Finlight Research - Market Perspectives - Jun 2016

Market PerspectivesJune 2016

Jun. 7th, 2016

www.finlightresearch.com

A melt-up before the meltdown?

“That means the Fed still has a 'China

problem': any effort it makes to tighten policy

will, once more, activate the feedback loop

and suck capital from China with what are now

predictable consequences”– David Lubin (Citigroup)

2FinLight Research | www.finlightresearch.com

Executive Summary: Global Asset Allocation

� Activity indictors, like PMIs in the G3 and China, continue to suggest global stagnation.

� The probability of the occurrence of a stress scenario on a global scale is still high. We see warnings from fundamental, behavioral and credit signals.

� Valuations of both stocks and bonds are at or near record high levels

� The S&P 500 Index is likely to break out to new highs, and thus exacerbate already stretched valuation levels. Earnings remain perhaps the most important issue, at this stage.

� Over the last few weeks, we saw the Fed suddenly going from Dovish to Hawkish, and then reintroducing a more dovish narrative after the large miss on US non-farm payrolls >> More uncertainty is building, but not yet visible in implied volatilities.

� 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 consumer spending rose at the fastest rate in seven years, with a +1.0% MoM� US Q2 GDP growth is forecasted at 2.9% by the Atlanta Fed model� The Michigan sentiment index is back at healthy levels� Thanks to Utilities, US Industrial production jumped by +5.8%, the most in 18 months� The IFO Business Climate Index for Germany came in at its highest reading this year (107.7 in

May, beating market expectations of 106.8)� The Bad

� Non-Farm Payrolls were a huge miss at 38,000 (vs 170,000 expected), but unemployment rate went lower, at 4.7%, because a severe drop in the labor force

� The sharp decline in US core durable goods orders (-0.8% MoM and by -8.7% YoY) signals a continuing decline in capital investment and in business confidence

� The Caixin manufacturing PMI index slipped to 49.2, for the 15th consecutive month of contraction.

� 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. And that hardly ends well. Further US dollar strengthening would oblige China to devalue its pegged yuan and accelerate foreign capital outflows.

� Brexit: The decision by the U.K. to depart from the EU has the potential to become meaningfully disruptive to global financial markets. Recent polling shows that the « leave » vote is gaining momentum.



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.


Consumer’s Sentiment

� The Michigan sentiment index is back on its highs in nearly a year.


US GDP

� US GDP growth for Q2-2016is seen at 2.9% by the AtlantaFed model

� This forecast was upgradedfrom 2.5, making a summerrate hike more likely

� But other weak US data,particularly the softer payrolls,make the rate hike moreprobable in July than in June.


US Credit Conditions

� According to Senior LoanOfficer Opinion Survey data,banks have reportedtightening lending standardsfor 3 consecutive quarters.The last time we saw a similarmove was in late 2007/early2008.

� Tightening of credit is usuallyseen as a long leadingindicator for recession

� Banks are currently tighteningtheir credit conditions to largefirms, driving down the C&Iloans expansion with a leadtime of about 18 months

� But we’re still far from levelsof tightening associatedwith the past recessions


Chinese Economy

� We expect China to allow further depreciation of the yuan� The Caixin/Markit PMI fell to 49.2, suggesting the same negative fundamentals are still in action.� At this stage, an additional depreciation of the yuan seems a much needed stimulus for the

manufacturing sector and exports.

� The question is: Are markets going to react to such a depreciation like in August 2015 or early 2016? Notsure, but the risk is real…

Source: Alhambra Investment Partners


Chinese Evergreening Credit

� Evergreening credit is due tocorporates borrowing new credit torepay interest and principal due.Around $1.2 trillion in new debt wereissued by Chinese firms during 2015just to pay interest on their existingobligations

� According to a Deutsche Bankanalysis, evergreening credit hasbeen increasing since 2009. It nowrepresents approximately 6-9% oftotal system credit, and 10-15% ofcorporate credit.

� The danger with evergreening debtis that it would likely turn intononperforming assets if economicconditions deteriorate.

