Finlight Research - Market Perspectives - Aug 2016

Market Perspectives
Aug 2016
Aug. 12th, 2016
Month II Post-Brexit
www.finlightresearch.com
Alice in Wonderland

“My understanding is that there have been
movements that are quite biased, one-sided
and speculator-driven. We will pay the closest
possible attention [to the yen] and watch it
intensely to ensure that speculator-driven
movements won't accelerate, and if
necessary, we will take firm action”
– Mr. Asakawa, Japanese vice-minister of
finance for international affairs
2
FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation
In July, market concerns over the US economy and the Brexit
impact eased, inducing a risk-on environment. the S&P 500 has
made new all-time highs, the VIX has fallen, bonds started to sell off,
and cyclicals have outperformed defensives.
Precious metals remain firmly in a bullish trend, supported by a mixture
of Fed hold-on posture, NIRP policies, and global uncertainties. Gold
outperformance is rarely good news for real growth
Our biggest concerns relate to the lack of earning growth (earnings
recovery keeps getting pushed further into the future), the need for more
business confidence, and corporate investment.
The market remains expensive and needs increased earnings to
move higher.
A key concern at this stage remains the lack of diversification as
most safe assets appear too stretched
Central banks continue their irrational game, with the hope to levitate
financial asset prices long enough to allow fundamentals to catch up.
At this stage, investors appear more afraid of missing out on a rally
than getting caught in a selloff
We make minor adjustments to our asset allocation this month, except
on Energy where we’ve turned UW.
We summarize our views as follows
3

MACRO VIEW
The Good
China's PMI readings were mixed but not disastrous. The official manufacturing reading
slipped to 49.9 from 50, when the Caixin Manufacturing PMI rose to 50.6 from 48.6 in June. This
was the first reading above the 50 threshold in 17 months.
US jobs number was a strong one. 255k jobs were created in July (versus expectations of
185k). But we see more revisions to the initial estimate that was reported in previous months.
The Bad
US GDP grew at an anemic rate of 1.2% in Q2. Combined with Q1, US economy is growing at
the slowest rate since 2011
Corporate investment remains moribund
European banks are retreating after the stress test results.
Growth shock from Brexit seems to be completely ignored by the market outside of the UK
Profit margins seem more vulnerable than ever
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.
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.
4

5
Any Brexit Effect?
The common belief is that direct impact of
Brexit on US / European corporate
profitability will likely be contained.
Brexit is more and more appearing as a
UK confined shock.
Based on JP Morgan economic activity
surprise indices, any global contagion
seems hard to detect, at this stage
We feel cautious about the apparent
resilience of the Eurozone economy.
We fear the second order effects due
to contagion through political, economic
and financial channels

6
US Macro Data
Despite the last sluggish US GDP
reading, US macro data have been
better than expected over the last
few weeks.
JP Morgan Economic Data Surprise
Index is now close to its highest
level since the mid-2015
It’s however worth noting that these
positive macro surprises may be
partly due to lowered expectations
after the Brexit shock.

7
US Durable / Capital Goods
Durable goods orders plunged 6.4% YoY (and 4%
in June).
The picture of business capital spending
remains ugly.
Capital spending has now contracted for 3
consecutive quarters, for the first time since the
GFC.
Orders for non-defense capital goods
excluding aircraft was down 3.8% YoY
(and only +0.2% in June)
Capital spending continues to contract
in lieu of stock buybacks and other
forms of financial engineering
These trends in fixed and private non-
residential investment seem to point to a
lower employment.

8
Inventories & Growth
The consensus expects the
decline in inventories to feed
production, employment and
growth.
The issue with this assumption
is the inventories-to-sales ratio
is still too high, implying a
continued reduction in
inventories and a lower growth.

9
US Employment
US jobs number was a
strong one.
255k jobs were created in July
(versus expectations of 185k).
However, we see more
negative revisions to the
initial estimate that was
reported in previous months.

