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Market Perspectives Jun. ‘19

Jun. 14th, 2019 www.finlightresearch.com

Remember, bulls get fat, bears get fat, but pigs get slaughtered!


“

At best, news is the tardy recognition

of forces that have already been at work for some time and is startling only to those unaware of the trend� - Ralph Nelson Elliott

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

Over the past month or so, the macro narrative has taken a decisive negative turn. The Beige Book was very defensive in its characterizations of the US economy. Near-term recession risks appear limited. But many financial indicators are flashing yellow, the yield curve is flashing red and the trade war is starting to weigh on growth. The standoff China and the US now threatens to spiral. Market volatility has picked up, but reached levels are hardly consistent with a bottom formation, yet. Treasuries are pricing in the slowdown equities refuse to see. Investors are hedged but are not positioned for a full riskoff. Our feeling is that they expect the Fed to cut rates enough to offset the trade war headwind. 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  US nonfarm productivity (a measure of hourly output per worker) increased at a 3,6% annualized rate in Q1-2019. This is the fastest pace in more than 4 years.  US Real GDP increased at an annual rate of 3.1 % in Q1-2019 (after 2.2% in Q4-2018)  The University of Michigan consumer confidence is near all-time highs  Jobless claims are the lowest in 40 years. There are more job openings than people available to fill them. The Bad  Chinese economy is decelerating again. Chinese PMI is back to contraction.  The same for Japan's manufacturing PMI, the flash PMI for Germany (for the 5th straight month).  Markit PMIs for the US missed estimates with the manufacturing gauge at its lowest level since Sep. 2009 The Ugly: Ugly yesterday, ugly today!  Trade tensions (US-China, US-Europe) remain a key risk to our outlook. the concern now is that what was everyone's worst-case scenario is now the base case  Main systemic risk resides in China because of high leverage, growing indebtedness, and current unsustainable housing bubble.  The financial and economic implications of Brexit are concerning (especially as the no-deal option becomes more plausible than ever), but no one seems to care, at this stage

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Hunting Recession – The Big Four Economic Indicators

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The overall picture remains mixed with 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. Sales and income will be especially interesting to watch, from here

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Hunting Recession – Tariffs are Key

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Trump’s administration tariffs are starting to weigh on growth… According to Goldman simulations, the effect of tariffs on US GDP may reach 0,9% if implemented both on China and auto imports

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Hunting Recession – Russell 2000 Non-Earners

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The share of nonearners in the Russell 2000 continues its move up. It has reached levels usually seen during or prior to a recession

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Hunting Recession – Deterioration in PMIs…

Last PMI data prints showed the Global ex-US manufacturing PMI moving into contraction territories. Its US counterparty seems to follow a similar path down.

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Hunting Recession – …As well as in New Orders

The same is true of the ISM manufacturing index and, specially, its new orders components (usually seen as a leading indicator) Like durable goods orders and consumer durable goods orders, factory orders for April are trending downward, and are presently just above the zero threshold on YoY basis

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Hunting Recession – US Construction Spending

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Construction spending has also slowed At this stage, the slowdown is apparent in spending. The sector employment should follow…

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Hunting Recession – Economic Surprises

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More generally, economic data have continued their slide down started in the beginning of 2018 The Citi US economic surprises index decreased from 80 in Jan. ‘18 to -69 in Apr ‘19 The deterioration in economic data has been significant enough to induce a substantial repricing in Fed’s moves.

Source: Citi

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Hunting Recession – No Spike in Swap Spreads Yet…

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Two-year swap spreads for both the U.S. and the Eurozone are declining This probably means:  There is no issue of liquidity  Credit conditions are not tightening yet  Recession isn’t looming yet

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Hunting Recession – Consumer Confidence at Cyclical Highs

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Both the Conference Board’s consumer confidence and the University of Michigan’s consumer sentiment indexes are just below their cyclical highs Consumer confidence edged up despite trade escalation, strengthening in May to 134 (best reading since Nov. ‘18) It is worth noting that both the present situation and expectations components improved Thus, recession doesn’t seems imminent, yet!

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Hunting Recession – Corporate Profits

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Corporate profits usually leads the S&P500 by 5-6 quarters. For now, inflation-adjusted corporate profits stand near their historical highs. And we don’t see any clear sign of a top formation in these profits.

