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Market Perspectives Apr. ‘19

Apr. 19th, 2019 www.finlightresearch.com Bull markets do not die of fear, but of euphoria…


I have to say, that from a contrarian

perspective, when an article like 'Investors Rush To Buy Up Stocks' appears on the very front page of the Wall Street Journal, you know a whole lot of good news is in the price. It conjures up the image of two of Bob Farrell's famous Ten Market Rules to Remember: #5 - the public buys the most at the top and the least at the bottom, and #9 - when all the experts agree something else is going to happen.“ - David Rosenberg Baron’s cover story

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Executive Summary: Global Asset Allocation      

Many things point to an end-of-cycle behavior. But we see no credible signals of a recession. Economic data is still mixed. Some numbers have surprised to the upside, but the overall trend remains weak, specially in Europe. Globally, macro is showing negative divergence from the rally in risk assets The Brexit mess continues. But US-China trade talks seem to be on the right track. Despite the impressive start to the year, the mediumterm outlook for returns across assets is relatively poor Bull market might go on a little longer, but we think we are close to the top Given the massive amount of leverage built up in this cycle, we expect the next recession to be much deeper than most may expect We summarize our views as follows 

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MACRO VIEW

The Good  The Chinese Caixin Manufacturing PMI reading for March moved to expansion territory for the first time in 4 months, probably thanks to infrastructure stimulated spending and tax cuts  US spending for February increased 1.0% (vs -0.3% expected). ISM manufacturing index increased to 55.3  US Nonfarm payrolls showed a net gain of 196K, relieving concerns about February’s reading  Leading economic indicators increased 0.4% (vs. February’s reading of 0.1%) The Bad  The bond market continues to send warning signals about growth  Manufacturing PMI is signaling a contraction in EU and Japan.  Durable goods orders for February declined -1.6% (-0.9% expected), pointing to sluggish investment. Ex-transportation, orders edged up by 0.1%  Q4-2018 US GDP growth was revised down to 2.2% from the prior 2.6%. The Atlanta Fed is now estimating Q1-2019 GDP at 1.5%, which is historically low. The Ugly  Main systemic risk resides in China because of high leverage, growing indebtedness, and current unsustainable housing bubble.  Trade tensions (US-China, US-Europe) remain a key risk to our outlook.  The financial and economic implications of Brexit are concerning, but no one seems to care

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Hunting Recession – The Big Four Economic Indicators

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The overall picture is characterized by relatively strong Employment and Income, an Industrial Production in recovery mode and Real Retail Sales rising but below trend (since end of 2015) After having been trending lower since Nov. ‘14, the average of these indicators has started showing signs of improvement mid-2016 and set a new all-time high in Nov. ‘18. The picture remains pretty good (but less than late 2018). Sales and income will be especially interesting to watch from here

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Hunting Recession – Leading Economic Indicators

3-month average percentage change in Leading Economic Indicators seem to point to a lower GDP growth. It could be a false signal like in 2012 and 2016 if the Fed enters the game again…

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Hunting Recession – Government Tax Receipts

A similar picture of weak growth arises from "Federal government current tax receipts: Personal Current Taxes." (currently at 0,9% YoY)

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Hunting Recession – Where Are We In The Cycle?

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With output gaps in DM economies moving further in positive territories, we are clearly late cycle. More precisely, we are in the late stage of the longest expansion on record. Growth acceleration from here seems very improbable. However, we see no obvious signs for an imminent recession…

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Hunting Recession – Where Are We In The Cycle?

The Fed recently indicated that raising interest rates further became highly unlikely. Thus, we will likely have a pattern that has already been witnessed many times in the past The last 2 times the Fed stopped raising rates were followed (a few months later) by a recession.

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Consumer Confidence

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The Conference Board Consumer Confidence Index fell from 131.4 in February to 124.1 in March (the 5th decline in 6 months). But this is still a strong level. Expectations component is however hovering near 100

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Consumer Confidence vs. Business Optimism

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The NFIB Small Business Optimism Index rebounded modestly (+0,1) from the previous month substantial drop. At 101,8, it is still at a comfortable level… The Consumer Confidence Index and the NFIB Small Business Sentiment (both are measures of market mood) have been highly correlated since before the GFC. But, Small Business Sentiment deterioration has been a better warning signal for the previous 2 or 3 recessions.