10
US Employment
Four out of the five months (till May) of this year have seen
downward revisions, with an average revision at -10,000
jobs.
Last year we saw 7 negative revisions, the most since 2008.
We see these negative revisions as a warning signal. A
turning point is probably in place for employment and
growth.
Mean
revision
Negative
months
2016 -10,000 4 out of 5
2015 -4,000 7
2014 37,000 1
2013 21,000 4
2012 24,000 3
2011 28,000 3
2010 40,000 1
2009 12,000 4
2008 -73,000 11
2007 5,000 6
2006 23,000 5
2005 31,000 3
2004 21,000 4
Source: Fuller AM

11
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.

12
GS – Global Leading Indicator (GLI)
The July Final GLI came in at
2.4%yoy. Its MoM momentum
came at 0.34% (close to its
last month’s 0.36%)
GLI has been in expansionary
territory since September
2015, and seems now to be
heading towards “Slowdown”
Only five of the ten underlying
components of the GLI
improved in July
We continue to think that the
acceleration we’ve been
witnessing since Jan. ‘15 is
quite modest for a typical
expansion phase

13
EQUITY
Global stock valuations appear stretched while volatility has fallen
With easy liquidity, stocks hit new all-time highs, when earnings continue to be revised to the down side.
For now, it appears that fundamentals no longer matter… Price momentum and trend remain strong,
although we are in a seasonally weak period.
The US earnings season also proved better than feared Earnings beat rates appear high. But, companies
are currently beating estimates mostly because those estimates had been significantly lowered at the
beginning of2016.
Furthermore, a stronger dollar will induce another headwind to already weak earnings
Other data points to some sort of corrective action over the next two months. Some sentiment indicators
(high NAAIM Exposure Index, low CBOE put/call ratio, low Inverse ETF volumes) are cause for concern.
We are seeing levels of euphoria and complacency worthy of (at least) an intermediate market
top.
Capital spending continues to contract and to be replaced by stock buybacks and other forms of financial
engineering.

14
EQUITY
Despite our OW (tactical) positioning, our equity outlook remains cautious. We see the market
more vulnerable than ever to growth and policy disappointments.
We still think that key fundamental data will eventually matter… in a BIG BIG way. For now,
investors are buying the rumor of better future earnings. One day, they will be selling the news of bad
effective earnings.
We keep the same scenarios, but lower the probability attached to the primary one.
Our main scenario from here (70% chance) : A massive top forming around the current levels
Equities remain expensive, earnings growth poor and profit margins are showing increasing
evidence of peaking. On Price/Sales metric, equities are trading at the top of the historical range.
A resumption of earnings growth going into 2016 will be necessary for equities to move higher.
Our alternative scenario (30% chance) : The S&P500 breaks the 2170 resistance, opening the way
to 2225 - 2300. Such a breakout would need a new round of stimulus and/or a new impulse to macro
fundamentals
A pull back below 2155 is needed in order to confirm our primary scenario!
Above 2225, we’ll be obliged to recognize the alternative scenario is in.

15
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 2155 level is preserved.
We will turn Neutral if the spot breaks below the 2150-2155 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. As expected, US equities proved more resilient than their Eurozone
counterparts as the Fed kept its dovish stance. We remain Neutral Japan and UW Europe vs.
US.
We remain UW in US small caps vs large caps.
We remain OW defensive, high dividend and value stocks vs. cyclical stocks.
We remain UW EMs vs DMs despite the recent EM outperformance and robust flows going into
EM Equities (since the start of July).
An “on hold” Fed and a range bounded US dollar is positive for EM sentiment
But, we see risks to the downside. 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.

