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Market Perspectives Jan. & Feb. ‘19

Feb. 1st, 2019 www.finlightresearch.com Fix the roof while the sun shines…


“

Everybody has a plan until they get

punched in the mouth.

-

Mike Tyson

2 FinLight Research | www.finlightresearch.com


Executive Summary: Global Asset Allocation  

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It seems as if economic growth is slowing everywhere. Over the recent weeks, market conditions switched from panic to exuberance / complacency mode. We are back at a point where we expect a poor long-term risk-reward for most risk assets Our conviction is that QT effect is largely underestimated. Monetary normalization and QT are taking liquidity from the market. QT would finally induce an effective rate of roughly 5% With QE behind us, Central Banks are also acting as sources, rather than suppressors of volatility. Despite the impressive rally, the behavior of some assets (SPX, Credit, Volatility…) seems to suggest we are in a contracting economy.

01/02/2019 View

07/12/2018 View

05/11/2018 View

28/09/2018 View

Jan & Feb'19

Dec'18

Nov'18

Sep'18

Equity

UW

UW

UW

OW

S&P 500

OW

OW

OW

OW

Euro Stoxx 50

UW

UW

UW

UW

N

N

N

N

MSCI Emerging Markets

UW

UW

UW

UW

Fixed Income

OW

N

UW

UW

T-Note 10Y

N

OW

OW

OW

Bund 10Y

N

UW

UW

UW

OW

OW

OW

OW

NIKKEI 225

US TIPS Euro HICP

OW

OW

OW

OW

Credit

UW

UW

UW

UW

Inv. Grade

OW

OW

OW

OW

US High Grade

OW

OW

OW

N

EUR High Grade

UW

UW

UW

N

High Yield

UW

UW

UW

UW

US High Yield

N

N

N

N

EUR High Yield

UW

UW

UW

UW

EM Sovereigns

OW

OW

OW

OW

Forex

N/A

N/A

N/A

N/A

We remain OW cash in our asset allocation.

EUR-USD

N

N

N

N

We summarize our views as follows 

USD-JPY

UW

N

N

OW

Commodity

N

N

N

N

Energy

OW

UW

N

OW

Base Metals

UW

UW

UW

UW

Precious Metals

OW

N

UW

UW

Agri

OW

OW

OW

OW

Alternatives

OW

OW

OW

OW

Return Enhancers

UW

UW

UW

UW

Risk Diversifiers

OW

OW

OW

OW

3 FinLight Research | www.finlightresearch.com


MACRO VIEW

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The Good  US housing sector stocks have rebounded recently due to lower rates and a more dovish Fed  US Initial jobless claims declined to 199K. Bespoke notes that this is the lowest level since 1969 The Bad  US Housing data continues to deteriorate. The LEI declined in December for the second time in 3 months.  The weaker tone in Euro area economic data continued with weaker than expected PMI and IFO. According to Eurostat, Industrial Production declined by an alarming 3.2% YoY in November 2018.  Chinese GDP was the slowest in a quarter century. Factory activity in China is at its lowest level in 3 years The Ugly  Main systemic risk resides in China because of high leverage, growing indebtedness, potential resurgence in yuan devaluation fears, and current unsustainable housing bubble.  Escalating US-China trade tensions remain a key risk to our outlook.  The continued lack of visibility on Brexit weighs on investor sentiment.  ETF liquidity: We remain convinced that their current success lies at their vulnerability to any significant shock (specially in the Fixed Income sphere)

4 FinLight Research | www.finlightresearch.com


Hunting Recession – Yardeni Boom Bust Barometer

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Yardeni BBB divides the CRB Spot Raw Industrials by initial claims for unemployment. A rising ratio is supposed to reflect a growing economy and vice versa. It is fairly evident that we are in a slowdown phase with declining momentum . Furtermore the BB index is currently breaking below its 2009-18 recovery trendline. Slowdown may develop in a recession.

Slowdowns

Recessions

Source: Yardini Research

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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. No inflection is visible at this stage  All the lights are green = No recession on the horizon.