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Hunting Recession – US Labor Market

Initial unemployment claims are an important leading economic indicator of US recessions. Initial claims have bottomed out (13 months, on average) before each recession since the 60s. Initial claims have probably reached their trough for the current business cycle. To be confirmed!

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Hunting Recession – US Labor Market

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The labor market still looks strong. But weaknesses start to appear: The YoY percentage change in overtime hours is dropping, another sign of a late cycle behavior.

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Hunting Recession – Late Cycle Vol?

The graph represents, in percentile terms, an equally weighted combination of 3 (normalized) vol indices: VIX (equity volatility), MOVE (bond volatility) and CVIX (US dollar volatility). Percentiles are calculated from vol values since 2010 

Volatility across the three major asset classes stands at an extremely low levels (1,9%)  Expect higher level of volatility over the next few months.

Volatility is getting more volatile. The last cycles were measured in months. Before 2018, cycles were measured in years. 14

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EQUITY

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Stocks have completely recovered from their sharp correction of late 2018, registering the strongest start to the year in almost two decades. Stocks seem to be priced for perfection, when bond market is already pricing rate cuts, macro data is still weak (despite some improvements recently) and earnings estimates are revised downward. S&P 500 valuation remains stretched relative to history, when growth is expected to slow.

Divergences between earnings projections and valuation trends in the S&P500 have already reached extremes Bulls continue to accumulate, making the most optimistic assumptions about the sustainability of corporate profit margins and valuations A lot of signs suggesting that we are closer to a topping process than a new leg up in this bull market. It is clearly not the time to invest long term, even if “the fear of missing out” can do miracles. The decline in the VIX to 12 could mean it is time to start considering buying volatility (through futures or CDX protection).

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EQUITY Bottom line :

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According to our positioning rules, we’ve moved from UW to OW as the index broke above the Feb. ‘16 uptrend. We continue to see any relief from here as corrective, not more. Such a recovery should be used to prepare for another sell-off.. Our positioning rules are adjusted as follows:  Remain OW above 2845 (short term trend since Mar. 19) to target the 3000 area, then 3200  Move to Neutral between 2845 and the Feb. ‘16 uptrend  The setup weakens again below the Feb. ‘16 uptrend. Go UW. We remain Neutral on Japan vs. US stocks and UW Europe vs US, given the headwinds from fading Euro area PMI momentum and political risk (in Italy and Brexit)

We remain UW US small vs large caps. We maintain our OW defensives vs cyclicals (and avoid financials above all) and OW value vs growth stocks. For the current slowing growth environment, we prefer high quality stocks (strong balance sheets, stable sales and earnings growth…) We remain UW EMs vs DMs. Our view has finally paid off in recent months. For us, it is still too early to buy into the current EM weakness. Uncertainty on EM growth remains high, especially as US growth is slowing, China growth data remain mixed and US-China trade tensions linger.

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US Equity – Earnings Estimates

2019 earnings have been downgraded substantially since the start of the year, especially for Small Caps The S&P500 continues its move higher

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US Equity – S&P500 Earnings

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Corporate earnings are expected to decline YoY in the Q1-2019, for the first time since 2015. This remains true even if we take into account the 2018 tax cut effect (by, for instance, comparing 2019 earnings to 2017 earnings, and annualizing the change) At this stage, the consensus is that earnings will return to growth in Q2, despite the fact that the downturn in profits is much broader today than during the 2015-16 earning recession.

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US Equity – Corporate Profit Margins

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For now, profit margins continue to defy gravity rules. The tax cuts in 2018 explain a big part of the move Corporate profit margins as a percentage of GDP is cyclical and should mean-revert, sooner or later, to near 6%-8%, specially as the impact of tax cuts wanes The combination of an average profit margin and an average valuation (on P/E for instance) would weight a lot on S&P500 level.