16
US Earnings
The S&P500 stands within an
earnings recession.
For Q2 2016, the estimated earnings
decline is -3.5% YoY (+0.4% if energy
is excluded), marking the first time the
index has seen 5 consecutive quarters
of YoY declines in earnings since
2008/2009
For all of 2016, the estimated S&P 500
growth rate is now projected at -0.4%
for earnings and +1.7% for revenues.
For Q3-2016, 62 companies have
issued negative EPS guidance and 28
companies have issued positive EPS
guidance
Analysts still expect earnings
growth and revenue growth to
return in the second half of 2016

17
US Earnings
Earnings recovery is getting pushed
further into the future
Trailing Twelve Month EPS on the
S&P500 reached a top in Q3-2014
(around $106) and have been down
since. Q3 2016 TTM EPS is expected
to be only $92
EPS growth for Q3 2016 was expected
at +11% in Mar. ‘16. It’s now flat.

18
US Earnings
Based on JP Morgan model for
expected EPS growth, we see realized
EPS growth (over next 5 years) on a
negative slope for the coming
months / years
EPS growth should be flat for the
period 2015 – 2020, and negative over
2016-2021

19
EMU vs US Equity Valuation
European forward PEs appear
relatively low relative when
compared to the US …
But European stocks are not as
cheap as they look, as earnings
expectations continue to be
revised down and the effects of
Euro depreciation fade.
Thus, we remain UW Europe
vs. US

20
Market Sentiment - Risk Appetite
According to Deutsche Bank’s
risk appetite indicator, US
equity market is somewhere
between complacency an
mania, as of and of July.

21
Market Sentiment – Inverse ETF Volume
Inverse ETF volume has dropped to
very low levels (2nd lowest level in
more than 5 years), which
was historically a signal of market
peaks.
might be another sign of
complacency

22
Market Sentiment – VIX Index
Another sign of complacency and
euphoria: The VIX index is back to
levels last seen in August of last year,
even as the market enters a period
historically known for its turbulences.
Usually, volatility does not last long at
current levels and tends to bounce in
sharp spikes.
Going long VIX could be done through
the volatility ETF $VXX despite its
negative carry (because we feel
confident this is the right timing). Current
level = $37. Target = $50. Stop @ $33
A safer (but less exciting) way to do it, is
to buy the UBS ETRACS Daily Long-
Short VIX ETN (XVIX). It is basically
long 100% the VIX Mid-Term Futures
index Excess Return, mitigated by a
short 50% the VIX Short-Term Futures
index Excess Return

23
Market Positioning – Dow Jones
Both hedge funds and institutional investors are more net long Dow futures than they've ever
been over the past 5 years

24
Market Positioning – VIX
In the same time, hedge funds are very short VIX futures

25
S&P500 – A Long-Term Perspective
Despite the fact that we’re
running into 5 straight quarters
of earnings contraction, the
S&P500 is making new all-time
highs.
Equity markets still appear at
lofty valuations, whatever the
valuation metric we use.
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

26
S&P 500 – A Medium-Term Perspective
In our previous report, we
said: “For now, we stay
OW, as we see the index
ready to resume its
uptrend. We expect a
final leg up (target ~
2160 - 2170!).”
Our target was reached
and exceeded.
We remain OW as long
as the 2155 level is
preserved.
From here, we will turn
Neutral if the spot breaks
below the 2150-2155
range
We will switch to UW as
soon as the 2000 – 2010
range is materially broken
to the downside.

27
S&P500 – A Short-Term Perspective
Our prop. Short-Term trading model has no strong conviction, for now
Since Jun 30 (SPX @ 2098.86), the model has been flat to modestly short, targeting 2083 and
2062
600.0
800.0
1000.0
1200.0
1400.0
1600.0
1800.0
2000.0
2200.0
2400.0
39000.0
41000.0
43000.0
45000.0
47000.0
49000.0
51000.0
53000.0
janv.-06 sept.-08 juin-11 mars-14 déc.-16
S&P500
NAV
Quant Model
S&P500

