FinLight Research - Market perspectives Jan 2014

Market Perspectives
Jan 2014

January 3rd, 2014
www.finlightresearch.com

MACRO VIEW
The Good
Earnings outlook looks good. Expected Q4-2013 earnings growth rate for the S&P500 is now
projected to be in the 7-10% range
Durable goods orders for Nov. surprised on the upside
Q3 GDP was revised up to 4.1% (annual growth rate) thanks to consumer spending (a good thing)
and increasing inventories (a puzzling thing that should be monitored closely)
Initial jobless claims are still encouraging
Consumer confidence from the Conference Board produced a slight beat of expectations
ISM manufacturing beat expectations and the New Orders sub-index which historically correlates to
the economy improved.
Merger activity picked up especially in the latter quarter of the year.
The Bad
Personal income growth has been disappointing
Real household incomes are in worse shape than they were four years ago when the recession
ended.
China's PMI hit a three month low, pointing to some slowdown in economic growth
Investment sentiment remains very bullish
Pending Home Sale Index for November missed expectations by a wide margin. The underlying
downtrend for housing sales appears to be accelerating.
The Ugly
Smell of war in Middle-East (Iraq and Syria)
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Big Four Economic Indicators
The global picture is that of a slow recovery. Among the 4 indicators, two (Real Retail Sales and
Industrial Production) have already reached their all-time highs. Nonfarm Employment remains on a
positive trend. Only Real Personal Income is still struggling.

3

Industrial Production
November industrial production rose much more than
expected (+1.1% vs. +0.6%), led by a 0.6% increase in
manufacturing production which accounts for about
three quarters of industrial production
Manufacturing production is up 5.1% annualized rate
in the past three months.
Industrial production in the US has now reached a new
all-time high.
The contrast between the U.S. economy and the
struggling eurozone economy

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Manufacturing
ISM manufacturing index reading looks consistent with a GDP growth of at least 4%.
ISM New orders index continues its steady improvement implying better manufacturing conditions in the
near future.
It is interesting to note that ISM Manufacturing represents less than 10% of USA employment, and
approximately 20% of the business economy.

5

Manufacturing
Business spending is picking up on the back of rising confidence
Markit’s final U.S. Manufacturing Purchasing Managers Index rose to 55.0 in December 2013, beating
November's 54.7 reading and an initial December estimate of 54.4.
This upward movement was led by a solid increase in output, boosted growth in the sector and
increased demand for plants and machinery.
Manufacturing conditions in the Eurozone have improved significantly over the past year, and are now
tracking improvement in U.S. manufacturing.

6

Employment
Initial Jobless Claims fell to 339K vs. an expected 344K, while Continuing Claims were also much lower
at 2,833K vs. 2,890K.
Unemployment should continue to trend lower, despite another debt ceiling debate next month

7

Retail Sales
Retail Sales have accelerated over the past two months.
The question now, of course, is how this key indicator behaves during the holiday season

8

Real Personal Income
This indicator remains the laggard of the Big Four.

9

Household Income
At this point, real household incomes are in worse shape than they were four years ago when the
recession ended.
The real median household income series spent most of the last 14 years struggling slightly below its
level at the beginning of 2000.
The real recovery from the trough is still very weak.

10

Real Estate
Comparing Median New Home Sale Price to Median Household Income shows that prices restart
inflating after July 2012, drawing a trend similar to that of Nov 2011.
Is that a second U.S. housing bubble?

11

Real Estate
The Pending Home Sales Index measures housing market activity based on signed sales contracts for
existing homes in a given month. This index is subject to revisions because of cancellations (especially
when mortgage rates are increasing)
For November, the index gained 0.2% mom, was reported at 101.7 vs. 101.5 for October (revised down
from 102.1, shows a 1.2% drop from September 2013 and 2.2% drop from the October 2012). However,
it dropped 1.6% vs. November 2012
A negative trend in contract signings on existing home
sales is emerging

12

Investment Sentiment
Investment sentiment remains very bullish, generally
viewed as a contrarian market indicator. Bespoke
analyzes the AAII series, where bulls are over 50%
for the first time since January..
Equity allocations among individual investors
reached their highest level since June 2007. Stock
and stock fund allocations rose by 4.1 percentage
points to 68.3% (Historical average = 60%). In June
2007, equity allocations reached 68.6%.
Bond and bond fund allocations fell 2.1 percentage
points to 15.2%, below the historical average of
16%. This is the smallest fixed-income allocation
since May 2009, when bond and bond fund
allocations were 14.2%.
Cash: 16.5%, down 2.0 percentage points

13

Consumer Confidence
The current reading of the Conference Board Consumer Confidence Index at 78.1 is 6.1 above the
November 72.0 (previously reported at 70.4).
Mechigan Consumer sentiment is now only 3 percent below the average reading

14

Consumer Confidence
National Federation of Independent Business (NFIB) Small Business Optimism Index continues to track
fairly closely the Conference Board Consumer Confidence.