6 FinLight Research | www.finlightresearch.com


Hunting Recession – RIA Economic Output Composite Index

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RIA Economic Output Composite Index is an indicator for US economic activity blending multiple surveys / indices (Chicago Fed National Activity Index, Chicago PMI, ISM Composite Index, Richmond Fed Manufacturing Survey, New York (Empire) Manufacturing Survey, Philadelphia Fed Manufacturing Survey, Dallas Fed Manufacturing Survey, Markit Composite Manufacturing Survey, PMI Composite Survey, Economic Confidence Survey, NFIB Small Business Index, and the Leading Economic Index) Historically, RIA EOCI has been able to signal turning points in the US economy. It is currently showing signs of weakness 7 FinLight Research | www.finlightresearch.com


Hunting Recession – LEI

There is little doubt that the US economy is in a state of slowdown and the LEI is confirming it! The LEI has been in a downturn over the last 6 months, and seems to suggest (as a leading indicator) economic data is likely to continue to weaken over the months ahead.

8 FinLight Research | www.finlightresearch.com


Hunting Recession – Europe isn’t in a Better Shape…

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Industrial Production across the Continent declined by an alarming 3.2% YoY in November 2018 (the worst since the recession of 2012-13) Germany, supposedly the strongest country in the Eurozone, has led the contraction (-4.7% YoY, the lowest reading since the global financial crisis)

Germany Industrial Production YoY - NSA Source: Bloomberg

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US Labor Market

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The labor market is no longer improving. Initial Claims ( like Continued Claims) have been sideways for the past 6 months. Any upwards trend in Initial Claims would be a bad signal for the whole economy.

10 FinLight Research | www.finlightresearch.com


US Labor Market

 

Nevertheless, Small businesses are having trouble filling jobs, when consumers are saying it's easy to find a job. Both indicators are close to their historical highs, but don’t seem to turn down yet. Two possible outcomes :  Either a slowdown driven plateau / reversal  Or a continued improvement in labor market, inducing higher wages and inflation At this stage, we favor the first alternative.

11 FinLight Research | www.finlightresearch.com


Hunting Recession – Labor Market

A trustful indicator we look at is the ratio of weekly average wage earnings to part-time employment (for economic reasons) A rise in this indicator is a signal that business activity is strengthening (and vice versa) It is worth noting that the 6/15 EMA price oscillator crossover below zero usually signals a recession.

Source: Federal Reserve Bank of St. Louis, Pring Research

We are not there yet!

12 FinLight Research | www.finlightresearch.com


Hunting Recession – Chinese Economy

 

The recent performance of Chinese real estate has been concerning Roughly 25% of Chinese GDP is tied to real estate (through the construction industry, industrial and financial sectors) Based on a Kansas Fed study, 10% decline in demand for real estate could lead to a 2.2% decline in GDP. That means that a 25% decline (similar to the one we’ve seen in the US after the housing bubble) would erase the current GDP growth! 13 FinLight Research | www.finlightresearch.com


EQUITY

In our previous report, we said: “Given we are in the "seasonally strong" period of the year, the market may be able to muster a counter trend rally into January. Said another way; there is still potential for attaining the 2850-3000 region, but the medium-term target is 20-30% lower.” So far,we’ve proven right!

Equities rebound from their Dec. ‘18 lows has been impressive. All the fears and factors that caused the sell-off have magically vanished

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The question is: Is that the start of a new melt-up, or just a relief rally (in a bear market) before turning down towards new lows? Are we really out f the woods? The market rallied on rumors of an imminent agreement with China on trade and dovish Fed. Nevertheless, we think that as long as growth continues to be globally shaky, it is a risky time to buy the market as another large correction is likely ahead of us Our expectation remains that the market is involved in a corrective rally, which will likely take us much higher than most would expect. But, at one point in time, the rally will come back under pressure again because of central bank QT and global growth weakness (which will finally weigh on S&P 500 corporate earnings) The big picture remains unchanged: Valuation remains extremely elevated, whatever the measure we use. From a long-term perspective, investors buying at current levels should expect significantly belowaverage (flat to negative) returns. Thus, the January rally could be an opportunity to reduce risk! 14 FinLight Research | www.finlightresearch.com


EQUITY Bottom line :

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According to our positioning rules, we’ve remained UW as the index stayed below 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. Next important level to watch: 200-day MA at approximately 2740 Our positioning rules are kept unchanged:  Remain UW below the Feb. ‘16 uptrend and target 2375  Go OW above, as another attempt at all time highs becomes likely again. Then, we can target 3000, 3200 and even 3500 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.