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US Equity – Profit Margins

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Naturally, any business reaches a better profitability when what it sells rises in price faster than the cost of production As wages are on the rise, labor market is tightening and material costs are rising faster than prices charged, profit margins should turn south.

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US Equity – Market Breadth

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The number of S&P500 stocks above their 50-dma has softened when the index moved higher This bearish breadth divergence may be a signal of underlying weakness and of a top formation.

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US Equity – Market Breadth

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The 52-week new high/new low ratio on the NYSE is hovering near 8, depicting strong internals. The ratio seems, however, range-bounded. Its rising trend has vanished since Feb. ‘19

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US Equity – Where Are We Heading?

The following graph from Fidelity Investments overlays the current rebound to the average of the last 3 nonrecessionary bear markets. The market seems to be following the same recovery roadmap as the last 3 nonrecessionary bear markets (94, 98 and 2011)

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US Equity – Where Are We Heading?

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Historically, margin debt decreased rather steeply before a recession. Despite the modest rebound since the December lows, the steep decline in margin debt we’ve seen since 2018 may be interpreted as a warning signal for stocks

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US Equity RV – Defensives vs Cyclicals

In our Sep. ‘18 monthly report, we said: “Cyclicals vs. defensives ratio is now starting to roll over. The reversal in this ration could reflect one of 2 scenarios :

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A bullish one : The S&P 500 continues its move up with defensives taking the lead A bearish one : A correction in the S&P 500 makes defensives outperform cyclicals

We favor the 2nd scenario….”

As expected, worries about growth have favored Defensives vs. Cyclicals. The relative rebound in Cyclicals we’ve seen since the end of 2018 remains limited. We keep our defensive bias. 25 FinLight Research | www.finlightresearch.com


US Equity RV – Growth vs Value

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Value stocks have never been cheaper since 2001! But nothing seems to be able to stop the bleeding Growth stocks have been consistently outperforming value stocks since the end of GFC. The move has even accelerated since the last leg of the bull market started in November 2016 We still expect this outperformance to come to an end soon. We remain OW value vs growth stocks. This has been our worst trade since mid 2016!

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US Equity – S&P500 LT Valuation

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Stocks are perfection

priced

for

Whatever the valuation measure you use, the market looks stretched (specially if earnings growth continues to wane) The current valuation is the second highest in history, only surpassed by the numbers in 2000 at the peak of the Dotcom Bubble.

Current overvaluation suggests a cautious longterm outlook. It’s consistent with flat to negative LT returns.

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S&P500 – A Medium-Term Tech. View

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The bull trend in the S&P500 was broken in 2018 The correction is still intact and tends to point to harder times to come.

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S&P500 – Market Sentiment

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Sentimentrader’s “Dumb Money Confidence” has reached its highest level in a decade. Each time the indicator was this high in the past 20 years, the S&P500 delivered negative returns over the next 2-8 weeks and certainly at least a bit more volatile trading..

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S&P500 – A Short-Term Tech. Perspective

According to our positioning rules, we’ve moved from UW to OW as the index broke above the Feb. ‘16 uptrend. We continue to see any relief from here as corrective, not more. Such a recovery should be used to prepare for another sell-off.. Our positioning rules are adjusted as follows:  Remain OW above 2845 (short term trend since Mar. 19) to target the 3000 area  Move to Neutral between 2845 and the Feb. ‘16 uptrend  The setup weakens again below the Feb. ‘16 uptrend. Go UW. 30 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT GOVIES

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The Fed has done a back-flip on interest rates, and indicated that it will most likely pass on any rate hikes for 2019 (when at least 2 hikes were expected back in Dec. ‘18) UST long yields have continued their plunge for multiple reasons: the Fed reversal , concern over the global growth and depressed inflation

At more than $10 trillion, outstanding negative yielding bonds represent now roughly 20% of the global investment-grade bond market The backdrop for monetary policy remains favorable for bonds. But, given low existing yields and rising fiscal debts and deficits, locking money in 10y-30y Treasuries seems hardly sensible, except from a tactical perspective. As a ”macro” hedge against escalation of Italian political risk or other global concerns, we keep our short 5y French vs German govies (acquired when short-term spreads were trading close to their historic lows) With the Fed now on hold, we move Neutral on duration at the front end (through 2 and 3-year notes).