15

Market Flows
Mutual fund asset allocation, as represented seems heavily weighted towards equities. The ratio of
assets in money market and fixed income funds to total mutual fund assets is at near record lows.
However, according to ICI data, the rotation out of fixed income into equities has only just begun : 2013
was the first year of inflows in equities after five straight years of outflows !

16

Market Flows
Commodities and EM are the big losers in terms of ETF flows.

17

China PMI
HSBC China PMI fell to 50.5 in December, from 50.8 the previous month, but showed a steady
increase of new orders
The official PMI, published by the National Bureau of Statistics, dipped to 51.0 in December, as export
orders and output weakened

18

GS – Global Leading Indicator (GLI)
Nothing
new
November.

compared

to

The December Final GLI locates
the global industrial cycle on the
border between the ‘Expansion’
and the ‘Slowdown’ phase.
5 of the 10 underlying components
improved in December
the GLI continues to signal solid
activity growth, but with no clear
evidence of further acceleration at
this stage

Bottom line: positive outlook for
global growth but acceleration is
probably behind us.

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FinLight Research

EQUITY
we have been left with no other choice than to take a bullish stance on equities, even if we still
wait for a limited correction (5% to 10%).
US equities are boosted by an improving economy and upward. Japanese equities are boosted by
expectations of additional BoJ stimulus.
EM equities should underperform given the subpar EM growth and Fed tapering
The improvement in the PMI in the last quarter should favor Cyclicals over Defensives

Bottom line:
We keep our bet on a limited correction, with a test of 1700 - 1650 level on the S&P 500
We UW Europe and EM vs. the US and Japan.
We prefer more defensive high-yielding stocks.

20

Equity - Long-Term Valuation
Market overvaluation suggests a cautious long-term outlook… But periods of over- and undervaluation can last for a long period

21
FinLight Research

Equity – S&P 500
The market looks stretched but the SPX has room to extend further from current levels

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Equity – S&P 500
Macro hedge funds exposure to equity is still high

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Equity – NIKKEI
The monthly close in December is noteworthy as it breaks the primary downtrend from June 96
This is a bullish signal to watch. The next potential target is around 16 800

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FinLight Research

Equity – NIKKEI
But CFTC non-commercial positions on NIKKEI have been decreasing since mid-2013

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FinLight Research

Equity – Emerging Markets
EM equity funds witnessed outflows for the 10th consecutive week to January 1.
Most analysts continue to expect subpar EM growth implying further EM equity underperformance this
year. The Fed tapering is another negative factor.
According to Consensus Inc. data, Risk-Love sentiment is euphoric. In the past, episodes of such high
Risk-Love saw EM equities going sideways to down

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FinLight Research

Equity – Emerging Markets
When the US dollar is strengthening (and this is our macro view), Emerging Market equities tend to
underperform developed markets.

27
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Trading Model - SPX
Our trading model stopped its shorts

28
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Risk Aversion
Nothing new since last report. At 0.07, the RAI remains in neutral territories. Equity 6m-momentum
should go down

29
FinLight Research

FIXED INCOME & CREDIT
We retain our core strategic view for higher long-end yields going forward.
But given the sharp upward move in treasury yields over the past month, we tactically stay neutral govies
(but keep an eye on the 3.00% threshold on 10y UST) on the short-term and wait for a better spot to go
short / UW
We also stay OW EMU and Germany vs US and UK.
A way to express our short duration bias is to take 2y/10s curve steepeners which benefit from better
carry than outright short duration. We are long 5Y Bobl vs. 5Y UST.
We remain long duration in German bunds at the short end.
We are OW TIPS
We stay overweight peripheral vs. core govies.
Given the spread tightening that happened in the last two months on IG bonds, the potential for any
further tightening seems very limited
We stay neutral on credit as a whole
We stay OW High-Yield (BB and B) vs Investment Grade. We also OW European HY vs US High Yield as
the latter has higher gearing et more exposed to hike risk in benchmark rates

Bottom line : neutral Govies, Neutral credit, OW TIPS, keep our OW High Yield and EM sovereigns vs
High Grade

