk appetite has been drifting lower, driving down the 6m-momentum in US stocks

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US Stocks

� VIX is now oscillating between the low and medium regimes. It has been doing so since the beginning of 2013 (similar to 2004 but with more uncertainty in macro data)

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US Stocks - Hindenburg Omen Indicator

� Among the 2,000-plus common stocks listed on the NYSE, market analysts monitor four criteria that trigger a signal

� The daily number of stocks that hit 52-week highs AND the number of stocks that hit 52-week lows are both 2.2% or more than the sum of NYSE issues that rise or fall that day.

� New 52-week highs cannot total more than twice the number of new 52-week lows.� The McClellan Oscillator, which measures the difference between the number of rising

stocks versus the number of falling stocks, is negative.� The NYSE Index rises above its 10-week moving average –meaning it’s greater in value

than it was 50 trading days ago.

� If ALL of these measures are hit on the same day, we start to get nervous. If this occurs a second time, within a 30-day period, the Hindenburg Omen is triggered, and a serious stock market decline is expected to follow within the next 40 days.

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US Stocks - Hindenburg Omen Indicator

� Multiple Hindenburg Omens have been triggered over the past few months

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US Stocks

� Consumer confidence has tended to lead the downturns in S&P500.

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US Stocks

� Factory orders (a good proxy for the physical side of the economy) seems to validate the performance of the equity market. It is less the case for Durable Goods Orders

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US Stocks

� Consumer / business confidence may be essential for stocks to draw another leg up

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US Stocks

� P/E-VIX ratio points to complacency : Investors are becoming overly about equity prospects � A higher volatility is likely to accompany any additional gain in PEs.

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EM Stocks

� Emerging markets tend to perform better than developed markets when the US dollar is loosing value.

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FIXED INCOME & CREDIT

� Tightening US labor market (due to slow labor force growth and moderate job gains) will push the Fed to phase out its QE, implying higher rates and underperformance of all rate-sensitive sectors

� Credit market losses in August have been large, making 2013 among the worst years on record for investment grade credit

� The last time the spread of stocks to investment grade credit was this high was in 1999 - a rather ominous sign.

� The Treasury market appears fully priced for a September taper. Though this is the most likely scenario, we should consider alternative scenarios and their potential impact on the markets

� Bottom line : UW on US / € Govies, Neutral to UW on HY, UW on TIPS (at least till the September FOMC meeting). OW European vs. US IG credit because of the improving economic data in Europe

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FIXED INCOME & CREDIT

� Since early May, 10-year Treasury yields have risen more than 110bp and the mortgage universe has extended by roughly 2 years

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FIXED INCOME & CREDIT

� End-user demand for Treasuries has deteriorated rapidly in 2013. � But net issuance in Treasuries (net of the Fed’s purchases) is on an upward trend

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FIXED INCOME & CREDIT

� Positive macro momentum continued in the Euro area. The strong Euro area PMI points to higher goviesyields � Stay short duration in 10Y Bunds (bund target ~2.0 – 2.1%)

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FIXED INCOME & CREDIT

� With Treasury yields at a multi-year high and the market awaiting a host of catalysts in September, the downside risk looks predominant in HY

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FIXED INCOME & CREDIT

� With Treasury yields at a multi-year high and the market awaiting a host of catalysts in September, the downside risk looks predominant in HY

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FIXED INCOME & CREDIT

� Over the past few weeks, TIPSbreakeven rates narrowedsubstantially.

� Breakevens have becomeincreasingly negatively correlatedwith rates as nominal yields haverisen.

� Outflows from TIPS ETFs are alsosignaling new selling pressures onTIPS.

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COMMODITY

� WTI crude oil has staged an important break out. Spot WTI surged by more than $10 per bbl since the end of June, as its term structure steepened.

� The strength and clarity of this move provides the signal we were waiting for to raise commodities (energy + industrial metals) to ‘overweight’ (OW). Crops are still weak (UW).

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Crude Oil

� In July, commodity markets delivered a 5/5 message. This is only the second 5/5 month in WTI crude oil in the past six years (the other one is July 2007), which points to a marked increase in commodity prices and volatility.

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Precious Metals

� Given the debt limit trend, the fall in gold seems hardly sustainable.

� Next ST target = 1475

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Precious Metals

� However, our theoretical price (using US$, sovereign CDS and Real Rates) is stuck at 1200

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

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

Source : Bloomberg data, FinLight Research calculations

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Precious Metals

� The bull trend in silver will be more clear above the 26-26.40 area

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Precious Metals

� Geopolitical risk from the Middle East is once again a huge issue leading to sharp increases in oil / gold prices

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EXCHANGE RATES

� Despite positive economic surprises out of Europe and China, the downside risks on several EM currencies (particularly those with large current account deficits, deterioration on the fiscal front and high inflation) have increased over the last month.

� Overweight DXY� Neutral EUR vs USD : the currency will stay in a range 1.30-1.35

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DXY Index

� DXY has held the important support at81.00/80.30.

� According to JPM, a break above82.50 should set the stage for adeeper recovery toward the83.50/83.80 zone

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EUR-USD

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

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EUR-USD

� Our preference is the short side of the EURUSD. The list of EU problems continues. They soon will be making headlines.

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USD-JPY

� USD/JPY is attempting to base above important support levels in the 95.60/93.50 zone (38.2% retrace from Nov 2012)

� The pair has dropped below its 26-week moving average. A further decline in the pair is likely to push hedge funds to unwind their positions � Short-term target ~ 95 then 92

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Bottom Line: Global Asset Allocation

� Monetary conditions are tightening in the US, without a better economy. This creates downsides to both equities and fixed income on the short-term, and thus the risk of asset deflation.

� Overweight high yield relative to investment grade. There is still a bit of value in HY� Underweight govies and TIPS� Underweight EM relative to DM� Buy volatility as a hedge for stocks� Overweight commodities except crops and precious metals� Overweight Gold & Silver to play ST targets with very close stops