Two months ago, we closed our (worst bet in 2018) short 10y Bunds vs USTs because of softness in Eurozone data and uncertainties about the Brexit. We keep our Neutral view on the BundUST spread. 31 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT GOVIES

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According to our positioning rules, we’ve remained OW Treasuries as the 10-year yield stayed below the primary uptrend from Jul. ‘16 lows Since our Feb. Report, the 10y yield have reached a low of 2.338 (a strong support area) before rebounding. It’s currently around 2,55. We choose to move Neutral from here.

Our positioning rules are adjusted as follows:  Remain Neutral between 2,28 and 2,67  Move to UW above the 2,67  Go OW below 2,28 as a break of this support area would open the way to near 2,0 The 2-10 UST curve slope has been in a consolidation phase since Dec. ’18. The underlying flattening trend seems intact for now. Re-adjusting to a more inflationary world would imply a steeper curve. We will wait for a confirmation (with slope around -10bps) before getting into 2y10y steepeners.

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FIXED INCOME & CREDIT INFLATION-LINKED

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In our Feb. Report, we said: “We keep our OW US breakevens view (long TIPS, short nominal bonds). We target 10-year breakevens to reach 190bp (our initial target of 225bps seems unreachable, at this stage). We will move Neutral there.”. Our target was reached and we’ve moved to Neutral. CPI suggests inflation is stabilizing below Fed targets. But we see (in the Underlying Inflation Gauge, for instance) some inflation pressures that are currently not being reflected in CPI / PCE. We expect CPI and PCE to surprise to the upside in the next 6-12 months. Given an on-hold Fed, better growth expectations and recovery in risk appetite, we will move back to OW US 10y-breakevens above 2,0 We expect Eurozone Breakevens to trade sideways overs 1H-2019. We don’t see any recovery in inflation before the end of the year. We switch to Netral HICP Inflation

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FIXED INCOME & CREDIT CORPORATE CREDIT

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Q1-2019 marked the strongest start to the year for credit (like for most risk assets), in almost two decades Fear of missing out continues to drive spreads tighter, to levels hardly sustainable. Fed’s reversal explains a lot of it. We expect the spread widening to resume (both in IG and HY) in 1H-2019 because of the weak macro backdrop and the shift we are expecting to higher vol.

We continue to believe that the credit cycle has peaked in Feb. ‘18. We remain UW on credit overall.

Within the credit asset class, 

The magnitude of the spread widening has been more pronounced in EUR vs. USD. We remain OW on US vs EUR HY and IG given persisting macro, political, and technical headwinds in Europe.

We continue to see better value in IG, despite its recent underperformance, and reiterate our preference for IG over HY, especially in EUR credit. 

In terms of valuation, HY looks too rich : the embedded excess credit premium in HY(premium left after taking into account expected default losses) remains close to its postcrisis lows. Furthermore, IG remains more attractive on a volatility-adjusted basis. We continue to prefer leveraged exposures to IG spreads over HY.

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FIXED INCOME & CREDIT CORPORATE CREDIT

In high yield, we keep our bias towards higher quality as we don’t think this is the point in the cycle to search for yield and given the erosion of credit risk premium embedded in CCCs and Bs. Any unpriced risk would weigh on low quality bonds (High Yield and EM debt). We maintain our OW leveraged loans vs HY as

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the supply/demand balance tilted in the favor of loan issuers fundamentals for the broader universe of leveraged loan issuers have improved a lot in 2018

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FIXED INCOME & CREDIT EM DEBT