30

Fixed Income – 10y UST
The upside trend on 10 year US Treasury yields is likely to continue in 2014
The main drivers affecting the U.S. Treasury market are the overall U.S. economic outlook (GDP
expected around 2.5% + inflation expected around 1.2% and thus below Fed’s target) and the way
(speed + communication) the Fed is going to unwind its current monetary policy accommodation
In the central scenario where Fed implements its exit strategy properly, we target
3.70% on 10y US benchmark yield (Feb 11 level)
A 50bps steepening on the yield curve, because the Fed will probably keep short-term rates rock
bottom until 2015
Alternative scenario : A disastrous exit from the $4 trillion balance sheet would drive 10y yield in the 4.55% range

31

The price action since Oct 30 appears similar to that from July into Sep 6
At this stage, a little pullback is very likely

32

Looking at the channel formed off the Mar. 89 peak, the break of 3.00% could open the door to another
leg higher targeting 3.76 (Feb. 11 high) and 3.90 (downtrend).
Breaking the downward sloping channel would give a strong signal on the ability of the Fed to unwind its
monetary policy accommodation
A pullback on the 3.90 level will probably be concomitant with a downside move in stocks

33

Fixed Income – Global
Yields increased sharply, specially on the 5y and 10y maturities, in reaction to early Fed tapering in
December
The 2s/10s continued to steepen globally – Source: JP Morgan

34

Inflation
While the PCE deflator (Fed's favorite inflation measure) remains near 1%, the GDP price index rose at
an annual rate of 2% during the Q3-2013, suggesting inflation might be running higher than Fed expects
Increasing inflation is driving TIPS higher versus govies

35

High Yield
High-yield default rate falls to a six-year low.
The par-weighted US high-yield default rate decreased to 0.66%, its lowest level since December 2007
(0.38%). The default rate is down from 1.26% at the end of last year and is considerably below the longterm averages of 3.9%

36

High Yield
With underlying macro fundamentals
improving, the HY market continues to
weather the rise in Treasury yields well
HY fully absorbed the increase in Treasury
yields in 2013 with spreads and yields
contracting significantly.
Present situation is clearly similar to the
one experienced in 2006-2007
HY new-issue activity totals a record high in
2013, in US as in non-US…
The spread between HY and IG is now on a
record low

37

EXCHANGE RATES
Since our last report, we’ve been long USD against EUR and JPY. None of our targets (1.31 and 108.3)
was reached during the month.
US dollar should start trading again on monetary-policy outlooks more than the risk-on / risk-off
moves of recent years
The US dollar shows clear signs of bottoming out
Rising U.S. Treasury yields as the Federal Reserve scales back quantitative easing are expected to help
boost the U.S. dollar against most of the world’s major currencies in 2014
However, as Fed funds rate is expected to remain low, the US dollar should stay sideways through 2014H1

Compared to the EUR, a widening of yield differentials in favor of the dollar will probably be driven by a
more aggressive action from the ECB.
On the EUR, we target a pull back to 1.31-1.25.
On USDJPY, we target 107-108 region, but set a stoploss at 103.70

38

US Dollar - DXY
FX hedge funds and non-commercials are
increasing their exposure to DXY

39

EUR-USD
With softer euro zone data, low inflation and
continued contraction in private sector lending,
the ECB may move again by launching a
quantitative-easing program (probably in the
latter half of 2014)
There is speculation that ECB would adopt a
negative deposit rate. The German 2-year yield
peaked around 26 bp in mid-December and is
now trending lower
On the other side, the bias is to a stronger US
growth and a more hawkish Federal Reserve
The US 2-year yields is moving up, helped by
the positive data surprises.
A material top seems to be forming in EURUSD chart, after the spot failed to go through
the 1.38 resistance area
We target a pull back to 1.31, then to 1.25.

40

EUR-USD
Yield differential between US and Germany implies in the 1.20 – 1.25 range

41

USD-JPY
The initial target for wave 5 has been met at
104.71
The market could extend its move to 107-108
but we should keep an eye on any signs of a
meaningful turn like crossing down the May
2013 high at 103.73
After identifying the top of wave 5, a
subsequent correction / consolidation should
be expected.
At this stage, we keep our target of 108 and set
a stoploss at 103.70

42

USD-BRL

Looking at the chart, it seems reasonable to
wait for a correction within the tunnel, without
negating the USD upward trend.
We target 2.60

43

COMMODITY
We expect a better performance for commodities in 2014. The GSCI index should deliver 5% to 10%
thanks to energy, backwardation, higher prices on base metals and a stabilization in precious metals.
Agriculture prices should trend lower on higher supply
Over the short run,
After being neutral, we become OW on commodities, with a clear preference for energy and base
metals, over precious metals and agri.
We stay UW precious metals (targeting 1180-1150 on gold and 18-17 on silver) because of rising
real interest rates. Technically, the bias seems skewed to another significant move lower.
Reaching a base will give a buying signal not only on physical gold but also on gold miners.
On MT, we stay UW copper. The downside risk due to increasing supply is too significant to be ignored.
We target 6600, and ultimately 6000.
On MT, we are bullish on commodities. The institutional money is starting to flow back into the
commodities space.