28
FIXED INCOME & CREDIT
GOVIES & INFLATION-LINKED
Treasury yields had gotten so oversold due after the Brexit vote that a reversal became necessary
G3 government yields are inconsistent with fundamentals. Eurozone (like Japanese) yields appear too
low when compared to nominal GDP growth.
In our view, this is a bubble inflated by investors who think that central banks will support such prices
indefinitely..
We continue to think that the ECB and BOJ's experiments with negative interest rates will not end well
The endgame will be disastrous given the extreme levels reached by valuation and market
positioning
We’ve been OW since the UST 10y yield broke below 1.65 in June. For now, we remain OW.
Inflation isn't on anyone's radar right now. Inflation expectations haven't moved up yet. Any
surprise on the inflation front would make a lot of damage on the market.
Inflationary signs should be watched closely as they will foreshadow a steepening decline in
Govies.
We remain Neutral 10y-TIPS and HICP Inflation as we expect breakevens to trade sideways from
here

29
CORPORATE CREDIT
Credit spreads tightened significantly on both sides of the Atlantic, in the HY in particular.
After a brief pause following the Brexit vote, the search for yield is back.
The demand for corporate bonds is illustrated by their outperformance vs their CDS, with CDS basis at
its narrowest levels in more than a year
The global scarcity of yield should continue to support US HG spreads, as ECB / BoJ continuous
easing should push Japanese and European investors to search for yield outside home
We remain overweight US vs EUR credit (more on IG than HY) because of our fundamentally bearish
view on European credit, the relative yield disadvantage and the fact that the re-leveraging cycle looks
more mature in the US.
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). We remain UW on HY and Neutral on IG.
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 as the rate of turnover in corporate bonds has steadily declined since 2009,
despite the huge inflows

30
EM DEBT
The dollar strengthening we still expect would weigh on EM debt
We remain Neutral on EM bonds, because of all the macro challenges facing the EM economies at a
time when the Fed is likely to be more hawkish
Bottom line : We change nothing to our views : 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 (duration hedged), 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

31
Sovereign Yields vs GDP Growth
G3 government yields are
inconsistent with fundamentals.
Eurozone (like Japanese) yields
appear too low when compared to
nominal GDP growth.
They have been so since the ECB/BoJ
started their QE policies.
In our view, this is a bubble inflated by
investors who think that central banks
will support such prices indefinitely..
The endgame will be disastrous
given the extreme levels reached by
valuation and market positioning.

32
TED Spread – Liquidity Stress?
TED Spread is usually used as an indicator of funding market stress. It widens on liquidity
issues in the banking sector, and its widening tends to precede market corrections.
TED spread is currently at levels last seen around Jan. ‘12 and before that in Mar. ‘07.

33
US Govies – ZIRP Impact
Zero interest rate policy
and Fed’s asset
purchases have got an
obvious impact on the
trendline through the
highs of 10y-yields before
and after the GFC.
The 10y-UST yield
appears now to be
capped around 2.0-2.5
over the short term.

34
US Govies – 10y UST
In June, we moved to OW
as the 10y yield broke
below 1.65.
Technically speaking, the
risk of an impulsive decline
has diminished.
Our positioning rules remain
unchanged:
We’ll turn Neutral again
above 1.65 and we’ll remain
so as long as the 1.90 level
is preserved.
We’ll move also Neutral
around 1.25-1.28
Above 1.90, we’ll move to
UW.

35
US Govies – Yield Curve Slope
The big picture remains the same. The UST yield curve continues its flattening.
Over the last weeks, the curve flattened on bad durable goods, then steepened modestly on the
good employment report. But the big trend remains intact.
We remain long flatteners on the US yield curve and short duration in 2y USTs

36
EUR Credit – Brexit Impact
Over July, credit spreads tightened
significantly on both sides of the
Atlantic, in the High Yield segment in
particular.
However, credit has not reached a low
in spreads while equity indices are at
all-time highs
In addition, we saw a sharp trend
reversal at the end of the month
(mainly in the US HY) on the back of
falling oil prices.
For now, we stick to our preference
for US vs European credit on growth
considerations and Brexit (forgotten)
fears
OptionAdjustedSpreads(Bps)

37
EUR Credit – Brexit Impact
After the Brexit, the distribution of
EUR credit spreads FYE 2016 kept
sensibly the same modal.
But it was clearly twisted to higher
spreads (wither a higher mean and
a fatter tail)
Distribution of EUR Credit Spread
Outlook for FYE 2016

38
CDS Basis
High Grade CDS-Bond Basis has
narrowed to tights last seen in May.
‘15.
HG bonds are trading only 22bp wide to
their CDS, on average.
The basis tightening could explained by:
bond outperformance driven by the
demand for cash bonds and the
search for yield
the increase in the 5y swap spread
(as bond performance is usually
monitored versus treasuries)
This basis normalization is a good sign
for bond liquidity.