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EQUITY

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Global equities have met near-term targets for a correction, before rebounding. We see many signs of topping in the market. A broadening trade war keeps the downside bias intact. The June ’28 G20 meeting could be a moment of truth. The rallying bond market remains a very concerning sign for growth and equities. The earnings growth benefits of the tax reform have largely run their course. Corporate profits fell from 11.2% annual growth in Q4-2018 to 1.6% annual growth in the Q1-2019, which is more consistent with economic growth.

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. The long-term risk-reward doesn't favor bulls. Bulls continue to accumulate, making the most optimistic assumptions about the sustainability of corporate profit margins and valuations Divergences between earnings projections and valuation trends in the S&P500 have already reached extremes Thus, we believe that the downside potential is much greater than the upside potential at this point in time 15 FinLight Research | www.finlightresearch.com


EQUITY Bottom line :

In our April Report, we said “We continue to see any relief from here as corrective, not more. Such a recovery should be used to prepare for another sell-off..”. May provided the expected sell-off. But before we say the low is in, we need to see the VIX spike above the 25-30 range (panic levels).

According to our positioning rules, we’ve moved from OW to Neutral equities as the S&P500 broke below 2845 (short term trend since Mar. 19)

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Our main scenario over the medium-term: another capitulation decline in the weeks/months ahead, providing a new buying opportunity (target = 3300 – 3500 on the S&P500) and igniting an ultimate leg up. According to our positioning rules, we’ve moved from OW to Neutral as the index broke below the uptrend since Mar. ‘19 Our positioning rules are adjusted as follows:  Remain Neutral between 2859 and 2915  Move to OW above 2915. Breaking this level means the uptrend resumes  The setup weakens again below 2859. Go UW.

We remain Neutral on Japan vs. US stocks (because of cheap valuations but uncertain earnings) and UW Europe vs US, given the headwinds from weak economic momentum and political risks (Italy, Brexit) 16 FinLight Research | www.finlightresearch.com


EQUITY Bottom line :

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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 late-cycle 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, and despite the recent rally, 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 Equities – Medium-Term Risk-Reward is Bearish

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Goldman Sachs' Bull/Bear Indicator tends to show that risks in equities are biased to the downside over the medium to long-term.

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Equities RV – Cyclicals vs Defensives

The correlation between the manufacturing PMI and Cyclicals vs Defensives RV seems to point to further downside risk for cyclicals, and as a consequence, to further medium-term downside for equities. We keep our preference for Defensives vs Cyclicals.

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Equities RV: US vs EMs

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The renewal of trade concerns has weighed on EM equities, erasing most of their gains for the year The ratio of the iShares MSCI Emerging Markets ETF (EEM) to the S&P ETF broke below it 2018’s lows We remain UW EMs vs DMs

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Equities RV – Stocks vs Bonds

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We have been OW stocks vs bonds for a while. But recently, we’ve got uncomfortable with the sharp disconnect between equities and bond yields. “Something has to give”. And we think it’s equity. Furthermore, bonds relative performance vs stocks seems to have reached an important support. We prefer to move UW stocks vs bonds, from here.

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S&P500 – A Long-Term Tech. Perspective

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S&P500 is experiencing a long-term overbought condition If history is any guide, this should be resolved through a corrective process with a retracement of 61,8% to 100% of the previous advance (since 2009)! The fundamental and economic backdrops seem to point to the same direction…

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S&P500 – A Short-Term Tech. Perspective

According to our positioning rules, we’ve moved from OW to Neutral as the index broke below the uptrend since Mar. ‘19 Our positioning rules are adjusted as follows:  Remain Neutral between 2859 and 2915  Move to OW above 2915. Breaking this level means the uptrend resumes  The setup weakens again below 2859. Go UW. 23 FinLight Research | www.finlightresearch.com


FIXED INCOME & CREDIT GOVIES

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The growth scare story is back because of renewed trade tensions, weaker macro data and geopolitical concerns. The UST 10-year yield pushed to its lowest since 2017. German bund yields reached their all-time lows Market probability for a rate cut by the December FOMC meeting exceeded 80%, driving a bullsteepening in the nominal 2s10s curve (a steepening we still see as corrective). 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 dovish stance, we stay Neutral on duration at the front end (through 2 and 3-year notes). We keep our Neutral view on the Bund-UST spread, and remain Neutral on duration at the front end of the US yield curve (through 2 and 3-year notes).