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Inflows into EM bond (as well as equity) funds provided a supportive backdrop for EM bonds (specially hard currency bonds) Despite the recent rally in risk assets, our central view remains unchanged: EM assets will continue paying for dollars withdrawal from the system, induced by increasing deficits in DMs. EM equities/corporate bonds have been liquidated to fill the void, and EM sovereigns stand next in line. Liquidation of EM sovereigns bonds will be the final and most violent leg of the EM crisis. We keep our underweight on EM external and local debt and maintain our preference for EM credit over US HY Bottom line : Neutral Govies, Neutral US vs Eurozone Govies, UW credit overall, UW Eurozone vs US in IG credit, UW Eurozone vs US in HY credit, Neutral 10y-TIPS breakevens and EUR HICP Inflation, UW High Yield vs High Grade specially in EUR, UW on EM sovereigns, OW EM credit vs US HY. We remain deeply concerned by the liquidity issue in credit markets. HY and EM debt ETFs mask an inherent liquidity mismatch that is not adequately understood by all investors. This is the Achilles’ heel of the credit market at this point of the cycle.

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In Bonds We Trust‌

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At more than $10 trillion, outstanding negative yielding bonds represent now roughly 20% of the global investment-grade bond market

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Towards an Eurozone Japanification?

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Disappointing EU data are weighing on confidence and yields. German 10- year yields are back in negative territories for the first time since 2016... They have also fell below those of Japan for the first time since 2016! The 10-2 curve slope is also at its lows since 2016.

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US Govies – Is QT Already Dead?

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Futures expect the Fed to cut funds rate in 2019 and 2020 Till Dec. ‘18, markets have been pricing 2 hikes in 2019. They are now seeing 1 cut!

Source: FactSet, Federal Reserve Board, Compustat, Goldman Sachs Global Investment Research

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US Govies – Yield Curve Inversion?

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We are witnessing the same pattern as just before previous recessions: The curve slope is turning negative, when federal funds rate is expected to remain unchanged for the next few months We will wait for a confirmation of the inversion before getting into 2y-10y steepeners.

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US Govies – Spec Positioning

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Historically, massive speculative shorts were put on between 2,80 and 2,90 on the 10-year UST yield. Below 2,8, short squeezes become likely. There are still enough shorts outstanding to push yields lower (2,2?) Could that the beginning of a new bull market in Treasuries?

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US Govies – A Tech. View

According to our positioning rules, we’ve remained OW Treasuries as the 10-year yield stayed below the primary uptrend from Jul. ‘16 lows Since our Feb. Report, the 10y yield have reached a low of 2.338 (a strong support area) before rebounding. It’s currently around 2,55. We choose to move Neutral from here.

Our positioning rules are adjusted as follows:  Remain Neutral between 2,28 and 2,67  Move to UW above the 2,67  Go OW below 2,28 as a break of this support area would open the way to near 2,0 42 FinLight Research | www.finlightresearch.com


US Govies – A Tech. View of the Curve

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The 2-10 UST curve slope has been in a consolidation phase since Dec. ‘18 The underlying flattening trend seems intact for now. Only a clean break above 25-30 bps may question it. Next target = -10bps! Inversion is at the door…

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US TIPS – Inflation Expectations

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The New York Fed’s Underlying Inflation Gauge (UIG - All Data), like the Median CPI, are pointing to an annual inflation rate near 3.0%, well above the CPI statistics. It looks like underlying inflation pressure is more pronounced than commonly thought, but has yet to appear in CPI Historically, UIG has been leading vs Core CPI / PCE. Expect CPI and PCE to surprise to the upside in the next 6-12 months.

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US Credit – Bulls (Still) in Command

Corporate-bond ETFs are poised for their biggest quarterly inflow on record

Massive inflows went into IG, less into HY

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US Credit – Corporate Debt at Record Levels

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We continue to watch closely the unprecedented leverage accumulated by US small caps in a lowinterest easy-lending environment. Net debt continues to diverge from free cash and profits. It’s worth noting that 2019 is the first year with significant maturing debt. The picture will become darker as soon as financial conditions start to tighten or earnings to shrink.