39
EXCHANGE RATES
Central banks remain one of the key drivers of foreign exchange,
The failure of the Fed to hike rates in H1 (and the reluctance of ECB/BoJ for additional easing) has
pushed some to suggest that the dollar rally is over. We don’t agree on that. The US economy is in a
better shape than suggested by the Q2 GDP.
While we remain structural Dollar bulls, the near-term picture looks confusing. US dollar hasn't
been able to rally despite the BOJ / ECB interventions and the recent positive employment reports
In our previous reports, 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 strong 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

40
EXCHANGE RATES
Two months ago, we moved to UW on the EUR-USD after the clean break below 1.13.
We remain UW for the moment. We will move to Neutral above 1.14, and to OW if the spot breaks
above the 1.165 resistance to target 1.18
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
In June, we turned Neutral on USD-JPY as our target of 102 was reached.
For now, we remain Neutral, but we see the risk of continued losses in USD-JPY ahead of the next
BoJ meeting end of Sep. ‘16
Our positioning rules on USD-JPY remain unchanged:
Remain Neutral below 106.6
Move to OW above
We may turn to UW after a clean break of the 100.30-100.90 resistance area, and target 98-99
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

41
Market Positioning - EUR
Hedge funds appear to be more and more bearish on the euro, when institutional investors are going
long the currency

42
US Dollar Index
The US dollar has been in a
range over more than a year
In our previous report, we said:
“Next target ~97.10. Only a
break above would open the
way towards 99-100…” Our
target has been reached, but
the index reversed its course.
We feel confused by the fact
that the dollar hasn't been
able to rally despite the BOJ
/ ECB interventions and the
recent positive employment
reports.
On the downside, 92 .7
remains the level to watch.
Breaking the support level of
92.7 to the downside will open
the door to a much more
substantial correction.

43
EUR-USD
2 months ago, we moved to UW
on the EUR-USD after the clean
break below 1.13.
We remain UW for the moment.
We will move to Neutral above
1.14, and to OW if the spot
breaks above the 1.165
resistance to target 1.18
Over the medium-term (2H-
2016), we maintain our downside
projections towards 1.08-1.04-
parity. For that, we need a clean
break through the 1.0910-
1.0981 area.

44
USD-JPY
The relationship between USD-
JPY and the 10y UST-JGB
spread remains strong.
If the BoJ remains on hold in
September, JGB yields could rise
by 10-20bps.and the USD-JPY
could sink to 99-97

45
USD-JPY
In June, we turned Neutral on
USD-JPY as our target of 102
was reached.
For now, we remain Neutral.
Our positioning rules on USD-
JPY remain unchanged:
Remain Neutral below
106.6
Move to OW above
We may turn to UW after a
clean break of the 100.30-
100.90 resistance area,
and target 98-99

46
COMMODITY
Since end of July, commodity prices seem on a upward trajectory. But, for now, we see that more
as a technical move than as a fundamentally-driven one.
We don’t see any sustainable recovery without a pick-up in global growth or a material
tightening on the supply side. It is likely that supply destruction (due to pull-back in capital
investment) will be the main catalyst for the next sustainable recovery in prices.
We also expect a considerable volatility along the way
We remain UW commodities over 3-6 months as we believe the recent rally might be short-lived
The supply side has adjusted but still has a way to go in many commodities before erasing
current imbalances. In order to get more cuts in supply, we think there needs another leg
down in prices to force capitulation
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 supportive
fundamentals 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 energy
and metals.