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FIXED INCOME & CREDIT GOVIES

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According to our positioning rules, we’ve moved from Neutral to OW Treasuries as the 10-year yield broke below 2,28 (please see our previous report, in which we said “Go OW below 2,28 as a break of this support area would open the way to near 2,0”) 10-year yield holds now just above 2,05 important support. We chose to move Neutral again and to adjust our positioning rules are adjusted as follows:  Remain Neutral between 2,0 and 2,25  Move to UW above the 2,25  Go OW below 2,0. Downside risks heighten materially through this level

We expect a gradual yield curve steepening, driven by still-acceptable US growth and the Fed's dovishness (+ tolerance for temporary inflation overshoots) The 2-10 UST curve slope has been in a consolidation phase since Dec. ’18. The underlying flattening trend seems intact for now. We see the recent steepening (roughly from 12 to 28bps) as corrective. The underlying bias remains in favor of further flattening back towards 10bps with a scope to break through. We remain Neutral on the 2-10 curve and will get into steepeners either when the slope reaches -10bps or breaks through +30bps.

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FIXED INCOME & CREDIT INFLATION-LINKED

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Tariffs are facially inflationary. New tariffs will put upward pressure on core PCE inflation, and would be a force for lower front-end real yields. But the reflationary expectation we’ve seen since the beginning of the year, has now almost fully faded

We remain Neutral on US Breakevens. Given an on-hold to dovish Fed, perspectives on growth and tariffs, we will move back to OW US 10y-breakevens above 2,0 Inflation data in France and Germany came in softer than anticipated. We expect Eurozone Breakevens to trade sideways overs 1H-2019 and don’t see any recovery in inflation before the end of the year. We remain Neutral HICP Inflation

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FIXED INCOME & CREDIT CORPORATE CREDIT

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With accumulation of concerns around growth and trade in May, High yield bond prices came under pressure, alongside stocks, before bouncing in early June. 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. Credit fundamentals are deteriorating (higher debt as a share of the economy, higher leverage, lower coverage…). At a given point in time, a mountain of BBB-rated debt will start getting downgraded into the junk category. We remain UW on credit overall.

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FIXED INCOME & CREDIT CORPORATE CREDIT

Within the credit asset class, 

The “low rate for longer” ECB policy should support credit and reduce market volatility. But EUR credit valuations look too rich, at this stage. We remain OW on US vs EUR HY and IG given persisting macro, political, and technical headwinds in Europe.

Trade related growth risks should be more negative for HY than HG. We reiterate our preference for IG over HY, especially in EUR credit. 

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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 up-in-quality stance 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 favor leveraged loans over HY bonds 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 28

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FIXED INCOME & CREDIT EM DEBT

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Valuations are attractive despite the recent rally. The pause in US dollar strength gives a breath of fresh air to local and hard-currency markets. But risks are still around the corner: trade tensions and slower global growth. 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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Fed’s Rate Policy – Has the Fed Over-tightened?

Based on Atlanta Fed's estimates of the "shadow" fed funds rate (that adjusts the actual rate for the effects of QE), the Fed seems to have effectively tightened far more than in previous cycles: more than 6% since 2014 vs 4% in previous cycles! Rate normalization can hardly go much further without impacting the real economy…

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Global Bonds – Market Positioning

JPMorgan’s Treasury survey shows that outright longs are at highs since late 2010

Since the Fed’s dovish pivot in Jan. ‘19, global bond funds have seen some $160 billion in inflows

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US Govies – A Tech. View

According to our positioning rules, we’ve moved from Neutral to OW Treasuries as the 10-year yield broke below 2,28 (please see our previous report, in which we said “Go OW below 2,28 as a break of this support area would open the way to near 2,0”) 10-year yield holds now just above 2,05 important support. We chose to move Neutral again and to adjust our positioning rules are adjusted as follows:  Remain Neutral between 2,0 and 2,25  Move to UW above the 2,25  Go OW below 2,0. Downside risks heighten materially through this level

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US Govies – Curve Inversion?

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With the recent rally in UST yields, the yield curve has pushed deeper into inversion on the 3m-10y slope. The 2y-10y slope is now around +10bps. The move has been limited (and partially reversed) because of the Fed’s dovish stance (which pushed the short-end of the curve lower) Nevertheless, the underlying flattening trend seems intact for now. The curve slope remains one of main things to keep an eye on.

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US TIPS – Inflationary Trend Heading South…

The reflationary expectation we’ve seen since the beginning of the year, has now almost fully faded TIPS breakevens (on 5y, like on 10y-TIPS) have plunged in recent weeks (minus around 25bps) and are back to near their lows of Dec. ’18 As breakeven inflation closely follows global growth, we see breakevens plunge as a bad sign for equities.