We keep our bias towards higher quality credit

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Credit RV – US vs EUR Credit

We have been OW on US vs EUR HY and IG since Nov. ‘18, given persisting macro, political, and technical headwinds in Europe

Despite a better policy picture in Europe, we maintain our view.

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EXCHANGE RATES

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Concerns about global growth are inherently supportive for the dollar (as a reserve currency), even if the US economy is slowing as well But the recent reversal in Fed’s stance and rising US deficit offer bear arguments on the dollar We still think that the US dollar has some room to go up over the short to medium-term. Over longer horizon, we expect the expanding US budget deficit to put pressure on the dollar. EUR-USD: We have a negative bias on the EUR. The Euro is being used to fund the emerging market carry trade. Going short the Euro is also being used to hedge against Brexit. Despite the corrective process the EUR-USD has been stuck in since November, the MT picture remains bearish. Only a clean break above the 1,1450-1,1460 resistance area may undermine this view.. Since our Feb. Report, and according to our positioning rules, we’ve switched from Neutral to UW (then back to Neutral) twice as the EUR-USD broke below 1,1235 before rebounding on the 1,12 support. We are now Neutral again. From here, we adjust our positioning rules as follows:  Remain Neutral above 1.1150 and below 1.1460  Move to UW below 1.1150 to target 1.10 and even 1.06  Move (tactically) to OW above 1.1460 to target 1.1680 and even 1.18

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EXCHANGE RATES

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USD-JPY: According to our positioning rules, we’ve moved from UW to Neutral as the USD-JPY broke above 111. Our bias remains to the downside as growth concerns and higher volatility tend to benefit the Yen. We adjust our positioning rules from here:   

Remain Neutral between 110 and 114 Go UW below 110. and target 106.50 Go OW above 114

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EUR-USD

Despite the corrective process the EURUSD has been stuck in since November, the MT picture remains bearish. Only a clean break above the 1,1450-1,1460 resistance area may undermine this view.. Since our Feb. Report, and according to our positioning rules, we’ve switched from Neutral to UW (then back to Neutral) twice as the EUR-USD broke below 1,1235 before rebounding on the 1,12 support. We are now Neutral again. From here, we adjust our positioning rules as follows:  Remain Neutral above 1.1150 and below 1.1460  Move to UW below 1.1150 to target 1.10 and even 1.06  Move (tactically) to OW above 1.1460 to target 1.1680 and even 1.18 50 FinLight Research | www.finlightresearch.com


COMMODITY

Like other risk assets, commodities are up 20% off their December lows.

The move was mainly done on improving sentiment, and less on fundamentals, except some supply disruptions (vs a stable demand) that induced tighter markets and a better backdrop for backwardation (= positive roll returns for longs) than in 2018

From here, we expect commodities to generate more return through backwardation than through spot prices.

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COMMODITY

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This shift into a persistent positive carry environment gives us some comfort to overweight commos as an asset class, over the short term Nevertheless, we prefer to keep our Neutral stance, because of all trade tensions and Chinese macro. In fact, 

a trade war threatens a global economic slowdown, which would likely weigh on the prices of many commodities.

China macro remains critical for commodity prices, particularly base metals. And we don’t see any structural catalyst for higher prices (like the Chinese demand in the 2000s)

Over the medium term, we still think that the secular bear market in commodities hasn’t reached an end yet. Another wave of dollar strengthening and/or headwinds in China would make the bear trend resurface again.

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COMMODITY

Bottom Line : Energy:

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Despite the impressive rally from the lows of December, macro / growth anxiety persists. Some fundamental factors (as well as technical) support the idea that prices will hardly go higher We expect prices to slide lower in 2H as shale and OPEC production will likely increase Backwardation is key for investors. With lower stocks and supply disruptions (Iran, Libya, Venezuela…), steeper backwardation would generate most of the total return. According to our positioning rules, we’ve remained OW as the spot stayed above 51. Crude is now testing the uptrend from 2016. Holding below would be very bearish over the medium term. We choose de move Neutral and wait to watch how price action develops from here. Our tactical rules are adjusted as follows:  Remain Neutral between 65 and 59  Move to UW below 59, targeting 45  Move to OW above the higher of 65 and the uptrend from 2016

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COMMODITY Base Metals:

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The global (and Chinese) economy seems to be losing steam, making investors more reluctant to take a strong view on metals. Thus, we expect another pullback shortly. We need much better growth fundamentals before the next bullish phase really takes hold Despite the fact that Chinese metals demand seems to be improving, we remain UW on industrial metals.