� We still see further problemsahead


EQUITY

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

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

� Earnings are perhaps the most important issue at this stage.� Any breakout to the upside will prove to be unsustainable in the absence of a real improvement in

corporate earnings prospects� Earnings reports are mixed:

� US earnings recession continues. S&P 500 consensus forward earnings estimates seem to be stabilizing, suggesting the yearlong earnings recession may be ending. But for that, the dollar should not strengthen a lot from here.

� Earnings reports are slightly beating (significantly reduced) expectations.� To sum up, we see limited upside from here, but the S&P 500 may challenge its old highs before

turning decisively south (unless we get a new round of QE). The bounce will soon become an opportunity to sell into

� 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


EQUITY

� Our scenarios remain unchanged.� 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 new highs around 2150-2170

� We will turn Neutral if the spot breaks below 2075 � We will switch to UW as soon as the 2020 – 2035 range is materially broken to the downside. � Any clean break below the ‘09 trend would make us move massively UW

� We like the low US beta. We remain Neutral on Europe and Japan vs. US despite the policy divergence between the Fed and the ECB/BoJ

� Small-caps have been strengthening, suggesting risk appetite is growing But, 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. 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 earningsrecession. For Q2 2016, the estimated earnings decline is -4.8% YoY (-1.5% if energy is excluded).

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

� For all of 2016, the estimated S&P 500 growth rate is now projected at 0.8% for earnings and 1.8% for revenues.

� For Q2 2016, 81 companies have issued negative EPS guidance and 31 companies have issued positive EPS guidance

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


US Earnings

� The proportion of S&P 500companies with negative expectedforward 12-month EPS is at itshighest levels since 2009.

� Spikes in this measure havehistorically induced a similar move,six months later, in companiesreporting negative actual EPS (overLast Twelve Months – LTM).


Equity Buybacks

� Buybacks continue to influence earnings

� According to Deutsche Bank, S&P 500 companies spent $485bn or 2.7% of market cap on net buybacks in the 4 quarters through 1Q16, contributing 2.2% to S&P EPS growth

� But to what extent are buybacks able to continue at the same stance, given the charts below?


Equity Buybacks

� But their impact on stocks prices is clearly fading…

� Since end of 2015, the stocks that have the largest buyback programs have underperformed the S&P 500 by some 8%

Source: ycharts.com


Investor Sentiment

� After an extremely weak reading of 17.8% (a level that breached the lowest levels reached during the financial crisis) a week ago, the American Association of Individual Investors (AAII) Bullish Sentiment bounced to 30.2%

� Practically none of these new bulls came from the bearish side, as Bears remained stable at 29.4% (vs. 29.1% a week ago)

� Many are pointing to this contrarian indicator as a sign of an imminent surge in stock markets

� But one has to keep in mind that this contrarian indicator has been a bullish sign when stocks were near local bottoms..

� Instead, the S&P50 is now near its all-time highs

� Extremely low bull sentiment numbers, when they occur close to a recent market top, do not signal a bottom, but they may predict that a bull-trap is forming.


Investor Sentiment

� Based on StockCharts.com analysis, this type of counter-trend pattern (very low bullish sentiment with market flirting with the top) also occurred:� in 2011 (before a 19% drop) � and again in mid-2015 (before a 13%

drop)


Risk Appetite

� The CNN Money Fear & Greed Index (components of which are: Put/Call ratio, Stock Price Strength, Stock Price Breadth, Market Momentum, Junk Bond Demand, Safe Heaven Demand, Market Volatility) has been at "greed" or "extreme greed" levels for the past 3 months

� We see a dichotomy between this “greedy” sentiment and the fading medium-term upside momentum.� A reversal of this sentiment indicator would be followed by a reversal of the stock market uptrend

� Source: http://money.cnn.com/data/fear-and-greed/

Source: CNN Money

CNN Money Fear & Greed Index


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 metrics are virtually useless when it comes to timing market tops and bottoms, but

they do tend to have pretty reliable predictive value when it comes to long-term returns� 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


S&P500 – A Long-Term Perspective

� Price-to-sales (P/S) ratio is another metric pointing to lofty valuations.

� The median P/S ratio on the S&P 500 stands at 2.2, well above the 2007 and 2000 levels

� The median P/S at those levels suggests that the majority of large caps are too expensive, unlike the bubble of 2000 when overvaluation was concentrated in the Tech sector.

Source: Ned Davis Research


S&P 500 – A Medium-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 - 2170!).