44

Precious Metals - Gold
Gold prices under the all-in sustaining costs of $1,200 - $1,400 per ounce will curb the development of
new mines, which will effect the supply of gold within 5 to 10 years
We are positive on gold for 2014 as we expect outflows from gold ETFs to stabilize in the coming year
On the ST, the bias seems skewed to another significant move lower. Much of gold’s weakness comes
from the likelihood of the Fed tapering its QE program as the U.S. economic outlook is starting to improve

Real yields increase still explains a big
part of the downside move on gold

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FinLight Research

Precious Metals - Gold
Our theoretical price (implied by US$, sovereign CDS and Real Rates) stands now at 1142, versus a
market price at 1205 (as of Dec 31). Our fair price should continue its downward movement as US$
and real rates go up.

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FinLight Research

Precious Metal - Gold
Like for silver, a near-term base seems to be
developing around 1180 (In our previous
report, our target was 1180 – 1150). A clean
rebound would imply a short-term recovery
We are in a corrective action. From here, the
bias seems skewed to another move to the
downside.
Target ~1150
But breaking 1270 to the upside would imply
another move higher into the 1330 area

47

Precious Metals – Gold Miners
The downturn in PM prices has created golden opportunities within miners.
The stocks we prefer are Gold Corp (that appears as the least volatile of the miners and the most
conservative bet for those interested in making an investment in a gold miners) and Silver Wheaton (for
its effective correlation to silver price)
Prefer to invest in broader baskets (like GDX) over individual names for diversification and risk control
reasons.
Prefer larger miners to junior miners, as the latter tend to be more volatile and are at far greater
operational risk if PM downtrends persist.
We have to wait until the gold reaches a floor somewhere in the area 1150, before going long GDX

48
FinLight Research

Precious Metal - Silver
On the open of Dec 31, more than 7,500 contracts were sold pressuring prices to a new low of 18.72
intraday, inducing a immediate rebound of 1$.
This is 3rd time in 2013 this kind of rebound occurs identifying the 18.70 level as a near term base. Going
through 18.8 – 19 would imply a test of 17 which stands below the cost of production

49

Precious Metal - Silver
The pivot area to watch is 20.51-20.93 where
multiple levels are converging.
It is important to know if the primary downtrend
from Nov 12 will hold again, as it did on two
occasions: Aug 13 and Oct 13
Breaking above this downtrend would give
a strong positive signal on gold.
Without a clean break above this downtrend,
continuation to the downside should be
privileged
Target ~ 17$

50

Precious Metal – Market flows
Spec positions on gold have almost vanished
Money continues to flow out of gold ETFs

51

ALTERNATIVE INVESTMENTS
We are always OW on AI as we expect a 10% return in the coming year versus 5% on a traditional
balanced portfolio (stocks + bonds+ cash).
Our overweight position focuses on Commercial Real Estate (even if the current message is still mixed)
We are OW Equity long-short market-neutral, Convertible arbitrage, CTA’s and Global Macro

52

Hedge Funds Exposures
According to BoA Model :
Market Neutral funds increased market exposure to 9% net long from 7% net long.
Equity Long/Short market exposure reduced to 29% net long
For Macros funds, the following significant moves were reported:
They reduced their long exposure to S&P and NASDAQ.
They kept their long exposure to US Dollar.
They switched from short exposure to now long exposure to 10-year treasuries and
commodities
They maintained short EM exposure
Based on CFTC data, the following HF moves were reported:
Equities: Large specs marginally decreased their net longs in the S&P 500 but increased long
position in NASDAQ and Russell 2000.
Interest Rates: Large specs strongly added to their 10-yr short position.
FX: Large specs decreased their longs in EUR and shorts in JPY.
Metals: Large specs increased Gold, Silver, Platinum and Copper long exposure
Energy: Large specs maintained Crude longs and reduced Natural Gas and Heating Oil short
position.
Agriculture: Large specs decreased their long positions in Soybean and increased short Wheat /
Corn exposure.

53

December 2013 Performance Review

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Bottom Line : Global Asset Allocation
Most of the important recent news was good
The economic outlook for 2014 seems rather benign. Growth in
the US is likely to pick up, but there is always the possibility of
another shock somewhere. And the simple fact is that the
eurozone is one shock away from plunging into a deflationary trap.
The global economy looks poised to display better growth
performance in 2014. Leading indicators are pointing upward - or
at least to stability
We summarize our views as follows

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FinLight Research - Market perspectives Jan 2014

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