. Agriculture:

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Agricultural commodities remain in surplus (thus, with negative roll returns) US – China trade sentiment remains the primary driver of price over the short-to-medium term. The two countries seem to get closer to a trade deal, which will be materially bullish for agri markets (notably grain, oilseeds and cotton). We maintain our constructive outlook through 1H19, and we anticipate a significant price recovery led by the grains in 2Q19. We remain OW on Agris as a whole

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COMMODITY Precious Metals:

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Political and economic uncertainty tends to be gold's best friend . The Fed's recent dovish tone adds a positive factor for it. But, improved risk sentiment has halted the strong ETF build momentum we’ve seen in Q4-2018 But, we believe it is too early to trumpet the beginning of a new bull cycle in gold. For that, we need gold to break decisively above that multi-year resistance and start achieving new market highs.

Growing demand and constrained supply should push prices higher on the medium term (target = 1400-1450 over 6-12 months). But, we still look to have further downside to come on the short term (higher dollar and / or higher real interest rates) We remain bullish precious metals over the long-term, no matter what happens (on US dollar, China, growth…)! However, we see the (medium-term) risk of a still missing one corrective leg down to 1113 and lower..

Following our positioning rules, we’ve moved from OW to Neutral on gold as it broke below 1 295.

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We remain constructive on gold, and view any pullback from current levels as counter-trend, as long as the primary uptrend from Aug ‘18 is preserved. Our positioning rules are adjusted as follows:  Remain Neutral between 1300 and the primary uptrend since Aug. ‘18  Move OW above 1300 to target 1340 and 1490  Turn UW after a clean break below the support area around 1260 and the primary uptrend. 55 FinLight Research | www.finlightresearch.com


Precious Metals – Gold Fundamentals

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Gold prices have moved higher since Sep. ’18 because of unbalanced supply and demand

Mine production is on record levels but supply growth continues to slow In 2018, and according to the World Gold Council:

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gold demand grew 4% from 2017, when investment demand was down 7%. gold supply increased by only 1% (the slowest rate since 2008).

Growing demand and constrained supply should push prices higher on the medium term. But, we still think that gold (like silver) is still due for a correction on the short term (higher dollar and / or higher real interest rates) 56 FinLight Research | www.finlightresearch.com


Precious Metals – Gold Stocks

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Our negative bias on gold is supported by the Highs-Lows indicator (as calculated on the most actively traded mining and exploration companies) that tends to show that liquidation in gold stocks (mainly juniors) is still underway. This indicator is based on the net number of gold stocks which have made new highs minus lows on a quarterly basis. We need to see some substantial improvement on this indicator before returning to gold

Source: Bloomberg

The probability of correction to the level of $1,200 is very high

57 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

Following our positioning rules, we’ve moved from OW to Neutral on gold as it broke below 1 295. We remain constructive on gold, and view any pullback from current levels as countertrend, as long as the primary uptrend from Aug ‘18 is preserved. Our positioning rules are adjusted as follows:  Remain Neutral between 1300 and the primary uptrend since Aug. ‘18  Move OW above 1300 to target 1340 and 1490  Turn UW after a clean break below the support area around 1260 and the primary uptrend. 58 FinLight Research | www.finlightresearch.com


Energy – Crude Oil

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According to our positioning rules, we’ve remained OW as the spot stayed above 51.