We remain UW EMs vs DMs. Our view has finally paid off in recent months. For us, it is still too soon 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. Escalating trade tensions could weigh on CNY, and push all EM assets lower. 15 FinLight Research | www.finlightresearch.com


US Equity – S&P500 Earnings

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Earnings reports seem consistent with the economic data (still growing but at a slower rate) To date, 22% of the companies in the S&P 500 have reported actual results for Q4 2018. YoY earnings growth rate for Q4 is 10.9% today

71% of S&P 500 companies have reported a positive EPS surprise (versus about 80% in Q3 and 90% in Q2) It is worth noting that net earnings revisions are falling towards new lows in the US, Europe and Japan. 16 FinLight Research | www.finlightresearch.com


US Equity – Corporate Earnings Cycle

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Historically, earnings peaks have preceded equity peaks. Bull markets can be decomposed in 2 phases: (i) corporate earnings rise, and stock prices rise with them, (ii) corporate earnings begin to fall but stocks continue to rise During the current bull, phase (i) went from 2009 to 2014 and phase (ii) from 2014 on Phase (ii) appears as a plateau in earnings rather that a clean downturn. This is probably due to the boost from the corporate tax cut in 2018 As the tax cut is behind us and economic growth slowing, it seems reasonable to expect earnings peaking soon and equity rally getting into its later stages 17 FinLight Research | www.finlightresearch.com


US Equity – Market Breadth

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Stock market’s breadth has improved decisively… The NYSE advance-decline line has recovered from its Dec. ‘18 lows and has finally broken above its 200-dma, opening the way to a new bullish leg (likely driven by short-covering)

18 FinLight Research | www.finlightresearch.com


US Equity – Market Momentum

 

On the NYSE, more stocks are making new highs than lows. The picture is clearly healthier than a few weeks ago…

19 FinLight Research | www.finlightresearch.com


US Equity – Market Momentum

Nevertheless, and despite the incredible move we’ve seen since the Dec. lows, as much as 65% of S&P500 stocks are still trading below their 200-dma

20 FinLight Research | www.finlightresearch.com


US Equity – Bull-Bear Indicator

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Goldman Sachs’ Bull/Bear Indicator tends to show that while the market’s top isn’t necessarily in, it is getting closer Thus, risk-reward is now playing to the advantage of medium-term bears.

21 FinLight Research | www.finlightresearch.com


US Equity – S&P500 LT Valuation

Even after a near 20% decline in the S&P 500, valuation remains at extreme levels (similar to those leading into the Great Depression and the tech bubble) .Current valuations are consistent with flat to negative LT returns.

22 FinLight Research | www.finlightresearch.com


US Equity – S&P500 LT Valuation

 

Consumer confidence seems to be delivering a similar long-term message Historically, consumer confidence has been strongly correlated with 5 to 7 year inflation-adjusted returns on the S&P500. Thus, given the extreme levels reached by the CB Consumer Confidence Index, we expect S&P500 returns over the next 7 years to be extremely poor.

23 FinLight Research | www.finlightresearch.com


Equity RV – EM vs DM Equities

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Since the low point in October, EM equities have been up 11% relative to DM. Economic divergence between EMs and DMs is enough to explain this outperformance

24 FinLight Research | www.finlightresearch.com


US Equity – Volatility trending higher…

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Equity vol is trending higher despite the rally. This is breaking with the post crisis behavior The last time we saw a similar behavior was in 2007

25 FinLight Research | www.finlightresearch.com


S&P500 – A Medium-Term Tech. View

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According to our positioning rules, we’ve remained UW as the index stayed below 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 kept unchanged:  Remain UW below the Feb. ‘16 uptrend and target 2375  Go OW above, as another attempt at all time highs becomes likely again. Then, we can target 3000, 3200 and even 3500

26 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT GOVIES

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As expected, the FOMC has emphasize its intent to be patient and data dependent. Up until recently, the Fed was forecasting 3 interest rate hikes for 2019. Things are now scaled back to 0 or 1 hike. We still expect the Fed to resume tightening in H2-2019 with probably 2 more hikes. Ten-year treasury yields dropped from its peak near 3.2% to under 2.7%.