� Important levels to watch are 2075 and then the 2020 –2035 range

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

� We will switch to a UW stance as soon as the 2020 – 2035 range is materially broken to the downside.


S&P500 – A Short-Term Perspective

� Our prop. Short-Term trading model has turned long on May 4 S&P500 close (@2051.12) and massively short on Jun 6 (SPX @ 2109.41)

� The model is now short SPX again, targeting 2104 and 2062.

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FIXED INCOME & CREDIT

GOVIES

� The last jobs report was weak enough to discourage ideas of a June hike and drive treasury yields down. The market is now pricing the odds of a rate hike at a +15% probability of a +25bp move in June, and around a +30% chance of a move in either June or July

� Treasuries have been range-bound for the past 4 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.

� But, the fundamental picture and geopolitical risks are likely to keep yields low over the near term.

� In the Euro area, 10Y Bund yields are also stuck close to record lows, because of lack of conviction on a sustained pick up in inflation and the ongoing ECB and BoJ easing

� 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

� Downward pressures are fading on inflation expectations in the US (less in Europe). The recentoil price rebound has lifted inflation expectations towards the Fed’s 2% target

� Breakeven may have structurally bottomed here. Reflation should gain the upper hand in H2-2016

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

� We have been OW 10y-TIPS breakevens since Dec ‘15. We now choose to turn Neutral as we look for breakevens to end the year near their current levels. The Fed rate hike we expect in July, the lower oil prices and the faster pace of dollar appreciation we see from here, the retail demand appears that seems to have weakened, all argue for tighter breakevens.

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

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 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 6-month high for Oil prices, stocks flirting with their highs, higher market inflows, a drop in rates, 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 to move up and balance sheets are deteriorating. Renewed weakness in oil prices will bring this issue under the spotlights again. At current low levels of implied volatility, investors might consider hedging their US HY holdings with puts.

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

� We prefer to trade up in quality. We still prefer IG over HY on a risk-adjusted basis as we expect volatility on spreads to remain elevated and we believe IG corporates better positioned to absorb the impact of rising rates and bad news 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, and on a risk-adjusted basis, we find that BBs still offer the best return per unit of volatility.

� 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

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

� 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, Neutral 10y-TIPS and Neutral HICP Inflation, UW High Yield vs High Grade, Neutral on EM sovereigns with a little preference for local bonds


“You have a better chance of observing

another era like the previous 40-year one on

the planet Mars than you do here on good old

Earth… The bond market's 7.5% 40-year

historical return is just that - history. In

order to duplicate that number, yields would

have to drop to -17%!

Tickets to Mars, anyone? ”– Bill Gross


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US Govies – 10y-UST

� We change nothing to ourprevious positioning.

� Tactically, we remainNeutral on 10y USTs aslong as the 1.94 level ispreserved. Above, we’llmove to UW again.

� We think a base shoulddevelop somewhere insidethe 1.65-1.77 range.

� Our ultimate target remainsat 2.45 by H2-2016

� The critical level to watch is1.65. Below, we may switchto OW again.


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US Govies – Curve Flattening

� We have been long flatteners (2-10y) onthe US yield curve since Dec. ’14, playingthe view that “when the Fed hikes, the yieldcurve flattens”

� The difference 2-10y UST spread is now at100bps, almost exactly in the middle of its30 year range.

� We keep our flattening bet (targeting a 50bp flattening in H2-2016) as we think that the market is not prepared for 2 further rate hikes in 2016


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European Credit Fundamentals

� Despite the recent rally in European credit, mainly justified by Brent crude prices (getting above $50/bbl for the first time since Nov. ‘15) and some modestly positive headlines, credit fundamentals seem to be deteriorating for both HY and IG…

� Revenue and EBITDA growth slowed to just 1.9% and 2.2% YoY respectively

� Net leverage increased to 3.9x


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Credit vs Equities

� IG Credit (like HY) hasunderperformed equities over the pastmonth, with the S&P 500 flirting withits highs and CDX.IG getting wider.

� We still see a better value (andprotection) in corporate debt(specially IG) than in equities, asspreads already price a worse growthenvironment.