Source: YCharts, EPB Macro Research

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US TIPS – A Tech. View

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A big top structure has probably formed here… The main support level to watch from here is the 1.68%, which has been a pivotal support and resistance area for the last 5 years If this level breaks (which is plausible, given RSI current levels), we can see a sharper plunge in inflation expectations.

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US Credit – Level of Government Yields is concerning

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With the recent Treasury rally, 10-year yield is now close to 2% HY spreads are on their tights over 5 years. If UST yields fall below 2%, HY spreads should widen substantially (go above 500bps)

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US Credit – Where is My Risk Premium?

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 post-crisis lows. We reiterate our preference for IG over HY

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US Credit – Fundamentals are Deteriorating

We continue to see better value in IG vs HY: 

Net leverage in HY credit is moving up, led by debt growth acceleration (+10%, a level last seen in Q4-2015), and EBITDA slowdown

With revenue growth slowing down further, interest coverage is also deteriorating, specially on HY.

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EXCHANGE RATES

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From our point of view, US-China trade war escalation is dollar-positive, because of the safe-haven appeal of the dollar… More generally, concerns about global growth are inherently supportive for the dollar (as a reserve currency), even if the US economy is slowing as well Interest-rate differentials remain one of the major driving forces of the US dollar in the short run, especially against the euro. US dollar is also driven by the real growth differential between the US and other major DM economies US dollar is supported by repatriation flows by US entities cutting foreign exposures, and by the fact that the amount of negative yielding bonds outstanding reaches a new record On the other hand, Fed’s dovish stance, future rate cuts 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.

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EXCHANGE RATES

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EUR-USD: Markets are likely to remain skeptical about a growth recovery in the Eurozone. ECB dovish tone is supposed to weaken the EUR further. Despite the corrective process the EUR-USD has been stuck in since November, the MT picture remains bearish. Only a clean break above the 200-dma may undermine this view.. Since our Apr. 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 1,1150 before rebounding near 1,11. We are now Neutral again. The move through the trend across the highs since January was proven a false breakout. From here, we adjust our positioning rules as follows:  Remain Neutral above the trend across the lows since Nov ‘18 (around 1,1070) and below the 200-dma (currently at 1,1368)  Move to UW below the trend across the lows since Nov ‘18 to target 1.10, then1.08  Move (tactically) to OW above the 200-dma to target 1.1570

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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 110. Our bias remains to the downside as global risk aversion rises amid ongoing trade tensions. Growth concerns and higher volatility tend to benefit the Yen.

We adjust our positioning rules from here:   

Remain UW below the trend line through the lows since 2016 (currently around 108,90) Go Neutral between the trend line from the 2016 base and 112,40 Go OW above 112,40

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US Dollar Index

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For now, US Dollar remains strong, well supported by US repatriation flows (from sales of foreign securities)

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EUR-USD

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Despite the corrective process the EUR-USD has been stuck in since November, the MT picture remains bearish. Only a clean break above the 200-dma may undermine this view.. Since our Apr. Report, and according to our positioning rules, we’ve switched from Neutral to UW (then back to Neutral) twice as the EURUSD broke below 1,1150 before rebounding near 1,11. We are now Neutral again. The move through the trend across the highs since January was proven a false breakout.

From here, we adjust our positioning rules as follows:  Remain Neutral above the trend across the lows since Nov ‘18 (around 1,1070) and below the 200-dma (currently at 1,1368)  Move to UW below the trend across the lows since Nov ‘18 to target 1.10, then1.08  Move (tactically) to OW above the 200-dma to target 1.1570 FinLight Research | www.finlightresearch.com

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USD-JPY: Another Facet of Cyclicals?

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We have long believed that USDJPY performance should be consistent with that of Cyclicals vs Defensives Actually, USD-JPY seems increasingly correlated with US Cyclicals!

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USD-JPY

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Our bias remains to the downside on USD-JPY as global risk aversion rises amid ongoing trade tensions. According to our positioning rules, we’ve moved from Neutral to UW as the USD-JPY broke below 110. The rising trend line from the 2016 base has been broken. We expect the USD/JPY to suffer much more downside from here. First target = 104.60.