Overall, the bond market shows an end-of-cycle behavior. With the Fed raising rates (and putting in QT) and long-end of the curve rallying, the treasury curve continues to flatten. 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) Tactically, we remain short duration at the front end (through 2 and 3-year notes). We close our short 10y Bunds vs USTs because of softness in Eurozone data and uncertainties about the Brexit. This has been our worst bet in 2018!

27 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT GOVIES

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As the primary uptrend from Jul. ‘16 lows was broken, our medium-term view became more skewed in favor of lower yields. According to our positioning rules, we’ve move from Neutral to OW 10y USTs as the yield broke below 2.75 Our positioning rules are adjusted as follows:  Remain OW below the primary uptrend from Jul. ‘16 lows  Go Neutral above it and below 3.0  GO UW above 3.0 The US (2-10) yield curve has been range-bound since July and is now near 20 bp. Re-adjusting to a more inflationary world would also imply a steeper curve. We will wait for a confirmation before getting into 2y-10y steepeners.

28 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT INFLATION-LINKED

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Since end of Oct. ‘18 TIPS breakevens have dropped from around 2.1 to 1.7 before rebounding modestly during January (following the rise in the price of oil). 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. Eurozone headline inflation falls further in January on weaker oil prices (when core inflation ticks up to 1.1% driven by services). Breakevens should trade sideways overs 1H-2019. We don’t see any recovery in inflation before the end of the year. We maintain our OW HICP Inflation but through a 6month forward positioning

29 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT CORPORATE CREDIT

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Total credit to non-financial corporations is now near all-time highs. This is hardly reassuring when the Fed is on a tightening path Credit spreads have moved wider and have broken out of the old channel near the lows. Credit weakness was broad-based and more about fundamentals (concerns around credit quality/ weakening growth) than technical (weaker flows) Furthermore, we see more fears about higher risk corporate credits. This widening should continue (in both the IG and HY) in 1H-2019 because of the weaker macro backdrop, the decreasing liquidity and the shift into a higher vol regime It is worth keeping in mind that Fed tightening is usually followed by higher volatility and widening credit spreads

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

Within the credit asset class, 

HY vs IG spread decompression was one of our core themes since mid-2017. After months of HY outperformance, decompression made a striking comeback in July. Given the level of HY/IG spread ratio (still at its historical lows since the GFC), we think that this decompression has room to run. We reiterate our preference for IG over HY, especially in USD credit.

30 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT CORPORATE CREDIT 

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 

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.

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 rate hike (and/or dollar strengthening) would weigh on low quality bonds (High Yield and EM debt). We move back to OW leveraged loans vs HY as negative flow technicals (especially from mutual funds and ETFs) come to an end after the LL declined by almost 5% in Q4-2018. We expect loans to close their Q4 performance gap vs HY bonds..

31 FinLight Research | www.finlightresearch.com


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 the QT and 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 : OW Govies, Neutral US vs Eurozone Govies, remain short duration in 2-3y USTs, UW credit overall, UW Eurozone vs US in IG credit, UW Eurozone vs US in HY credit, OW 10y-TIPS breakevens and EUR HICP Inflation (6-month forward), UW High Yield vs High Grade, 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.

32 FinLight Research | www.finlightresearch.com


US Debt – Trends in Debt-Deficit are Concerning…

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The federal deficit hit a low in 2015, at about 2.5% of GDP before turning up to current levels of 4%. The CBO projects a 5% deficit within a few years in the absence of any recession. A recession would most likely push the deficit towards 10% of GDP. Given the expected trend in federal deficit and the implied one in debt as a percentage of GDP, locking money in 10y-20y Treasuries at around 3% nominal rates seems hardly sensible.

Source: CBO June 2018 Long-Term Budget Outlook

33 FinLight Research | www.finlightresearch.com


US Govies – Trends in Debt-Deficit are Concerning…

Since 2016, we’ve been in an unusual combination of rising deficits and rising rates

The previous 2 ratehiking cycles were accompanied by shrinking federal deficits (and even a modest surplus in the oldest one). This is normal as the process of raising rates are usually associated to a booming economy…

34 FinLight Research | www.finlightresearch.com


US Govies – A Tech. View

In our previous report, we said: “Go OW below 2.75. Breaking below this level will make us question seriously our upward bias.” Here we are! We move from Neutral to OW 10y USTs. As the primary uptrend from Jul. ‘16 lows was broken, our medium-term view became more skewed in favor of lower yields.