� This growing valuation gapbetween the 2 asset classes istranslated in fund flows: Accordingto data from Lipper, HY and IG bondfunds have accumulated a combined$37 billion of inflows YTD, when $56billion has exited equity funds.


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EXCHANGE RATES

� We’ve already moderated our view for the dollar as the (dovish) Fed has kept pressure on it, capping any higher yields attempts. But still believe in a stronger USD medium term, particularly versus Euro and Chinese yuan

� 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, higher short rate differentials between the US and its G10 peers, 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.

� According to our positioning rules, we’ve moved to UW on EUR-USD as it broke below 1.13. � Our positioning rules are adjusted as follows:

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


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EXCHANGE RATES

� We remain Neutral on USD-JPY, “watching for signs of near-term stability or basement somewherebetween 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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EUR-USD

� In our previous Monthly Report,we said “The picture on EUR-USD is not clear. But, given ourview on the DXY index, weexpect a downtrend to developfrom here… To gain confidencein such a scenario, the spotneeds to break below 1.13.”

� According to our positioningrules, we moved to UW after theclean break below 1.13.

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

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


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USD-JPY

� We change nothing to ourprevious positioning. We remainNeutral on USD-JPY

� 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


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COMMODITY

� The S&P GSCI total return indices gained 5.2% in May, despite the firmer US dollar.� Fundamentals appear to be firming for commodities. The main risks remain Fed rate hikes and

new signs of weakness in China.

� We remain UW commodities over 3-6 months as we believe the recent rally might be short-lived� The supply side has adjusted but still has a way to go in many commodities before erasing

current imbalances. In order to get more cuts in supply, we think there needs another legdown in prices to force 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 at least 2

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 substantialshrinkage 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.


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COMMODITY

� Bottom Line :Energy:

The recovery in oil prices have continued over May despite the firmer US dollar. Supply disruptions(outage in Canada, unrest in Nigeria, Libya), the drawdown in US inventories and the drop in US oilproduction appear to be the main catalysts

A technical look at oil prices suggests near-term profit taking in energy-related positions is likely agood 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 to anend by mid-2017

� Fundamentals (oversupply, global inventories, mild growth and demand, restarting of production in partsof Canada shut down by wildfires, increase in exports from Iraq) continue to put pressure on prices.

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

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

� Our positioning rules on crude are:� We remain Neutral as long as the spot stays within the spot stays within the Feb channel

(currently at 42 – 50)� Turn UW below the channel support� Move to OW above the channel resistance or below 29.


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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.

We regard the recent rally in gold to be without fundamental basis, mainly due to dollar weakening and FED dovish tone.

� The recent Fed uncertainty has opened further upside potential for gold� But, 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.

� We remain Neutral on gold, and watch for a clean break above 1295 to become OW again� 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)


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COMMODITY

Base Metals:

� Metals prices have rebounded even as fundamental conditions have not improved. The recentprice increases are more a technically-driven move, mainly linked to the last round of Chinese easing.So when China's stockpiling ends, these metals will go south

� We continue to expect industrial metals price weakness due to a combination of excess supply andweak demand

� From our point of view, lower prices are still needed to oblige producers to cut production and torebalance oversupplied markets. Thus, we remain UW on base metals.

� From a longer-term point of view, we believe that metals prices are headed for multi-year declinesas the current China-driven super-cycle appears to have peaked

Agriculture:

� The recent sharp rally in grains may not have far to go, because of glutted markets especially onsoybeans and corn.

� We see more weather events weighing on grain harvests specially in Latin America (like soybean inBrazil due to dry weather). Some grains might appear in deficit but global stocks are still at record levels

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


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Precious Metals - Gold

� We regard the recent rally ingold to be withoutfundamental basis

� The move was mainly justifiedby the dollar weakening andFED dovish tone.

� But the Fed would have to stepin during the summer, providingthe fundamental basis for adollar strengthening, and goldweakness.

� Our positioning rules areunchanged:� Remain Neutral between

1200 and 1295� Turn UW if the spot breaks

below 1200� Go OW below 1070 and

above 1295 (to target 1380– 1420)


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Crude – Market Positioning

� The rally we recently saw in oil prices could be explained by lower production mainly due to: outage inCanada, unrest in Nigeria, Libya, sharp drop in the number of US rigs.