We adjust our positioning rules from here: 

Remain UW below the trend line through the lows since 2016 (currently around 108,90) Go Neutral between the trend line from the 2016 base and 112,40 Go OW above 112,40 45

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COMMODITY

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Commodities come under pressure as US expands trade war (Mexico, after China) and PMIs disappointed. Gold benefited from its safe-haven status, when oil and agris benefited from underlying supply stress At this stage, we prefer to keep our Neutral stance, because of all trade tensions and Chinese macro. In fact, 

If the US-China trade war doesn’t find a resolution, a global economic slowdown would follow, likely weighing 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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A weakening outlook for long-term demand, combined with near-term oil supply disruption has lowered spot prices while increasing futures price backwardation The supply and demand balance is strongly bearish. This, with some other fundamental factors (as well as technical) support the idea that prices will hardly go higher for now Crude supply continues to grow, and imports have adjusted to the OPEC+ cuts. This is also bearish for crude. Based on OPEC’s estimates, it is very likely, that in Q4 the oil market will be faced with a very considerable surplus. Thus, the price of crude oil is likely to continue falling. The risk to our view resides in the geopolitical factor. But only an extraordinary event can trigger a rally.

Crude has tested the uptrend from 2016 and failed to break through it. This is very bearish over the medium term. According to our positioning rules, we’ve switched from Neutral to UW as the spot went below 59.

Our tactical rules are adjusted as follows:  Remain UW below 58 and continue to target the 45 area  Move to Neutral between 58 and the uptrend from 2016 (currently around 64)  Move to OW above the uptrend from 2016 47 FinLight Research | www.finlightresearch.com


COMMODITY Base Metals:

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Metals have been heavily influenced by the ongoing trade dispute between the US and China China accounts for around 50% of global demand. So if the ongoing trade dispute isn’t resolved in the near term, price upside would be capped. On the other hand, any relaxation in trade tensions could boost industrial metal prices Macro headwinds persist, weighing further on industrial metals As such, we remain cautious (UW) the complex, for now

Agriculture:

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The medium to long term outlook for agri commodities is particularly bullish from both a fundamental and momentum point of view We maintain our constructive outlook through H1-2019 because of heightened weather risks, declining world grain inventories and well-oriented long term price momentum We anticipate a significant price recovery led by the grains in Q2-2019. We remain OW on Agris as a whole, with a preference for grains

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COMMODITY Precious Metals:

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We remain bullish precious metals (specially Gold) 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.. Political and economic uncertainty tends to be gold's best friend . The Fed's recent dovish tone adds a positive factor for it (by lowering real rates and capping dollar strengthening). Unlike other commodities that have suffered from the trade dispute, Gold has taken advantage from its safe-haven status 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. For now, Gold is still searching for the catalyst which would push it out of the well-established trading range of the last few months. A sharp pullback in the dollar would do the job… As said in our April Report “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”

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COMMODITY Precious Metals:

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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 (currently around 1290) is preserved. Following our positioning rules, we’ve moved from Neutral to OW on gold as it broke above 1300 Our positioning rules are adjusted as follows:  Remain OW above 1310 and target 1355 and even 1378. Breaking higher would open 1,450-1,490.  Move Neutral between 1310 and the primary uptrend since Aug. ‘18  Turn UW after a clean break below the primary uptrend since Aug. ’18 Although Silver looks relatively cheap compared to Gold, we believe it can get even cheaper in the near term (back to the range of $13-13,5) :

Speculators are net short silver, but their short positioning is small compared to its historical low of Sep. ‘18

Silver doesn’t have the safe-haven characteristics Gold have.

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Commodities – Still in Small Shape

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The TR CRB Index continued its decline, mostly driven by oil prices. The ex-energy version of the TR CRB has staged a small rebound.

Source: YCharts, EPB Macro Research

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Commodities – The Dollar Dominance

After a 2-year period of consolidation, the US dollar seems to have resumed its outperformance vs commodities. USD to Commodities ratio is now breaking to new highs.

Buy dollars rather than investing in commos!

52 FinLight Research | www.finlightresearch.com


Energy – Crude Oil Fundamentals

Based on OPEC forecasts of global supply and demand, we expect the global oil market to be more or less balanced in Q2 and Q3, and in substantial surplus in Q4. The risk to our view is a cancellation of the OPEC+ deal before the end of the year. In that case, surplus will weigh heavily on oil prices.  Bearish on oil price

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Energy – Crude Oil Fundamentals

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The picture is even clearer when we look at inventories. The move seems to continue towards oversupply (during a season that usually sees draws, rather than storage), with inventories climbing above the five-year average  Bearish on oil price

54 FinLight Research | www.finlightresearch.com


Energy – Crude Oil Fundamentals

The impact of inventories on oil prices could be put into perspective through the following graph (courtesy of O. Kombaiev) The graph shows the strong long-term relationship between the average Brent oil price and the OECD commercial closing stocks Given the important surplus we expect in Q4-2019, stocks in the OECD countries should move substantially higher accordingly, weighing on oil prices. The $50-55 range seems a reasonable target for Brent.