Our positioning rules are adjusted as follows:  Remain OW below the primary uptrend from Jul. ‘16 lows  Go Neutral above it and below 3.0  GO UW above 3.0 35 FinLight Research | www.finlightresearch.com


US TIPS – Breakeven Inflation

Since end of Oct. ‘18, inflationary expectations (as implied by 10y US TIPS) have dropped from around 2.1 to 1.7 before rebounding modestly during January (following the rise in the price of oil). Most of the drop in the 10year Treasury yield was due to decreasing inflation expectations.

36 FinLight Research | www.finlightresearch.com


US Credit – Complacency?

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US companies balance sheets are not in good shape! Gross debt is reaching new all-time highs. According to Moody’s, default outlook remains benign despite the high level reached by net corporate debt as a percentage of GDP. Analysts still justify that by comfortable profit coverage ratios and low rates. Things would change when a recession hits, profits fade and rates go up.

37 FinLight Research | www.finlightresearch.com


US Credit RV – Leveraged Loans vs HY

In our Dec. ‘18 report, we’ve downgraded leveraged loans from OW to Neutral vs. HY bonds, as we saw cautious commentary about loosening underwriting standards and deteriorating covenant protection in LL, inducing negative flows from the asset class. We move back to OW LL as negative flow technicals (especially from mutual funds and ETFs) come to an end after the LL declined by almost 5% in Q4-2018 We expect loans to close their Q4 performance gap vs HY bonds.

38 FinLight Research | www.finlightresearch.com


US Credit RV – EUR vs USD IG Credit

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The spread differential between EUR and USD IG bonds continues drifting wider to levels last seen in 2013. We reiterate our OW stance on US vs EUR HY and IG as risks remain more pronounced to the downside in the EUR market (growth concerns, political uncertainties…)

39 FinLight Research | www.finlightresearch.com


EXCHANGE RATES

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Concerns about global growth are inherently supportive for the dollar. But the recent dovish turn from the Fed induced a downside pressure 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: Developments around the Brexit will likely remain central to the outlook for EUR-USD Despite the corrective process the EUR-USD has been stuck in since November, the medium-term picture remains bearish, as Euro area growth fails to revive

Only a clean break above 1.18 – 1.1850 may undermine this view.. According to our positioning rules, we’ve remained Neutral as the EUR-USD stayed between 1.1265 and 1.1525 From here, we adjust our positioning rules as follows:  Remain Neutral above 1.1235 and below 1.1590  Move to UW below 1.1235 to target 1.10 and even 1.06  Move (tactically) to OW above 1.1590 to target 1.1680 and event 1.18

40 FinLight Research | www.finlightresearch.com


EXCHANGE RATES

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USD-JPY: According to our positioning rules, we’ve moved from Neutral to UW as the USD-JPY broke below 112.14. 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 UW below 111. and target 106.50  Neutral between 111 and 114  Go OW above 114

We still look for CNY underperformance vs USD and major EM currencies. With the Chinese economy slowing and UST yields on the rise, we think Chinese policy-makers have little choice, but letting the yuan fall. Following the China PMI miss, USD-CNY reached its 10 year highs. Reasonable target from here: USD-CNY in the 7.0-7.3 range. An advisor to the PBOC has been quoted saying the level of 7.0 may break by year-end (especially if tensions with the US continue to deteriorate) PBOC won’t jump in to support the CNY without a sharp worsening in capital outflows

41 FinLight Research | www.finlightresearch.com


EUR-USD

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Despite the corrective process the EUR-USD has been stuck in since November, the MT picture remains strongly bearish. Only a clean break above 1.18 – 1.1850 may undermine this view..