47
COMMODITY
Bottom Line :
Energy:
The market has been reporting higher oil production when demand seems to be slowing.
Oil remains a wild card but a bottom may be forming with supply/demand imbalances coming to an
end by mid-2017
Ample supply and growing inventories remain the major problem plaguing the oil market
The carry along the oil forward curve has turned negative, discouraging long positioning in oil
We think that the bottom is in for oil, but we don’t expect a significant rally from here. Any growing
evidence that the downtrend in U.S. crude production is ending, would induce another sharp drop in
prices.
We actually expect the spot to test again the 25-30 area before putting in a permanent rebound. At this
stage, we watch a few key levels ($40, $36, $31, $25). We need to see how we do around these levels
to make our projections.
We expect oil to remain within the US$25-45 range for a while, and volatility to persist.
According to our positioning rules (please see our previous reports), we’ve turned from Neutral to UW
as the WTI broke below the trendline across the lows since Jan. ‘16.
Our tactical rules remain unchanged:
Move to Neutral as soon as the spot reintegrates the channel drawn from Jan. ‘16
Remain UW below the trendline resistance (currently around $47)
Move to OW above the channel ceil or below $29.

48
COMMODITY
Precious Metals:
Outlook for precious metals continues to be dominated by the Fed dovish stance, macroeconomic
and political uncertainties and the subsequent impact on US dollar, real yields and sovereign credit.
Mixture of Fed hold-on posture, NIRP policies, and global uncertainties constitute a constructive
environment for Gold. Gold did pull back after the US employment report, but remains firmly in a bullish
trend. The performance of silver has been even more impressive.
According to our positioning rules, we turned OW on Gold as it broke above 1295, two months ago.
We feel, however, cautious about the sustainability of the recent rally as long positioning becomes
very crowded
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 still 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 1428
Go Neutral again between 1200 and 1295
Turn UW if the spot breaks below 1200
Go OW again below 1070

49
COMMODITY
Base Metals: .
We remain UW on base metals on continuing excess supply.
Industrial metals have remained range bounded over the last few weeks. From our point of view, lower
prices are still needed to oblige producers to cut production and to rebalance oversupplied
markets.
From a longer-term point of view, we believe that metals prices are headed for multi-year declines
as the current China-driven super-cycle appears to have peaked
In base metals, we see limited further upside potential for copper, as it appears to be one of the most
oversupplied markets.
Agriculture:
The S&P GSCI Agri TR Index posted another big loss in July. Grains were hurt by surprisingly strong
official estimates for US crops.
Corn futures, for instance, hit a seven-year low after the US Department of Agriculture hiked by 7.1
bushels per acre, the estimate for the average domestic yield this year – a figure far above market
expectations.
We choose to remain Neutral on Agris, as we have no conviction at this stage and given big
uncertainties around forecasts for 2016-17

50
Crude – A Fundamental View
US inventories remain well above the last
five years range.
Without an OPEC commitment to reduce
production, supply is going to be biased
higher
Higher supply and weaker demand would
naturally lead to higher inventories and
lower oil prices

51
Crude – Market Positioning
Sentiment seems to shift to the extreme bearish side: Money managers increased their shorts in
WTI crude oil futures
With a record short position, the market seems to be at a critical point. Any bullish news might
induce a massive short-covering, pushing prices higher.

52
Crude – Tech. Perspective
In its recent move to $50, the
WTI appeared as overbought.
Another retracement lower
should be expected from here.
It will likely search for the $30-35
area.
This view will be invalidated if
the trendline from the highs of
mid-2014 is broken to the
upside. $46-47 is the
invalidation level to watch.

53
Crude – Tech. Perspective
More precisely, and according to
our positioning rules (please see
our previous reports), we’ve
turned from Neutral to UW as
the WTI broke below the
trendline across the lows
since Jan. ‘16.
Our tactical rules are
unchanged:
Move to Neutral as soon as
the spot reintegrates the
channel drawn from Jan.
‘16
Remain UW below the
trendline resistance
(currently around $47)
Move to OW above the
channel ceil or below $29.