55 FinLight Research | www.finlightresearch.com


Energy – Crude Oil

Crude has tested the uptrend from 2016 and failed to break through it. This is very bearish over the medium term. According to our positioning rules, we’ve switched from Neutral to UW as the spot went below 59.

Our tactical rules are adjusted as follows:  Remain UW between below 58 and continue to target the 45 area. Breaking lower will open the way to $30-35!  Move to Neutral between 58 and the uptrend from 2016 (currently around 64)  Move to OW above the uptrend from 2016 .FinLight Research | www.finlightresearch.com

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Precious Metals – The Gold-to-Silver Ratio

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The gold/silver ratio is now at a multi-year high Past spikes in this ratio have preceded precious metals bull trends. Usually, bull markets in precious metals favor silver over gold. Nevertheless, we prefer to stay on the sideline on silver, for now… We continue to feel that the risk for Silver is skewed to the downside in the near term due to a potential increased in short speculative positioning. Furthermore, and given its weaker safe-haven characteristics, we expect Silver to continue to underperform Gold in the near term. 57 FinLight Research | www.finlightresearch.com


Precious Metals – Silver Positioning

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Specs are net short silver, but their short positioning is small compared to its historical low of Sep. ‘18 There is plenty of room for more speculative selling, which would put silver spot prices under intense pressure.

We continue to target the $13$13,5 range over the mediumterm.

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Precious Metals – Gold

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Gold is currently testing its multiyear highs. We remain constructive on gold, and view any pullback from current levels as counter-trend, as long as the primary uptrend from Aug ’18 (currently around 1290) is preserved. Following our positioning rules, we’ve moved from Neutral to OW on gold as it broke above 1300 Our positioning rules are adjusted as follows:  Remain OW above 1310 and target 1355 and even 1378. Breaking higher would open 1,450-1,490.  Move Neutral between 1310 and the primary uptrend since Aug. ‘18  Turn UW after a clean break below the primary uptrend since Aug. ‘18 59 FinLight Research | www.finlightresearch.com


ALTERNATIVE STRATEGIES

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Alternative strategies performed reasonably well in May, given the extent of the meltdown we’ve seen in equity markets. The HFRI Fund Weighted Composite Index fell -1.5% for the month (outperforming US equities by 4,8%) because of trade war escalation and higher economic growth uncertainties. Losses were led by equity-sensitive strategies, and were partially offset by mixed performance in fixed income-based Relative Value Arbitrage strategies. The most notable green shots over the month: Market Neutral L/S strategy which gained +0,9%, RV Volatility with 2,2% and Macro Multi-Strategy with 1,8%. CTAs did relatively well (performance depends on the benchmark we use!) for the third month in a row. 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 stick to our preference for L/S Equity Market Neutral, Volatility RV and Global Macro strategies. Global macro should (finally) capitalize on new trading opportunities / strategies to take advantage of central banks actions and higher economic/market uncertainties

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ALTERNATIVE STRATEGIES

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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. Despite their recent performance, we stick to our Neutral stance on CTAs on 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

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CTAs

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CTAs did relatively well for the third month in a row. CTAs performance depends on the used benchmark. But whatever the benchmark we use, CTAs are on an upward trend since the beginning of the year. Lyxor Peer Group CTAs is the one we prefer: it is daily and based on 26 funds.

CTAs have provided a good hedge during the last risk-off episode. They did it better than during 2018 thanks to long fixed income positions and the persistent downward trend in yields even after the equity rebound. Source:HFR, Bloomberg, Lyxor AM

FinLight Research | www.finlightresearch.com

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

Over the past month or so, the macro narrative has taken a decisive negative turn. The Beige Book was very defensive in its characterizations of the US economy. Near-term recession risks appear limited. But many financial indicators are flashing yellow, the yield curve is flashing red and the trade war is starting to weigh on growth. The standoff China and the US now threatens to spiral. Market volatility has picked up, but reached levels are hardly consistent with a bottom formation, yet. Treasuries are pricing in the slowdown equities refuse to see. Investors are hedged but are not positioned for a full riskoff. Our feeling is that they expect the Fed to cut rates enough to offset the trade war headwind. 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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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.

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About Us…

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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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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

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Profile for Finlight

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