According to our positioning rules, we’ve remained Neutral as the EUR-USD stayed between 1.1265 and 1.1525 From here, we adjust our positioning rules as follows:  Remain Neutral above 1.1235 and below 1.1590  Move to UW below 1.1235 to target 1.10 and even 1.06  Move (tactically) to OW above 1.1590 to target 1.1680 and event 1.18 42 FinLight Research | www.finlightresearch.com


COMMODITY

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During the first 9 months of 2018, commodities did well like in a standard late-cycle phase. In Q42018, they completely did poorly, falling from best to worst performing asset class over the year. From a fundamental perspective, we see a strong rationale to be tactically bullish commodities near-term. But 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.

43 FinLight Research | www.finlightresearch.com


COMMODITY

Bottom Line : Energy:

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The terrible move down of crude prices was caused by a surge in Russia-OPEC oil production that was ramped up to counter the Iran sanctions. Russia-OPEC announced over a month ago that they would be cutting oil production by 1.2mbd. More recently, Saudi Arabia has moved very aggressively to also cut exports to the U.S. That, combined with draws in oil inventories, was enough to boost oil prices. 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 remain in the mid-50s for the near future. In 2019, we expect to trade sideways ($45-60 range on WTI) in 1H before sliding lower in 2H because of slowdown in global growth

According to our positioning rules, we’ve moved from Neutral to UW as the spot broke below the uptrend since early 2016 (just below 60) and decided to remain so below 57.

We are now more constructive on oil as process broke above the downtrend since Oct. ’18. We switch to OW.

Our tactical rules are adjusted as follows:  Remain OW above 51  Move to UW after a clean break of the resistance area around 51 44 FinLight Research | www.finlightresearch.com


COMMODITY Base Metals:

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The uneven performance of base metals in 2018 (+4% in 1H18; -22% in 2H18) was a result of a combination of a strong US dollar, a cyclical slowdown in China and the threats of a US-China trade war. Since the start of the year, base metals have enjoyed a little rebound. But nothing spectacular! 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 We remain UW on industrial metals.

. Agriculture:

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US – China trade sentiment remains the primary driver of price over the short-to-medium term for agris. Any trade agreement would be materially bullish for agri markets (notably grain, oilseeds and cotton). We maintain our constructive outlook through 1H19 on bullish fundamentals. We remain OW on Agris as a whole

45 FinLight Research | www.finlightresearch.com


COMMODITY Precious Metals:

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   

Gold has been trading more firmly recently. Geopolitical uncertainty and dollar weakness continue to support the metal. The Fed's recent dovish tone adds a positive factor for it. But, we believe it is too early to trumpet the beginning of a new bull cycle in gold. Evidence points to gold’s intermediate downward trend remaining intact. Before gold can rally on a sustained basis, the U.S. dollar should show a sharper deterioration, real rates stop going higher and US growth begins to slow. 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 Neutral to OW gold as it broke above 1 265. Our first target of 1 325 has been reached We remain constructive on gold, and view any pullback from current levels as counter-trend. Our positioning rules are adjusted as follows:  Remain OW above 1295 to target 1 340 and 1450  Turn Neutral between 1295 and 1275  Turn UW below 1275. Next targets 1230 (trend across the lows since Aug.), 1150 and 1113 where Gold could put in a longer-term base.  Go OW again in the 1070-1 113 area 46 FinLight Research | www.finlightresearch.com


Commodities – Still out of favor

 

Commodities appear relatively undervalued, but still out of favor

We think there is still room to go lower as long as the Chinese macro doesn’t stabilize and global growth concerns don’t vanish. Thus, we prefer to keep our Neutral stance. In order to change our view, we need the US dollar trend to reverse and recession risks to recede

47 FinLight Research | www.finlightresearch.com


Industrial Metals - Copper

Copper has a unique ability to diagnose global growth trends. Copper has been rising as the global economy accelerated from 2016 through late 2017, making a top in early 2018 and then declining as the global economy decelerated.

The rally we’ve witnessed in the S&P500 and other risk assets since end of 2018 was not transcribed back in industrial metals  That probably means that the recent rally was more about technicals than fundamentals

48 FinLight Research | www.finlightresearch.com


Precious Metals – Gold Fundamentals

  

On the supply side, gold market shows a combination of falling discoveries and decreasing exploration budgets since 2012. For years, gold miners have been using their money to buy up rivals rather than in exploration. According to a recent study from the Canadian Imperial Bank of Commerce, gold deficit will emerge in 2019: “On the back of stronger demand over the next two years, primarily from bar hoarding, net central bank buying and exchange-traded products”

Peak production, according to this study, will be reached in 2021 (around 34 million ounces), before declining to under 16 million ounces by 2030.