Crude is now testing the uptrend from 2016. Holding below would be very bearish over the medium term. We choose de move Neutral and wait to watch how price action develops from here. Our tactical rules are adjusted as follows:  Remain Neutral between 65 and 59  Move to UW below 59, targeting 45  Move to OW above the higher of 65 and the uptrend from 2016

. 59 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

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Hedge funds (as measured by the HFRI Fund Weighted Composite Index) gained +1.0 in March, bringing the 1Q-2019 performance to +5.9% (the strongest first quarter for industry performance since 2006) March performance was led by Macro and CTA strategies, thanks to the Fed’s policy reversal and the induced interest rates decrease. Macro strategies delivered 1,8% in March, led by the quantitative, trend-following “HFRI Macro: Systematic Diversified/CTA Index”, which performed +3.6%, the strongest monthly gain in 14 months. We had everything wrong on CTAs! CTAs have benefitted from the rally in both bond and equities 

In our Feb. ‘19 Report, we said :” Our conviction is that CTAs will provide a precious help to portfolio allocators when things go wrong. But, to come back on CTAs we need to see new trends emerging and/or recession starting to loom… Furthermore, we’re not comfortable with the current positioning of CTAs: 

Substantially long bonds because of the upward momentum we’ve seen in fixed income. The bond market performance could be put at risk by any positives news on the labor market or inflation

Substantially short stocks as the momentum in equities remains negative despite the rebound”

We were wrong as we’ve misjudged their positioning in FI! We have been surprised by the dovish stance of the Fed and its announcement of the end of the balance sheet runoff in September (earlier than previously expected) 60 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

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Relative Value strategies added 0.5% in March (3.8% for Q1-19), led by the HFRI RV: Yield Alternatives Index (+2,5%) and the HFRI RV: Convertible Arbitrage Index (+1,2 %) We continue to believe that diversifying portfolios with an increased allocation to “all-weather” alternatives (those uncorrelated to traditional return sources in equities and fixed income) is particularly attractive at this late-stage of the business cycle characterized by high valuations and complacency, unpredictable macroeconomic (CB decisions, Brexit negotiation, trade war…) and geopolitical events. Despite CTAs benefiting from green shots of rebound, we remain Neutral on the strategy for the short to medium term, because we still have little visibility on a lot of issues (like trade war, Brexit…) that can induce abrupt trend reversals

We reiterate our OW stance on Fixed Income Arbitrage, as it tends to perform well in rising bond yield environments. The strategy has demonstrated its ability to generate steady returns with limited volatility over time. It also managed to be resilient during the sell-off without suffering during the rebound. For this same reason, we maintain our preference for L/S Equity Market Neutral and Global Macro strategies. Global macro should (finally) capitalize on new trading opportunities in central banks actions and benefit from any higher economic/market volatility

61 FinLight Research | www.finlightresearch.com


Bottom Line: Global Asset Allocation      

Many things point to an end-of-cycle behavior. But we see no credible signals of a recession. Economic data is still mixed. Some numbers have surprised to the upside, but the overall trend remains weak, specially in Europe. Globally, macro is showing negative divergence from the rally in risk assets The Brexit mess continues. But US-China trade talks seem to be on the right track. Despite the impressive start to the year, the mediumterm outlook for returns across assets is relatively poor Bull market might go on a little longer, but we think we are close to the top Given the massive amount of leverage built up in this cycle, we expect the next recession to be much deeper than most may expect We summarize our views as follows 

62 FinLight Research | www.finlightresearch.com


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.

63 FinLight Research | www.finlightresearch.com


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...

64 FinLight Research | www.finlightresearch.com


Our Standard Offer

Provide assistance with asset allocation and related risk control and/or risk budgeting techniques

• Global Asset Allocation (GAA)

Provide assistance with alternative investments (including real assets) in terms of profiling, and integration in a GAA

Offer a turnkey 3step factor-based process in GAA with factor selection, risk budgeting and dynamic portfolio protection

Provide tailormade quantitative analysis of your portfolios in terms of asset allocation, risk profiling and risk contribution

• Alternative Investments

• Factor-based GAA Process

• Risk Profiling

65 FinLight Research | www.finlightresearch.com

Profile for Finlight

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