54
Precious Metals – A Relative-Value View
The gold miners (represented
by the HUI Index) to bullion
ratio shows that the metal
has been outperforming
equities since 2006.
With the recent rebound in
gold prices (from Jan. ’16),
the gold miners
outperformance has been
impressive.
But given the higher
production costs and the
lower miners profitability, we
don’t expect, this
outperformance to
continue, nor the ratio to
return to its historical
average..
HUI Index
GOLD Index
HUI to Gold Ratio
Source: quandl.com

55
Silver – Market Positioning
According to the CFTC Commitment of Traders report, Money managers have a record long position
in silver.
This crowded long positioning in precious metals should be watched closely. Any negative
price action would be exacerbated by investors trying to get out of their longs to reduce risk.

56
ALTERNATIVE STRATEGIES
In July, market concerns over the strength of the US economy and Brexit impact eased, inducing a
rebound in risk assets and fueling directional hedge fund strategies
The HFRI Fund Weighted Composite Index posted gains of 1.7% in July. Gains were led by
driven by Equity Hedge (+2.4% MoM) and Event-Driven (+2.1% MoM) strategies, as equity recovered
Brexit losses, and credit and arbitrage deal spreads tightened
CTAs realized most of their gains in the last week of July after Fed/BoJ meetings. The strategy
was up 1.2% over the month.
CTAs gained on their shorts in crude oil and agris, their longs in precious metals and equities.
On the negative side, systems faced losses on their fixed income portfolios.
Global Macro funds made money from the surge in the U.S. dollar, as they hold substantial long
exposure to the USD against G10 currencies.
But, at the end of the month and after the FOMC meeting, their accumulated performance was
completely erased, as the US Dollar reversed its course.

57
ALTERNATIVE STRATEGIES
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.
Within the hedge fund universe, we continue to prefer strategies with moderate market
directionality (“risk diversifiers” type) such as L/S Equity Market Neutral, Global Macro and CTAs.
The reason behind that is that we continue to consider traditional asset classes as richly valued.
We reiterate our OW rating on :
Equity Market Neutrals both for their “intelligent” beta and their alpha contribution.
CTAs: We keep particularly a clear OW stance on CTAs as a diversifier in portfolios and a hedge
against future stress. 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: +1.6% MoM, +3.0% Ytd) and prefer funds that trade
volatility globally (all assets / all regions).

58
Cross-asset Volatility
Volatility across asset classes has reset to its
lows, during the summer.
We do not expect such low levels to persist
for long. A pick-up in volatility is probably
imminent.
We favor long vols on S&P500 and Gold
It’s worth noting that low volatility (combined
with major coming policy events) is not a
particularly supportive environment for Global
Macro strategies.

Bottom Line: Global Asset Allocation
In July, market concerns over the US economy and the Brexit
impact eased, inducing a risk-on environment. the S&P 500 has
made new all-time highs, the VIX has fallen, bonds started to sell off,
and cyclicals have outperformed defensives.
Precious metals remain firmly in a bullish trend, supported by a mixture
of Fed hold-on posture, NIRP policies, and global uncertainties. Gold
outperformance is rarely good news for real growth
Our biggest concerns relate to the lack of earning growth (earnings
recovery keeps getting pushed further into the future), the need for more
business confidence, and corporate investment.
The market remains expensive and needs increased earnings to
move higher.
A key concern at this stage remains the lack of diversification as
most safe assets appear too stretched
Central banks continue their irrational game, with the hope to levitate
financial asset prices long enough to allow fundamentals to catch up.
At this stage, investors appear more afraid of missing out on a rally
than getting caught in a selloff
We make minor adjustments to our asset allocation this month, except
on Energy where we’ve turned UW.
We summarize our views as follows
59

60
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...
61

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•Risk Profiling
Offer a turnkey 3-
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62

Finlight Research - Market Perspectives - Aug 2016

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