49 FinLight Research | www.finlightresearch.com


Energy – Crude Oil

According to our positioning rules, we’ve moved from Neutral to UW as the spot broke below the uptrend since early 2016 (just below 60) and decided to remain so below 57. We are now more constructive on oil as process broke above the downtrend since Oct. ’18. We switch to OW. Our tactical rules are adjusted as follows:  Remain OW above 51  Move to UW after a clean break of the resistance area around 51 . 50 FinLight Research | www.finlightresearch.com


Precious Metals – Gold

 

Following our positioning rules, we’ve moved from Neutral to OW gold as it broke above 1 265. Our first target of 1 325 has been reached We remain constructive on gold, and view any pullback from current levels as countertrend. Our positioning rules are adjusted as follows:  Remain OW above 1295 to target 1 340 and 1450  Turn Neutral between 1295 and 1275  Turn UW below 1275. Next targets 1230 (trend across the lows since Aug.), 1150 and 1113 where Gold could put in a longer-term base.  Go OW again in the 10701 113 area 51 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

Most hedge fund strategies have experienced an opposite move in Dec ‘18 and Jan ‘19. Those who suffered in December (L/S Equity, Special Situations) rebounded in January and vice versa.

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.

   

We reiterate an 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 keep preferring 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 CTAs suffered from the trend reversal in equities at the turn of the year. Absolutely normal given the sharp gyrations the strategy had to deal with… 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… 52 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

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

53 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

  

Most hedge fund strategies have experienced an opposite move in Dec ‘18 and Jan ‘19. Those who suffered in December (L/S Equity, Special Situations) rebounded in January and vice versa. It is worth noting that few strategies have been resilient during the sell-off without suffering during the rebound: Fixed Income Arbitrage and Merger Arbitrage. Others did a good job: Global Macro and L/S Market Neutral

Source: HFR & Lyxor AM

54 FinLight Research | www.finlightresearch.com


Bottom Line: Global Asset Allocation  

    

It seems as if economic growth is slowing everywhere. Over the recent weeks, market conditions switched from panic to exuberance / complacency mode. We are back at a point where we expect a poor long-term risk-reward for most risk assets

01/02/2019 View

07/12/2018 View

05/11/2018 View

28/09/2018 View

Jan & Feb'19

Dec'18

Nov'18

Sep'18

Equity

UW

UW

UW

OW

S&P 500

OW

OW

OW

OW

Euro Stoxx 50

UW

UW

UW

UW

N

N

N

N

MSCI Emerging Markets

UW

UW

UW

UW

Fixed Income

OW

N

UW

UW

T-Note 10Y

N

OW

OW

OW

Bund 10Y

N

UW

UW

UW

OW

OW

OW

OW

NIKKEI 225

US TIPS Euro HICP

OW

OW

OW

OW

Credit

UW

UW

UW

UW

Inv. Grade

OW

OW

OW

OW

US High Grade

OW

OW

OW

N

EUR High Grade

UW

UW

UW

N

Despite the impressive rally, the behavior of some assets (SPX, Credit, Volatility…) seems to suggest we are in a contracting economy.

High Yield

We remain OW cash in our asset allocation.

Monetary normalization and QT are taking liquidity from the market. With QE behind us, Central Banks are also acting as sources, rather than suppressors of volatility.

We summarize our views as follows 

UW

UW

UW

UW

US High Yield

N

N

N

N

EUR High Yield

UW

UW

UW

UW

EM Sovereigns

OW

OW

OW

OW

Forex

N/A

N/A

N/A

N/A

EUR-USD

N

N

N

N

USD-JPY

UW

N

N

OW

Commodity

N

N

N

N

Energy

OW

UW

N

OW

Base Metals

UW

UW

UW

UW

Precious Metals

OW

N

UW

UW

Agri

OW

OW

OW

OW

Alternatives

OW

OW

OW

OW

Return Enhancers

UW

UW

UW

UW

Risk Diversifiers

OW

OW

OW

OW

55 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.

56 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...

57 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

58 FinLight Research | www.finlightresearch.com

Profile for Finlight

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