� But the sharp reduction in the WTI short speculative position (which are back to their lows) has,no doubt, contributed to the upside move.


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Crude – Tech. Perspective

� Another factor that has supported oil prices so far has been the persistent contango on futures curve. This configuration has been favorable for those able to buy the spot and to store it.

� Huge armada of supertankers (as floating storage) have formed around the world with some 200 Mln barrels of (offshore) oil waiting to be delivered. Just have a look to the maps on: http://fingfx.thomsonreuters.com/gfx/rngs/1/1253/1888/index.html

� But, cantango is now vanishing, making offshore storage uneconomic and thus untenable.

� In the absence of a sustained demand, these storages would have to be emptied at lower prices an the downturn in oil should resume.


46

Crude – Technical Indicators

� The uptrend since Feb’ 16 has been going on for a long time now and has induced some overboughtconditions (MFI, RSI). The MACDs suggest the market is stretched, but have yet to turn down.

� The 10-week Momentum indicator is near its multi-year resistance� Oil is probably forming a topping around the $50 level. We will be on the lookout for a reversal

pattern.


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Crude – Tech. Perspective

� According to our positioningrules (please see our previousreport), we’ve been Neutralsince the WTI broke above 39mid-March.

� We remain Neutral as long asthe spot remains within theFeb uptrend channel

� We’ve adjusted our tactical rulesas follows:� Remain Neutral as long as

the spot stays within thespot stays within the Febchannel (currently at 42 –50)

� Turn UW below the channelsupport

� Move to OW above thechannel resistance or below29.


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ALTERNATIVE STRATEGIES

� The HFRI Fund Weighted Composite Index posted gains of 0.4% in May, weathering uncertainty about the timing and frequency of near term rate hikes by the Fed. Gains were led by Event Driven (on accelerated M&A activity) and Relative Value Arbitrage strategies (on moves on U.S. yields).

� CTAs continued to struggle in May, losing money for a third consecutive month. CTAs performance (-2.1% MoM, +0.1% Ytd) was hit by their FX (USD shorts) and fixed-income clusters, as markets proved largely directionless.

� Global Macro funds advanced +0.3% in May (-0.7% Ytd), benefitting from the return of risk appetite, the appreciation of the US dollar against most currencies and their short US duration positions. 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..

� Equity Long-Short posted +0.8% in May (+0.4% Ytd). Performance still lags the market, however, as most managers have kept their positioning cautious despite the strong market rally from mid-February

� 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.


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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 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 (HFRI RV: Volatility Index: +2.1% MoM, +1.7% Ytd) and prefer funds that trade

volatility globally (all assets / all regions). This is our way to take advantage from the higher volatility regime.


50

Managed Futures / CTAs

� CTAs as represented by the SG CTA Index, has returned roughly to where it was about 6 months ago, giving back most of the 10% it gained from Oct. ‘15 to Feb. ’16

� Don’t worry… Be happy… ☺

� It’s hard for systematic models to capture moves that materialize out of nowhere, and to make money when the market refuses to provide the directional volatility it needs.

� Markets remain choppy, but our conviction is that a trend will emerge over the next few months.


Managed Futures

Source: SG CTA Index

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Equity Long/Short

� L/S Equity funds remain defensive

� 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).� The cyclical-to-defensive ratio remained low in May.


Bottom Line: Global Asset Allocation

� Activity indictors, like PMIs in the G3 and China, continue to suggest global stagnation.

� The probability of the occurrence of a stress scenario on a global scale is still high

� Valuations of both stocks and bonds are at or near record high levels

� The S&P 500 Index is likely to break out to new highs, and thus exacerbate already stretched valuation levels. Earnings remain perhaps the most important issue, at this stage.

� Over the last few weeks, we saw the Fed suddenly going from Dovish to Hawkish, and then reintroducing a more dovish narrative after the large miss on US non-farm payrolls >> More uncertainty is building, but not yet visible in implied volatilities.

� 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...


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with factor selection, risk budgeting and

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Provide assistance with alternative

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assets) in terms of profiling, and

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investments (including real

assets) in terms of profiling, and

integration in a GAA

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allocation and related risk control

and/or risk budgeting techniques

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Economy & Finance

Finlight Research - Market Perspectives - Jun 2016